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DEMONETISATION AND ITS IMPACT ON MICROFINANCE SECTOR

Introduction
Microfinance Institutions (MFIs), irrespective of legal form, seek to promote financial inclusion by providing financial services to clients of financially un-served and under-served households. Over time, the microfinance sector has become an integral part of the financial infrastructure catering to the vulnerable sections of society in India. In the Indian microfinance industry NBFC-MFIs hold a significant share and are regulated by RBI. As on date, there are 71 NBFC-MFIs registered with the RBI.

Demonetisation and micro-finance sector

• In November 2016, the Indian government launched a huge demonetisation drive when they banned 500 and 1000 Rupees notes. In a country where 69% of the population lived in rural areas and 90% of the transactions are cash based, the move was paralysing.
• For the Micro Finance industry this came as a blow too. Most of the borrowers of the MFIs are based in rural areas; they borrow in cash and repay in cash. Typically, MFIs that have had a repayment rate of 99% have had a fall of upto 12% in repayment rates. For many MFIs the non-performing assets (NPA) have risen by 7-10%.
• ICRA’s estimates show that MFIs (including some erstwhile ones that have now become small finance banks) raised nearly Rs.5, 500 crore through the securitisation route in the first six months of FY17. However, they raised only around Rs.1,650 crore in the second-half of the fiscal, resulting in total securitisation volumes of around Rs.7,150 crore for the full year.
• In comparison, MFI securitisation volumes had increased by 80 per cent to around Rs.9,000 crore in FY16. Securitisation involves pooling of assets such as micro loans, and creation and issuance of securities backed by cash flows from the underlying assets.
• The dip in micro loan securitisation volumes is primarily due to the impact of the demonetisation event on the portfolio of most MFIs.

Negative impacts have been discussed below:

Impact on collections:
a) Microfinance entities traditionally use cash in their lending and recovery operations. The installments on microfinance loans have weekly / fortnightly / monthly collections of small denominations. On account of non-availability of cash post demonetization, the borrowers were not in a position to service their loans which led to delay and drop in collection rates.
Impact on lending:
a) Despite the efforts to increase cashless disbursement, majority of the disbursements were still cash based. Because of the withdrawal limits imposed on current accounts, MFIs were not able to withdraw cash for further disbursement and the incremental disbursements were restricted to the collections.
b) The main reason for this significant drop in disbursements was due to the focus of MFIs shifting from disbursements to collections and they also adopted a wait and watch approach in order to comprehend the position.
Impacts on farmers:
a) Particularly farmers and SMEs that make up most of the customers are affected in a big way. The drying up of liquidity that the demonetisation drive has caused has affected cash dependent rural communities in a big way.
b) In Tamil Nadu, farmers-suicide due to debt issues is almost a daily occurrence. There have been several cases where farmers have had to borrow from local lenders at higher rates, to pay off the MFIs, as MFIs tend to be stricter on their debt collection dates.
Interruption in economic activities in rural economy:
a) Inability in the repayment of dues and hence lack of new credit will hinder the business of small farmer and entrepreneurs. This have drastically affect the blossoming rural economy.
Delay in loan repayment:
a) Repayment of loans to MFIs has dropped as it is unable to accept cash in older denominations from the poor people which has affected its ability to repay the banks. Banks would block the process of financial support to MFIs, which would lead to shutting down of many NBFC MFIs. This would also have an adverse impact on SMEs.
Threat to existence of small MFIs:
a) Outstanding dues of these institutions will further hinder the availability of term loan from the lending institutions imposing a threat to their survival. Despite 60 days extension by RBI in due repayment, political interference is making the prospect of recovery less optimistic.
b) MFIs with high financial leverage and low collections efficiencies are expected to face deterioration in their credit profile.
Positive impacts have been discussed below:
• While these are certainly tragic incidents, there are various avenues the government and the MFIs have explored and continue to explore. One positive outcome of it all is that, the top 8 MFIs in India that hold about 40% of the market share, have now been provided the small finance bank licenses. This would mean they can have their own cash out points and the demonetisation drive is very likely to increase usage of their accounts.
• MFIs have also been lobbying with the Reserve Bank of India (RBI) to extend deadlines for the usage of the banned currency notes and farmers have had some special exemptions to this extent.
• RBI has also provided MFIs with a further 90 days extension before classifying loans as NPAs, if payments were due in November and December 2016.
• There have been some signs of recovery in certain parts of the country where repayments had fallen immediately after demonetisation.
• Due to demonetisation and the push for a cashless economy, awareness has been created regarding use of technology like e-wallets, PAytm, USSD, AEPS, etc which would drive the people towards financial inclusion.
• Though this demonetization has brought adverse impact on the rural economy, it should be taken a step to connect the rural people with the banking sector directly.
• More focus on opening accounts under PMJDY which would promote financial inclusion.
• This move is expected to ‘break the ice’ between marginalized, illiterate and ignorant rural people and banks and hence providing them to approach the main stream avenue of credit.
• MFIs are increasingly looking for cashless disbursement and collection through Jan-Dhan accounts and by leveraging technology. With 8 NBFC-MFIs converting into Small Finance Banks (SFBs) by March 2017, the competitive environment is bound to undergo a major shift within the microfinance industry as a whole. As these entities are expected to remain focused on microfinance, cashless disbursement and collection of loans is bound to increase in the future.
• Even though the collections are less, many MFIs are conducting center / group meetings to make borrowers aware of the impact on their credit profile due to default on repayment and the role credit bureaus. These meetings are also used to educate the borrowers to overcome any kind of slowdown in their business activities and to encourage banking habits in order to move towards non-cash based model.

Way Forward

According to a December, 2015 Reserve Bank of India report titled “Report of the Committee on Medium-term Path on Financial Inclusion”, the number of branches per 1, 00,000 of population in rural and semi-urban areas is less than half of that in urban and metropolitan areas.
• The presence of ATMs is also very low in rural areas. However, NBFC-MFIs have a very strong reach in rural areas and semi-urban areas where banks have a considerably lower penetration.
• Therefore, with a view to mitigate the hardship and financial crunch currently being faced by NBFC-MFIs and the rural and semi-urban community, the government / RBI may consider the following:
1. Exchange of SBNs:
a. The Government may take advantage of the extensive infrastructure and reach that NBFC-MFIs have in rural and semi-urban areas by allowing them to be eligible to exchange SBNs against valid compliance documents and by putting in place other checks and balances.
2. Acceptance of SBNs:
a. NBFC-MFIs may be allowed to act as facilitators and collect repayment of loans from their customers through SBNs until December 30, 2016 while complying with all other control and KYC requirements stipulated by the RBI in this regard.
b. This would help reduce cases of unintentional defaults in loans and also ensure that the overall asset quality of the NBFC-MFI sector does not get eroded.
3. Enhance the withdrawal limits:
a. In order to provide necessary operational flexibility and at the same time being mindful of the growing business needs, the Government/ RBI may consider relaxing the daily / weekly withdrawal limits for companies involved in the micro-financing sector.

Conclusion

If MFIs, particularly the smaller MFIs, continue to experience worsening repayment rates and defaults, their sustainability is questionable. Bearing in mind the importance of microfinance for financial inclusion and livelihoods of a client-base of around 40 million, demonetisation has dealt a severe blow to the microfinance sector in more ways than one. It has considerably damaged the repayment behaviour and credit discipline that is central to the success of the microfinance model. Even if there is recovery in sight in the coming quarters, the report highlight the tremendous stress that the sector has borne following demonetisation.

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