Following demonetisation and political interference in the rural credit scenario, microfinance institutions (MFIs), including non-banking finance companies (NBFCs) and small finance banks (SFBs), stare at significant credit costs and capital erosion in FY2018, says a research note.
In the report, India Ratings and Research (Ind-Ra), says, "The current upheaval has validated Ind-Ra’s earlier opinion of borrower overleverage and idiosyncratic and systemic risks due to political ecosystem prevalent in the industry. Furthermore, borrower discipline, a key ingredient for the smooth functioning of microfinance, has severely deteriorated in certain districts of affected states and may take years to be restored. In addition, MFIs need to structurally look beyond joint liability group (JLG) loans for loan growth and product diversification by building capabilities."
Ind-Ra’s analysis of MFIs indicate slower pickup in collection than its expectations. It found aggregate collection efficiency (CE; collection/billing for that month; aggregate CE includes CE for the period November 2016-May 2017) of the majority of MFIs with significant exposure to affected states on portfolio outstanding as of December 2016 was 75%-80% in May 2017 compared with a low of 50%-60% in December 2016. Maharashtra was one of the worst affected states, with monthly collections in some districts in single digits. During the revival period after December 2016, the intensity of political interference in affected states was such that demand for loan waivers did not die down in some districts even after local elections.
With slow pickup in collection, the ratings agency feels that there is a possibility of erosion in equity for MFIs. It says, "In case collections (on portfolio as on 31 December 2016) do not increase from the current level, MFIs with significant exposure to affected states and with aggregate loans under management of Rs1,000 crore and above could require an equity of Rs100 crore to Rs300 crore, depending on loans under management, to ensure their capital levels remain over the regulatory minimum. The aggregate recovery level on the December 2016 portfolio should exceed at least 85% by 2QFY18-3QFY18 to prevent capital erosion beyond the regulatory minimum, without additional infusion for some MFIs. At 95% collections on portfolio at end-December 2016, MFIs are likely to witness marginal capital erosion."
Talking about defaults, Ind-Ra says, unintentionally defaulting borrower may not clear four or more EMIs. "Our interactions with borrowers over the last six months indicate that earning members have lost one-three-month month wages or income due to demonetisation in FY2017. However, business almost recovered in 1QFY2018. The analysis suggests that incremental incomes of such borrowers in FY2018 would be enough to repay three missed EMIs at best. However, MFIs may need to take haircuts on borrowers that have missed more than three EMIs or are intentional defaulters. The extension of loans by three months may work if default is unintentional," it added.
According to the ratings agency, under the current situation MFIs need to focus more on idiosyncratic risk mitigation. It says, "MFIs need to go back to basics by focusing on vintage, quality of penetration (incremental borrowers to be new-to-microfinance), low ticket sizes, product diversification (one size fits all approach may not be incrementally fit for its borrowers)."
Ind-Ra opines that investors in MFIs need to increase their investment horizons to enable MFIs to develop tested products over one-two loan cycles. Over time, the regulator may relook at qualifying asset requirements to expand the target borrower segment for MFIs, it added.
The demand for JLG loans is expected to continue, Ind-Ra says, adding loan growth expectations of MFIs and promoters and investors are aggressive than what the borrower segment can absorb sustainably. "The focus of MFIs on growing mainly through group loans has led to high competitive intensity and borrower overleverage levels. MFIs need to change their focus. To mitigate risks in group loans, MFIs need to pursue smaller ticket sizes and bring new-to microfinance borrowers, establish vintage, select patient investors with investment horizons suitable for product experimentation and development, and enhance operational capabilities and processes," the ratings agency concluded.
