COVID-19 AND ITS IMPACT ON RETAIL AND SME LENDERS IN INDIA

There has been no prior experience as to the financial impact of a pandemic like COVID 19 on world financial markets. The nearest experience of such widespread disruption was the Second World War which was over many years and where large parts of humanity were left physically untouched by the event. Of course, there have been many smaller economic disruptions due to unforeseen events which provide some markers as to what to expect.

There were issues even before COVID-19:

Indian Banks and Non-Banking Finance Companies (NBFCs) have been grappling with a deluge of Non-Performing Assets (NPA’s) for the past three years. This resulted from a diverse set of reasons, the most prominent being poor credit decision making by public sector banks and NBFCs which were also prone to systematic fraud. Some private financial institutions like Yes Bank, DHFL and IL&FS are facing bankruptcy as their credit-bets started unravelling. Efforts by the regulator to manage this have been partially successful, however, the scale and scope of NPA’s have made all these efforts look insufficient. India’s financial managers were still struggling with these issues when the pandemic struck.

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

Before the pandemic struck, there was a distinct move towards retail assets by all the financial institutions as these had demonstrated better credit performance compared to SME and Corporate Assets. COVID has disturbed this oasis of stability as unemployment has spiked to unthinkable level in days and a large part of the workforce is unsure as to when they will return to work.

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). Each of these institutions has defined its customer and product focus building significant expertise in their lending niche. 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 behaviour:

  • MFIs to Face Losses in Urban Portfolios:

    Credit performance of MFIs has been exceptional due to two key lending practices; loans are linked to the individual’s earnings and are repaid on a daily or weekly basis. In addition, a larger group within which the individual resides guarantees the payment of the individual.

    During and post-COVID, the urban worker is going to be hit the worst. These are individuals running micro-businesses without any safety net. With the lockdown, it is likely that they will denude their working capital as well as the small assets that they have acquired for their business making it difficult for them to restart their business.

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.

MFIs rural customers are in better shape as their economy has recommenced and the crop has been harvested infusing cash. I anticipate that MFIs will not have significant losses from this customer segment.

Standalone MFIs as well as banks and NBFCs who have acquired smaller MFIs to diversify their lending are going to take some losses in their urban portfolios. One key problem here is going to be that a lot of the urban poor 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.

Salaried employees working for the government and large corporates will not have any salary erosion and their credit behaviour should mirror their past track. Those working for smaller SMEs which is the majority in the private sector will be impacted by the pandemic which 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 it is likely that many of their customers will 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.

Two-Wheelers:

These portfolios will perform better than the unsecured portfolios but will still see losses along with the job losses in the economy. Rural demand will continue to be robust and loan performance will also be good. Given the focus on individual transportation, there will be a strong second-hand marketplace which will enable the lenders to get a fair value for the assets they repossess. We anticipate a period of heightened losses in urban areas as customers earning capacity decreases. The eventual losses will be mitigated over a 12-18 month period as the repossessed assets are sold and recoveries have been made.

Automobiles:

The loans are both from salaried individuals as well as self-employed. The least impacted segment will be the salaried segment, that is the high-end white-collar worker, government employees and those employed with reputable private companies. Those individuals who are rendered unemployed will likely turn in their cars and go back to two-wheelers. Losses will be moderated by 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. If recovery is sharp then many of them will bounce back and be able to pay their outstanding loans. This is a hardy segment with some financial assets and should do better than anticipated. Once again some short term additional write-offs followed by a couple of 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:

These portfolios consisting of CVs which are earning assets and pay for themselves have already been hit by the current lockdown and restriction in movement.

The health of these portfolios is going to be dependent completely on the rapidity of recovery and goods movement back to normal. We anticipate that this will take another 3-4 months which means that most borrowers will not be able to pay their dues for about six months. The logical way to deal with this is to restructure the loans. Larger transporters will be able to secure this with their lender.

The most hit by this slowdown will be the single truck owner who is likely to be forced to sell his vehicle. CV portfolios will see significant losses in the next 12 month period.

A new policy to scrap older CVs (Clunker Policy) could come to the rescue if announced and executed quickly.

 

Housing Finance:

As the bulk of these loans are for housing which provides accommodation for the borrower the anticipated loan losses here will be the least of any segment. Despite the proclivity to pay there will be some customers who will be unable to pay the monthly dues due to livelihood loss caused by COVID. The pain in this segment will be drawn over a period of time as there will be some payment waivers and the lenders will be inclined to show leniency in payment delays. Once the COVID pandemic is over and people are able to recover their livelihood then the longer-term impact will not be too significant.

In a scenario of the continuing impact of COVID on the economy, there will be considerable foreclosures resulting in a decline in the property market and eventual losses for the financial institutions.

Overall, this segment will perform the best and losses recognised may be high to begin with but the recoveries will follow as the assets will be sold over a period of time

  • 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.

    It is my estimation that this set of borrowers will be the worst hit and a large number will not be able to get back into a stable business cycle given the huge increase in the degree of difficulty caused by COVID. As these loans are largely secured by property and the process for foreclosure is fairly routine under the safesi act, Indian lenders will see a huge amount of property being foreclosed. The key problem here will be the sale of this property due to insufficient demand. This will tend to drag the process longer than necessary with the attendant risk to the lenders

    Losses to Financial Institutions will not be immediate but it will take two or three years for the entire cycle to be completed. 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 2-3X 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.

What’s Next for PSU Banks?

The newspapers and news channels have gone to town about the Punjab National Bank fraud with a potential loss of over 12k crores and counting; these are large numbers by any standard. The debate has veered towards taking political sides and somehow blaming the Reserve Bank of India, the Congress and or the NDA depending who is writing or talking on the news.

Unfortunately the debate has not focused on the real issues. To me there are only two:

First, why are PSU Banks more prone to frauds and unpleasant financial surprises?
And second, will a change in ownership of these Banks or privatization resolve this issue once and for all?

Historically two events have shaped the Banking Industry in India.
The nationalization of Banks in India in 1969 which led to the evolution of the Public Sector Banking, and the 1991 liberalization leading to the opening of Private Banks in India.

PSU Banks currently provide approximately 70% of the credit in the country, while the private banks
provide the rest.
Meanwhile, Private Banks in three decades have attained size, built strong technology infrastructure, have established a workable credit culture, have built capable and durable management bench strength, and have made and learnt from their mistakes in delivering
credit.

Their CASA ratios are good and their ability to manage their NPA’s have been well demonstrated. The Private Banks that did not do this well have closed down or have merged with the stronger private banks. Altogether a logical growth story.

The PSU Banks have not had a smooth ride and can be classified in two broad categories: the three large Banks who have been able to demonstrate a slightly better credit culture, have raised funding to meet their capital adequacy requirements, and have been profitable.

They now are grappling with high NPAs and have the management to work their way through the current crisis. The large PNB fraud has brought to the fore some of their management inadequacies and we can only wait to see their response to the current crisis which will provide a good indication as to their capacity to self correct and survive.

Their largest shareholder, the Government of India will need to demonstrate continued support in terms of equity infusion for these Banks to stabilize.

The remaining PSU Banks face an existential threat. They have extremely high NPA’s resulting from a compromised management, inadequate credit analysis capability, poor operational controls and a management which has got compromised over the years influenced by external pressures. With this as as their heritage survival in the present state is going to be difficult.

Finding a Workable Solution
Given the relatively bleak scenario in terms of credit delivery, how do we ensure that Indian industry gets the credit that it needs to grow?
● We must get over our fixation of PSU Banks and let them either be privatized or allow them to die in an orderly manner. They are unlikely to be the change agents who will provide credit to propel our industry. Two or three of the largest PSU Banks may be able to attract capital and grow. For these handful of Banks, we should have a clear disinvestment plan which enables this effort.

For the remaining PSU Banks we must prohibit them from lending, focus them on cleaning up their NPA’s and encourage them to sell whatever assets they can. These Banks will have to be nudged to closure over a period of time during which their only reason of existence will be to clean up the mess that they have created.

Large Private Banks will automatically step into the space and expand their lending. They are well-positioned to do so. The large market opportunity presented as the PSU Banks retreat and Private Banks take over the credit delivery role will be large and it is reasonable to expect that even the well-run mid-sized Banks will be able to attract the capital required to aggressively grow.

Large NBFC’s also will step in to provide credit to the customers that are not obtaining credit from Banks. The ecosystem of NBFC’s is well-established and has survived the numerous business cycles and will scale up very rapidly.

Large Corporates with good credit history have gone out to the capital markets frequently for their long term and working capital requirements. I see this trend becoming more significant.

Digital NBFC’s, Banks and Payment Banks will also change the landscape and provide more niche services as they attain size.

Going ahead the financial framework also has to ensure that there is one effective regulator for the Banks. Logically, the Reserve Bank of India (RBI) is this regulator. Currently, ambiguity exists as the PSU Banks also have dual reporting to the Ministry of Finance.

If we are to have effective governance of the banking industry, it is essential that
the entire regulatory responsibility for Banking be vested with the RBI without any interference of the Government.

In Summary

It is time for India to let go of its public sector banks.
The larger public sector banks should be privatized and sold at the earliest to obtain a decent market valuation. Funds received here should be utilized to capitalize the other public sector banks to ensure that they are able to absorb all the losses that they have to incur as the NPA’s go through the resolution process and have to be written off.

The other public sector banks should be restricted from lending, their healthy customers given a chance to find alternative borrowing arrangements and over a period of time closed as operating lending entities.

The private sector banks, NBFC’s and other Fintech start-ups will be happy to take on the onus of meeting the credit requirements of the country. We will also have a healthier financial services sector which will partner industry to provide the growth impetus required.

About the Author
Tushar Kanti Chopra is the founder Chairman of ATS Services Private Ltd, and has
been a banker with Citibank and Bank of America for over two decades.

Collections Receivables

How Can Organizations Manage their Collections Efficiently

Companies in India face a number of organizational challenges that get in the way of effectively managing their collections receivables.

Because many of these processes are still being developed and fine-tuned, there are many challenges to work through, which include a lack of efficient infrastructure, limited capital, and outdated technology. Not surprisingly, these challenges also get in the way of overall operations and result in a disturbed cash flow.

Small and Medium Enterprises (SMEs) are also impacted by these challenges; the ambient environment for SMEs can also be prohibitive to their growth, especially because loans and approvals are not easy to come by.

When SMEs turn to private lenders, they’re often faced with high interest rates, making the payback process critical and cumbersome in the face of outstanding receivables.

It’s easy for this to become a vicious cycle for organizations of all sizes.

Common Collections Mistakes made by SMEs

Let’s say we have a database of 100 clients with payments due. Of these 100 clients, 70 always make payments on time. 20 of these clients might be habitually late with payments and 10 of these have gone into deep lapse, i.e. a customer base that has become completely unresponsive with significant payment delays (90 days or more).

“A very important concept to understand is that all customers are not cut from the same cloth” says Aditya Bhushan, Managing Director at ATS. “If the loyalists are approached with the same tactics as the stragglers, you risk delaying your payments even further. In 17 years, we’ve seen this occur many times.”

A delayed payment loop is definitely not the outcome we need. But there is a way to manage the collections process more efficiently, and it’s rooted in understanding your customer’s payment behaviour patterns, dispute resolution procedures, efficient follow-up and escalation, proper monitoring.

Can a Collections Receivable Backlog be Prevented?

With a combination of intelligent segmentation, analytics, and timely outreach, collections receivables backlogs can be prevented.

  1. Segment Your Data
    Segmenting and correctly labeling your data is a crucial first step. If 70% of your customers pay on time with minimal reminders – even better if they’re on autopay! – then we recommend you don’t disturb them with repetitive or unnecessary messaging.
     
  2. Identify Risk

    Strong analytics and experience are important for identifying risk. Once you have a window into an established payment or behaviour pattern – e.g. some people avoid calls from collectors – you can determine the risk of non-payment.

    This is the point where we typically step in for our clients and recommend next steps. When we identify the segment perpetually in deep lapse, our experts look into each case selectively and approach towards a negotiated settlement.

  3. Prioritize Human Intervention

    A phone call or an automated message? An email or a text? One message or a series of reminders until the payment comes in? Once you’ve segmented your target audience and identified the risk, you can prioritize how much human intervention a particular customer will need.

    In the example we’ve mentioned above, 80% of the clients make timely or slightly overdue payments. In our experience, these clients do not require special intervention for payment reminders. Moreover, the time and effort saved here can be invested into tougher accounts in order to improve the overall collections efficacy.

  4. Implement Digital Outreach

    Once you’ve decided your mode of communication (text, email, phone call), you must automate and digitize your outreach process. We’ve built processes and software for our clients that allow CRMs to integrate with emails and diallers to initiate payback. Most often, a full human resource is not required for this outreach.  

A digitized and analytics-based follow-up isn’t just the way forward; it’s the most efficient and economical way forward. Talk to us about how we can set up this process for you.

Risk Identifier

How to Identify Early Risk in Credit

In a post-recession economy, managing collections in a timely manner can be a tricky business; especially because of the impact this particular task has on working capital.

In this environment, having a set of checks and balances in place that can identify early credit risks from customers is more than recommended. It’s actually crucial for ensuring the financial health of an organization by mitigating losses.

Additionally, early risk identifiers can also facilitate early intervention along with the necessary corrective action. Since false signals are possible, risk identifiers are generally integrated with credit risk management as well, the process for which weighs in several variables. But that’s a different story.

Risk Identifying Signals

The need for early risk identification is clearly beyond debate. However, in nascent stages, organizations often wonder which markers to watch out for; or which identifiers require more attention than others.

The mapping of early risk identifiers focuses primarily on individual borrower behaviours, and it’s possible your client servicing teams have already begun to notice these signs. If you already have a systematic addressal process in place, chances are you’re in good shape.

In case you don’t have a process in place, this first set of identifiers will help you establish a launchpad for the right conversations to gather your resources.

Key Early Risk Identifiers

  1. Credentials of Your Borrower
    Ideally speaking, the approval or pre-approval stage can set the scene for future risk or liability. This can be true of loan sanction or premium renewal scenarios.A close review of credit history and existing balance sheets can offer clear insights into an individual’s reliability. But in the grand scheme of plentiful paperwork, these signs are fairly easy to miss.
  2. Early Payment Defaults
    A payment default or a bounced cheque early on in the repayment cycle is usually not a good sign. How aggressively the situation is tackled may be a part of the process that gets fine-tuned over time, but this signal shouldn’t be ignored.
  3. Customer Response
    If your customers are ignoring calls, being evasive about their availability, or in extreme cases, they resort to being verbally aggressive with your representatives, you may have a potential red flag on your hands.On the other hand, you may even see repeated requests for payment extensions in quick succession.You may need to consider alternative forms of communication – an email or a targeted ad, for instance – to gain their attention and to make them more responsive.

One of the major reasons that underscores the need for early risk identifiers is that organizations cannot fully rely on human instinct and experience alone. By the same token, they can’t fully rely on technology alone either; we’ve seen several instances where false identifiers showed up on flagged cases.

Timely intervention and a well-adjusted course of action could mean the difference between on-track payments or a non-performing portfolio.

Therefore, you must enable your servicing teams to respond effectively to early warning signs, and this is a domain that  where ATS has garnered significant human experience and technological skill.

We’ve worked with numerous clients over the years to help them manage their credit risks successfully. And we can develop tailor-made solutions for you as well.

If you’re interested in learning more about our Risk Management services, please contact us and our Sales team will get back to you.