SFBs were the most affected, as asset quality deteriorated post demonetisation, since some SFBs had expanded
aggressively, giving higher ticket loans in the months prior to demonetisation. PAR > 30 for SFBs jumped post
demonetisation, and was at 8.95% in December 2017 as compared with the industry average of 3.62% during the period.
However, banks and MFIs invested significantly in educating borrowers and helping them exchange notes of demonetized
denominations, which gradually improved collection efficiency and reduced their overall PAR. Further, collection
efficiency of fresh loans disbursed after January 2017 has been strong. As a result, the PAR for the industry has been
trending downward.

As of March 2020, overall PAR >30 for the industry as a whole was 1.79%; but SFBs had better asset quality with PAR
>30 lower than the industry average. However, asset quality of the industry has been deteriorating in the last one year
owing to floods in multiple major states in the second quarter of Fiscal 2020, affecting collection efficiency. As a result,
PAR values had increased. Further, in the third quarter of Fiscal 2020, PAR levels negated the recovery process, with
disruptions seen in Assam, where political intervention affected recoveries, leading to rise in PAR>30. In the last quarter
of Fiscal 2020, the pandemic, and subsequent disruption to services and employment owing to the nationwide lockdown,
deteriorated the asset quality further.

Asset quality of player groups in microfinance industry as of March 2020 (PAR >30 days)

3.50%
3.00% 288% 276%
2.47%

2.50% 2.25%
2.00% sore 1 ae 1.79%
1.50% 1.40%

114% | 1.11% — 0.88% 1.00% 23%
400% | 977% 0. |

0 ill
0 al

0.50% I ° i 0.24" 0.22
0.00% a fi

Dec 2018 ll 2019 Dec 2019 March 2020

=Banks =NBFCMFIs =SFBs | =NBFC =Others =Industry

Note: PAR>30 excludes delinquencies >180 days; Data excludes banks SHG, Dats includes data for bank JLG
‘Source: MFIN, GRISIL Research

Asset quality is expected to deteriorate significantly as measures taken to control the spread of COVID-19 are going to
impair MFI borrowers’ ability to repay loans. PAR>30 days is estimated at 10% to 11% by end of Fiscal 2021. If
containment of COVID-19 takes longer, the impact on asset quality may be more severe.

Profitability — sharp moderation in the medium term

In Fiscal 2019, spreads generated by NBFC-MFIs substantially increased because of higher securitisation volume. As
banks, owing to the IL&FS default, chose a cautious approach towards lending to NBFCs, including MFIs, securitisation,
including via direct assignment route, were commonly used to raise funds for NBFCs. Banks were comfortable to buy
asset pools as they were acquiring granular retail assets as against bulk term loans. For NBFC-MFIs it was also favourable
as the 10% regulatory margin cap was not applicable on funds raised through the securitisation route. Spreads widened
in the second half of Fiscal 2019 due to the following reasons:

* Operating expenses reduced marginally despite NBFC-MFls remaining aggressive in expanding their overall branch
network over the fiscal;

¢ Transition to Ind-AS accounting framework, and the subsequent expected credit loss provisioning framework, saw
NBFC-MFI’s profitability jump to near four-year high of approximately 4.4%, as credit costs declined 45-50 bps

* — Other income jumped 110-120 bps as players up-fronted income from the securitised portfolio, in line with provisions
of Ind-AS. This was previously accounted over the tenure of the loan.

However, in Fiscal 2020, profitability is estimated to have declined a marginal 5-10 bps, based on rising credit costs,
largely due to floods in several states during the year. Spreads, though, are expected to be stable as players pass on the
cost to customers, and, hence, operating expense is also expected to remain stable.

In Fiscal 2021, due to COVID-19, the impact on the profitability of NBFC-MFIs would be in the range of moderate to
severe, depending on the time taken to control the pandemic. On the outbreak of the pandemic, SFBs with their access to
lower cost of borrowing and regulated environment would be in a better position to withstand the pressures as compared
to the NBFC-MFIs and gain some market share. However, expected risk aversion to the segment due to external shock

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