Microfinance institutions (MFIs) and small finance banks (SFBs) are likely to face severe asset quality issues in the short term, as near-term collections would see unprecedented disruptions on account of the COVID-19 linked nation-wide lock-down, says India Ratings and Research (Ind-Ra).
In a report, the ratings agency says, "While our rated non-banking finance company (NBFC)-MFIs in the investment grade category have adequate liquidity for one and a half to six months (assuming nil collections and no moratorium), there may be refinancing and funding challenges for some entities in the next three-six months. SFBs would face similar risks on the asset side and managing deposits base may also become challenging. However, they would be better placed on the liability side by virtue of them being banks where the Reserve Bank of India (RBI) is the lender of the last resort. As a result, Ind-Ra revised its outlook on NBFC-MFIs and SFBs from stable to negative."
According to Ind-Ra, the asset quality concerns on NBFC-MFIs are driven by COVID-19 situation in India. It says, "MFIs are among the hardest hit in the initial period of the lock-down; their field staff cannot go for collections. Given that collections mostly happen in cash, they may fall drastically in April 2020 before seeing a modest recovery in May 2020 if the lock-down is lifted. The recovery could be on account of a significant share of the borrowers being involved in providing essential goods and services, so cash flows would not dry up for them."
"Also, a section of the borrowers would have low debt outstanding as their loans would have run down and they would repay to avail the next cycle of loans. If MFIs are unable to disburse the next cycle of loans to such customers, this could aggravate the collection issues. This could also be contributed by homogeneity in borrower behaviour, loss of business opportunities and lower demand," it added.
Ind-Ra has brought down its estimates for gross domestic product (GDP) growth to 3.6% from 5.5% for FY20-21.
Speaking about the demonetisation experience, the ratings agency says, during that time, while the immediate disruption was high in north, west and central India, east and south were performing better.
It says, "The states of Uttar Pradesh, Maharashtra and Madhya Pradesh, where there were local and state elections, the collections did not return to normal and MFIs wrote off a large portion of the portfolio (e.g. in Maharashtra, MFIs wrote-off up to 50% of their exposures) over FY2017-FY2019. Overall, credit costs for impacted institutions (including SFBs) were in the range of 5%-10%, depending on state-wise portfolio distribution."
"The impact of the lock-down is nationwide and hence precedencies may not necessarily hold. Any reasonable data-based estimates on credit cost would require collection data over the next four months, including two months of moratorium period and two months of normal repayment environment. However, the credit costs could exceed pre-provision operating profits of about 4%-6% for NBFC-MFIs and they could see some capital erosion," Ind-Ra added.
Ind-Ra says while its rated NBFC-MFIs in the investment grade (six) have sufficient liquidity to cover liability obligations for one and a half to five months, it could take much longer for the credit support to normalise, considering domestic banks to be the dominant fund supplier to most MFIs and banks may curtail funding/refinancing to MFIs for the short-to-medium term, given the uncertainty towards inflows, if the lock-down is extended.
"Cumulatively," it says, "NBFC-MFIs will have to forgo two months collections of around Rs26 billion, which is almost equivalent to the cumulative liquidity that they currently hold on the balance sheet. This situation has aggravated, as most of the banks still are uncertain in terms of passing the moratorium benefits to NBFCs. While the RBI has announced targeted long-term repo-operation 2.0 of Rs500 billion for NBFCs, half of which is targeted for small and mid-sized NBFCs and MFIs, the banks’ appetite to flow the same remains uncertain."
For small finance banks, while the deposit accretion is slow, it have multiple tools available, the ratings agency says.
There have been a few important observations regarding most small SFBs that Ind-Ra has direct or indirect coverage on over the last few months. "While they were accruing deposits at break-neck speed (FY2019 and first half (1H) of FY2020 growth), the deposit accretion almost stopped in March 2020 and in fact there was deposit attrition as the banks faced perception issues on account of the Yes Bank Ltd reconstruction and Punjab and Maharashtra Cooperative (PMC) Bank issues," it says.
The rollover of deposits was also minimal, the ratings agency says, adding, "These SFBs raised INR63 billion of deposits in 4QFY19, while only Rs23 billion in 4QFY20. The initial management commentary is that the renewal rates have picked up in April 2020. We also expect that their exposures to MFIs to have an overhang on deposit accrual and deposit rollover or renewal."
"Overall, the SFBs have provided a two-month moratorium period to most of its individual or MSME borrowers. They do have access to refinance institutions and as banks, to additional tools to raise non-deposit liabilities to manage their asset-liability management. Moreover, SFBs maintains an excess statutory ratio in the range of 5%-10% of the total assets which supports its liquidity position, and have built retail deposits, including current account savings account deposits, in the range of 30%-35% of the total funding reflecting granular deposit base," Ind-Ra added.
For SFBs, the asset side risks are somewhat lower than NBFC and MFIs, the ratings agency says, adding, "On the asset side, most SFBs have exposure to microfinance borrowers and could be exposed to similar risks as NBFC-MFIs. However, given that many of these borrowers would also have deposits with banks, especially recurring deposits that are collected with their loan repayments, these SFBs have seen lower delays with such borrowers in their pilots; the lock-down and its aftermath would be a big testing ground for that."
"Although most SFBs have majority MFI exposure as a per cent of its loan book, they also have non-MFI exposure – loan against property, MSME and SME loans and vehicle financing. This portfolio is also expected to get impacted due to the lock-down as these banks mostly serve the self-employed segment with median credit profiles. We expect that the banks would face delinquencies and challenges on the asset front, this would hamper deposit accretion at least for the next three to six months. This and the overall environment could slow down the growth of SFBs significantly," the ratings agency concludes.