In June, CFI published a blog post asking whether repayment moratoriums are good for clients. As one of the key tools being used by policymakers to mitigate the consequences of COVID-19 on microfinance clients, moratoriums have provided vital relief to people at a time of unprecedented need.
But when we assess the value of moratoriums, we must also carefully consider what impacts they are having on the financial institutions that serve low-income and underserved segments. From confusion caused by moratoriums announcements to the liquidity impacts for financial institutions serving the BOP, the implications of loan moratoriums are proving to be very mixed.
COVID-era Moratoriums: Confusion and Rumors
Moratoriums for loan payments was one of the first measures taken by policymakers around the world when the pandemic shut down businesses. Consumer and MSME borrowers were told they could hold off on repaying their debts, usually for a few months. While this measure seems straightforward, the way in which it was implemented and communicated has varied widely across markets – and often within markets – leading to significant confusion.
While a moratorium seems straightforward, implementation and communication varied widely across markets.
Some moratoriums were mandatory, others were offered as recommendations. The timeframes varied, anywhere from one through six months. Some financial institutions implemented them with an “opt in” approach for customers, while others in the same market took an “opt out” approach. Some regulators said customers needed to request deferments in writing, then later said they could do so via phone, SMS, or email, adding further challenges to financial institutions. In some cases, financial institutions told their clients they could hold off on principal payments but not interest payments. Others said clients would need to pay the combined principal and interest in one balloon payment at the end of the period. And in many markets, it was not clear which borrowers and institutions the moratoriums would apply to, leading to false rumors and public turmoil.
A key issue contributing to the confusion is that the FSPs that serve the poor are made up of many types of entities, typically licensed and supervised by different regulators, with moratorium parameters often differing between them. So consumers and MSMEs were hearing mixed messages and weren’t sure which ones applied to them.
So far, it’s small and mid-size non-bank financial institutions (NBFIs) that are finding themselves most negatively impacted by the moratoriums in their markets, both by the liquidity implications as well as the confusion over how to implement the moratoriums and who it applies to. Many of their clients are no longer able to repay their loans, and even those who can pay are refusing to because they believe the moratoriums apply to them.
Moratorium parameters often differ between types of entities which serve the poor.
In some countries, such as India, the Reserve Bank of India (RBI) stated that banks and NBFCs are “allowed” to provide moratoriums to their borrowers, but didn’t specify the conditions around how the moratorium should be carried out.
In discussions with the Central Bank of Egypt, they said that the moratorium announced by the central bank applied only to bank loans, but somehow got miscommunicated, leading many MFI customers to initially believe it applied to them as well. At that point, the regulator responsible for non-bank financial institutions in Egypt, the Egyptian Financial Regulatory Authority (FRA), announced its own moratorium. FRA took a more nuanced approach to a moratorium for microfinance clients, in coordination with the MFIs themselves and the Egyptian Microfinance Federation. The mid-March moratorium stated that MFI clients could repay a portion of their loans, down to 50 percent, for a period of two months (March and April), with extensions allowed on an as-needed basis. FRA’s view was that MFIs could not afford a sudden and complete stop in repayments, especially as they don’t have deposits to fall back on, nor would it be a good precedent in terms of microfinance borrower culture. The Bank of Zambia told us they chose to not impose any moratorium, leaving it to individual financial institutions to decide how to address the issue with their clients.
In Peru, MFIs were struggling even before COVID, and there’s now a debate about a proposed law that would forgive all interest charges for six months. It’s still under discussion but industry observers estimate that the law would force at least 26 MFIs into serious solvency problems.
Most moratorium announcements have overlooked the loan repayments that MFIs themselves must pay to their bank lenders. Many central banks have urged the banks under their supervision to extend the moratoriums to their MFI/NBFI clients but have not mandated it. And, according to one observer in India, there are banks who fear that extending moratoriums to MFIs will affect their own bank’s credit rating, so are reluctant to do so. MFIs and NBFIs thus find themselves caught in the middle between client moratoriums and their own creditors. Not only are MFIs struggling to meet their current loans in this environment, but their banks and investors are hesitant to issue new loans to them, further exacerbating the situation.
FSPs: Caught in the Middle and Facing a Liquidity Crisis
In this pandemic environment, with no loan repayments coming in, deposits being drawn down, and maturing debt commitments coming due with little sign of being renewed or rescheduled, many MFIs are facing the possibility of a serious liquidity crisis. Many industry observers suggest that MFIs won’t get back to their normal repayment rates until 2022. The reduction in cash reserves means shortages in their operational budgets, including their ability to pay staff costs, which also exacerbates their ability to collect repayments. One recent analysis shows that a slip in client repayment rates from 95 to just 85 percent would render most MFIs insolvent in less than a year. In a June 2020 survey in Rwanda, 95 percent of the microfinance banks and limited liability microfinance institutions reported emergency need for liquidity support in the next three months.
Allowing a collapse in the microfinance sector could very well end up negating overall COVID economic relief measures. So far, most MFIs are continuing to operate and few have indicated that they are struggling from serious liquidity shortages, particularly the larger players. According to a recent CGAP survey of MFIs, only 14 percent of respondents reported having less than three months of liquidity on hand (as of April 2020). This figure jumps to 25 percent when operating expenses and debt repayments are factored in. What concerns observers, though, is what happens when the moratoriums end and borrowers are still unable to repay. When the lockdowns and moratoriums end, many microfinance clients will need additional credit to resume business activities, not to mention repay other liabilities accrued to meet their household needs during lockdown.
Allowing a collapse in the microfinance sector could negate overall COVID economic relief measures.
MFIs that are in a precarious position because of the liquidity squeeze described above won’t be in a position to provide this critical credit. This will be compounded by MFIs being unable to access further credit from wholesale lenders such as banks as their collection efficiency will plummet during and after lockdown. In financial situations like this, where there is considerable reduction in consumer demand and a broader economic slowdown, banks become risk averse – even more so when dealing with the poorest segments of society and the institutions that serve them.
Recommendations for Policymakers and Regulators
Going forward, we’d make the following recommendations, which can also be found in the recent CFI policy brief:
Authorities must carefully consider the appropriateness of blanket moratoriums for all institutions and build some flexibility into the policy.
As we’ve seen so far in Egypt, offering only a partial moratorium to MFI clients has so far proven successful and has eased the impact on the MFIs. The risks of poorly-thought out moratoriums don’t just apply to MFIs, either: a recent stress test by the Bank of Uganda showed that more than half of Uganda’s commercial banks would have collapsed if the central bank had enforced a three-month customer loans repayments holiday at the onset of the COVID-19 pandemic. In India, industry experts are starting to worry about the impact that twice-extended moratoriums will have on the banks. As The Economist notes, “Much of the RBI’s early response to the pandemic involved protecting borrowers. It may yet find itself being forced to step in to save some lenders.”
Moratorium mandates must be clearly thought out and communicated uniformly across all institutions.
Moratorium announcements can be very confusing to consumers and financial institutions alike. Regulators and policymakers must articulate clearly who the moratoriums apply to, and announcements affecting different groups should occur at the same time to avoid confusion. If moratoriums are to be made optional, say by letting customers opt in, the procedures should be simple, straightforward and clearly communicated. There should also be a clear understanding between the regulator and financial institutions on how they wish to see the moratoriums carried out, with measures in place to ensure that instructions are carried out accordingly. For example, merely recommending that banks extend moratoriums to their MFI clients without following up to ensure this is happening will probably not deliver the results that central banks want to see.
Policymakers and regulators were caught off guard by the pandemic, and are struggling to do everything they can to alleviate the suffering people are facing. While moratoriums were implemented with good intentions, the effects may end up being detrimental in the long run.