COVID-19 may be major tail-risk event for microfinance industry, says RBI paper

COVID-19 could be the biggest tail-risk event in a long time for the microfinance industry, the Reserve Bank of India (RBI) said in a paper, published as part of its September bulletin. At the same time, the pandemic and its impact may also incentivise digitisation in the industry, it said.

“Owing to the disruptions in supply chain and business operations, the likelihood of loss of livelihoods and consequent drop in household incomes is high. NBFC-MFIs, being specialised institutions extending collateral-free loans to low-income groups, are particularly exposed to credit risks in this scenario,” the paper said. Further, repayment rates have dropped significantly, posing liquidity risks. The collection efficiency of microfinance securitisation pools first fell to 83% in March 2020 and then moved sharply to a low of 3% in April 2020, before recovering to 21% in May 2020 and 58% in June 2020.

The structural liquidity profile of MFIs may be affected due to problems in loan collections and rise in credit delinquencies due to Covid. The moratorium availed of by borrowers would affect inflows. Two
different stress scenarios are depicted in the report, with the scenario-1 assuming 40% drop in loan collections and scenario-2 assuming 80% drop in loan collections (outflows are assumed to be constant in both scenarios).

It was found that in scenario-1, cumulative gaps get narrowed but still remain positive across time periods. In scenario-2, cumulative gaps up to six months and up to one year turn negative, indicating a need for additional funding at an aggregate level. Hence MFIs, especially smaller ones, need to diversify their sources of funds for sustaining healthy portfolio growth.

“Going forward, building capital buffers and managing liquidity would be crucial for MFIs in fortifying their balance sheets against COVID-19 led disruptions,” the paper said.

Even as Covid-19 is expected to afflict the microfinance sector with financial risks in near term, it may also incentivise digitisation in this market segment, the paper said. Efforts to migrate loan collections to digital platforms may greatly improve operational efficiency and help minimise event-based disruptions.