Demonetisation May Lead To Equity Erosion For Microfinance Institutions, Says India Ratings
Microfinance Instiututions face risks due to structural issues like a build up of excess leverage among borrowers.
- India Ratings cautions on rising risk in microfinance
- Microfinance institutions may face capital erosion if recoveries don’t pick up
- Demonetisation, political interference bringing out structural weaknesses in the sector
- Focus on growth has led to deterioration in risk profile
- Excess build up of leverage among borrowers seen across some states
Demonetisation has brought weak spots in the microfinance sector to the fore, said rating agency India Ratings & Research in a report which warns that companies in this business could face significant credit costs and equity erosion this year. Inherent weaknesses in the microfinance sector, such as excess leverage among borrowers, have been exposed due to demonetisation and political interference in the rural economy, said the rating agency.
India Ratings had warned about a build up of risks in microfinance even before demonetisation was announced in November last year. Since then, the cash shortage brought on by the currency exchange program and increased instances of farm loan waivers, have disrupted the market further.
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.India Ratings Report
In the initial phase of demonetisation, many borrowers lost one to three months of their wages, leading to missed equated monthly installments (EMIs). While the recovery in the first quarter of FY18 will cover three months of missed installments, it may not help cover payments that have been outstanding for longer.
"Mirofinance institutions (MFIs) may need to take haircuts on borrowers that have missed more than three EMIs or are intentional defaulters," the report said.
If they fail to recover atleast 85 percent of their December 2016 portfolio by the second or third quarter of the current financial year, it will result in capital erosion beyond the regulatory minimum. MFIs will need a 95 percent recovery rate to minimise their capital erosion, the report added.
To be sure, there has been some improvement in the environment. The aggregate collection efficiency has improved from a low of 50-60 percent in December 2016 to 75-80 percent in May 2017, said India Ratings.
Excessive Leverage Among Borrowers
India Ratings reiterated concerns raised in an earlier report about the build-up of excessive leverage among microfinance borrowers, particularly in some states.
According to the rating agency, a typical two-income joint liability group (JLG) borrower household can service Rs 50,000- Rs 60,000 of debt in over two years. The peak leverage of a section of JLG borrowers is approaching this level, said the report.
Credit bureau rejection reports indicate lenders are often pursuing existing microfinance borrowers to build books and low addition of new-to-microfinance borrowers as that could entail high operating costs.
According to India Ratings, the increase in the gross loan portfolio of MFIs in nine of top 10 states was driven more by an increase in ticket size, rather than by a rise in penetration. The average outstanding loan ticket size in these states was Rs 20,399 as of the end of the first quarter of fiscal 2017, as compared with the sector average ticket size of Rs 19,930.
The continued focus of MFIs on states, where the penetration of microfinance is already high, has increased the risk of unreported multiple borrowings in such states. Hence, the chance of a surge in delinquencies is significantly high in these states, cautioned India Ratings.
The rating agency added that MFIs need to go back to basics by focusing on vintage, quality of penetration, low ticket sizes and product diversification. It also flagged off the need to reassess the selection process for JLG loans to ensure better borrower selection. “The agency feels the sector needs to reinvent itself on risk management, operating capability and product offerings," said the report.