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The asset quality of microfinance portfolios of small finance banks and non-bank microfinance institutions (together referred to as MFIs) have been improving since June 2017, shrugging off the demonetisation impact, which had cranked up delinquencies and affected borrower behaviour.
While idiosyncratic risks remain, two things underscore the improvement: portfolio delinquencies (for a representative set of MFIs ), measured in terms of principal due from borrowers who have defaulted on more than one instalment (also called 30 days-past-due or 30 dpd), have improved to 5.6 per cent as on December 2017 from 7.6 per cent as on June 2017; and, cumulative collection efficiencies have risen to 99 per cent for disbursements since April 2017.
The improvement stems from the hard yards put in by MFIs to improve collections and engage and educate borrowers about credit discipline.
The presence of credit bureaus and measures undertaken by industry associations and self-regulatory organisations have also helped improve the overall environment, especially credit discipline.
Despite the improvement, asset quality performance continues to remain weak in Vidarbha and a few districts of Madhya Pradesh, Karnataka and Uttar Pradesh.
In future, portfolio delinquencies for the industry will settle at a level higher than that observed in the pre-demonetisation period.
Steady state profitability
Crisil estimates ultimate credit losses for MFIs because of demonetisation to be 5-7 per cent of portfolio outstanding as on October 31, 2016. This will impact their near-term profitability; though we expect profitability to show a gradual improvement going forward. Credit costs are likely to stabilise at 1.5-2.5 per cent on a steady-state basis. MFIs with larger rural presence, weekly collections and lower equated instalments are expected to incur lower credit costs. Post-tax return on assets are likely to be 2-2.5 per cent.
What’s good to see is that stakeholder confidence remains strong despite the post-demonetisation asset quality woes. After demonetisation, MFIs have raised around ₹4,000 crore of equity and ₹7,000 crore of debt from capital markets. Additionally, banks and refinance institutions continue to extend funding. In the first nine months of fiscal 2018, MFIs have raised ₹23,750 crore. However, dependence on bank funding remains high, and accounted for 60 per cent of borrowings (including securitisation) as on December 2017. This underscores why priority sector eligibility for direct bank lending to MFIs remains critical.
Growth prospects bright
The business prospects for MFIs remain good as total demand remains large at ₹3-lakh crore. At present, MFIs and banks have a microfinance portfolio of ₹1.25-lakh crore. The NABARD-run SHG linkage programme has a portfolio of ₹0.25-lakh crore (excluding Andhra Pradesh and Telangana). Hence, unmet demand potential is large at 50 per cent. A large number of households in central, west, north and east are yet to be tapped.
Advantage small finance banks
Several large MFIs that transformed into small finance banks (SFBs) are looking to diversify into inclusion adjacencies such as micro, small and medium enterprise loans and affordable housing loans. The demand potential in these segments also remains buoyant over the medium term given the untapped potential.
However, SFBs need to overcome two key challenges: building liability franchise and garnering retail deposits to support growth, and the impact on near-term profitability because of high credit costs, SLR and CRR requirements, and increase in operating expense ratios.
The SFBs are currently managing their liability profiles by availing themselves of wholesale funding from SIDBI, NABARD and Mudra Bank, attracting institutional deposits by offering higher interest rates, raising funds through certificate of deposits and securitisation. Profitability should also improve over the medium term as credit cost stabilises, cost of funds decreases and operating efficiency increases.
Healthy capitalisation is critical
MFIs with strong credit profiles or healthy capitalisation have shown resilience despite asset quality challenges.
Capitalisation will continue to be the key given the inherently weak borrower segment for MFIs, their susceptibility to socio-political issues, and consequent potential volatility in asset quality and profitability.
The writer is Senior Director, Financial Sector and Structured Finance Ratings, CRISIL Ltd
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