Stress in MFIs, MSME space should stabilise in coming months: Experts

Non-banking financial companies (NBFCs) have emerged as a preferred option for numerous underserved sectors, particularly small businesses and households, because these players are in areas where traditional banks could not go. At a panel discussion of the Business Standard Insight Summit 2024 titled ‘Reaching the last mile’, heads of emerging NBFCs –Shachindra Nath, vice-chairman and managing director (MD) of U GRO Capital; and Venkatesh N, founder and MD of IIFL Samasta, discussed various issues. Edited excerpts: 

How challenging is it to serve the last mile? 

  Shachindra: Generally, it is said that NBFCs have better last-mile reach. Actually, it is not true. NBFCs cannot match the banking sector’s reach into the markets. State Bank of India's branch network, big public sector and private sector's branch networks are almost a multiplier of all NBFCs put together. 

So, for some reason, we just unnecessarily give too much of credit to NBFCs, which are serving the last-mile reach because they have better reach. 

They don't have better reach. It is a function of legacy versus new generation or you can call some favour of customisation. NBFCs can assess a customer differently and provide a credit solution that differentiates them from banking (companies).

So, it is not that we (NBFCs) have better reach, it is that we are better equipped to adapt to newer things. 

This also may be the case because banking is considered to be more fiduciary because they hold public deposits and that's why they become more risk averse.

 

Do microfinance institutions (MFIs) reach the last mile? 

  Venkatesh: Microfinance institutions have made significant strides in reaching underserved areas, especially with the help of Jan Dhan accounts and Aadhaar for e-KYC. While MFIs have extended credit to remote regions where banks haven't ventured, challenges remain. The income assessment process is difficult as MFIs often rely on customers' self-reported earnings, which is a problem when transitioning borrowers to larger loan amounts. Despite these challenges, last-mile access has improved significantly over the past 10-15 years. 

Has technology enabled better reach? 

  Venkatesh: Technology, especially AI (artificial intelligence) and ML (machine learning), holds promise for improving income assessment and credit evaluation. However, there is still some resistance to fully utilise technology, especially when basic tools like WhatsApp are not being used effectively. The sector is experiencing some turbulence, partly due to inadequate income assessments that have left customers over-leveraged. 

Do you face challenges with income assessment and do you lend to first-time borrowers?  

Shachindra: We don’t lend to first-time borrowers, as India lacks large institutions dedicated to micro, small and medium enterprise (MSME) financing. Only a few entities, including SIDBI and U GRO, are exclusively focused on MSMEs. Our approach to income assessment for MSMEs is data-driven, using banking data, goods and services tax (GST) records, and bureau reports to evaluate cash flows and creditworthiness, making the process more digitised and accurate. 

Are regulatory arbitrage advantages narrowing between banks and NBFCs?  

  Shachindra: The regulatory differences between NBFCs and banks have narrowed, especially for larger NBFCs. However, smaller NBFCs still enjoy significant advantages. While banks have more stringent regulations due to their deposit-taking nature, NBFCs benefit from flexibility in their operations. The future may see large NBFCs either being regulated like banks or converting into banks to mitigate systemic risks, especially when they reach a certain size. 

Is it true that once NBFCs grow beyond a certain size, they need to become banks to survive?  

  Shachindra: Yes, NBFCs may need to transition to banks once they reach a significant size. The interconnectedness of the financial system means that very large NBFCs could pose systemic risks. Regulations are likely to evolve in the direction of requiring NBFCs of a certain scale to either grow cautiously or convert into a bank to manage these risks. 

Why has there been prolonged stress among MFI borrowers?  

Venkatesh: The stress among MFI borrowers has been prolonged due to several factors, including agricultural setbacks like heatwaves and excessive borrowing in certain regions, particularly in UP and Bihar. RBI's intervention to cap the number of lenders per customer has also been a response to overheating. While these challenges have contributed to the stress, the situation is expected to stabilise in the next few months as MFIs recalibrate their practices. 

What about stress in the MSME segment?  

  Shachindra: Unlike the personal loan and microfinance segments, the MSME sector has shown resilience. Despite a slight dip in turnover in some segments, MSMEs are adapting and recovering. Small businesses in Tier II, III, and IV towns are recovering steadily and are expected to reach pre-Covid levels within the next few quarters. 

Has front-loading growth been a problem post-deregulation of margin caps?  

  Venkatesh: The deregulation of margin caps has led to a rise in credit costs, particularly among smaller entities with higher borrowing costs. Larger entities were able to adjust better, but many smaller MFIs are still grappling with higher operational costs. 

Have banks become reluctant to fund MFIs post-stress?  

  Venkatesh: While banks haven't completely shied away from funding MFIs, liquidity remains tight, and there is a recalibration underway to address the underlying issues that led to stress. MFIs are now focusing on strengthening internal practices and managing their funds more prudently. 

How does U GRO Capital balance technology and traditional credit models? 

  Shachindra: U GRO Capital relies on a hybrid model that combines technology with traditional credit assessment methods. We use data analytics to assess cash flows and creditworthiness, but we also maintain conventional credit evaluation practices. 

How significant is co-lending for U GRO Capital?  

Shachindra: Co-lending has been critical for U GRO Capital's growth, especially since banks have lower borrowing costs than NBFCs. By partnering with banks, we can pass on these benefits to small business customers, enhancing affordability and helping scale our operations. 

What is the reasonable spread or ROE (return on equity) for MFIs?  

  Venkatesh: Credit costs have risen since Covid, now hovering around 3.5-4 per cent. Operating costs are high due to frequent customer meetings and the joint liability group lending model. Pre-Covid, credit costs were around 1 per cent, but the current environment requires recalibration. 

What’s your roadmap for MFIs? 

  Venkatesh: We are already providing products beyond microfinance, such as unsecured business loans and consumer loans.

Expanding our product range will allow us to meet the evolving needs of our customer base.