By Narasimhan Srinivasan, India-based development finance and livelihoods consultant
The Covid-19 pandemic and its mitigation measures have significantly disrupted the Indian microfinance sector amidst the larger damage to the rest of the economy. Like many countries, India responded by enforcing a lockdown, which has dramatically affected normal life and livelihood activities. While large and medium sized enterprises partially or fully shut their operations with employees able to work from home or benefit from salary protections, people at the bottom of the pyramid - mostly contract workers, daily wage labourers or micro-entrepreneurs - of course face the greatest impact from the lockdown, unable to either offer their services or pursue their livelihoods. In the case of self-employed people who are in hawking, petty trades or the service sector, it’s not just their mobility that is affected, but also the critical supply chains behind their businesses. This article will explain what MFIs, wholesale lenders and the central bank have been doing to address the significant challenges being faced, and why there remains much to be done.
The costs of lockdown
The first lockdown in India was announced on 24 March 2020 for an initial three weeks, and this was extended in many locations for at least three weeks more. The lifting of the lockdown and resumption of livelihoods activities will depend on assessed risks of the virus spreading in those regions. Critically, the 170 highest risk districts identified also account for 80% of the total bank credit, and it follows that these districts - with their high population densities and economic activity - also represent a high proportion of microfinance loans across the country.
Moreover, the sudden hike in unemployment arising from the lockdown has cascading consequences. First is the immediate reduction in demand for goods and services from these people. This reduction in demand leads to the closure of enterprises that provide the supply to meet this demand. Second, many of these now unemployed workers were supporting households in rural areas (whose demand will now also shrink due to reduced income) and the images of millions of migrant workers walking hundreds of kilometres back to their villages shows the scale of this problem (not to mention the increased vectors for the virus to spread). Third is the inability to make loan repayments that depend on their income.
An asset and liability maturity mismatch
The Reserve Bank of India (RBI), in a proactive move, on March 27th announced that the microfinance institutions and banks can offer a moratorium of 3 months, which would enable borrowers to postpone their repayment instalments. While interest will continue to accrue, borrowers can make their scheduled repayments at the end of the moratorium. But there is a mismatch here. The MFIs face the requirement to repay their maturing debt obligations to wholesale funders. However, the RBI moratorium was interpreted by the Indian Banks Association and a couple of major banks in a different manner, and they in turn have made it clear that MFIs will not get a moratorium on their own obligations. For an industry that depends on loans from banks and other financial institutions for over 65% of its funding, this is a severe hardship: while on the one hand 100% of their borrowers are offered a moratorium (~15% of whom have reportedly opted for regular repayment and rejected the moratoria, based on my conversations with MFIs), the inflows of cash coming from repayment would stop at the same time the outflows in terms of liabilities to be honoured will have to be kept up - exactly the liquidity crunch that Daniel Rozas and Sam Mendelson have been describing in their ongoing liquidity series on this site.
My back-of-the-envelope calculations show the shortfall because of this to be about US$5 billion over the three months. The severe mismatch between the maturity of liabilities and assets might very well lead to MFIs defaulting. At the time of writing, the RBI has received representations on this matter and is set to issue its guidance. A second announcement by RBI has lent some clarity to the treatment of standard assets under moratorium and provisioning. But more clarity will be needed.
When the moratorium ends, many microfinance clients will need additional credit to resume business activities, not to mention repay other liabilities accrued to meet their household needs during lockdown. MFIs that are in a precarious position because of the mismatch described above won’t be in a position to provide this critical credit, which would largely negate the rationale behind the RBI’s relief measure. This will be compounded by MFIs being unable to access further credit from wholesale lenders such as banks as their collection efficiency will plummet during and after lockdown. But in a situation like this, where there is considerable reduction in demand and a broader economic slowdown, banks become risk averse - even more so when dealing with the poorest segments and the institutions that serve them.
Challenges and solutions
In short, in the Indian microfinance sector, the basic issues that arise from COVID-19 and the lockdown are:
The disruption of liquidity in the hands of borrowers on the ground;
The possibility of higher than normal non-performing assets building up;
The disruption of liquidity in the hands of lending institutions such as MFIs;
The need for finance for restarting livelihoods at the end of lockdown; and
A general downturn in the economy, leading to reduced demand - disproportionately impacting people at the bottom of the pyramid.
What are some solutions to mitigate these challenges? I see four:
To postpone repayment of clients’ loan instalments until liquidity in the hands of borrowers on the ground improves;
To postpone the repayment of maturing debt by MFIs to wholesale lenders to align institutions’ and clients’ liquidity;
To ensure adequate financial resources for MFIs through continued wholesale financing so that they can support end-client borrowers in resuming as fast as possible their livelihood activities; and
To ensure differential treatment of the assets covered under moratoria and loans that may be delinquent because of the impending recession and supply disruptions, so that the lending banks can still fund the MFIs so that the MFIs that intermediate the loans and their end-clients can all carry on their normal operations as much as possible.
The RBI response
In the two packages announced so far, the RBI has been trying to address some of these problems. First, they announced a moratorium of three months and with an implied promise that further action for postponement or rescheduling of loans would be possible depending on developments. Second, the RBI has also provided liquidity to the banking system both as a general measure and also with specific facilities targeted at NBFCs and MFIs - amounting to approximately US$14.5 billion so far, with a promise of more if required. Third, it has sought to help the banks to deal with the moratorium requirements and impacts on MFIs (although the Indian Banks’ Association is yet to come out with an unequivocal coordinated policy for the same).
The reduction in the RBI’s signal rate (the repo rate at which the central bank lends short-term money to commercial banks in the event of any shortfall of funds) and also its willingness to refinance institutions through ‘repo’ operations at low rates has made available adequate funds for MFIs. Banks therefore need to do their part, shed their current risk aversion, and fund the MFIs.
So the real challenge is less to do with the central bank’s policy, and more with how the banks implement it. Banks are in a situation where if they have already extended moratoria to MFIs may not want to provide additional facilities. Secondly, given the nature of retail distribution to millions of people and the possibility that they might default, banks might be hesitant in the current context of a slowing economy. Typically financial institutions try to conserve liquidity during crises on the premise that ‘cash is king’. The risk factor for banks in the Indian context stems not merely from the reality of issues on the ground now, but also anticipating the risks arising from post facto reviews made by auditors, regulators and others.
Sharing risk to build confidence
So bankers’ confidence in taking a realistic view of risks and following that instinct in financing institutions during the crisis needs to be built up. To do this, the RBI, alone or via other public sector organisations, can back up the liquidity that it has provided to the system with a guarantee facility that can take a first loss of up to 5% or so on incremental lending given to MFIs and other institutions dealing with vulnerable people. One of the moves by the RBI and the government has been to increase the guarantee cover in respect of small loans given to particularly vulnerable borrowers (‘Mudra’ loans) from 50% to 75%. Expanding these measures would enable the lending institutions to lend to ground level borrowers with greater confidence. However, wholesale lenders lending to these retail lenders would also like a similar guarantee cover.
As explained earlier, putting liquidity in the hands of vulnerable people must be a key priority to revive demand and ensure that enterprises at the bottom of the pyramid become active again. This will in turn translate into demand and reciprocally stimulate the more organised players in the supply chain. But without restoring demand at the bottom of the pyramid, it will be difficult to sustainably revive economic activity over the long term. Supporting MFIs and their clients is not a sector-specific issue. It has far-reaching consequences for economic revival in this country.
Narasimhan Srinivasan is an India-based consultant in international development finance and livelihoods