Additional Rs. 3000 Cr debt funding to smaller MFIs likely in FY22

Acuité believes that the latest measures announced by RBI to mitigate the fresh systemic risks arising from the intense impact of Covid 2.0 are timely and will benefit the MFI sector. While the industry was in a gradual recovery phase from Q3FY21 through an improvement in the delinquencies and disbursements levels, the second Covid wave has started to disrupt that nascent recovery. In our opinion, the latest RBI announcement on special long term repo operations (SLTRO) of Rs 10,000 Cr for Small Finance Banks (SFBs) will not only ensure higher direct disbursements to microfinance borrowers but also lead to better funding access for smaller microfinance institutions (MFI) with asset size less than Rs 500 Cr as SFB loans to the latter would also be categorized as priority sector exposure. Further, the fresh restructuring window provided for loans upto Rs 25 Cr will also support the MFI sector in alleviating the additional asset quality stress emanating from Covid 2.0.

With the steady moderation in the Covid infections since the first peak in mid Sept 2020, there has been a visible improvement quarter on quarter in collection efficiency and portfolio delinquency levels for MFI players. The disbursements also started to gain momentum with Q3FY21 disbursals in line with similar period last year and Q4FY21 estimated to be 20% higher than Q4FY20. While a study undertaken on the MFI sector by Acuité indicates that bad loan provisions have impacted the profitability of the sector and few MFIs are set to report losses in FY21, the overall operating environment was conducive for a further recovery and healthy growth in the sector till India was hit by Covid 2.0 from March 2021.

Clearly, the second wave of Covid has been much more intense than what we witnessed last year. As compared to a daily new case peak of 98,000 on Sept 16, 2020 in last calendar year (2020), the daily average in the first week of May 2021 has almost climbed four times or 400,000 cases. On similar lines, the daily mortality levels have also shot up from around 1200 in mid Sept 2020 to a current level of 4200 in the week ending May 7, 2021. The impact of the second wave has not only been in the large cities but also in the hinterland, sparking a crisis in healthcare infrastructure. While no national level lockdown has been contemplated yet as in last year, the virulence of the second wave has led to lockdowns at local levels in various states and the intensity of such lockdowns may increase if the case load continues to increase further. This has already started to impact the improving trend in collections and disbursements particularly from the second half of April 2021. Given the wider coverage of the virus across semi urban and rural areas in this cycle, the risks of a sharper impact on the lives and livelihoods of the microfinance borrower is higher in the near term. Acuité expects 30 day delinquencies to increase at least by 30% by June 2021 even if the pandemic intensity starts to taper down from the middle of May and may more than double if there is no taper down of the pandemic intensity and the local lockdowns continue till end of Q1FY22.

In the context of the re-emergence of asset quality stress in the microfinance sector, RBI’s measures to provide better funding access to the sector has come in a timely manner. Small Finance Banks (SFBs) which are primarily erstwhile larger MFI-NBFCs, have started to play an important role in providing credit to the informal sector including microfinance borrowers in both urban and rural areas. RBI has announced in its latest relief package on May 5, 2021 that SFBs can tap a Rs 10,000 Cr special long term repo operations (SLTRO) funding programme which can provide funds at the repo rate of 4.0% for a tenor upto 3 years. This is meant to be deployed for fresh disbursements to its traditional clients i.e. microfinance borrowers as well as micro and small businesses with an exposure upto Rs 10 lakhs. The SLTRO programme will be available till October 2021 and will enable SFBs to provide additional credit to individual and self employed borrowers impacted by the latest Covid disruption. Acuité believes that the SLTRO for SFBs should make a larger quantum of funds available for disbursements in the microfinance sector over the next few months which will provide relief to the borrowers whose livelihood may have been impacted due to Covid 2.0.

The other measure announced for SFBs will have a significant positive impact on the funding position of smaller MFIs with asset size upto Rs 500 Cr who had not benefitted adequately from the TLTRO and other measures announced earlier in FY21. While SFBs do undertake on lending to such smaller MFIs to channelise credit to the sector, such exposures to MFIs had not been considered as priority sector lending (PSL) earlier. RBI has now permitted the categorisation of such lending as PSL up to March 2022. In our opinion, this will enhance the financial flexibility for smaller MFIs as SFBs will be incentivised to take a larger exposure to the former without breaching their stringent PSL requirements which stand at 75% of adjusted net bank credit as compared to only 40% for scheduled commercial banks.

An analysis undertaken by Acuité Ratings on the funding position of the MFI sector reveals that smaller MFIs continued to face funding constraints in FY21 despite the steps such as the TLTROs and refinancing programmes from SIDBI and NABARD. While the total debt funds received by the sector did witness a sequential improvement to Rs. 10,876 Cr during Q3FY21 vis a vis Rs. 9,854 Cr during Q2FY21 [Q1FY21: Rs.5973 Cr], NBFC-MFIs with Assets under Management (AUM) >2000 Cr raised the majority or 82.6% of these funds. Over 40 % of the MFIs having AUM <500 Cr hardly received any fresh disbursements even in Q3 FY21. Clearly, the banking and even the NBFC sector continued to prefer players with larger scale while deploying their funds in the microfinance sector. With increased concerns on borrower delinquencies in a pandemic environment, there has also been sharp drop in securitization volumes in FY21 which further limited the funding sources and led to a liquidity stress for many small MFI players.

Chart 1: Fresh Debt - NBFC MFIs

Chart 2: Fresh Debt Funds Receipts – AUM Wise

RBI’s move to classify small MFI loans from SFBs as priority sector is expected to boost lending to the former segment. While scheduled commercial banks have funded large MFIs, they have been reluctant to sanction loans to those smaller in size; however, SFBs understand the small microfinance segment in a better way since the majority of the SFBs have started their operations as a small MFI. Acuité expects that this measure will lead to an incremental funding to the sub 500 Cr MFI segment to an extent of Rs 2000-3000 Cr over FY22 and therefore provide support to the liquidity position of these players. Further, the cost of these incremental borrowings is expected to be less for such loans as SFBs will be able to access SLTRO funds at a repo rate of 4.0% and upto a tenure of 3 years. Consequently, the profitability pressures in the small MFI segment may also get partly offset.

The study on the NBFC-MFI sector by Acuité Ratings reveal that although there had been an impact of the Covid pandemic (Covid 1.0) in FY21, there was an improving trajectory in the delinquency levels by March 2021. Given the imposition of the 6 month loan moratorium by RBI from March – August 2020, the stress on asset quality expectedly was not visible till Sept 2020 but was subsequently reflected in the Dec 2020 quarter. With the taper down of the first wave in Q3 and Q4 of FY21, the delinquencies had started to improve till the emergence of Covid 2.0 from April 2021.

Chart 3: NBFC-MFI Delinquency trends

It has been observed that the asset quality impact has been divergent across players despite the delinquency challenges at an industry level in FY21. The stress has been more pronounced for players operating in certain geographies or states and also those to cater to the urban poor segment. Understandably, the prolonged lockdowns and migrant exodus had affected economic activity in urban areas for the larger part of FY21 and made loan recoveries difficult.

RBI’s decision to provide a fresh restructuring window for all individual and business loans that are standard as on March 2021 and with lender exposure upto Rs 25 Cr is also directed to address the fresh wave of borrower stress due to Covid 2.0. Further, a flexibility has been provided to the lenders to extend the moratorium upto 2 years for all those restructuring that have already been completed in FY21. Acuité believes that such a proactive measure will not only support the stressed borrowers in the informal sector but particularly alleviate the potential buildup of near term stress in the MFI sector through lower provisioning requirements. While the central bank has consciously decided against a blanket loan moratorium for Covid 2.0, the lenders including the NBFC-MFIs have been given the discretion to provide temporary moratorium wherever required and, in our opinion, this will result in a more focused approach while managing the stressed loans. However, MFI players need to be cautious while restructuring such borrower loans since any major restructuring exercise over a significant part of their loan portfolio without being accompanied by a restructuring of the MFI debt can lead to an asset liability mismatch.

The current challenges notwithstanding, it has been observed that the microfinance industry has been resilient to disruptions and challenges over the last one decade. The industry had its own share of lows and highs and had overcome challenges such as the Andhra Crisis, Demonetization and the impact of the IL&FS meltdown on the financial services industry. The resilience in the sector is supported by consistent capital infusion from the various stakeholders despite the intermittent stress and the potential opportunity in the sector; while it is currently serving nearly 60 mn unique low-income clients, the untapped market is estimated at 180 mn borrowers. The rebound in disbursals and collections post resumption of economic activities from Q3FY21 had been a testimony to the underlying pent-up demand. Although the sectoral recovery has been interrupted in the near term due to Covid 2.0, Acuité believes that the timely regulatory and systemic support along with strong structural demand for microfinance would bring back the growth momentum to the sector over the medium term.