It’s been over five months since RBI has come up with the new regulatory framework for microfinance (MFI) loans. With respect to financial and operational standpoints, NBFC-MFIs faced several headwinds, particularly after Covid-19, with escalated credit costs being one of the challenges.
The revised guidelines were earlier made effective from Apr 1, 2022. But later the effective date was extended to Oct 1, 2022, when some regulated entities (REs) notified RBI about difficulties with respect to their implementation.
The new guidelines are expected to have a positive impact on the NBFC-MFI sector. They are applied to all commercial banks (excluding payment banks), primary/state/district central co-operative banks, and NBFCs, including MFI and housing finance companies (HFCs).
However, to what extent the new guidelines have been implemented, and how far they are adopted? Vivriti Asset Management has spoken with 14 NBFC-MFIs across India to find that out. Let’s take a dig at some of the parameters of the new regulatory framework to examine and evaluate their responses.
1) Definition of MFI loans/Qualifying asset
As per earlier regulations, loans were classified as ‘qualifying asset’ in the NBFC-MFI framework if it meets some of the following criteria
Indian MFIs have long been in discussion with the Reserve Bank of India (RBI) to raise the limit of inflation-adjusted household income for taking loans to INR 3 lakhs/year to widen the scope of eligible borrowers. It has been estimated that the hike would add ~5 crore MFI customers to the current count of ~6cr.
Implementation and implications
Considering indebtedness at a household level is a welcome move for the industry, in the long run, and so is the hike in the cap for annual household income for qualifying assets, which is expected to increase the market size for MFIs. Let us examine these two aspects one by one:
(i) Ascertaining the household income
Upon interacting with 14 NBFCs across India, it is revealed that their field staff has started capturing the source of income of each member of the household. The assessment is done via discussion with the entire household.
We believe assessing the income of an MFI borrower/household is a challenging task as the majority of the income is unorganised, seasonal, and earned in cash and most of the MFIs will gravitate towards self-declaration. This results in a mismatch in the evaluation of the level of household income by different entities. For example, the household whose income level is determined as less than INR 3 lakhs by an MFI could be determined as more than INR 3 lakhs by an NBFC leaving no standard data points of reference.
As per the latest Consumer Pyramids Household Survey by CMIE, Indian households are divided into five income classes where the INR 2 lakhs-5 lakhs bracket comprises the majority of households, a share which rose from ~33% last year to ~50% recently.
(ii) Ascertaining household indebtedness
When it comes to loan obligations, a few conservative MFIs have set internal fixed obligations to income ratio (FOIR) thresholds of 40%-45% for the households. For monthly loan obligations, bureau checks are being carried out on the entire household. The issue is that monthly EMIs are only available for MFI loans and not all retail loans. Very few MFIs have designed EMI calculators to compute EMI based on the total outstanding and tenor of the loan. Most MFIs are considering the EMIs based on a discussion with the borrower/bank pay-outs. For loans such as gold loans/Kissan Credit Card loans, most MFIs are not considering them for computing indebtedness. Some MFIs are also considering the indebtedness only on account of self-declaration.
In order to assess indebtedness at a household level accurately, credit bureaus will take roughly 3-6 months to report EMIs of all outstanding facilities of the household. System alignment will take time. Originations will have a dual reporting mode, both manual and system-driven, resulting in higher oversight by the operations/credit team in MFIs.
Further, in the near term, MFIs will see higher rejections on account of bureau-linked indebtedness levels, overdue loans of spouses or children, and incorrect information being captured by field staff.
Overall, the TAT to onboard a client has increased by 1-2 days since verifying indebtedness levels and FOIR for the household is taking time and customer eligibility is now known at the head office instead of the tab instantaneously under the previous regime for some MFIs. The delay will result in higher operating expenses along with an increase in the cost of the bureau in the near term. In order to adhere to the guidelines, most MFIs are taking self-declaration of household income and of household indebtedness.
Given the varied practices adopted by MFIs for assessing and onboarding a borrower due to regulatory interpretation, there is potentially less homogeneity among players, making benchmarking between companies more arduous in times to come.
2) Minimum tenor and ticket size of loans
Earlier there were thresholds placed on NBFC-MFIs with respect to the minimum tenure, which is 24 months for loan amounts exceeding INR 30,000. No such thresholds exist in the new regulation. However, our survey revealed that despite the removal of the thresholds, many MFI lenders continue to have an internal threshold on ticket size based on credit quality and the cycle of customers. We believe these internal caps on ticket size by MFIs are conservative and necessary.
3) Minimum requirement for MFI loan mix
For entities to qualify as an NBFC license, RBI earlier required NBFC-MFIs to have at least 85% of their net assets in qualifying assets. Under the new regulation, the minimum requirement was modified to 75% of total assets, which includes cash and other assets. The inclusion of total assets instead of net assets expects to put higher stress on the liquidity of NBFC-MFIs. As a result, entities that had a higher mix of non-microfinance loans as of Mar 2022 and entities that had maintained higher liquidity are (a) reducing higher liquidity buffers, (b) reducing the extent of loan write-offs (c) and pausing disbursements of non-MFI loans till the mix of microfinance loan increases.
4) Pricing of loans
(i) Interest rates
Earlier, RBI has stipulated the interest rates that are to be charged by NBFC-MFIs in a manner that is lower of
a. Cost of funds + 10% — for entities with an outstanding portfolio of greater than 100 crores — and 12% for Others,
b. 2.75x of the average base rate of the five largest commercial banks
Over the last two fiscal years, NBFC-MFIs began facing a rise in annual credit cost by 2%-4% (compared to ~1% at the pre-pandemic level) due to the pandemic-related provisioning and the increased stress on the restructured book. Problems emerged when banks started reducing their interest rates with the easing monetary policy leading to a fall in the Base Rate (the minimum rate set by RBI below which banks are not allowed to lend). This led the interest rates to be set as per criteria (ii) above, the trajectory of which has been shown below
The falling interest rates posed a problem for small to medium players/lower-rated entities due to higher pressure on their margins/spreads given the interest cap by RBI. However, the margin pressure for the large NBFC-MFIs was not as severe as small/medium players as the cost of borrowing of large NBFC-MFIs was lower compared to small/medium ones.
The revised guidelines enhanced the flexibility in setting the interest rates stating that the pricing of loans should be sanctioned by a board-approved policy. However, this came with a rider that lending rates and other charges/fees on microfinance loans should not be usurious. These imply that MFIs would be able to price the cost of delivery of their service under the new regime and help smaller MFIs serve underpenetrated areas.
Upon interacting with 14 NBFCs across India, it has been revealed that NBFC-MFIs rate hikes have been executed by sections of the industry in the range as depicted below—
Our survey also revealed that most MFIs have increased the yield at a uniform rate irrespective of risks across customers and geographies. A limited number of MFIs raised the yield by following a risk-based pricing approach based on
- Underlying risk of borrowers (linked to their CIBIL scores)
- High-risk geographies
- Non-home state geographies
In our view, the new guidelines provide headroom for absorbing higher credit costs as pricing is driven by market forces or the cost of borrowing. We expect rates will continue to be at elevated levels in the near term till the industry recovers the losses on account of Covid, after which competitive pressures and a different policy rate trajectory may influence pricing.
De-regulation of interest rates provides a good opportunity for the industry to have differentiated pricing based on the riskiness of borrowers even within the same group. This will eventually pave the way to an improvement of the credit habit of borrowers as it will reward them with lower interest rates and vice-versa. Going forward, MFIs could eventually charge interest rates based on the underlying risk of each borrower.
(ii) Processing fees
Processing fees are another part of the pricing of MFI loans which was limited to 1% of the gross loan amount previously. However, the restriction has been lifted in the new RBI regulations. Our survey revealed that most MFIs have increased the processing fees by 100 bps to 2% after the new rules were implemented.
We have already mentioned the increase in operating expenses due to higher TAT for onboarding customers, frequent training, and CIBIL being run for 3-4 members per case instead of 1 (under the previous regulation) for NBFC-MFIs due to new regulations. Hence, lifting the restrictions on processing fees seem plausible as the increase in fee is expected to cover the immediate increase in operating expenses of NBFC-MFIs.
Here are a few takes of the market practitioners regarding the new regulations:
Kartik Mehta, MD of Ahmedabad-based Pahal Financial Services, said “The entire eco-system will need to reinvent themselves to be able to follow the new regulations. Entities will need to have a certain minimum level of technological evolution to be able to sustain in this segment. Also, the front-end acquisition teams of all the REs will need to be retrained to be able to capture the essence of the new regulations.”
When asked about the de-regulation of interest rates, Mehta said, “By introducing risk-based pricing, the regulator has created a window for good customers to get a competitive pricing thereby navigating the REs towards a more market-led efficient delivery model.”
As per Vivek Tiwari, MD, CIO & CEO of New Delhi-based SATYA MicroCapital, “The new regulations are instrumental in making more credit available to the mass population with increased income limit. In a way, they will help increase the market potential of microlending by at least double in the near term. They will also bring more product innovations, a larger reach, and competitiveness in customer service and pricing. With relaxed pricing norms, institutions will be able to serve under-penetrated markets even with higher operating costs.”
With respect to the impact of new regulations on the rejection rate, Tiwari commented, “We have seen an increase in rejections in existing areas of operations across 100 districts. Now, we will be looking for an opportunity with a deeper penetration in new territories with lesser credit offtake at present. Product innovations coupled with new reach will reduce rejections going forward which will, in turn, include more people in the microlending net in the next 2-5 years.”
NBFC-MFIs are not only an economic tool to further financial inclusion in India but also a medium to impact livelihoods in rural and urban areas and to empower women who comprise the largest part of their borrower base. The new regulations are expected to fuel growth in the industry once the challenges with respect to their implementation are sorted out in the near term.
The views provided in this blog are the personal views of the author and do not necessarily reflect the views of Vivriti. This article is intended for general information only and does not constitute any legal or other advice or suggestion. This article does not constitute an offer or an invitation to make an offer for any investment.