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    Covid-19 and its impact on retail and SME lenders in India

    There has been no prior experience as to the monetary impact of a pandemic like COVID 19 on world financial markets. The nearest experience of an extremely shaken economy was after the First World War which led to the collapse of the American economy, infamously known as the Great Depression. This was directly linked to the collapse of a great number of world economies. However, this was almost a century ago, and quite a few parts of humanity were left physically untouched by the event. Of course, there have been many smaller economic disruptions due to unforeseen events that provide some markers as to what to expect.

    There were issues even before COVID-19:

    Due to a diverse set of reasons, the most prominent being poor credit decision-making by public sector banks and NBFCs. These institutions were also prone to systematic fraud. Thus, Indian banks and NBFCs were already in some hot water for the past three years.  As the credit-bets start to fall apart and unravel, many private financial institutions like  Yes Bank, DHFL, and IL&FS are facing bankruptcy. Efforts by the regulator to manage this have been partially successful. The sheer scale and scope of NPA’s have made all these efforts look insufficient. The continued struggle was being faced by India’s financial managers despite all mitigation strategies.

    COVID-19 has added more dangerous elements to an already strained fabric of lending:

    Motivated by profit, there was a recent and distinct move towards retail assets by all the financial institutions. Compared to SME and Corporate Assets, the retail assets fared much better. As the pandemic drew near, the number of unemployed youth in the country increased, and reached an all-time high. The facade of stability has been disrupted since COVID has started. 

    Key players in the Indian financial services landscape are Private and Public Sector Banks; Non-Banking Financial Companies (NBFC); Housing Finance Companies (HFC) and Micro Finance Institutions (MFI). By creating a reputation for themselves by being experts in the lending niche, they have denied their customer and product focus. We take a forward look at what these institutions will need to deal with in the immediate future and what will be the implications of the pandemic on credit behavior:

    • MFIs to Face Losses in Urban Portfolios:

      Credit performance of MFIs has been exceptional due to two key lending practices –  loans are granted by linking an individual’s income that is paid on a weekly or weekly basis. The guarantee of the repayment is by placing the borrower in a larger group. It is seen that during the pandemic, the urban worker is hit the worst. This is likely to continue after the pandemic ends. No safety nets are provided to people with small businesses. Small businesses will struggle to keep afloat or even shut down since they will denude all their working capital and the small assets they have acquired. 

    MFIs will have to make the difficult decision of supporting these individuals with additional loans to restart their business and regain the capability to repay their loans.

    The story is completely different in rural areas. MFIs rural customers are in relatively better shape. Their economy has been revived as crop harvesting has restarted and the harvest of infused cash. I anticipate that MFIs will not have significant losses from this customer segment.

    Diversification of lending has to be looked into by standalone MFIs as well as banks and NBFCs who have acquired smaller MFIs for the losses in their urban portfolios. As urban poverty rises, many minimum wages and low ranking workers have moved back to their villages. Some mitigation can be possible if customers with good credit records are provided additional credit or top-up to restart their micro-businesses once normalcy returns. This segment will see significant credit losses.

    • Losses Anticipated for NBFCs (and Banks) Who Focused on Higher Risk Portfolios

    Unsecured lending is done both by NBFCs and Banks. Banks have focused on individuals with credit history while NBFCs have done subprime lending which reflects their cost of funds. This segment has been performing well for the past few years as it is priced to risk.

    As government salaried employees, as well as employees of large MNCs, will have no erosion because they have job stability. Also, their credit behavior should mirror their past track. On the other hand, employees of smaller SMEs which are the majority in the private sector will be impacted by the pandemic that will result in job loss or at best lower and delayed salary payment. Their ability to repay the loans will be impaired and will result in higher losses in this portfolio.

    We anticipate significant losses for NBFCs who are focused on the higher risk portfolios. The banks with unsecured loan exposure will get away with higher losses but many of their customers will likely be able to meet their loan commitments albeit with some delay.

    Higher loan losses will be inevitable. Mitigation here is the price to risk.

    • The Impact on Secured Lending

    Retail secured lending comprises two-wheelers, automobiles, commercial vehicles, and housing loans.


    The portfolios in this category will fare considerably better than the unsecured portfolios. This doesn’t mean that you won’t see any losses or job losses. As the earning capacity in the urban areas faces a crisis, the losses will be heightened. The eventual losses will be mitigated over 12 months as the repossessed assets are sold and recoveries have been made. They will follow the overall monetary market trends. In rural areas, there will be a demand for loans and their performance will be exemplary. A new market will emerge wherein people will be looking to repossess their goods at a fair value.


    The loans are both from salaried individuals as well as self-employed. High-end white-collar workers, government employees, and employees of reputable private companies will be the least impacted salaried segment. To cut down on additional expenditure, unemployed individuals will sell their cars and return to their two-wheelers. Losses will be moderated by the sale of repossessed assets.

    The segment that will be most impacted will be those who are self-employed. Their performance will largely depend on the recovery and return to normalcy. If disruption to their earnings is more than 4 -6 months then the impact will be considerable. Building on the assumption that recovery is sharp, many of them will be able to bounce back and be able to repay their outstanding loans. All hope is not lost. This is a resilient segment with some considerable segments that should do better than anticipated. There will be an era of short-term write-offs and this will be followed by a few years of increase in recoveries. 

    Management of foreclosures, restructuring of loans, and efficient sale of repossessed assets by the financial institution will determine the final losses in this category of loans.

    Commercial Vehicles:

    Resumes and CVs which are earning assets to pay for their living and daily expenditure have been hit hard by the lockdown period and restriction in movement. The rate of recovery and the health of these portfolios is highly dependent on the recovery of goods and the resumption of normal movement. As the start of this recovery period will take another 3 or 4 months, most borrowers will be grappling to pay their dues for the next six months. I recommend the logical solution of restructuring the loans in which larger transporters will be able to secure this with their lender. A new policy to scrap older CVs (Clunker Policy) could come to the rescue if announced and executed quickly.

    Housing Finance:

    A lot of people have taken home loans to finance their dream home or keep a steady roof over their family’s heads. This was taken before the pandemic struck. Due to the suddenness of the pandemic and rapid cutbacks by companies, many people have lost their sources of income, and this will directly affect their ability to repay their monthly dues. The subjective leniency shown by the lenders will draw out the recovery of this segment over a relatively long period. Once the COVID pandemic is done with, the long term impact of this repayment will not be too significant. Imagining the worst-case scenario of the continuation of the pandemic which will further the economy, there will be considerable foreclosures on homes that will result in a decline in the property market and eventual losses for financial institutions. 

    Overall, this segment will perform the best, and losses recognized may be high, to begin with, but the recoveries will follow as the assets will be sold over a while.

    SMEs the Worst Hit and the Consequent Impact on Financial Institutions
    The smaller and mid-sized SME companies are impacted the most by the disruption in the supply chain. They will need to pay their employees, purchase raw material, resume production, and wait for their receivables to be paid before normalcy is restored. Their credit requirements are largely met by Loans against Property.
    I speculate that this set of borrowers will be the worst hit. A large number of borrowers will be damaged beyond the point of no return and as a result, won’t be able to get back in the game of stable business cycle due to the increase in difficulty and obstacles posed by COVID. Seeing that a large percentage of these loans are largely secured by property, the process for foreclosure is fairly routine under the sarfaesi act, Indian lenders will see a huge amount of property being seized. Now, there is an overflow of houses and properties on the market for sale, however, owing to the lack of money in circulation, there will be insufficient demand. This will tend to drag the process longer than necessary with the attendant risk to the lenders.
    The cycle of losses and gains has to be completed and it will take at least two or three years for the economy to recover, but keep in mind that the Losses to Financial Institutions will not be immediate. The loss to the economy, on the other hand, will be significant as many of these SMEs have developed a niche skill in production.

    In conclusion, Retail and SME lenders can anticipate 2-3 times the write off compared to the prior year in most categories. If they segment their portfolio holdings on a risk basis they can separate the customers based on the continuity of income. By doing this the lenders will be able to focus on the riskier portfolio segments. Remedial action will need to be pro-actively taken and many loans will need to be rapidly restructured. For those not responding, collection activity will need to be efficiently carried out, the asset valued, and sold at the earliest. The quantum of losses incurred by the financial institution will largely depend on their underwriting standards and the quality of execution in their ability to restructure, collect, foreclose, and sell the assets. The game for these institutions has suddenly changed but will present new challenges and opportunities.

    COVID like the disease itself leaves an ever-expanding footprint. In short, the financial impact on our institutions will need to be managed on a war footing. Let’s ready ourselves for the long haul.

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