Effect of Demonetisation on NBFCs and MFIs

Narendra Kumar

14 Oct, 2020

In many countries such as the US and the UK, large credit rating agencies such as  Equifax, Experience, and the Trans Union allow credit scores to be given to lenders documenting the borrower’s past repayment data.

However, in India, most people give little or no thought to their credit scores unless they plan to apply for a new credit card or loan. For those who lack credit, the attainment of a good credit score is often a vicious cycle, which means you cannot get credit without a score, and you cannot build your score without getting credit. Barely twenty per cent of the Indian population has a valid credit score, and hence, most Indians are unable to get a loan from banks in the country.

Hence, the role of the NBFCs and MFIs fill the gap between loan seekers and borrowers. The retail sector, the unorganized sector as well as the micro, small and medium enterprises, are the prime customers of the NBFCs and Micro Finance Companies (MFIs). The NBFC registration with RBI and the Micro Finance Company Registration are witnessing a gradual increase in credit due to the increasing demand for finance.

Working Mechanism of NBFCs and MFIs

For the care of the individuals who are unable to get credit from the traditional banking system, NBFCs and MFIs seem to be a ray of hope for them. Basically, the NBFCs and MFIs charge interest at a little higher than other banks, but their easy accessibility, promptness in providing credit, wider reach, and greater efficiency, as compared to banks, makes them a lucrative option in the hands of borrowers, especially when the amount of the loan is high and the loan seekers have already been denied by the banking system due to their low credit scores. NBFCs and MFIs basically focus on traditional data sources to extend lending. They need to realize the value of alternative data and the need to invest in technology in order to develop advanced credit scoring models that incorporate non- traditional data sources. Only then will they be able to establish a reasonable basis for extending credit that traditional credit bureaus currently do not take into consideration.

The Post-Demonetization Impact on NBFCs and MFIs

As per the demonetization drive announced by the Government of India on 8^th November 2016, all the INR 500 and INR 1000 denominated currency notes cease to be recognized as legal tender w.e.f. 9^th November 2016. The primary aim of the demonetization was to curb the malicious activities of corruption, black marketing, money laundering, terrorism, etc.

As stated earlier, the NBFCs and MFIs strives to cater to the financial needs of small sections of the society, such as daily wage workers, farmers, small traders, and retailers hailing from rural areas as well as remote urban areas. Therefore, an instalment on credit is usually collected on a weekly or even a daily basis.  Demonetization hampered the cash transactions thereby leading to defaults in the payment of instalments as well as final repayment. Most of the customers of the NBFCs and MFIs do not have bank accounts and their livelihood depends upon cash transactions. Moreover, the limit imposed on cash withdrawal further intensified the concern. As the cash was not readily available, collections of the NBFCs and MFIs have dipped substantially as people who genuinely wanted to pay their dues have lost access to their cash.

Over the medium term, the real estate sector where the cash component is an important part of transactions, especially in the secondary market, could face a slowdown. This could impact NBFCs and MFIs^[1] adversely to some extent.

As per a report by “The Hindu”, Mortgage financier Company Can Fin Homes stock fell down by 20 per cent while Manappuram Finance stock hit the ground by 16.6 per cent from their previous close. Some of the other NBFCs, like Capital First (-13.6%) Edelweiss Financial (-9.5%), LIC Housing Finance (-7.7%), also came under the negative impact of demonetization.

The Long-Term Impact on NBFCs and MFIs

Despite of the near-term disruptions in the collection cycles along with a hike in over-dues, putting the liquidity strength and the disbursal cycle under pressure impacting the growth and profitability of the NBFCs and MFIs in the short run, the entities will not be majorly impacted in the long term as the cash flows of the borrower segment are in smaller quantity. It is expected that post demonetization the application for NBFC Registration will increase.

Conclusion:

After the demonetization period, NBFCs and MFIs are promoting cashless disbursement of the credit and encouraging collection through Jan-Dan accounts and continuously upgrading their technology. Many NBFCs and MFIs are conducting meetings in the remote locations to encourage the borrowers to open up bank accounts to overcome any slowdown in their business activities and become aware of the negative impacts of the default in loan repayments on their credit scores. Therefore, it can be said the NBFCs-MFIs have adapted themselves towards the changes occurring post demonetization and are working in a positive direction in order to avoid any further disruptions.

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