The nationwide lockdown to fight COVID-19 presents a major crisis for banks with high exposure to the microcredit segment. With many small businesses on the verge of shutting down, loan repayments may stop.
In 2010, when the microfinance crisis broke out in the southern state of Andhra Pradesh, banks with high exposure to Micro Finance Institutions (MFIs) witnessed a devastating phase.
The extent of the crisis prompted banks to shut lending channels to microfinance companies temporarily. Bad loans were zooming. One of the private lenders, Yes Bank, had to even recall some of its loans given to certain MFI customers.
Now, a decade later, these problematic microloans may be returning to hurt banks as the economy feels the impact of the COVID-19 lockdown. The economic paralysis expected after the lockdown is hurting cash flows of low-income groups in the society, who are the main customers of MFIs. Their loan repayments to banks may stop.
The warning signals are visible. Brokerage house Ambit Capital in its report on April 8 cut the target price of Bandhan Bank sharply to Rs 65 from Rs 395 cautioning that the asset quality will take a significant hit in FY21 on account of likely deterioration in its microfinance portfolio.
Ambit expects the lockdown to impact the livelihoods of microcredit consumers, mostly daily-wage earners. The problem is likely to get escalated since the collections of dues are entirely in cash, Ambit said.
Also, even after the lockdown is over, there is high political risk looming over the sector. Politicians may ask borrowers not to repay banks, similar to what happened during the Andhra Pradesh microfinance crisis in 2010 and, again, during the demonetisation programme in 2016, the brokerage said.
Bandhan has about 62 percent of its portfolio concentrated in Eastern India and much of its business is in microcredit.
In the event of a substantial rise in bad loans from the segment, Bandhan will be forced to slow down its loan growth. This will lead to compression in net interest margins, even leading to losses in the next two financial years, Ambit said in its report.
According to Bandhan Bank’s third-quarter investor presentation, nearly 61 percent of its loan portfolio is tied in microcredit. Total loan book, as at the end of December, stood at Rs 65,456 crore and gross NPAs at about 2 percent of the overall book.
Already, there is some evidence of stress in Bandhan’s microloan book. In Q3, Bandhan made an additional provision of Rs 200 crore on standard advances in microfinance portfolio after evaluating risk observed, “in certain areas of a northeastern state”. As at end December, on a year-on-year basis, Bandhan’s microfinance book grew by 33.4 percent. The total microfinance book, as at end December stood at Rs 40,100 crore.
In the 12 months to December 2019, the total number of active microfinance borrowers of Bandhan grew 21 percent to 10.5 million. A closer look at Bandhan’s microloan book reveals high concentration in West Bengal, 46 percent of its loan microfinance book. Assam contributes 16 percent.
Beyond the microfinance loan book in Bandhan’s portfolio, the next major component is mortgage loans, which constitutes about one-third of its loan book.
Bandhan began as a microlender founded by Chandrashekhar Ghosh.
Microfinance loans are mostly consumed by low-income groups such as small vendors and self-employed individuals who, almost instantly, get affected when the economic downturn begins. This category of borrowers depend on their daily wages to make repayments to banks. They have no financial security to use in hard times.
Besides Bandhan, analysts expect an impact on other banks such as IndusInd Bank with exposure to MFI loans. IndusInd had acquired about Rs 20,000 crore microlending book from Bharat Financial (the earlier SKS Microfinance). The bank has, however, consistently maintained that the portfolio is under control.
But not all analysts share this optimism. On April 3, global rating agency Moody's placed IndusInd's domestic and foreign currency issuer ratings of Baa3/P-3 under review for downgrade. "The review for downgrade of IndusInd's ratings reflects the downside risks to asset quality amid the deteriorating macro environment and financial market volatility. The bank's loan portfolio includes a relatively higher proportion of microfinance and vehicle finance loans than its peers, which are at high risk of being negatively impacted by the economic shock as customers in these segments tend to have limited buffers to withstand economic stress," the agency said.
The 2010 microfinance crisis happened after some of the microlenders began to charge a very high rate of interest from poor borrowers ultimately leading to large scale loan defaults.
A controversial state law that restricted microlenders operations severely added to their woes. The call from local politicians to borrowers not to pay back loans to companies worsened the situation. Even honest borrowers stopped repayments. This led to a big spike in non-performing asset levels of banks in the region.
Microlenders typically borrow from banks to raise resources. They then lend to their retail borrowers at a margin.
Microlenders faced another crisis in the aftermath of the demonetisation in 2016, which hit the informal economy causing job losses.
Right now, the 21-day lockdown to fight COVID-19 spread is, in a way, a repeat of the 2010 microfinance crisis for those MFIs and banks with high exposure to the microcredit segment.
Many small businesses are already on the verge of shutting shop. Reverse migration of workers to home states threatens the availability of manpower. Potential job losses/ pay cuts are likely to impact the purchasing power of consumers. If the lockdown gets extended, the economic scenario could turn much worse.Banks like Bandhan could face tough days ahead.