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Lingering impact of the note-ban can lead to significantly higher credit cost, capital erosion and the resultant over-leverage for microlenders in the current financial year, warns a report. The same level impacts could be seen on non-banking finance companies and similar state-run financial institutions, says a report by India Ratings. "MFIs and other small finance banks are also likely to face significant credit costs and capital erosion in FY18, following demonetisation and political interferences in the form of farm loan waivers," the agency warned. In a surprise move, the government had on November 8, 2016 banned high value notes putting everyone in a tight spot. The agency said this warning is based on an analysis of MFIs which indicates that their aggregate collection efficiency (particularly for those with significant exposure to affected states) on portfolio outstanding as of December 2016 was 75-80 per cent in May 2017 compared with a low of 50-60 percent in December 2016. "In case the collections do not increase from the current level, MFIs with significant exposure to affected states and with aggregate loans under management of Rs 1,000 crore and above could incur credit costs and capital erosion and, thus, higher leverage," the agency warned further. At 80 per cent, these MFIs could require an equity of Rs 100-300 crore depending on loans under management to ensure their capital levels remain over the regulatory minimum. Maharashtra is one of the worst affected states, with monthly collections in some districts in single digits.
During the revival period after December 2016, the intensity of political interference in affected states was such that demand for loan waivers did not die down in some districts even after local elections. The impact would be more for MFIs, NBFCs and small finance banks in states like Uttar Pradesh, Uttarakhand, Maharashtra and Madhya Pradesh, the report warned. In addition, MFIs need to structurally look beyond joint liability group loans for loan growth and product diversification by building capabilities. On possible equity erosion, the report says unless the aggregate recovery level on the December 2016 portfolio does not exceed at least 85 per cent by 2Q/Q3 of FY18 it can lead to capital erosion beyond the regulatory minimum, demanding additional capital infusion for some MFIs. At 95 per cent collections on portfolio at end-December 2016, MFIs are likely to witness marginal capital erosion. Lower-than-worse-case credit costs and equity erosions are supported by the fact that 15-20 per cent of AUMs of MFIs are off-balance-sheet, where credit enhancements, over- collateralisation and first loss default guarantees could range between 5 and 15 per cent, notes the report. The report also called up on MFIs to look beyond the joint liability group loans to ensure better credit culture by changing the borrower selection and operating processes. "MFIs need to develop expertise in other secured and unsecured credit products and roll them out gradually. Instead of pursuing growth, they need to adopt best practises of NBFCs, minimise employee churn, and innovate lending and risk sharing mechanisms," concludes the report.