Demonetisation Adds To Rising Risk Across The Microfinance Sector
Microfinance institutions across the country face an increased risk of over-leveraged borrowers, according to a new report by India Ratings & Research. And the government’s move to withdraw old Rs 500 and Rs 1,000 currency notes could make things worse in the short term. The resultant liquidity crunch is likely to hurt repayment capacity of borrowers and lead to short-term delinquencies in loan accounts, the rating agency added.
A typical two-income joint liability group borrower household can service Rs 50,000 - 60,000 of debt over two years and the peak leverage of a section of borrowers is approaching this level, raising concerns of increased delinquencies, India Ratings said.
These delinquencies, India Ratings said, could be exacerbated by demonetisation which has reduced cash availability in the system, hurting small and large businesses. In particular, a section of borrowers associated with the construction sector could be negatively impacted.
If the government continues taking steps towards curbing black money in the economy then the construction sector could be affected negatively resulting in people looking out for new jobs and thus, delaying their loan payments.Jindal Haria, Associate Director - Financial Institutions, India Ratings
MFIs, which operate largely on cash, are already starting to feel the pinch, BloombergQuint reported on Wednesday. While institutions like Bandhan Bank have stopped all loan disbursements for a week citing lack of cash, microfinance players across the country are being urged by self regulatory organisations (SROs) like the Microfinance India Network (MFIN) to delay collections for a week.
This, India Ratings said, could also mean a cash flow mismatch for MFIs in the coming months and the ongoing quarter.
The agency expects MFI borrowers to face cash flow mismatch, thereby re-prioritising their expenses. As a result, MFIs could witness high overdues, indicating lack of diversification in MFIs’ borrower profiles.India Ratings Report
While a cash flow mismatch could mean that MFIs might be required to make extra provisions for overdue loans in the next quarter, the report warned they may not have adequate operating and capital buffers to tolerate credit costs.
Overleveraged And Overcrowded
More than one-third of microfinance borrowers are already in their fourth or fifth borrowing cycles, India Ratings said. The first borrowing cycle is the first loan taken by a borrower. Ticket sizes rise as borrowing cycles increase.
India Ratings said borrowers with two loans running in the fifth and second cycle from different MFIs would have average outstanding dues of Rs 50,000 - 70,000.
Although such borrowers would have had a good repayment record, borrowings at this level, if not supported by income levels, could pose a significant credit risk to MFIs. In India-Ra’s opinion, such borrowers need to be assessed more stringently than those with loans in lower cycles from different MFIs.India Ratings Report
Bigger MFIs could be at greater risk as a bulk of their growth comes on the back of rising ticket sizes in a small number of states. For instance, MFIs operating in 10 major states saw their average ticket sizes increase to Rs 22,000 by the end of the first quarter of financial year 2016-17 compared to the sector average of Rs 19,390.
India Ratings believes that the continued focus of MFIs on some of the highest penetrated states has increased the risk of unreported multiple borrowings in these states. Hence, the chance of a surge in delinquencies is significantly high in these states. A large percentage of the poor population in these states have already borrowed from MFIs, indicating increased chances of multiple lending to the same set of borrowers.India Ratings Report
The report found that West Bengal is the highest penetrated state in the country followed by Kerala, Tamil Nadu and Karnataka as measured by the number of unique clients and gross loan portfolios.
The Silver Lining
Despite the near term challenges, Mithilendu Jha, associate director of structured banking at India Ratings said demonetisation may eventually benefit the microfinance industry. Borrowers may now be forced to move to formal bank accounts which could reduce dependence on cash as a mode of disbursements and collection, said Jha.
There is need for course correction in these companies, operating as they do with over-leveraged borrowers in geographically constricted markets, so much so that a single event could disrupt collections and bring business to a standstill, India Ratings concluded.
As a mitigation strategy, India Ratings has advised microfinance companies to consider diversifying both geographically and portfolio-wise while keeping ticket sizes small. Small ticket sizes ensure that borrowers in a joint liability group don’t feel too bogged down by additional pressure when one or two members stop repaying their loans, the report said.
MFIs need to build capabilities to successfully build and manage individual loan portfolios that would be backed by strong credit assessment capabilities and operational checks over time. Such portfolios are expected to be mostly secured. If unsecured, borrowers may hand over property documents to lenders.India Ratings Report