inefficient when it comes to competing with banks, they can cater to segments that are not the focus of the banks.
Nevertheless, the existing challenges in scaling up volumes on TReDs platforms, including lack of adequate
participation from large corporates and MSMEs, need to be addressed before NBFCs could benefit from the proposed
move.

Segment profitability and asset quality

Asset quality to deteriorate by approximately 150 bps and 200 bps post moratorium in Fiscal 2021

Asset quality in the segment has remained high, in the range of approximately 5% to 7%, in the MSME segment over the
past few years due to demand-side pressures and liquidity issues after demonetisation and implementation of GST. In
Fiscal 2020, the asset quality in MSME loans weakened due to slower revenue growth and stretched working capital.

On March 27, 2020, the RBI allowed a moratorium of three months on payment of instalments for existing loans
outstanding on March 1, 2020, and further extended it until August 31, 2020, which would immensely help MSME
borrowers. But for these measures, defaults are expected to have significantly increased in these segments, which are not
operating in view of the lockdown. MSMEs typically have limited financial flexibility. Hence, the measure would help
MSMESs conserve liquidity for more urgent needs such as salary payments to employees. Overall, these sets of measures
are expected not merely to ease the financial stress caused by the COVID-19 pandemic but also build confidence in such
extraordinary times. However, it is expected that asset quality post moratorium to increase by approximately 150 bps and
200 bps in Fiscal 2021, the intensity of which would depend on the length of the lockdown period and the resultant
economic slowdown.

MSME profitability to take a hit due to higher credit cost

The net interest income of unsecured SME loans is significantly higher than other SME products and ranges between
approximately 10% to 12% for non-banks and approximately 7% to 8% for banks. Conversely, operating cost of these
loans is relatively higher since 60% of them are sourced through direct selling agents (“DSAs”). DSAs’ commission in
this segment is the highest among all other retail loan segments, ranging between 1.0% and 3.0%. Delinquencies are
higher in the segment and the credit cost for Fiscal 2021 is estimated to be more than 3% for the financial institutions.
Overall, it is expected approximately 25bps to 30 bps decline in post-tax RoA for the industry to around 1.5% to 2.0%
for Fiscal 2021, as MSMEs likely to continue to face challenges on account of the COVID-19 pandemic.

LOAN AGAINST PROPERTY

A loan against property (“LAP”) is availed by mortgaging a property (residential or commercial) with the lender. LAP is
a secured loan, as it provides collateral to the financier in the form of the property. Its interest rate is lower than personal
or business loans. The end-use of the loan amount is not closely monitored. It could be used for either business or personal
purposes. It can be availed by both salaried and self-employed individuals. For all these reasons, LAP has become popular
among borrowers in recent years.

Evolving landscape of the LAP market
Key factors that contributed to high LAP growth are:

* — Quick turnaround time, lower interest rate, lesser documentation: LAP loans are disbursed in about half the time
taken for a secured MSME loan. It is also offered at a lower interest rate than secured MSME loans, unsecured
personal and business loans. LAPs requires lesser documentation than other secured SME products, leading to fewer
hassles for customers.

* Greater transparency in the system: Demonetisation, GST, and the Government's strong push for digitisation have
led to higher transparency in the system. This will keep pushing up loan amount eligibility of borrowers.
Formalisation will also help many new borrowers come under the ambit of formal lending channels.

* — Rising penetration of formal channels: Increase in penetration and availability of formal lending channels outside the
top 10 cities will reduce the market share of moneylenders.

* Higher comfort for lenders: Lenders are comfortable disbursing LAP loans, as they offer favourable risk-return
characteristics, compared with MSMEs and unsecured loans. They also offer higher recovery in case of default
(supported by the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest
Act, 2002) and better asset quality, which is only partly offset by lower yields.

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