Niren Patel & Aravind Venugopal
Micro-finance (MF) industry has been witnessing growth and recovery from the effects of demonetisation. The 3rd quarter of FY 2017-18 saw a 61% year-on-year increase in the number of loans disbursed and a 98% year-on-year increase in the loan amounts disbursed. Another welcome indicator is that the proportion of total gross outstanding loan portfolio that is at default risk (PAR) has been declining across the MF industry.
With emphasis being placed on financial inclusion and the general growth trajectory of the Indian economy, these development trends for the MF industry are expected to continue and gain in strength. Given these factors, M&A activity in the MF space is at an all-time high and is expected to continue.
While banks engaged in MF are regulated by the RBI based on the general rules applicable to banks, NBFC MFIs are regulated by the RBI based on their assets size. NBFC MFIs with asset size exceeding INR 5 billion are regulated as systemically important, which attracts greater regulatory oversight and a more onerous compliance regime. NBFC MFIs with asset size less than Rs 5 billion are regulated as systemically unimportant NBFCs, which attract a relatively less onerous regulatory and compliance regime.
It is important to note that 9 out of the 10 recent small banks licensed by RBI started off as MFIs. Small banks can offer basic banking services and provide loans to the financially excluded segment of the population and can also access deposits. Accordingly, there appears to exist a path for MFIs to scale up activities and become a small bank, which can engage in a broader range of financial services activities. One has recently witnessed a surge in fund-raising by MFIs.
Banks can charge interest on loans based on its marginal cost of funds-based lending rates. The quantum of interest that NBFC-MFIs can charge depends on its cost of funds and the base rate of 5 largest commercial banks. Additionally, certain states have enacted laws governing money lenders. Currently, there are conflicting and ambiguous decisions of high courts regarding the applicability of such laws to NBFCs. Depending on the states where an NBFC operates, the applicability of relevant money lenders statutes must be evaluated.
There has been a trend of larger financial institutions acquiring stakes in MFIs. Notable examples include Kotak Mahindra Bank’s acquisition of BSS Microfinance, IDFC Bank’s acquisition of Grama Vidyal Microfinance, DCB Bank’s acquisition of a stake in Annapurna Microfinance and IndusInd Banks’s acquisition of a stake in Bharat Financial Inclusion. This trend of larger financial services players acquiring micro finance entities is expected to gain momentum, considering the growth prospects in the MF space and the overall bad loans scenario for large banks.
While considering M&A activity in the MF space, as in other sectors, a tax efficient structure that complies with legal and regulatory requirements will have to be drawn up. Depending on legal and tax considerations, this can take the form of slump sale, asset transfer, court approved schemes, share sale etc.
If the transaction is structured as a share purchase, then under RBI rules, acquisition of control or stake exceeding 26% of an NBFC’s capital requires prior RBI approval. If loans are proposed to be acquired from an existing NBFC/ bank, RBI’s securitisation norms will not apply if the sale constitutes the sale of the seller’s entire portfolio of assets, consequent upon a decision to exit the line of the business completely.
The need for obtaining borrower’s consent in case of a transfer of loans depends on the terms of the underlying contract. Should the underlying loan agreement contain enabling language that permits a transfer of the loan without the borrower’s consent, then borrower’s consent will not be required.
If an NBFC-MFI proposes to acquire a bank’s MF portfolio, given the requirements regarding the maximum interest that an NBFC-MFI can charge, the interest rates of the underlying loans may have to be adjusted.
MF loans are unsecured by their very nature. Under Indian laws, their transfer can be considered as transfer of movable property if a well thought out structure is not adopted. From a transaction costs perspective, in many states, the transfer of moveable property attracts a relatively high stamp duty. This aspect must be borne in mind when a transaction is being structured and evaluated.
MF presents an excellent growth opportunity for those evaluating an entry into Indian financial services space. In the days to come, greater consolidation can be expected in the MF sector. Given the heavily regulated nature of the sector, parties should pay careful attention to regulatory requirements and efficient structuring to ensure compliance with applicable laws and commercial advantage.
Niren Patel is Partner and Aravind Venugopal is Principal Associate at Khaitan & Co