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NBFCs
India
Malegam committee report, positive for MFI sector. The Malegam committee
report endeavors to provide a comprehensive regulatory framework for MFIs on
financial and functional aspects—the AP MFI Act may not be required hence. Key
highlights: Bank loans to MFIs remain as ‘priority’, cap on interest rates at 24% will
affect several players though SKS has already reduced lending rates. We believe the
guidelines will encourage stakeholders to resume growth though at a measured pace.
Andhra Pradesh is taking longer than expected to return to normalcy—a key concern
for the industry. We will review our estimates for SKS on the back of these
developments.
AP MFI Act may not be required
The report, if accepted, will govern financial as well as functional aspects of MFIs. NBFCs-MFIs (the
newly defined category) will not be subject to moneylender laws (under the purview of the State
Governments) and the current AP MFI law will not be required. We believe a common
law/governance framework for NBFC-MFIs across the country reduce the risk of other State
Governments following AP MFI Act. This could be one of the first steps for stakeholders to restore
confidence in the sector.
Bank funding to continue, positive for the sector
The committee has recommended that bank lending to NBFCs which qualify as NBFC-MFIs will be
entitled to “priority lending” status. In another notification, RBI has extended the special
regulatory asset classification benefit for MFI loans. Normally, special regulatory asset classification
benefits are available to restructured accounts provided the dues to the banks are fully secured.
The move will increase confidence of the banks in funding MFI sector though SKS has sufficient
liquidity and may not require its lender to reschedule its loans.
Key highlights of the committee report
Cap on rates at 24%, margin cap may not be relevant for now. The committee has
recommended a cap on loans at a minimum of the following:
Average “margin cap” of 10% on MFI having loan book over Rs1 bn
A cap on interest rate of 24% on MFI loans.
The margin is calculated as a difference between cost of funds and lending rates. The cost of
funds (borrowings cost and pre-tax RoE) weighted to the leverage ratio forms the base. In case of
SKS, considering pre-tax RoE of 22% (as assumed by the committee in its illustration), SKS’s
lending rate will be capped at 26%. Nevertheless, the interest rate cap of 24% will prevail. SKS
has already reduced the lending rates to 24.5% across India. Please see the exhibit for a
calculation.
Restriction on heads of charges. MFIs can levy only three charges (1) processing fees of
1%, (2) interest (capped at 24% or margin of 10%) and (3) insurance charge. MFI can earn
insurance commission from the insurer and cannot collect any administration charges from
the borrowers.
Cap on ticket size. In order to ensure that small ticket personal loans are not classified
under microfinance, the committee has capped the ticket size of a MFI loan and total
indebtedness of a MFI borrower at Rs25,000. Higher ticket size helps MFIs to improve the
operating cost ratio though may expose these companies to higher NPL risks. We note that
most players are well below an average ticket of Rs10,000 and hence may not be affected.
Restriction on multiple loans. In order to avoid over-leveraging to the sector, the
committee has recommended that a borrower can be a member of only one Self-Help
Group (SHG) or a Joint Liability Group (JLG) and not more than two MFIs can lend to a single
borrower. We believe this will be applicable with prospective effect and MFIs will need to
form a credit bureau to ensure that they can monitor the usage of loans.
Minimum provisions of 1%. The committee has recommended that MFIs should maintain
provisioning for loans at all times at 1% of the outstanding loan portfolio or 50% of
overdues of 90 to 180 days and 100% of overdues over 180 days. 1% provisioning norm
seems to be higher than the NPL classification policy followed by MFI. We believe that this
will affect the profitability of MFI though will likely be prudent given the unsecured nature of
business.
Capital adequacy ratio of 15%. The committee has prescribed minimum capital adequacy
ratio of 15%. MFIs will be encouraged to raise funds from ‘social investors’ i.e. investors
who would like to accept muted returns of 10-12% for investing in the MFI industry. MFIs
will also be encouraged to raise Tier II capital to improve leverage for equity shareholders.
High capital requirements on loan assignments. In case of loan assignment or
securitization, the value of the credit enhancement should be deducted from the net owned
funds for the purpose of calculation of calculation of capital adequacy ratio. According to
the current regulations, the credit enhancement is added to the risk weighed assets. The
new regulations increase the capital requirements by 6-7X.
Other highlights
The MFI loan is repayable by weekly, fortnightly or monthly installments at the choice of
the borrower. Notably, the AP MFI act restricted MFIs to collected weekly loan
installments.
The responsibility to ensure that coercive methods of recovery are not used should rest
with the MFIs and the MFIs and managements should be subject to severe penalties if
such methods are used.
All sanctioning and disbursement of loans should be done only at a central location and
more than one individual should be involved in this function. In addition, there should be
close supervision of the disbursement function.
The committee has prescribed a cut-off date of April 2011 to implement the
recommendations, if accepted. The recommendations on the rate of interest must be
made effective to all loans disbursed after March 2011.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
NBFCs
India
Malegam committee report, positive for MFI sector. The Malegam committee
report endeavors to provide a comprehensive regulatory framework for MFIs on
financial and functional aspects—the AP MFI Act may not be required hence. Key
highlights: Bank loans to MFIs remain as ‘priority’, cap on interest rates at 24% will
affect several players though SKS has already reduced lending rates. We believe the
guidelines will encourage stakeholders to resume growth though at a measured pace.
Andhra Pradesh is taking longer than expected to return to normalcy—a key concern
for the industry. We will review our estimates for SKS on the back of these
developments.
AP MFI Act may not be required
The report, if accepted, will govern financial as well as functional aspects of MFIs. NBFCs-MFIs (the
newly defined category) will not be subject to moneylender laws (under the purview of the State
Governments) and the current AP MFI law will not be required. We believe a common
law/governance framework for NBFC-MFIs across the country reduce the risk of other State
Governments following AP MFI Act. This could be one of the first steps for stakeholders to restore
confidence in the sector.
Bank funding to continue, positive for the sector
The committee has recommended that bank lending to NBFCs which qualify as NBFC-MFIs will be
entitled to “priority lending” status. In another notification, RBI has extended the special
regulatory asset classification benefit for MFI loans. Normally, special regulatory asset classification
benefits are available to restructured accounts provided the dues to the banks are fully secured.
The move will increase confidence of the banks in funding MFI sector though SKS has sufficient
liquidity and may not require its lender to reschedule its loans.
Key highlights of the committee report
Cap on rates at 24%, margin cap may not be relevant for now. The committee has
recommended a cap on loans at a minimum of the following:
Average “margin cap” of 10% on MFI having loan book over Rs1 bn
A cap on interest rate of 24% on MFI loans.
The margin is calculated as a difference between cost of funds and lending rates. The cost of
funds (borrowings cost and pre-tax RoE) weighted to the leverage ratio forms the base. In case of
SKS, considering pre-tax RoE of 22% (as assumed by the committee in its illustration), SKS’s
lending rate will be capped at 26%. Nevertheless, the interest rate cap of 24% will prevail. SKS
has already reduced the lending rates to 24.5% across India. Please see the exhibit for a
calculation.
Restriction on heads of charges. MFIs can levy only three charges (1) processing fees of
1%, (2) interest (capped at 24% or margin of 10%) and (3) insurance charge. MFI can earn
insurance commission from the insurer and cannot collect any administration charges from
the borrowers.
Cap on ticket size. In order to ensure that small ticket personal loans are not classified
under microfinance, the committee has capped the ticket size of a MFI loan and total
indebtedness of a MFI borrower at Rs25,000. Higher ticket size helps MFIs to improve the
operating cost ratio though may expose these companies to higher NPL risks. We note that
most players are well below an average ticket of Rs10,000 and hence may not be affected.
Restriction on multiple loans. In order to avoid over-leveraging to the sector, the
committee has recommended that a borrower can be a member of only one Self-Help
Group (SHG) or a Joint Liability Group (JLG) and not more than two MFIs can lend to a single
borrower. We believe this will be applicable with prospective effect and MFIs will need to
form a credit bureau to ensure that they can monitor the usage of loans.
Minimum provisions of 1%. The committee has recommended that MFIs should maintain
provisioning for loans at all times at 1% of the outstanding loan portfolio or 50% of
overdues of 90 to 180 days and 100% of overdues over 180 days. 1% provisioning norm
seems to be higher than the NPL classification policy followed by MFI. We believe that this
will affect the profitability of MFI though will likely be prudent given the unsecured nature of
business.
Capital adequacy ratio of 15%. The committee has prescribed minimum capital adequacy
ratio of 15%. MFIs will be encouraged to raise funds from ‘social investors’ i.e. investors
who would like to accept muted returns of 10-12% for investing in the MFI industry. MFIs
will also be encouraged to raise Tier II capital to improve leverage for equity shareholders.
High capital requirements on loan assignments. In case of loan assignment or
securitization, the value of the credit enhancement should be deducted from the net owned
funds for the purpose of calculation of calculation of capital adequacy ratio. According to
the current regulations, the credit enhancement is added to the risk weighed assets. The
new regulations increase the capital requirements by 6-7X.
Other highlights
The MFI loan is repayable by weekly, fortnightly or monthly installments at the choice of
the borrower. Notably, the AP MFI act restricted MFIs to collected weekly loan
installments.
The responsibility to ensure that coercive methods of recovery are not used should rest
with the MFIs and the MFIs and managements should be subject to severe penalties if
such methods are used.
All sanctioning and disbursement of loans should be done only at a central location and
more than one individual should be involved in this function. In addition, there should be
close supervision of the disbursement function.
The committee has prescribed a cut-off date of April 2011 to implement the
recommendations, if accepted. The recommendations on the rate of interest must be
made effective to all loans disbursed after March 2011.
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