Having grown at a rapid clip, India’s microfinance sector today is in the midst of a crisis. Not only are defaults shooting up, state governments are intervening — legally — to keep lenders from coercing borrowers into repaying loans. Credit bureaus estimate that gross non-performing assets (NPAs) for the space shot up to 16% at the end of March, up from 8.8% a year earlier; in absolute numbers the NPAs stood at a not-so-insignificant Rs 61,000 crore, up from Rs 38,000 crore. It’s not just the small finance banks or non-banking financial companies, but banks too have been hit by bad loans. Not surprisingly, all lenders are reducing exposure to the sector; the gross loan portfolio contracted by about 7% to Rs 3.8 lakh crore at the end of March. The worst may not be over, say banks who believe there could be another two quarters of pain before the defaults start to taper off.
The microfinance business tends to be cyclical, typically blowing up every three-five years. However, some lenders are beginning to wonder whether there is also a structural issue. There are concerns about whether the JLG — joint lending group — model, which is the foundation for the business, can be entirely relied upon to ensure good collections. At the same time, it would take an enormous amount of time and effort to individually assess each customer’s creditworthiness. Importantly, it would also be a lot more expensive to do so and could even upend the business.
If for instance, credit appraisals need to be done for each customer, the business will fetch smaller margins. Today, the yields for lenders are high partly because the loans are unsecured. Indeed, lenders are rethinking their business models and it is possible they will approach it differently to ensure the NPAs don’t get out of hand. However, it is important they continue to disburse small-ticket loans because microfinance borrowers may otherwise end up in the clutches of the local moneylender.
Also, if the business is to remain a viable one for lenders, they must be allowed to recover their loans without being hampered by the law. Last week, the Tamil Nadu Assembly passed the Money Lending Entities (Prevention of Coercive Actions) Act, aimed at preventing coercive recovery activity. The punishment for non-compliance is harsh and includes imprisonment. Earlier this year, the Karnataka government promulgated an ordinance that proposes up to a 10-year prison term and a penalty of Rs 5 lakh for microfinance lenders that cause “undue hardship” to borrowers.
While the law may not be applicable to lenders regulated by the Reserve Bank of India, any such legislation tends to impact the repayment culture across the board. In TN, for instance, intimidation, attaching property, using third-party agents, persistent follow-ups, and late night calls are all not permitted. To be sure, lenders must refrain from being high-handed and using any bullying tactics. But following up on repayments is necessary.
The problem with such laws is that errant customers can get away by claiming they were intimidated even if that is not the case. Why third-party agents should be involved is not clear; lenders cannot be expected to have in-house staff for all the work. While not everything may be as kosher as it should, “politicising” the sector, whether via laws or by loan waivers, is not desirable. That will only scare away lenders and hurt small borrowers.