The Covid-19 pandemic will undoubtedly send long-lasting shockwaves across all sectors and segments of society. To understand what this means for the Financial Inclusion sector, LEAD is taking a journey – virtual, of course – across India, speaking with experts and industry leaders. By doing so, we will take the pulse of the sector and understand how the crisis will affect their business and the lives of their clients and members.
Perspectives from Microfinance
We will present findings in a series of blog posts, beginning by looking at Micro Finance Institutions (MFIs). In this first post, we report findings from two discussions, one with the head of a non-profit MFI and one with a sector expert, on how the current crisis is affecting the operations of MFIs in the short term and what kind of changes are expected in the medium term. Also, we will take a look at how the crisis and the moratorium are expected to impact repayments and what that means for both institutions and lenders. Finally, we will discuss what opportunities for digitization and increased coordination might arise as a result of the current crisis.
Adapting to a New Reality
The business model of most MFIs is based on in-person interactions and collection of repayments. While this is normally seen as a strength of the industry, as it builds loyalty with their customers, it becomes a vulnerability in the current lockdown situation and, if social distancing measures are maintained, in the medium term as well. In order to adapt to the current situation, some MFIs have started reaching out to their customers virtually, through calls, text messages, and group chats. Through these remote connections, some MFIs are checking on the status, health, and concerns of their customers, while also providing technical support to those who want to keep on repaying their loans in this period using digital services (At the time this blog was being written, there was still some unclarity on whether the moratorium is mandatory or optional. Currently, some banks are imposing the moratorium as mandatory, while others are allowing their clients to opt-in or opt-out. At the time of the interview, the MFIs we spoke with allowed their clients to keep on paying their loans to avoid accumulating interests). On the other hand, in rural areas, where connectivity is less pervasive and digital literacy is lower, it has been reported during the interviews that we conducted that some small teams are still visiting villages. Since no group meetings are being organized, where possible, customers are being visited one at a time and in consideration of social distancing protocols. However, in some areas where travel restrictions are tighter or with extremely poor connectivity or where staff might not be willing to go due to concerns for their health, repayments have completely stopped regardless of whether the customer wanted or not to do so.
Sector experts and MFI leaders alike foresee a spike in the number of defaulters following the crisis, especially in urban and semi-urban areas. This is because Small and Medium Businesses (SMBs), which are present in large numbers in cities and peri-urban areas are expected to bear the brunt of the negative economic consequences of the lockdown and any further restrictions to business activities that might follow. On the other hand, repayments from rural borrowers are mostly associated with the harvest of crops upon which the loan is generally settled; with a proportionally less dramatic, but still important, impact on the agrarian sector, according to some commentators, the number of defaulters may not be as high in rural areas.
Challenging Times Ahead
The current crisis presents an existential threat for the MFI sector. As noted in a recent blog post by CGAP, “a slip in repayment rates from 95 to just 85 percent would render many MFIs insolvent in less than a year”. Many borrowers, especially daily wage workers or small/micro business owners, are currently relying on their savings to meet essential living costs as their source of income has either drastically reduced or completely dried up due to the lockdown. When markets will reopen, these individuals will face a significant liquidity issue: on one hand they will need cash to keep on repaying their outstanding loans – including the interest that has kept on accumulating during the lockdown period – while, on the other hand, they will need liquidity to get their business back on its feet. In addition to the very concrete possibility for some borrowers to fall into debt traps, industry leaders and experts fear that borrowers will focus on the latter (business needs) and that repayment discipline will be negatively affected, which will also hamper the sector’s capacity to respond to the expected increase in loan demand.
This obviously could create a vicious cycle leading to a liquidity crisis. However, is there really going to be a surge in loan demand after the lockdown? Opinions are mixed. While there is consensus that loans to finance working capital and bootstrap business activities will surge, some think that loans for personal consumption may decline as individuals adopt a more risk averse attitude towards spending during the economic slowdown. Nevertheless, the sector should be ready for a worst-case scenario.
The Liquidity Conundrum – Impact on Citizens
After the lockdown, MFIs are anticipating constraints in terms of liquidity, especially for smaller organizations, which are likely to face significant struggles without support from banks. Self-regulatory Bodies like Sa-Dhan and the Microfinance Institutions Network (MFIN) have already sought the regulator’s intervention in getting funding support from banks for MFIs. MFIN has also requested regulatory forbearance in asset classification and provisioning rules. The negotiations are also around the extension of the moratorium, which also would include MFI borrowers, in hope to provide some additional breathing space to their customers. According to sector experts, however, this is not a long-term solution. They have expressed concern towards extending the moratorium, since it would result in building up interest against loans, increasing the financial pressure on the customers. Extending the moratorium may also have an implication on the number of defaulters in the agrarian sector, even if they are not directly impacted by the lockdown: some farmers might decide to take advantage of the moratorium and postpone their payments even if not absolutely necessary, which will create unnecessary pressures on many MFIs.
The Liquidity Conundrum – Impact on Institutions
As mentioned before, with repayments slowing down, MFIs are also going to need access to liquidity to recover from the crisis and there is concern regarding the willingness of banking institutions and NBFCs to lend to MFIs immediately after the emergency.
Experts have expressed the hope that the government will take a more active role in supporting the sector (and there has been an opening on that front in recent days), since, in the absence of an injection of liquidity, MFIs will be struggling to maintain their footing. Lobbyists, including associations of MFIs and self-regulatory bodies, are presently in talks with the Government and RBI to extend some special liquidity arrangements for the sector, probably in the form of funds, so that the sector has a cushion to fall back upon. Additionally, further clarity will be required to understand whether the moratorium extends to loans that MFIs themselves are receiving. If it does not, then there is the risk that many MFIs will become insolvent, which is why institutions like Sa-Dhan are raising their voice to fix this situation.
Suspending repayments, restructuring existing loans, and providing liquidity – MFIs are taking bold steps and making hard decisions to support their customers navigate this crisis, while at the same time trying to survive it themselves. However, since the percentage of NPAs reported by MFIs is expected to increase, there is an expectation that the government will intervene with credit guarantees with the hope that, over time, lost repayments will be recovered.
An Opportunity to Accelerate Change
The current crisis could also be an opportunity to push changes in process and policies to increase the uptake and the ease of conducting transactions online. This could include facilitating online loan repayments, which are one of the few features in the Indian MFI landscape that have not been digitized yet. Achieving this objective could be pursued by facilitating collaborations between MFIs and Fintechs.
There is no doubt that this is going to be an important test for MFIs in India. Not only their operating model is being disrupted, with potential long-lasting effects, but they are going to be at the forefront of a very likely economic crisis. After the crisis, the role of MFIs in providing credit to citizens will be essential to revive the demand and consumption of a large section of underprivileged citizens and bootstrap the economy. However, to fulfill this objective, as mentioned above, MFIs will be needing an injection of liquidity themselves. At the same time, during the crisis itself and in its immediate aftermath, they could play an important part as well, leveraging their direct connection with citizens and acting as a conduit to communicate timely and accurate information to citizens, at a time when fake-news travel faster than real ones, while also facilitating and supporting relief efforts undertaken by the government. These topics will be explored in further installments of this blog series. At the same time, to withstand this crisis there is a need for a coordinated effort and increased mutual support from all actors in the Financial Inclusion sector and in the next issue of this series, we will be looking at the role of fintechs in the crisis. How can they contribute to the recovery and what opportunities and risks do they face?
About the Authors
Neema Gupta is a Research Manager with the Financial Inclusion vertical at LEAD. A social researcher with over six years of experience working in the development sector, her expertise lies in migration studies and gender equality. She has a PhD in Population Studies with Specialization in Human Migration from the Jawaharlal Nehru University.
Fabrizio Valenti is the Head of LEAD’s Financial Inclusion team, overseeing the organization’s research portfolio on this topic. Commanding an extensive portfolio of international experience in development, he has previously worked for KSAR, Save the Children in Sierra Leone, UNDP in Indonesia as well as the University of Rome Tor Vergata, for which he has led projects in Italy and Bangladesh. Fabrizio has a PhD in Economics from the University of Rome Tor Vergata