Will the MFI sector survive the acts of god and man?

It’s not very often that Nobel Laureates find their studies criticised, but that’s precisely what happened when husband-wife duo, Abhijit Banerjee, 58, and Esther Duflo, 46, won the Nobel Prize in Economics in October 2019. The MIT professors won the award for their experimental approach, involving the use of randomised control trials (RCTs), towards alleviating global poverty.

In one such RCT study, done between 2005 and 2010, in a cluster in Hyderabad that was facilitated by a microfinance institution (MFI) named Spandana, the authors concluded that “monthly consumption, a good indicator of overall welfare, does not increase for those who had early access to microfinance, either in the short run . . . or in the longer run”. While the study did find that borrowers restricted their consumption of temptation goods and that “microcredit expanded households’ abilities to make inter-temporal choices, including business investment,” the conclusion was that microfinance did not make much of a difference in terms of increased incomes.

The findings incensed India’s microfinance poster boy Vikram Akula, founder of SKS Microfinance, later renamed Bharat Inclusion and sold to IndusInd Bank. In fact, Akula had even debated the RCT approach taken by Duflo at a 2014 debate at HBS. “She made her comments. I made mine. At the end of our panel, she had to leave for another commitment. The next speaker opened his comments by thanking me for scaring Duflo off. It was a tongue-in-cheek remark, but I appreciated the nod that, as a practitioner, I was able to raise some important questions about the Spandana study,” says Akula, who once again went public with his apprehensions when the couple won the award.

Akula points out that the findings from the narrow study were extrapolated to make a broad, sweeping claim about the impact of microfinance in India. “This is problematic because the microfinance industry in India between 2005 and 2010 was incredibly diverse. In 2007, the industry network Sa-Dhan had 129 MFIs. The top 30 MFIs had a total member base of 10.5 million. Spandana was the second-largest with 916,000 members, but it had only 8.7% of the total members in India,” states Akula, who has consistently bet on the success of MFIs. He co-founded another MFI, Vaya Finserv, in 2014 after exiting Bharat Financial Inclusion in 2012.

More importantly, Spandana’s loans were initiated as consumption loans. Therefore, it is not surprising that the study found that though some of Spandana borrowers invested their money, majority did not start businesses and, as a result, it did not increase income.  Even as the social contribution of MFIs remains a topic of debate, the fact is that the industry has over the past decade only grown in size, despite the multiple headwinds it has had to face.

Over the past decade, it has absorbed two crises and now it faces another. In 2010, there were a number of people in Andhra Pradesh taking their lives unable to repay their MFI loans and, in 2016, demonetisation struck. In 2020, the pandemic has come knocking. How will it fare this time?

Coming of age

Microfinance industry has evolved over the years on two models: the poverty lending approach driven by non-profit micro finance institutions, which in turn are donor-and government-funded. The second model involves the financial intermediation approach, which is operated by self-sufficient financial intermediaries.

In India, public sector banks (PSBs) continue to be the biggest driver of micro credit, lending 40% of the industry’s Rs.2.32 trillion (See: Banker’s trust), according to the MicroFinance Institutions Network or MFIN, which is a central bank recognised regulator run by the industry. Banks have easier access to finance and issue bigger loans, when compared to the other microcredit channels such as small finance banks (SFBs), non-banking financial companies (NBFCs) and MFIs (both non-profit and for-profit) and therefore they have always been ahead.

It is only after 2000 that MFIs modeled after Muhammad Yunus’ Grameen Bank began to increase rapidly, and their numbers kept growing till a spate of suicides by borrowers was reported in Andhra Pradesh in 2010. People were setting themselves ablaze, consuming fatal doses of poison or jumping to their deaths. By the first nine months that year, the state police had recorded nearly 14,500 deaths. The RBI in 2011 responded with a new regulatory framework for MFIs within the NBFC space, or NBFC MFIs.

The stronger regulatory framework came as a booster shot to the MFI sector which anyway had caught the fancy of foreign investors. The big change since 2010 is that unlike the concentration of MFI in South, this time around regional distribution of MFIs’ gross loan portfolio (GLP) is diverse. While East and North East account for 40%, South corners 27%, North holds 11%, West 14% and Central 8% (See: Dubious distinction). The top 10 states account for 83% of the GLP with West Bengal leading the pack followed by Tamil Nadu and Bihar.

Between 2007 and 2010, the MFI sector had also caught the fancy of foreign investors who ramped up investments nearly 5x from $30.5 million to $160.3 million. The listing of SKS Microfinance further added to the allure of the sector, with more MFIs going public. NBFC-MFIs continue to be the second largest provider of micro credit, accounting for 32% of total industry portfolio. The top-10 MFIs accounted for 70% of industry disbursements in FY20.

While the central bank’s response had turned the Andhra crisis into an opportunity, the crisis itself was a tough one to survive. At the peak, credit rating firm Crisil had stated that repayment in MFI loans in Andhra, which then accounted for 35% of all MFI loans, had fallen below 20%. It was a sharp fall from the 99% just before the state ordinance was issued. As a result, assets under management for the sector fell by Rs.30 billion to Rs.205 billion in 2011-12, with MFIs having large operations in Andhra suffering the most. Akula’s SKS was the worst hit as its loan book plummeted 70% after the crisis.

Four years later, demonetisation in November 2016 dealt another violent blow to the industry, and this time it had a widespread impact unlike the Andhra crisis. “From an event risk perspective, Andhra was very much a localised event which we have seen playing out in other states as well, including Maharashtra, but demonetisation was an industry impacting trend,” points out Ravi Kumar Dasari, associate director of Care Ratings.

Repayment of microfinance loans came to a complete halt post the note ban in November 2016 and the situation was further aggravated following the farm loan waivers in 2017 by UP and Maharashtra, directly impacting the repayment culture of borrowers. On aggregate, the sector saw the portfolio at risk (PAR) – arrears that run the risk of not being repaid – shoot up. The portfolio at risk of delinquencies of more than 30 days surged from 0.3% in September 2016 quarter to 6% by December 2017 and peaked at 14% by March 2017. Then there was a brief respite when, within a span of one year, the industry’s collection rate improved largely on the back of currency availability and the PAR figure fell to 4.41% by the end of March 2018.

Just as the industry sighed in relief, growing as it was at a healthy pace, the pandemic struck in March. The third blow had landed.

In April, Crisil raised a red flag saying the extended nationwide lockdown to contain the pandemic had impacted the income-generation ability and savings of borrowers of MFIs. The concerns were not unfounded. Even as the gross loan portfolio (GLP) for the sector grew 29%, from Rs.1.79 trillion in FY19 to Rs.2.31 trillion in FY20, the PAR metric showed signs of stress. Loans of delinquencies of more than 30 days rose from 1% as of March 2019 to 2.3% by March 2020.

Dvara Research’s telephonic survey conducted across 347 households in 47 districts across nine states showed that MFI borrowers were beginning to feel the pinch. “Households were showing income losses in the immediate aftermath of the lockdown and to tide over this, drew down their savings at home and bank, following which they used a variety of other sources to obtain cash flows including informal borrowings,” reveals Deepti George, head of policy at Dvara Research.

Collections which had plunged to near zero in April because of the lockdown have since rebounded to 70-75% in July, with restrictions being lifted gradually. “While the bounce back has been faster, improving it to the pre-pandemic levels of 98-99% will be an important monitorable from an asset quality perspective,” says Krishnan Sitaraman, senior director, Crisil. The MFIs are trying to reduce the impact of the lockdown by extending a helping hand to their borrowers, using money raised from the central bank and shareholders.

Softening the blow

To help all borrowers, microcredit or otherwise, through the lockdown, the RBI had announced a loan moratorium till May 31, 2020, and later extended it by another three months till the end of August 2020. But, even before the central bank, the biggest NBFC-MFI had announced an extension for its borrowers. CreditAccess Grameen, in which the Netherland-based CreditAccess Asia holds a majority stake, is valued at Rs.85.12 billion, with around 4.1 million borrowers and a gross loan portfolio of Rs.119.96 billion that fetched a profit of Rs 3.28 billion in FY20. The MFI does not expect to be impacted too heavily by the moratorium extension. Its CEO, Udaya Kumar Hebbar, in an earnings release said that only 10% of their borrowers may opt for it. The management also expects reduction in moratorium to be around 4-5% beginning September.

The company chose not to participate for the Outlook Business feature.

The second-largest listed MFI in the space Satin Creditcare, too, offered a moratorium. Even though 25-30% of their borrowers have opted for it, founder of the MFI sounds confident. “78% of our borrowers are engaged in animal husbandry and agriculture allied activities which comes under essential services, hence recoveries from these borrowers are expected to be much faster,” says HP Singh, whose Satin CreditCare has a loanbook of Rs.82-billion and posted a profit of Rs.15.5 million the last fiscal.

The MFIs outlook could be too optimistic, if we go by what Dvara Research’s George says. Though not comprehensive, her policy research institution in 2016 had conducted a survey of 400 microloan borrowers in Krishnagiri, a saturated microfinance market, that showed a median income of Rs.12,773 per month. The average loan per household was found to be double that number and, therefore, income disruption of more than a month could mean increasing difficulty in repaying loans. This is also because of the high interest rates the MFIs charge (See: Stress point).

The Malegam Committee, whose recommendations the RBI had taken in 2010, had capped loan pricing at 26%. Ideally, the pricing should have reduced over the past decade given the maturity of the sector. “But a majority of microloans continue to be priced in the range of 24-26%,” adds George.

Alok Misra, CEO and director of MFIN, believes that this is an extremely critical phase for MFIs to navigate and has said that the institutions should respond with empathy to their borrowers, allowing them time to get on their feet. He added that the MFIs should also “handhold those who availed the moratorium and are willingly to repay with relevant documents”. Sitaraman believes MFIs have already responded with a greater level of empathy than earlier, considering they did not ask for collections in April and May, thus extending a moratorium on a proactive basis.

The MFIs may be willing to be more understanding but George says that they also have to figure out how to assess the sustainability or affordability of the incremental loans, given a borrower household’s portfolio of loans and other liabilities. It is a whole new world, so MFIs will need to be generous and innovative.

Actually, the lenders can afford to be both because they are sitting on a pile of money. In FY20, the NBFC-MFIs raised over Rs.420 billion in debt funding from banks and other financial institutions, which is 33% more than the Rs.316.88 billion raised in FY19. Besides, in early April, to ease the pain for MFIs and NBFCs, the central bank had offered Targeted Long-Term Repo Operations (TLTRO) of Rs.500 billion. “MFIs have raised money through bond issuances under the TLTRO and partial credit guarantee schemes. Further, since most MFIs received moratorium from banks, they had low debt repayments, while disbursements, too, were negligible,” says Crisil’s Sitaraman.

CreditAccess Grameen raised Rs.21.81 billion in Q4FY20. “Our near-term focus will be ensuring healthy liquidity position and timely collections from field, which will help us provide additional financial support to our borrowers… we are confident of raising sufficient funds from domestic and international sources in the coming months,” says Hebbar (See: Sticky deliquency).

Similarly, Satin Creditcare, too, has tanked up. As March 2020, the company had Rs.16 billion in liquidity in addition to the sanctioned but undrawn credit lines of Rs.8.71 billion. “It is one of the highest in the industry. Besides, we have done a rights issue not because we are looking at an enhanced credit cost but just to build the confidence of our external stakeholders,” points out Singh, whose investors include ADB and MIT.

The funding could also ensure that the MFI players are able to absorb higher credit costs (write-offs), in case things don’t pan out as expected. Singh does not believe the write-offs will be much anyway, estimating it to be below 5%. The NBFC in Q4FY20 incurred Rs.828 million towards credit costs. “On the credit cost, my assessment is that probably it is not going to see that big a spike as we had anticipated before all this really started,” says Singh.

The mood at the smaller MFIs is vastly different. Those with less than Rs.2 billion loan-portfolio are seeing their funds dry up, and they have asked their banks to convert outstanding loans into equity or are asking banks to issue fresh loans. This is according to a report by Infomerics Valuation and Rating, the National Small Industries Corporation-empanelled credit rating agency. There are close to 100 such MFIs with a total loan portfolio of about Rs.50 billion, catering to 2.5 million marginalised women borrowers. The report adds that MFIs are likely to face further difficulty in recovering their loans even after lockdown because of the erosion of savings of borrowers and stoppage of savings (See: Wait and watch).

Another MFI association, Sa-Dhan, has reportedly identified about 25 firms which had thin or no profit margins even before the outbreak of COVID-19 globally. Sa-Dhan’s executive director P Satish was quoted as saying, “The smaller ones are facing more difficulty in accessing capital and liquidity”. The association has initiated discussions on the possibility of three-four MFIs coming together for a merger. It has sought Rs.87 billion as emergency credit line from banks for its members, including Rs.4.50 billion exclusively for small and mid-sized MFIs. Meanwhile, Sa-Dhan has also requested the finance ministry to provide an additional Rs.10 billion in capital for MFIs looking at consolidation.

Many MFIs are using the lessons they learnt during demonetisation. “The biggest learning for us was the need to have a diversified base. We were about 55% concentrated in Uttar Pradesh which post the note ban got reduced to 20%,” says Satin CreditCare’s Singh. “The biggest take away from COVID would be that the focus has shifted to technology,” he adds. From cashless disbursals, Satin CreditCare is now looking at cashless collections, with an app in place for repayments.

While smaller MFIs are staring at consolidation, Singh is not keen on buyouts: “I believe that the sector offers immense organic growth expansion, and besides, acquisitions come with their own baggage. We would rather consolidate our own operations.” CreditAccess Grameen, which is looking at tapping the capital market before August 2021 to comply with 25% public holding norm, is also banking on technology to grow its business. Incidentally, the NBFC had acquired Madura Micro Finance, another MFI in November 2019.

Crisil’s Sitaraman says that some MFIs they have been speaking to are considering raising more equity, similar to the Rs.40 billion raised to deal with demonetisation. “MFI is attractive to certain kinds of investors, global and Indian, who are looking at socially-relevant investing,” he says.  Care Ratings’ Dasari cautions MFIs from letting their borrowers fall into a deeper overdue bucket. “We saw during demonetisation that lot of MFIs found it difficult to manage and as a result, credit costs varied between 3% and 13%,” he says.

Dvara’s George believes the pathway for larger NBFCs (including MFIs) would be to expand and diversify, in order to eventually apply for a full service bank licence such as SFB or to emerge a multi-geography player. Though SFBs and banks still command 70% of MFI loans, Hebbar of CreditAccess Grameen believes that NBFC MFIs operating in rural areas have a higher ability to acquire more customers going forward. “Potential is quite high in the rural areas if you see the unbanked population,” Hebbar said in a recent media interaction.

The other possibility could be a closer partnership between MFIs and banks. “MFIs are good at origination given their deeper reach, relationship adaptability, local knowledge, innovativeness, responsiveness and collections. A partnership model will also ensure that bulk of the loan can be moved to the banks’ balance sheet and that will help the MFIs get over the challenge of the liability side,” points out Sitaraman.

While these are still early days, with the country still grappling with the pandemic, the MFI industry could well see the big getting bigger and the marginal players folding up or shrinking. Whether it is challenge of uncontrollable interest rates or liquidity drying up or a virus digging its claws in, the deepest pain is always felt by the borrowers. The victory of MFIs will lie in recognising this and responding accordingly.