Following demonetisation and political interference, microfinance institutions (MFIs), including non-banking finance companies (NBFCs) and small finance banks (SFBs) with exposure to states like Uttar Pradesh, Uttarakhand, Maharashtra and Madhya Pradesh, faced with asset quality overhang, are staring at significant credit costs and capital erosion in FY2018, says a research report.
In a note, India Ratings and Research (Ind-Ra) says, “The current upheaval has validated our 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 says as per its interactions with borrowers, unintentionally defaulting borrowers are unlikely to clear four or more equated monthly instalments (EMIs). “…borrower interactions over the last six months indicate that earning members have lost one-three-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 FY18 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.”
An analysis by the Fitch Group Company, indicates that aggregate collection efficiency of majority of MFIs with significant exposure to affected states on portfolio outstanding (as of December 2016) was 75%-80% higher in May 2017 compared with a low of 50%-60% in December 2016. “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 incur credit costs and capital erosion and, thus, higher leverage,” the ratings agency says.
According to Ind-Ra, collection pick-up is slower than expectation. Maharashtra was one of the worst affected states, with monthly collections in some districts being in single digits, it says, adding, 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.
Ind-Ra’s analysis indicates that 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 incur credit costs and capital erosion and, thus, higher leverage. “At 80%, these MFIs could require equity of Rs100 -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 2QFY2018-3QFY2018 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,” it added.
According to the ratings agency, lower-than-worse-case credit costs and equity erosions are supported by the fact that 15%-20% of assets under management of MFIs are off-balance-sheet, where credit enhancements, over-collateralisation and first loss default guarantees could range between 5% and 15% on an aggregate basis.
Ind-Ra feels that MFI should now look beyond JLG. “We acknowledge that JLG loans address an important credit need and have an important role in financial inclusion. However, borrower selection and operating processes need to be reassessed. Moreover, MFIs need to develop expertise in other secured and unsecured credit products and roll them out gradually (early experience not pleasant for most MFIs). Instead of pursuing growth, they need to adopt best practices of NBFCs, minimise employee churn, and innovate lending and risk sharing mechanisms,” it concluded.