Traditional lenders are pulling back in the short term as they wait to see the impact of de-monetization on their current portfolio and grapple with uncertainties in SME business performance and collateral prices. In the medium- and long-term, capital availability and lending will increase significantly as lenders get better visibility on business performance and more business transactions are recorded digitally.
– Shailesh Jacob
As the shock of the demonetisation move wears off, businesses are now bracing themselves for the coming two-quarters that are forecast to see lower demand. Many business models that depended on the flow of hard cash may just have been rendered permanently unviable from a lender’s perspective.
Access to funds
Traditionally banks and NBFCs had a difficult time in assessing credit-worthiness of small businesses due to unreliable revenue and profit records. This has been the downside of the preference for cash transactions. As businesses are forced to move towards digital wallets and e-banking, there will be a more tangible trail for transactions. This, in turn will help lenders to assess in better detail what kind of cash profits a business is generating. To that extent, access to funds should improve.
However, this is contingent upon the business being able to make the transition effectively. This will involve not just the revenue chain, but also the entire cost chain of labour, suppliers, and service providers. Additionally, apart from audited financial statements, revenue validation with the various indirect tax returns by lenders could also become a requirement.
Speaking about the impact on lending, a credit manager at a public sector bank who deals with SME lending and did not wish to be named said, “Post demonetisation, Liquid Income Programs (LIPs), which attracted a lot of SME borrowers that relied on cash transactions to a large extent, have more or less been discontinued. This is because of both the reduced risk appetite of lenders as well as the rising uncertainty about borrower revenues and profits due to the demand crunch.”
The other positive comes from the fact that banks are flush with deposits – as of January it is estimated that Rs. 14.97 lakh crore ($220 billion) has been deposited – a large part of which will not move out of Current Account Savings Account (CASA) or linked FD accounts for a while due to continued restrictions on withdrawals. As long as the bank is comfortable on the capital adequacy front, its ability to lend just went up significantly.
Coping mechanisms in the immediate demonetisation aftermath have also indicated a growing level of trust among businesses. Suppliers who can afford have begun extending credit where they did not earlier or have become more liberal with their terms.
This scenario is likely to lead to positive transformation as far as new channels of lending are concerned, according to Shailesh Jacob, Co-founder, Loan Frame Technologies Pte Ltd.
Traditional lenders are pulling back in the short term as they wait to see the impact of de-monetization on their current portfolio and grapple with uncertainties in SME business performance and collateral prices. In the medium- and long-term, capital availability and lending will increase significantly as lenders get better visibility on business performance and more business transactions are recorded digitally
He adds that one will continue to see an increase in formal alternative lending channels in the short term given a pullback in both traditional banking channels and informal money lending.
This trend will continue in the long term as formal alternate lenders create more surrogate lending programs based on digital transaction footprints and the availability of digital data will bring in more objectivity-based, risk-based pricing
Cost of funds
The liquidity rush following demonetisation was expected to help banks lower lending rates. Also RBI too was expected to go aggressive with rate cuts in its next policy meeting as an offset to the growth shock that demonetisation is likely to cause. Borrowers can expect disappointment on both counts.
In the face of uncertainty over the impact of demonetization as well as the US Fed’s stance, RBI decided to hold off on rate cuts for now. This went against market expectations of at least a 25bps cut and was in line with the expectations of a very small minority of economists and bankers.
The former expectation of lower rates due to the liquidity rush has also been dampened due to the recent hike in the Cash Reserve Ratio (CRR) by RBI . RBI has asked banks to set aside 100% of the deposits accrued between September 16 and November 11 incremental CRR. These amounts placed by the banks with RBI do not earn any interest and negatively impact the bank’s bottomline. Expectedly, banks have begun cutting deposit rates and have deferred any possible lending rate cuts in order to maintain their margins.
Industry expectations of lower rates though remain positive. Arihant Parakh, Director, National Plastics Group, Chennai is of the view that increased cash availability with banks will lead to a definite reduction in cost of funds. “However, government’s conservativeness may still hold back aggressiveness in rate cuts. In the long term, reduction in funding costs and increase in availability is necessary to give a boost to the industries, particularly to offset demonetisation’s demand-dampening effect. We do need to also consider this from the bank’s perspective. Due to the sudden surge in reserves and deposits, they may be put under undue pressure to advance loans with weaker credit appraisals, thereby possibly worsening the NPA problem,” he says.
Besides these two factors the other dampener for any expectations of lowered borrowing costs comes from the fact that bank balance sheets are badly stretched. According to Capitaline data for BSE500 companies, excluding banks and NBFCs, NPA levels stand at an egregious 8% even as average corporate debt: equity levels are at a staggering 0.63x and average interest coverage ratio has declined to a mere 4.9x. These problems largely emanate from big corporates and even viable MSMEs will end up paying the price in a sad case of adverse selection. Moreover, the higher dependence of MSMEs on cash means that MSME defaults are likely to rise in the coming months. This will only exacerbate the balance sheet stress of banks.
Organised MSMEs will no doubt benefit but the gains will come at the cost of changing ways of doing business and these gains will follow a substantial degree of short-term pain.
The article was authored by Ujval Nanavati for Economic Times on January 13, 2017.