Walking through the narrow alley between closely packed brick-structure shops that were opening up for business in the morning of 6th September, suddenly we came out into an open space with some greenery. Air was crisp with some hint of cow dung smell. A barely-there katcha footpath led to a small room that was already full with about ten nicely dressed-up ladies. They were part of a collection-centre of a micro-finance company in Western UP. The ladies were quite happy to talk about their work, and their difficulties in paying interest post demonetization. They had borrowed for various reasons – from buying livestock, sewing machines, to repairing rickshaws to selling cosmetics. Some were paying two to three installments of loan which they had missed earlier. The scenes were only slightly different in other collection centers.
Microfinance Institutions (MFI’s) 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 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 poster-boy of women empowerment as most of them lend only to women with a repayment rate of 98%.
The industry had the first setback after the Andhra Pradesh (AP) microfinance crisis in 2010 when State Government imposed a new rule of lending after getting complains of reckless lending, unethically high interest rates and coercive recovery tactics by some MFIs which had led to series of suicides by borrowers. AP portfolios of most MFIs declined by 35%. Post this crisis, a set of regulations were announced by RBI in 2011 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 on June 2017, there are 8 small MFIs with GLP (Gross Loan Portfolio) less than Rs 100 crore, another 21 medium-sized MFIs with GLP between Rs 100 and Rs 500 crore and 15 large MFIs with GPL above Rs 500 crore. Market share is clearly concentrated in the group of large MFIs..
The industry was once again hit hard by the demonetization drive in November 2016, when the government banned the use of the 500 and 1000 Rupees notes. 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 part of the country.
Lower recoveries and adverse impact on income after demonetization caused Portfolio at Risk (PAR) to increase considerably from 0.4% in FY 2016 to 14.1% in FY 2017 – a rise of 35%. Average loan amount disbursed in the quarter October to December declined by 25% on annual basis.
Lower recovery was due to many reasons. First, MFIs were advised by RBI not to accept old notes for repayment. With the shortage of new currency, interest payment fell sharply. Second, most of the MFI clients are small traders, shopkeepers or small business owners. Their businesses suffered as overall demand contracted. These small consumption demands were lost forever. 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, lot of productive hours was 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 cash crunch. This relaxation helped in short-term deferment of classification of these individual accounts from being termed as substandard.
The industry has been using technology extensively to increase efficiency. Most of the MFIs have in-house software that allows field officers to verify borrowers through Adhar numbers. They are also using credit bureaus to take out delinquent borrowers and restrict lending to borrowers who have already borrowed from more than two MFIs. Demonetisation has given further push to digitization.
The operating expenses have gone up due to investments in IT and collections infrastructure.
According to ICRA 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 5 times.
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 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 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 stated that business model of MFIs is still strong and expects a satisfactory recovery of loans disbursed since January 2017.
It is necessary for RBI to allow for easier provisioning norms for loans that turned bad due to demonetization as MFIs play a very important role in financial inclusion and women 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.