Many of the long-standing demands of microfinance companies, especially those operating under a non-bank licence (NBFC-MFIs or standalone MFIs) were met last week, when the Reserve Bank of India issued a circular redrawing the ground-rules for the sector.
Broadly the regulations move from entity-based rules that applied to NBFC-MFIs, to activity-based rules that apply to all lenders engaged in micro-finance. They also lift the pricing controls that have been in place on NBFC-MFIs since the AP loan crisis of 2010 and allow them to formulate board-approved policies to fix lending rates on such loans. They’ve also been asked to share the basis of their pricing and other loan details with customers, which is a big step towards transparency and increasing competitiveness in the sector.
Replacing the absolute cap on microfinance loans (at ₹1.25 lakh) with a broader definition that allows lenders to cover all households with annual income of up to ₹3 lakh, increasing the debt-to-income ratio to 50 per cent of monthly household income and ensuring that this slab is applicable to all categories of lenders and not just NBFC-MFIs, certainly removes the operational constraints which standalone MFIs faced.
But can these regulatory changes bring back investor interest in MFIs? That appears unlikely.
What has been hurting NBFC-MFIs, and led to a diminishing share for them in the micro-credit pie is their fundamental inability to keep pace with banks on interest rates, products, or risk management. The cost of funds for a commercial bank is less than 5.5 per cent and about 6.5 per cent for a small finance bank. For NBFC-MFIs, despite the fall in market interest rates, funds are available at almost twice the rate for SFBs.
The RBI’s consultation paper on microfinance in June 2021 shared data showing that the cost of funds for NBFC-MFIs remained at 11.3 per cent in FY20 and rose to as high as 12.9 per cent in FY21, despite the base lending rate falling to sub-4.5 per cent that year.
NBFC-MFIs depend on banks to meet 40-60 per cent of their liquidity needs, and the banking channel remains their primary source of funds. While there is an option to tap the bond markets, there are just handful of NBFC-MFIs such as CreditAccess Grameen and Northern Arc with credit rating of ‘A’ and above, which can access capital at par with full-stack NBFCs.
With loan losses provisioning increasing from 0.77 per cent in FY15 to 1.55 per cent in FY20, banks have steadily increased their risk premium for MFIs. With the current provisioning level breaching the 3 per cent mark, cost of funds for NBFCs is bound to remain high. Therefore, though the pricing cap is being dispensed with, standalone MFIs may not have much pricing power on lending rates in the face of competition. They may have to let go of yields and/or be forced to absorb additional costs to stay in the game.
Another key change in the regulation is the relaxation of the rule that NBFC-MFIs must have a minimum 85 per cent of their loan book devoted to microfinance. But on being able to broad-base their offerings and expand their portfolio of secured products (mainly gold loans which tend to be the low-hanging fruit), the fact remains that even under the extant law which permitted NBFC-MFIs to diversify up to 15 per cent of their loan book, many chose not to explore this option.
Lack of required underwriting skills or manpower to make headway into non-MFI loans was a constraint. The relaxation to 75 per cent under the new regulations, is unlikely to be a game-changer for standalone MFIs, especially under the current circumstances of asset quality challenges that the industry is grappling with.
Structurally, standalone MFIs continue to lag their larger competitors and it is moot if regulatory changes alone can help overcome these issues. The ultimate proof of deep-rooted issues is the dwindling investor interest in pure MFIs.
Several SFBs where the share of MFI loans is upwards of 85 per cent (such as ESAF and Utkarsh) are required to list in the stock market due to regulatory requirements. But their IPOs have been deferred many times for fear of investor appetite. The same holds good for Arohan Financial Services (which is a NBFC-MFI) and Northern Arc (an NBFC focussed on loans to low-income households). Both have been preparing for their listing, but their IPOs are yet to take wing.
That listed MFI Spandana Sphoorty Financial Services, embroiled in a battle between its former promoter and investors, had to finally rely on Kedaara Capital (which holds 47 per cent in the company) for its funds infusion could be another indicator of the funding constraints facing the sector, especially where the scale isn’t attractive. India has about 85 NBFC-MFIs and this number has remained stagnant since 2019.
This is not to say that microfinance as a business isn’t lucrative. With yields upwards of 15 per cent there are very few lending businesses which can match the spreads on MFI loan. But the business is not what it used to be in 2010, when private equity investors flocked in to revive battered MFIs post the AP loan crisis. Standalone MFIs started losing their plot to bank-led MFIs since 2016 and the terrain has changed almost irrevocably with the licensing of small finance banks which cater to small borrowers.
Geographical diversification remains a challenge, too. Most NBFC-MFIs are reduced regional players with dominance only in tier-2 and 3 regions, where banks or larger outfits won’t find economies of scale to operate.
Without a strong and dedicated refinancing vehicle such as a SIDBI or NABARD, standalone MFIs may continue to face growth challenges. It’s not going to be easy for them to get back in the ring.