Malegam Committee Report – First Thoughts

Death Knell for MFIs or time for transformation?

The much awaited Malegam committee report is finally here. A summary of key recommendations is as below:
• All NBFCs who have more than 90% of their loan portfolio dedicated to “low income borrowers” with loan sizes under Rs 25,000 are to be registered separately as NBFC – MFIs. All recommendations in the report apply only to this category of NBFC MFIs.
• “Low income” borrowers are defined as borrowers who’s annual income is less than Rs 50,000.
• All individual loan sizes are to be restricted to Rs 25,000.
• If the loan amount is less than Rs 15,000, the loan tenure must be minimum 1 year and if the loan amount exceeds Rs 15,000, the tenure must be at minimum 2 years
• Atleast 75% of loans given to be a borrower must be a business loan ie used for income generating purposes
• Interest rate cap of 24% per annum computed on a principal that declines with the loan installment repayment. This assumes a 15% Roe post tax and 3% roa at stable state.
• Maximum interest to be charged must also be capped at borrowing cost + 10% for large MFIs (loan portfolio of over Rs 100 crores) and borrowing cost + 12% for small MFIs
• Loan processing fee cap of 1% of the loan. No other charges allowed
• Only actual cost of insurance to be recovered, no other admin charges to be allowed
• Only 2 MFIs can lend to one borrower. MFIs to self regulate this through credit bureaus to be appointed and monitored by MFIN and Sa-dhan. If MFIs give loans to customers who have 2 loans already, the MFI granting the third loan should have a interest and principal moratorium until the previous loans are repaid
• No more collection at customers premises, only at a centralized location
• If coercive methods are used for recovery, management can be penalized under criminal laws
• AP act to be repealed
• Priority sector status to be removed.
• Entry barriers to new NBFC MFIs in the form of hike in capital requirements to Rs 15 crore from Rs 2 crore
• Social Development Fund to be set up to encourage social sector vcs who expect returns in the range of 10-12%

Key Issues

1. 2 MFIs to a customer: This is a near certain death knoll for the industry. Given that currently, there are more than 10 MFIs chasing customers actively and on an average 4-5 loans per customer, it means that at least one half of the industry needs to be wiped out.

Secondly, this will result into creation of a regulatory created monopolistic scenario with no benefits of any market mechanisms which could have led to interest rate falls. Malegam’s solution is to request banks to come into play with the BC model and also through the set up of more scheduled banks. BC models are yet to take off at the scale expected, and with exception of a few banks such as Axis or Corporation, several others are uninterested – perhaps due to inertia to evolve a new business model with thin margins.

Thirdly, implementation for the 2 MFI to a customer rule has been left to the discretion of the MFIs and credit beureus to be set up by MFIN and Sadhan are expected to address this. This is akin to the general who gives orders to a blind army and then blames the army for defeat. It is the RBI’s job to regulate and Malegam has not come out with any concrete suggestion for implementing any of its suggestions. Inability to verify across customers due to lack of a common field (until UID) remains a critical issue and customers could quite easily register under different names – they usually have inconsistent names and ages across documentation.

2. Transition to higher income customers with higher loan sizes: To ensure survival, most MFIs would try to now set up new entities that target the customers who’s family incomes are more than Rs 50,000 (most urban customers would fall into this bracket) and lend individual loans over Rs 25,000. This will ensure that they will not qualify as NBFC MFIs. There will now be a chase for customers in the Rs 50,000 – Rs 100,000 per annum bracket and individual loans appears to be the new direction for the industry.

In the meantime the industry will need to recover existing loans to make this transition. About Rs 20,000 crores has to be recovered, a large chunk from the sub Rs 50,000 segment. Given that there will be a freeze on new loans, one can start to see mass defaults (as repayment typically happened through refinancing of loans) and also, in the absence of new loans, the customers will not see a need to maintain creditworthiness. This remains an issue. The hope is the news of Malegam does not spread entirely to the field and customers continue to repay, however this is unlikely given that new loans have stopped for almost 2 months now and money lenders in AP have already hiked their rates by 100%. If news spreads, a mass default situation similar to the Muslim issue defaults are likely to happen. Perhaps why VM is mustering a lot of cheer on news channels.

Ofcourse, RBI may get wind of this and arbitrarily issue a circular to increase the annual income from Rs 50,000 to Rs 1,00,000. High degree of regulatory risk remains in the sector as through this report (if accepted as is currently), RBI will have signaled the direction of its thought process towards regulation – which is creation of a duopoly/ monopolistic scenario with very few players which will enable closer regulation. This fundamentally precludes the existence of the 50 odd or so MFIs actively present and the 10,000 others registered.

The market is likely to price a high premium for this risk and have low appetites for the sector. Aint looking so good for the Spandanas and Asmithas and Bandhans looking to IPO over the next couple of years.