Hurt by demonetisation, MFIs just starting to recover

Walking through the narrow alley between closely packed brick-structure shops that were opening up for business on the morning of September 6, suddenly we came out into an open space with some greenery. The air was crisp, with a hint of cow-dung smell. A barely-there katcha footpath led to a small room that was already full with about 10 nicely dressed ladies. They were part of a collection centre of a microfinance company in western UP. The ladies were quite happy to talk about their work, and their difficulties in paying interest post-demonetisation. They had borrowed for various reasons — from buying livestock, sewing machines, to repairing rickshaws to selling cosmetics. Some were paying two to three instalments of loan repayments that they had missed. The scenes were only slightly different in other collection centres.

Microfinance institutions (MFIs) are non-banking financial institutions that provide micro-loans which are repaid on a weekly, fortnightly or monthly basis. The MFIs have a unique lending system — in the absence of any collateral, the credit risk is reduced through group guarantees, peer support, individual household earning assessment and small first-time loans. These institutions are also posterboys of women’s empowerment, with a repayment rate of 98%.

The industry had the first setback after the Andhra Pradesh (AP) microfinance crisis in 2010 when the state government imposed a new rule of lending after getting complaints of reckless lending, unethically high interest rates and coercive recovery tactics which had led to series of suicides by borrowers. AP portfolios of most MFIs declined by 35%. Post this crisis, in 2011 RBI announced regulations for the new category of for-profit MFIs called NBFC-MFIs, including lending limits per borrower and cap on interest rates.

The industry has grown steadily after that, with total loan book jumping 130% to Rs 47,200 crore in 2014-15. According to Microfinance Institutions Network (MFIN) data, as of June 2017, there are eight small MFIs with GLP (Gross Loan Portfolio) less than Rs 100 crore, 21 medium-sized MFIs with GLP between Rs 100 crore and Rs 500 crore, and 15 large MFIs with GLP above Rs 500 crore. Market share is clearly concentrated in large MFIs.

The industry was again hit hard by the demonetisation drive in November 2016. As most of the transactions of MFIs, based in rural to semi-urban areas, were cash-based, this move was crippling for a few months. The repayment rate fell by 12% in some parts of the country.

Lower recoveries and the adverse impact on income caused Portfolio at Risk (PAR) to increase considerably from 0.4% in FY 2016 to 14.1% in FY 2017. Average loan amount disbursed in the quarter October to December declined by 25% on annual basis.

The lower recovery was due to many reasons. First, MFIs were advised by the RBI not to accept old notes for repayment. With the shortage of new currency, interest payments fell sharply. Second, most MFI clients are shopkeepers or small business owners. Their businesses suffered as overall demand contracted. For example, if one does not buy a cola for unavailability of cash, he will not drink more next day when cash is available. Third, a lot of productive hours were lost in the long queues outside the banks. Fourth, the borrowers were unable to get full payment for their work due to cash withdrawal limit of
Rs 24,000 per week, which restricted their payment capacity. Fifth, just after the demonetisation exercise, local political leaders misled borrowers in some areas of Maharashtra, Uttar Pradesh (election-bound), Madhya Pradesh and Kerala that their loans had been waived. This led to a sharp drop in loan recoveries.

The RBI provided relief to NBFC-MFIs, allowing additional 90 days relaxation in NPA calculations between November 1 and December 31, in view of the cash crunch. This relaxation helped in short-term deferment of classification of these individual accounts as substandard.

Provisioning norms

The industry has been using technology extensively to increase efficiency. Most MFIs have in-house software that allows field officers to verify borrowers through Aadhaar numbers. They are also using credit bureaus to take out delinquent borrowers. The operating expenses have gone up due to investments in IT and collections infrastructure. 
According to an Indian Credit Rating Agency estimate, higher expected costs will result in additional capital infusion of Rs 9,000 crore to 11,000 crore for MFIs and SFBs together in order to grow at a CAGR of 25-30% over the next three years, while maintaining a leverage at around five times.

The RBI has announced that MFIs need to set aside 50% of a loan that’s overdue between 90 and 180 days to cover the risk of default and the entire 100% of loan that is overdue for more than 180 days. Under the present provisioning requirement, the MFIs will struggle to meet minimum capital adequacy requirement (CAR) of 15%.

“Because of the reduction in collection efficiency, many small and medium MFIs are facing a pressure on balance sheet due to huge provisioning. There is fear of a rating downgrade, which will lower the fund flows to the MFIs, and eventually to woman borrowers”, said Rakesh Dubey, CEO of S V Creditline and president, MFIN. He further said that the business model of MFIs is still strong and expects a satisfactory recovery of loans disbursed since January 2017.

It is necessary for the RBI to allow for easier provisioning norms for loans that turned bad due to demonetisation as MFIs play an important role in financial inclusion and women’s empowerment. With the increase in liquidity in the rural areas, there are signs of recovery in collection rate. However, experts believe that there might be some more pain before the industry recovers.

(The writer is a research scholar at IIFT.)