Capital Trust Ltd Management Discussions.

Economic Scenario

Global Economy

The COVID-19 pandemic is inflicting high and rising human costs worldwide. Protecting lives and allowing health care systems to cope have required isolation, lockdowns, and widespread closures to slow the spread of the virus. The health crisis is therefore having a severe impact on economic activity. As a result of the pandemic, the global economy is projected to contract sharply by 3 percent in 2020, much worse than during the 2008 09 financial crisis. In a baseline scenario, which assumes that the pandemic fades in the second half of 2020 and containment efforts can be gradually unwound, the global economy is projected to grow by 5.8% in 2021 as economic activity normalizes, helped by policy support. On a positive note, while the world GDP growth rate in 2020 is expected to be in negative trajectory, the corresponding GDP growth rate of Emerging and Developing Asia is expected to be 1% led by India (1.9%) and China (1.2%).

There is extreme uncertainty around the global growth forecast. The economic fallout depends on factors that interact in ways that are hard to predict, including the pathway of the pandemic, the intensity and efficacy of containment efforts, the extent of supply disruptions, the repercussions of the dramatic tightening in global financial market conditions, shifts in spending patterns, behavioural changes (such as people avoiding shopping malls and public transportation), confidence effects, and volatile commodity prices. Many countries face a multi-layered crisis comprising a health shock, domestic economic disruptions, plummeting external demand, capital flow reversals, and a collapse in commodity prices. Risks of a worse outcome predominate.

Effective policies are essential to forestall worse outcomes. Necessary measures to reduce contagion and protect lives will take a short-term toll on economic activity but should also be seen as an important investment in long-term human and economic health. The immediate priority is to contain the fallout from the COVID-19 outbreak, especially by increasing health care expenditures to strengthen the capacity and resources of the health care sector while adopting measures that reduce contagion. Economic policies will also need to cushion the impact of the decline in activity on people, firms, and the financial system; reduce persistent scarring effects from the unavoidable severe slowdown; and ensure that the economic recovery can begin quickly once the pandemic fades.

Because the economic fallout reflects particularly acute shocks in specific sectors, policy-makers will need to implement substantial targeted fiscal, monetary, and financial market measures to support affected households and businesses. Such actions will help maintain economic relationships throughout the shut-down and are essential to enable activity to gradually normalize once the pandemic abates and containment measures are lifted. The fiscal response in affected countries has been swift and sizable in many advanced economies (such as Australia, France, Germany, Italy, Japan, Spain, the United Kingdom, and the United States). Many emerging market and developing economies (such as China, Indonesia, and South Africa) have also begun providing or announcing significant fiscal support to heavily impacted sectors and workers. Fiscal measures will need to be scaled up if the stoppages to economic activity are persistent, or the pick-up in activity as restrictions are lifted is too weak. Economies facing financing constraints to combat the pandemic and its effects may require external support. Broad-based fiscal stimulus can pre-empt a steeper decline in confidence, lift aggregate demand, and avert an even deeper downturn. But it would most likely be more effective once the outbreak fades and people are able to move about freely.

The significant actions of large central banks in recent weeks include monetary stimulus and liquidity facilities to reduce systemic stress. These actions have supported confidence and contribute to limiting the amplification of the shock, thus ensuring that the economy is better placed to recover. The synchronized actions can magnify their impact on individual economies and will also help generate the space for emerging market and developing economies to use monetary policy to respond to domestic cyclical conditions. Supervisors should also encourage banks to renegotiate loans to distressed households and firms while maintaining a transparent assessment of credit risk.

Strong multilateral cooperation is essential to overcome the effects of the pandemic, including to help financially constrained countries facing twin health and funding shocks, and for channelling aid to countries with weak health care systems. Countries urgently need to work together to slow the spread of the virus and to develop a vaccine and therapies to counter the disease. Until such medical interventions become available, no country is safe from the pandemic (including a recurrence after the initial wave subsides) as long as transmission occurs elsewhere.

(Source- World Economic Outlook, April 2020)

However, in Jun-20 The World Bank said the swift and massive shock of the coronavirus pandemic and shut-down measures to contain it have plunged the global economy into a severe contraction. It said this would be the most synchronised contraction in per capita output for economies since 1870, estimating a 5.2% contraction in 2020 with a 4.2% rebound next year.

"That would represent the deepest recession since the Second World War, with the largest fraction of economies experiencing declines in per-capita output since 1870," the World Bank said. According to The Global Economic Prospects report released in Jun-20 by World Bank (‘GEP report), 90% of economies would be in recession, higher than levels seen during the Great Depression of the 1930s.

While the baseline scenario assumes the outbreak recedes in time to allow economies to lift mitigation measures by around mid-year, a predominant downside risk of a protracted pandemic could see world output shrinking by 8% this year with a sluggish 1% recovery in 2021.

Source:Economic times

INDIAN ECONOMY

In 2019-20, the Indian Economy grew by 4.2% against the 6.1% expansion in 2018-19. Although it was the lowest growth rate in 11 years, the Jan-Mar growth rate of 3.1% (lowest in the 44 quarters) was still higher than the 2.2% growth predicted by most economists and rating analysts.

This was primarily due to fall in three components of demand, that is, slowed consumption demand and negative growth in investments & exports. Government reforms bolstered the formal sector over the past few years; however, income levels in the informal areas suffered as a result. In addition, Credit growth among non-banking financial companies steadily declined due to a freeze in the wholesale money market during most of 2019. This affected overall credit growth, particularly in the informal sector.

A slowdown in consumption demand, delayed and uneven progress of the monsoon, heavy rainfall in Aug-Sep 2019 along with delayed withdrawal of monsoon leading to floods, decline in manufacturing growth, inability of Insolvency and Bankruptcy Code to resolve cases in a time-bound manner, and rising global trade tensions adversely impacted exports, kept growth subdued in FY20.

In order to boost personal consumption, corporate profits and hence private led investment, several fiscal measures were introduced:??PM-KISAN scheme was expanded with direct money transfer to farmers in a targeted way??Corporates were provided an option to pay tax at a basic rate of 22%, provided they give up all the exemptions. While the new manufacturing companies needed to pay only 15%. This was against the basic rate of 30% for all companies while companies with revenue upto Rs.400 Crores were paying tax at basic rate of 25%.

??Personal income tax regime was simplified with reduced rates, in line with the streamlining of the tax code and enhanced funds in the hands of taxpayers to enhance individual consumption??Dividend distribution tax was removed to incentivize capital formation and attract foreign investment??Higher spending on long-term initiatives such as rural roads, water infrastructure, irrigation, warehousing and transportation to improve the productivity of the economy

In addition, there were supportive monetary measures:

??In mid-December 2019, the RBI announced a simultaneous purchase of long-term bonds and sale of short-term government bonds under its open market operations program to effectively bring down long-term rates.

??At its policy meeting in February 2020, the RBI announced the long-term repurchase of one-year and three-year bonds, a program that amounted to INR 1 trillion (0.5% of GDP) to keep short-term rates aligned with the recently cut policy rate.

??Despite higher liquidity and rate cuts by the RBI, credit transmission has remained a persistent issue over the past few quarters in both quantum and the pricing of credit. To ease this situation, the RBI lowered reserve requirements for auto loans, lending to micro, small, and medium enterprises, and allowed banks some flexibility, delaying classification of commercial real estate loans by one year where the projects were deferred due to reasons beyond the control of developers.

Source: www.manulifeim.com

However, due to sluggishness in urban consumption and other factors as mentioned above led to slow growth in rural wages and hence weak rural consumption.

In the fourth quarter FY20, Manufacturing shrank 1.4% as factories shut toward the end of March. Agriculture and public administration grew 5.9% and 10.1%, respectively. Construction contracted 2.2% while the financial sector, usually one of the fastest-growing, saw only a 2.4% rise. Gross fixed capital formation (GFCF), an indicator of investment, shrank 6.4% year-on-year in the March quarter. Major indicators such as crude oil production, commercial vehicle sales, aggregate bank deposits and cargo handled at airports, contracted in the fourth quarter.

Centres gross tax revenues fell an unprecedented 3.4% in 2019-20, while fiscal deficit increased to 4.6% of GDP, well above the revised estimate of 3.8%. (Source: the Hindu)

Indian Economy outlook

A nationwide lockdown was imposed on March 25, 2020 but business activity had begun grinding to a halt a few weeks before that. The core sector contracted by a record 38% in April as the lockdown hit all eight infrastructure sectors. Cement output fell 86% while fertilisers and crude oil shrank 4.5% and 6.4%, respectively, in Apr20.

In view of nationwide lockdown during April 2020 due to Covid-19 pandemic, various industries coal, cement, steel, natural gas, refinery, crude oil etc experienced substantial loss of production.

In view of pandemic global and local impact, the World Bank expects Indias economy to contract 3.2% in the current fiscal year, a sharp downgrade from its April projection of 1.5% -2.8% growth, citing stringent lock-down and spill overs from weaker global growth.The GEP report said the lock-down would severely curtail activity despite fiscal and monetary stimulus. Further, weaker global economic performance and balance sheet stress in the financial sector would also weigh on activity.

The latest report expects the economy to make a modest recovery to 3.1% growth in the next fiscal year, in comparison to the 6.1% expansion projected in the January report.

A number of firms including Goldman Sachs and Nomura have projected a contraction of as much as 5% for India in FY21. The report said the pandemics impact would be particularly hard on emerging markets and developing economies (EMDEs) with large informal sectors, like India. It would "take an especially heavy humanitarian and economic toll on these economies", it said The vulnerabilities associated with informality like widespread poverty, deficient public health and medical resources, and weak social safety nets have amplified the economic shock to livelihoods from Covid-19, according to the GEP report.

Moodys Investors Service on June 1, 2020 cut long-term sovereign rating for India from ‘Baa2 to ‘Baa3 a notch above junk (still in investment grade). The global rating agency maintained its negative outlook, citing structural weaknesses, weak policy effectiveness, and slow reforms momentum even before the Covid-19 pandemic.

Moodys feels India is heading for a sustained period of low growth, which its policymakers wont be able to mitigate. "While the action was taken in the context of Covid-19, it was not driven by its impact. Rather, the pandemic amplifies vulnerabilities in Indias credit profile that were building prior to the shock. As per Moody, Indian GDP is expected to contract by 4.0% in FY20 due to COVID-19 pandemic and lock-down measures, while same is expected to grow by 8.7% in FY21 and ~6% thereafter.

Source: Business Standard.

However, in order to fuel future growth, the Rs.20 lakh crore package has been announced by Finance Minister Ms. Nirmala Sitharaman with prime focus on improving liquidity through banking channels and structural changes to address sustainable reforms and enhance local manufacturing. The RBI has cut rates twice to record lows besides providing liquidity support and regulatory relief.

The brief package details are as follows:

Category Funds Allocation
Funding for MSMEs through W/C facility, sub-ordinate debt and Funds of funds Rs.3,70,000 Crores
Reduced EPF rates and EPF support for Business and Workers Rs,9,550 Crores
Special Liquidity scheme for NBFCs / HFCs / MFIs and Partial credit guarantee scheme 2.0 for liabilities of NBFCs / MFIs Rs.75,000 Crores

 

Liquidity injection for DISCOMs Rs.90,000 Crores
Reduction in TDS / TCS rates Rs.50,000 Crores
Free food grains supply to Migrant workers for 2 months Rs.3,500 Crores
Financial relief through interest subvention for MUDRA Shishu loans, housing CLSS-MIG, additional KCC credit, additional emergency working capital through NABARD and street vendors special credit facility Rs.3,06,500 Crores
Agri Infrastructure and other measures for agriculture and allied sectors Rs.1,50,000 Crores
Viability Gap Funding Rs.8,100 Crores
Additional MGNREGS allocation Rs.40,000 Crores
RBI measures (TLTROs, CRR cut, Marginal Standing Facility hike, refinancing of financial institutions and special liquidity facility for MFs) (On actual basis) Rs.8,01,603 Crores
Earlier measures including PMGKP Rs.1,92,800 Crores
Total Rs.20,97,053 Crores

Source: Times of India

Even though the announcements made are worth over Rs.20 lakh crores, the actual cash outlay by the government this year and the impact on the fiscal deficit will be far less (expected to be less than Rs.2.50 lakh crores, ~1% of GDP). Many of the governments proposals are credit-focused or are aimed at easing liquidity concerns for many affected sectors. In some of these cases, any costs incurred will be initially covered through banks or other financial institutions and thus not result in actual cash outgo by the Centre.

Source: the wire

Indian Financial sector

India has a diversified financial sector undergoing rapid expansion, both in terms of strong growth of existing financial services firms and new entities entering the market. The sector comprises commercial banks, insurance companies, non-banking financial companies, co-operatives, pension funds, mutual funds and other smaller financial entities. The banking regulator has allowed new entities such as payments banks to be created recently thereby adding to the types of entities operating in the sector. In November 2019, government also allocated Rs 10,000 crore to set up AIFs for revival of stalled housing projects. However, the financial sector in India is predominantly a banking sector with commercial banks accounting for more than 64 per cent of the total assets held by the financial system.

Indias gross national savings (GDS) as a percentage of Gross Domestic Product (GDP) stood at 30.50% in 2019. During FY16-FY20, credit off-take grew at a CAGR of 13.93%. As of FY20, total credit extended surged to US$ 1,936.29 billion. While during FY16 FY20, deposits grew at a CAGR of 6.81 per cent and reached US$ 1.90 trillion in FY20. Deposits under Pradhan Mantri Jan Dhan Yojana (PMJDY) also increased to Rs 1.28 lakh crore (US$ 18.16 billion) during the week ended April 8, 2020. As of November 2019, there were a total of 19 million subscribers under Atal Pension Yojna.

Access to banking system has improved over the years due to persistent government efforts to promote banking-technology and promote expansion in unbanked and non-metropolitan regions. As on January 31, 2020, the total number of ATMs in India increased to 210,263 and is further expected to increase to 407,000 by 2021. There has been continued focus on increasing rural penetration. As of September 2019, 44 regional rural banks were functioning in the country. RBI has allowed regional rural banks with net worth of at least US$ 15.28 million to launch internet banking facilities.

For digital initiatives, In FY19, over 3,133 crore digital transactions were registered and reached 1,527 crore in FY20 (till September 2019). Debit cards have radically replaced credit cards as the preferred payment mode in India after demonetisation. Transactions through Unified Payments Interface (UPI) stood at 1.24 billion in March 2020, valued at Rs 2.06 lakh crore (US$ 29.47 billion).Indias mobile wallet industry is also estimated to grow at a Compound Annual Growth Rate (CAGR) of 150% to reach US$ 4.4 billion by 2022 while mobile wallet transactions to touch Rs.32 trillion (US$ 492.6 billion) by 2022.

On demand side, the Government and Reserve Bank of India (RBI) have taken various measures to facilitate easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These measures include launching Credit Guarantee Fund Scheme for Micro and Small Enterprises, issuing guideline to banks regarding collateral requirements and setting up a Micro Units Development and Refinance Agency (MUDRA). In 2017, a new portal named Udyami Mitra was launched by the Small Industries Development Bank of India (SIDBI) with the aim of improving credit availability to Micro, Small and Medium Enterprises (MSMEs) in the country. Under the Interest Subvention Scheme for MSMEs, Rs 350 crore (US$ 50.07 million) has been allocated under Union Budget 2019-20 for 2 % interest subvention for all GST registered MSMEs, on fresh or incremental loans. In addition, there have been multiple measures for MSMEs to avail funding in post COVID era to re-initiate their business activities, as explained earlier in Rs.20 lakh Crore package by Finance Minister of India.

Even in future, there have been several growth drivers for the sustainable growth of financial services in India:

Demand:

??Increase in working population & growing disposable incomes

??Housing & personal finance are expected to remain key demand drivers.??Rural banking is expected to witness growth in the future.

Innovation in Services:

??Mobile, internet banking & extension of facilities at ATM stations to improve operational efficiency.

??Vast un-banked population highlights scope for innovation in delivery.

Policy Support:

??Wide policy support in the form of private sector participation & liquidity infusion.

??Healthy regulatory oversight & credible monetary policy by the RBI have lent strength and stability to the countrys banking sector.

Source: https://www.ibef.org/

NBFC Sector

There were 9642 non-banking financial companies (NBFCs) registered with the Reserve Bank as on September 30, 2019. Out of above 9461 were non-deposit accepting (NBFCs-ND) while there were 82 deposit accepting NBFCs (NBFCs-D) and 99 Housing Finance Companies (HFCs). Among NBFCs-ND, those with an asset size of Rs.500 crore or more are classified as non-deposit taking systemically important NBFCs (NBFCs-ND-SI). 9461 NBFCs-ND comprised 274 systemically important NBFCs-ND (NBFCs-ND-SI) and 9187 other NBFCs-ND. All NBFC-D and NBFCs-ND-SI are subject to prudential regulations such as capital adequacy requirements and provisioning norms along with reporting requirements.

NBFC Sector Analysis

NBFCs have served the unbanked customers by pioneering into retail asset-backed lending, lending against securities and microfinance. NBFCs are rapidly gaining prominence as intermediaries in the retail finance space. While NBFCs finance more than 80 per cent of equipment leasing and hire purchase activities in India, there market share in commercial loans stood at 26.6% in FY19. NBFCs aspire to emerge as a one-stop shop for all financial services. Non-Banking Financial Companies are expected to raise their share to 19-20 per cent by 2020 through recapitalisation program for public sector and New RBI guidelines on NBFCs with regard to capital requirements, provisioning norms and enhanced disclosure requirements are expected to benefit the sector in the long run

Although the NBFC sector grew in size from 26.2 lakh crore in 2017-18 to 30.9 lakh crore in 2018-19, the pace of expansion was lower than in 2017-18 mainly due to rating downgrades and liquidity stress in a few large NBFCs in the aftermath of the IL&FS event. This slowdown was witnessed mainly in the NBFCs- ND-SI category, whereas, NBFCs-D broadly maintained their pace of growth. However, in 2019-20 (up to September) growth in balance-sheet size of NBFCs-ND-SI as well as NBFCs-D moderated due to a sharp deceleration in credit growth

Credit extended by NBFCs continued to grow in 2018-19. Industry is the largest recipient of credit provided by the NBFC sector, followed by retail loans and services. Credit to industry and services was subdued in relation to the previous year. However, growth in retail loans continued its momentum. Over 40 per cent of the retail portfolio of NBFCs are vehicle and auto loans. The slowdown in auto loans in 2018-19 could be attributed to a slump in aggregate demand, exacerbated by postponement of vehicle purchases in anticipation of the implementation of BS-VI norms, the sharp increase in insurance costs in case of passenger vehicles and two wheelers, and sizeable enhancement in permissible axle load for commercial vehicles. In the consumer durables segment, a decline in credit extended was observed, reflecting muted consumer demand. NBFCs credit to commercial real estate decelerated in 2018-19, reflecting their risk aversion in light of the slowdown in real estate sector despite expansion of bank credit to the sector. On the other hand, credit to agriculture and allied activities saw a significant increase in 2018-19, partly attributable to the policy measure of September 2018 enabling co-origination of loans for lending to priority sector by banks and NBFCs.

In terms of resource mobilization, NBFCs-ND-SI mobilise around 70 per cent of their resources through bank borrowings and debentures. As investor confidence in the sector waned in 2018-19 and raising money through debentures became costlier, the reliance on bank borrowings increased. In fact, debenture issuances remained stagnant in 2018-19 whereas bank borrowings grew at a robust pace. The share of CPs declined marginally and CP issuances also decelerated in

2018-19. A slew of measures were taken by the Government of India and the Reserve Bank to alleviate the liquidity stress and strengthen confidence in the sector. Amidst generalised risk aversion affecting various categories of investors, banks emerged as a stable funding alternative for NBFCs in 2018-19. However, In 2019-20 (up to September), bank lending to NBFCs also decelerated in light of defaults by and rating downgrades of a prominent HFC and a NBFC.

In 2018-19, GNPA ratio of NBFCs-ND-SI deteriorated across all categories, except NBFCs-MFI, which reported significant improvement in the GNPA ratio. The improvement in the GNPA ratio of the NBFCs- MFI may be attributed to write offs of aging loans. The NNPA ratio for NBFCs-ND-SI edged up marginally, reflecting the maintenance of adequate buffers, especially by MFIs. In 2019-20 (up to September), the GNPA ratio of NBFCs-ND-SI exhibited an increase, while, the NNPA ratio registered no change.

The risk aversion among NBFCs-ND-SI coupled with their inability to mobilise adequate resources was reflected in the decrease in credit growth in spite of a fall in stressed assets ratio.

NBFCs are generally well capitalised, with the system level capital to risk-weighted assets ratio (CRAR) remaining well above the stipulated norm of 15 per cent, including in 2018-19 when they experienced an increase in non-performing assets. At the end of September 2019, the sector maintained the capital position although there was a deterioration in asset quality.

Although the balance sheet size of the NBFCs constitutes 18.6 per cent of Scheduled Commercial Banks, it has emerged as an important pillar of the Indian financial system. The sector, which had witnessed a robust expansion in 2017-18, experienced headwinds in 2018-19 and 2019- 20 (up to September) as market sentiments turned negative post-IL&FS event and recent defaults by some companies. Although GNPA ratio showed an uptick, their capital position remained stable. HFCs experienced deceleration in credit growth and muted profitability as market confidence in the sector waned.

The Reserve Bank and the government have taken several measures to restore stability in the NBFC space. The Reserve Bank took measures to augment systemic liquidity, buttress standards of asset-liability management framework, ease flow of funds by relaxing ECB guidelines and strengthen governance and risk-management structures. The government provided additional support through the partial credit guarantee scheme, encouraging PSBs to acquire high-rated pooled assets of NBFCs. Furthermore, the Finance Bill 2019 through amendments in the RBI Act, 1934 conferred powers on the Reserve Bank to bolster governance of NBFCs. These measures are geared toward allaying investors apprehensions and aiding NBFCs in performing their role better.

Source: RBI

Recent developments

Post IL&FS scam, mutual funds are reluctant to lend to NBFCs. The principle behind their operation, which is long-term lending and short-term borrowing, was already perceived as too risky by most commercial banks. Hence, when the NBFCs turned to the banks for funding, only the top ones managed to borrow, mainly from private banks. Situation have been further aggravated with renewed pressure on funding and liquidity post recent RBI takeover of YES Bank.

As the impact of coronavirus is beginning to be felt in India, further risks to economic growth and asset quality are increasing. Rising asset quality and funding risks will place pressure on ratings if conditions worsen materially, said a Fitch Ratings report.

The RBIs planned reconstruction scheme broadly protects the deposits and liabilities of the bank, but calls for a write-down on its Basel III AT1 instruments at present. This may trigger another round of investor risk aversion that tightens market access and raises overall funding costs for borrowers, with wholesale NBFIs likely to remain more vulnerable in this situation.

Commercial banks had recently become an important source of funding for NBFCs. So, if we see a deteriorating condition of more private banks in the near future due to a weak depositor sentiment, it will ultimately lead to constriction of liquidity. A liquidity crunch at a time when financial sector is already impacted by the general economic slowdown and the COVID-19 crisis will only lead to the asset quality risks getting worse. This will eventually force NBFCs to be more hesitant to lend to customers perceived as too risky by Banks as well as SMEs, which contribute largely towards Indias GDP.

Source: economic times

Policy Measures

NBFCs are meshed into a web of inter-linkages with banks and financial markets. Consequently, asset quality concerns relating to NBFCs constrain them to access liquidity with spill overs to financial markets. In order to restore confidence and maintain stability, the Reserve Bank and the government responded with several measures as summarized below:

??The Finance Bill 2019 through amendments in the RBI Act, 1934 conferred powers on the Reserve Bank to strengthen governance of NBFCs so as to protect depositors/creditors interest and secure financial stability. The amendments empowered the Reserve Bank to remove the directors of NBFCs; supersede their board and appoint administrators in order to improve governance; impose penalties in case of non-compliance with various requirements; and to resolve an NBFC by amalgamation, reconstruction or splitting an NBFC into different units or institutions.

??The government amended the Companies (Share Capital and Debentures) Rules by removing Debenture Redemption Reserve (DRR) requirement for NBFCs and HFCs.

??Banks were allowed to provide partial credit enhancement (PCE) to bonds issued by NBFCs-ND-SI registered with RBI and HFCs registered with National Housing Bank, provided the tenor of the bonds is not less than three years, proceeds from such bonds shall only be utilised for refinancing existing debt of the NBFCs-ND-SI/HFCs.

??To encourage NBFCs to securitise/assign their eligible assets, the Reserve Bank has relaxed the minimum holding period (MHP) requirement till December 31, 2019 for originating NBFCs in respect of loans of original maturity above 5 years, subject to certain conditions.??All scheduled commercial banks (excluding Regional Rural Banks and Small Finance Banks) were allowed to co-originate loans with NBFCs-ND-SI for the creation of eligible priority sector assets, facilitating sharing of risks and rewards.

??The Government of India rolled out the scheme to provide a one-time partial credit guarantee for the first loss up to 10 per cent to public sector banks (PSBs) for purchase of high-rated pooled assets amounting to Rs.1 lakh crore from financially sound NBFCs/HFCs.

In addition, during COVID-time several liquidity boosting measures have been announced by RBI and the government with details as follows:

??Targeted Long-Term Repo Operation (TLTRO) of Rs 500 billion that targets mid- and small-sized nonbank financial companies (NBFCs) and microfinance institutions (MFIs).??Reduction in Cash Reserve Ratio (CRR) of all banks by 100bps to 3.00% of net demand and time liabilities??Reduction in the reverse repo rate of 25bp, lowering the rate to 3.75% and increasing the corridor relative to the MSF rate to 90bp.

??A special refinancing facility of Rs 500 billion to institutions, such as NABARD, SIDBI and NHB, to reduce their issuance pressure on markets.

??Permitted all commercial banks, co-operative banks, all-India Financial Institutions and NBFCs to allow moratorium of six months on payment of instalments in respect of all term loans outstanding as on March 1, 2020.

??In respect of all accounts for which lending institutions decide to grant moratorium/deferment, and which were standard as on March 1, 2020, the 90-day NPA norm shall also exclude the extended moratorium/deferment period. Consequently, there would be an asset classification standstill for all such accounts during the moratorium/deferment period from March 1, 2020 to August 31, 2020.

Source: RBI

Company outlook

Capital Trust Limited has been in the business of lending to Micro Enterprises since 2008. With an experience of more than a decade for loans financed to more than 8 lakh clients, Company has been dynamic in responses to various obstacles faced along the journey and evolved innovative solutions in response of each contingency faced for enhancing the profitability and sustainability of the economically viable business. .

To counter the challenges faced at the time of demonetization and after effects including GST, the Company entered into new territories and simultaneously evolved new loan products with focus on shorter tenure, comparatively smaller ticket size and on-line payment modes (cash-less) including NACH, Wallets, Payment Gateways and Payment through links.

The company continues to operate in 10 states through 251 branches in Delhi, Uttar Pradesh, Uttrakhand, Madhya Pradesh, Punjab, Rajasthan, Odisha, Bihar, Chatisgarh and Jharkhand. The company is not disbursing in the states of UP, Delhi and Uttrakhand which were impacted by the demonetization. The loan portfolio of the company is evenly distributed, thus mitigating the locational risk to portfolio concentration in single location. The exposure in the states that were more impacted post demonetization (Uttar Pradesh, Uttarakhand and Delhi) has been reduced from Rs.405 crore or 73% of AUM as on Mar-17 to Rs.65 crore or 15% of AUM as on Mar-20. The highest exposure has been in Punjab among 10 states at Rs. 99 Crores, i.e. 21 % of AUM.

The company introduced Capital Magic Loans and Micro Business Loans. Capital Magic Loan is a multi-utility unsecured loan with tenure upto an year under quick disbursement mode offered by the Company through its mobile application Capital Sales. Micro business loan is a individual loan with 2 year tenure and higher ticket size to fulfil business related needs of the customer.

Even under the prevailing COVID situation and associated lock-downs/ moratorium scenario Company has been in touch with Clients through regular calls made to around 10 lakh clients using in-house developed calling application. There is extensive daily monitoring at Company, Cluster and Branch level and field staff strength increased to tackle difficulty in collection. Use of technology has been enhanced to facilitate digital collection, online meetings and digital receipt issuance to operate under lockdown while also following moratorium related norms.

Key strengths

The company operates with the following key strengths:

1. Robust Technology: Capital Trust Ltd. has developed an online service called Capital Sales that enhances efforts of financial inclusion by placing transparency, accessibility and technology at the heart of in this endeavour. The technology is mainly based on:

??Digitisation - With Aadhaar card as the starting point, the company sources the clients by reading the QR codes which instantly sends information to the credit bureau for checking the clients credit history. There is also geo-tagging feature to capture Client premises location and digital receipt issuance to facilitate post disbursement operations

??Automation - The services of an Android operating system are extended to clients that help them keep track of their loan progress, provide access to credit records, store KYC information and let clients repay instalments from their application with links to their bank accounts.

??Newer customer and staff channels Customers now get recorded calls for their due amount, arrears and newer eligible loans using OBD calls, SMS etc. Staff has been enabled with real-time information of customers demand sheet, arrears etc.

??New fintech products - Capital Magic and Micro Business Loans are a mix of Fintech and regular product. The company provides Capital Magic Loan to Clients within same day.

2. Focus of the company is on the ‘Missing Middle The Company continues to focus on missing middle, the economic segment that is excluded from the formal banking system as well the growing micro-finance industry.

3. Large Geographic Presence: The Company is working on hub and spoke model. For every district branch, there are four block level branches. Thus the company is close to the customers. Even though the company has now started digital product, the company has not stopped regular connect with the client. The company mainly operates in Hindi belt areas so there is no language barrier.

4. Experienced Human Capital: The company has strong human capital of more than 1900 people, who are full of knowledge and experience. The company has built a team of professionals, who have diversified experience and knowledge in their domain area. The Company has independent business, credit and compliance teams. Some of the employees in company have been with the company for more than 20 years showing great employment retention rate.

5. Effective Internal Audit: The Company has strong internal audit teams who do frequent internal audits of the branches. The frequency being quite regular helps in reduction in frauds and implementation of companys policies.

6. Large no. of lenders: The Company has more than 20 lenders, who have supported the company to reach to present level. The funders have supported the company even in the period when NBFC sector was in turmoil.

7. Liquidity of shares: The shares of the company being listed on NSE and BSE, therefore the investment by investors in the company is liquid, which can be encashed anytime. The liquidity also offers company the opportunity to tie up with institutional investors and PE funds which generally look for listed entities for investment.

8. Strong capital base: The net worth of the company is more than Rs. 154 Crores and even after huge write offs, the company has been able to increase its net-worth marginally. The company is highly capitalized as the Capital Adequacy Ratio is 47%.

The company can leverage this ratio to raise funds.

9. Multiple Products: The Company has varied products satisfying the needs of different set of customers.The company provides loans up to Rs. 60,000 in micro business and capital magic loans products.

10. Strong Systems and Processes: The Company has been in existence for more than 33 years. Over the years, the company has developed systems and processes which have been timely tested and implemented. The Companys audit team is capable enough to test the systems and enforce their implementation.

11. Renowned Board: The Board of the Company comprises of Renowned Professionals who provide proper guidance to the company. The Board is an optimum combination of Independent and Executive Directors.

Risk management

The company has a robust risk management framework in place to identify, which measures, monitors and manages the critical risks. While risk is inherent to every institution, it assumes greater significance in the context of Micro Credit due to the very nature of the business with its absence of collaterals quality and the vulnerable, financially excluded customer segment it serves. Risks may be avoided through pre-emptive action and hence the need to identify the risks and put in place various mitigation mechanisms.

Capital Trust has identified the following potential risks that could have an adverse impact on the company:

1. Credit Risk

2. Operational Risk

3. Liquidity Risk

4. Portfolio Concentration Risk

5. Compliance Risk

6. Reputation Risk

7. Strategic Risk

8. Contagion Risk

Credit Risk

Credit Risk for Capital Trust Limited is the risk of loss of interest income and the Companys inability to recover of the principal amount of the loan disbursed to its customers.

This risk can result from:

??Information asymmetry and excessive reliance on Credit Bureau check, not backed by soft information or market intelligence on a territory or group of borrowers, leading to adverse selection of borrowers.

??A volatile political presence in a region of exposure

??Exposure to activities with a high probability of variation in earnings??Default due to over-indebtedness or business failure

Credit Risk also includes Credit Concentration Risk, arising out of concentrated exposure to a particular geographical location/territory or to an activity in which a large group of borrowers are engaged in, vulnerable to external events.

Mitigation

1.1. Location Selection

Before establishing any branch, a detailed survey is conducted which takes into account the factors like credit culture, economic activity and political stability of the area. This mitigates the risk of operating in negative areas.

1.2. Credit Bureau Check

A credit check is done for every customer through an automated system-to-system integration with the Credit Bureau. As part of this check, the parameters like default history, multiple borrowings, Indebtedness and income check are looked at to verify a customers credit-worthiness and also ensure that they are not overburdened. This mitigates the risk of customer defaults.

1.3. Multi-Step Customer Verification

Capital Trust has established separate customer relationship (acquisition and maintenance) and customer evaluation (credit) personnel in order to ensure the quality of customers acquired as well as eliminate coerced borrowing practices which may lead to genuine customers becoming delinquent. This mitigates the risk of ghost borrowing and ring-leader scenario. Risk along with internal audit will be monitoring that customer verification process is followed properly else action to be recommended which should be accepted by business.

Operational Risk

Operational Risk is the risk of possible losses, resulting from inadequate or failed internal processes, people and systems or from external events, which includes legal risks but excludes strategic and reputation risk. The risk can emanate from:??Procedural lapses arising due to higher volumes of small-ticket transactions.

??Lapses in compliance with established norms; regulatory as well as internal guidelines??Misplaced/lost documents, collusion and fraud??Breakdown or non-availability of core business applications.

Internal Audit team checks the various aspects of operational risk by auditing the various SOPs/Processes.

Skill gap and sudden attrition of key personnel in the organization, is also an operational risk, which needs to be countered and addressed by the application of appropriate HR strategies.

Mitigation

2.1. Process Compliance

Capital Trust has an independent Internal Audit department which carries out surprise checks on field branches and rates them on pre-defined compliance parameters, identifies gaps in process compliance and rolls out initiatives to correct loopholes. This is done primarily to??Ensure that the designed processes are being followed on the field including interaction with the customers during various stages of the relationship lifecycle.

??Ensure all branch activities are carried out as per norms/procedures as mentioned in the operational manual.

??Identify any process lapses/deviations and provide guidance to branches/employees to ensure compliance.

This ensures that risks arising out of process lapses are mitigated. Risk should ensure that above mentioned guidelines is being followed up.

2.2. Employee Rotation Policy:

Capital Trust Limited has a policy to ensure that no field employee is posted in the same location for over two years as an effort to mitigate any chances of collusion or fraud. All field employees are either transferred to another branch or rotated to another role in a programmed manner so as to mitigate the chances of collusion with other employees or customers. The policy ensures that the employees have the predictability of their movements without putting them into undue hardships.

2.3. Document Storage and Retrieval:

Capital Trust recognizes the need for proper storage of documents as also their retrieval for audit and statutory requirements. We have put in place Physical Storage and Scanned Copies.

Portfolio Concentration Risk

Portfolio Concentration Risk is the risk to the company due to a very high credit exposure to a particular business segment, industry, geography, location, etc though in the context of micro finance, it pertains predominantly to geographical concentration.

Mitigation

Capital Trust intends to maintain a diversified exposure in advances across various states to mitigate the risks that could arise due to political or other factors within a particular state. With this in mind, Capital Trust has steadily diversified its presence from 3-4 states to 10 states.

Compliance Risk

Capital Trust is present in an industry where the Company has to ensure compliance with regulatory and statutory requirements. Non-Compliance can result in stringent actions and penalties from the Regulator and/or Statutory Authorities and which also poses a risk to Capital Trusts reputation.

Mitigation

The company has implemented a Compliance Management through its Compliance Committee with in-built work-flows to track, update and monitor compliances. The company has strong compliance team who monitors statutory compliances.

Reputation Risk

Reputation risk is the risk to earnings and capital arising from adverse perception of the image or the company, on the part of customers, counter parties shareholders, investors and regulators. It refers to the potential adverse effects, which can arise from the companys reputation getting tarnished due to factors such as unethical practices, regulatory actions, customer dissatisfaction and complaints leading to negative publicity. Presence in a regulated and socially sensitive industry can result in significant impact on Capital Trusts reputation and brand equity as perceived by multiple entities like the RBI, Central/State/Local authorities, banking industry and last but not least, Capital Trusts customers.

Strategic Risk

It is the risk to earnings and capital arising from lack of responsiveness to changes in the business environment and/or adverse business decisions, besides adoption of wrong strategies and choices.

Mitigation

This is being addressed and the risk mitigated to a great extent, by referring matters of strategic importance to the Management, consisting of members with diversified experience in the respective fields, for intense deliberations, so as to derive the benefit of collective wisdom.

Contagion Risk

Contagion risk as an enlarged version of systemic risk, refers to the probability of credit default among a large group of borrowers in a particular geographical Territory or State, arising out of external factors or political overtones, spreading to culturally-aligned neighboring Territory or State, resulting in moral hazard, thereby escalating the risk of possible default. Further in the context of micro credit, it could result mostly from ghost-borrowing and ring-leader scenarios.

Mitigation

This is being addressed by customer connect program wherein we pro-actively reach out to each individual customer as well as customers in each center to validate that the customers have genuinely applied for the loan and there has been no incidence of commission, following a relationship based mode of engagement so the customer feels a sense of loyalty to the company and is therefore less likely to be part of a mass default by others and implementing an analytics solution to study the credit bureau data and look for warning signs of increased defaults upto the pin-code level.

Operational Review

The company continues to operate in 10 states through 251 branches. The company has not entered into any new territory during the year. The portfolio has now diversified and concentration in UP has now come down to 22.74% . The maximum concentration in any state is not more than 25% indicating that the concentration risk has been reduced by the company.

State Mar-19 Mar-20

BIH 9.80% 17.45% CTG 1.15% 1.71% JHA 2.45% 3.71% MP 12.37% 13.75% ODS 9.95% 14.85% PUN 20.85% 20.98% RAJ 14.65% 13.84% DEL 0.96% 0.47% UK 5.09% 2.60% UP 22.74% 10.64%

Total 100% 100%

At aggregate level, although the portfolio has been reduced to Rs.471 Crores as on Mar20 from Rs.725 Crores as on Mar19, the proportion of new loan products has increased from Rs.2 Crs, i.e. 0.3% of portfolio as on Mar19 to Rs.134 Crs, i.e. 28.4% of portfolio as on Mar20.

At consolidated level 7.5% of portfolio is NPA, however, majority of the same is concentrated in Affected States. NPA is 4.0% in states other than Affected States representing 86.3% of aggregate CTL portfolio. Further, the NPA in fresh digital loan products is only 0.8% representing 28.4% of aggregate CTL portfolio.

INVESTMENT IN SUBSIDIARIES

The company continues to have two subsidiaries in the name of Capital Trust Microfinance Private Limited and Capital Trust Housing Finance Private Limited. There has not been any fresh investment in these companies during the year.

INTERNAL CONTROL SYSTEM

The Company has well documented internal financial controls with risk control matrix for all the critical areas of business and processes. Internal Financial Controls ensure that business is conducted on the set principles efficiently and the company adhere to policies, safeguarding its assets, prevention of errors, accuracy and completeness of the accounting records and the timely preparation of reliable financial information. The internal financial controls of the company are adequate and commensurate with the size of the business.

The Internal Auditors monitor the efficiency and efficacy of the internal control systems in the company, compliance with operating systems/accounting procedures and policies framed by the company. The department is also responsible to review and monitor the risk framework within the company. The department also undertakes audit of its branches covering all aspects of branch operations and credit audit. The department also provides independent assurance on the effectiveness of implementation of risk management framework, including the overall adequacy of the internal control system and the risk control function and compliance with internal policies and procedures.

The Company has adequate systems and procedures to provide assurance of recording transactions in all material respects. During the year, the Internal Auditors reviewed the operating effectiveness of the internal financial controls by undertaking an effectiveness testing of controls covered under the Risk Control Matrices for major processes.

The Internal Audit Department of Capital Trust upholds its departmental Vision of fostering a control environment of the organization, adding value to the organization by continuously improving operational efficiency and safeguarding the interests of the organization. The function will do so by recruiting and retaining the best talent from both internal and external sources in order to raise the profile of the Internal Audit Department within the organization.

The Mission of the Internal Audit Department of Capital Trust is to enable the organization in:

??Focusing on key business activities through motivated, skilled and experienced staff who are responsive to the customers needs;

??Engaging with different entities to facilitate positive changes to existing processes, practices and systems;

??Adopting continuous improvement initiatives and implementing best practices in developing its plan, policies and methods;

??Creating a dynamic working environment which encourages innovation and maximizes the use of new technology;

??Ensuring that its performance is monitored, measured and reported in satisfying the expectations of the different stakeholders.

The internal audit adopts a risk based audit approach and conducts regular audits of all the branches/offices of the Company and evaluates on a continuous basis, the adequacy and effectiveness of the internal control mechanism, adherence to the policies and procedures of the Company as well as the regulatory and legal requirements. The company has well drafted policies and procedure in the form of manuals.

These policies and procedures are well established and followed meticulously. The company adheres to audit process which encompasses risk identification, risk assessment, risk address and reviewing & reporting risk. The Company has established risk management and audit framework to identify, assess, monitor and manage credit, market, liquidity and operational risks. This is extremely important as many of our borrowers do not have any assets and also do not have adequate literacy skills. The company has three levels of the audit which include surprise branch audit, Pre disbursement audit for client identification and checking of credit worthiness of the clients and post disbursal audit. Under the post disbursal audit, the loan utilization is checked. The internal audit department also tracks the attendance of client in the centre meeting.

The audit recommendations are actively followed up and implemented. As part of the effort to evaluate the effectiveness of the internal control systems, our Companys internal audit department reviews all the control measures on a periodic basis and recommends improvements, wherever appropriate. In addition to inhouse internal audit department, the company has engaged independent internal auditor who submits its report to the audit committee.

Information Technology

The company has leveraged technology to effectively reach out to micro-borrowers to fulfil their requirements for income generating loans in a transparent manner. The With Aadhaar card as the starting point, our software validates identity and credit history instantly. Zxing, an open-source, multi-format barcode image processing library, scans QRs codes on the Aadhaar Card which instantly sends information to the credit bureau for checking the clients credit history, determining whether the person is eligible for a loan. Through the mobile application, a soft approval for a loan can be given to a client within seconds.

The company uses the Technology to its maximum and helped the company in attaining:

??One of the first NBFCs to start cashless disbursement of all loans since 2015.??Started process of cashless repayment for all loans in 2019.

??Automated closing of company and all branch books at 6PM daily through collation of issued Digital Receipts (SMSs sent to client on collection of any repayment).

??Client application with access to all details regarding the loan to promote transparency and authenticity.

??All staff have access to Capital Sales, the company application, that provides real-time information in even the most remote locations.

??All warehousing of information on cloud.

??Smart credit enabling client on-boarding and in-principle approval from scanning of clients Aadhar card at his doorstep.

??No manual entry allowed for any clients

The issuance of digital receipts for the repayments made by the clients, has helped the company is transparency and authenticity in transaction with the clients and reduction of frauds.

SEGMENT WISE OR PRODUCT WISE PERFORMANCE

The company has only one segment of business i.e "financing" so there is no segment wise or product wise performance available.

HUMAN RESOURCES

Capital Trust Limited is operating in ten states within India and has more than 1900 employees. The company is market-driven, and technology-based, serving customers in ten states in northern, central and eastern part of India with financial products, and services. The company aims to be the first choice of customers, employees and shareholders.

Capital Trust policy offers equal employment opportunity for all persons, without bias or discrimination. It applies to all employment practices including (but not limited to) recruitment, promotion and training. Selection of business partners is also guided by like principles.

The business of the company is directly affected by the wellbeing of all sections of the society where we operate in. It is CTL,s policy to maintain a working environment free of harassment and intimidation. Any type of harassment (including sexual harassment, verbal or implicit), or intimidation, is a violation of CTL policy, and is dealt with in accordance with corrective action procedures. The company has in place the Sexual Harassment policy, where the company has zero tolerance for any offence.

The human capital is major component in the finance industry besides capital. So having the right people at right place is the major strength of Capital Trust. We believe that the employees working with Capital Trust are realizing their dreams and in return the company achieves it goal.

Capital Trust does not hesitate in recognizing the co-existence of the Company and its Human Capital. Some of the employees in the company have been for more than 30 years with us. The company believes in long term relations with employees and the company has good retention rate.

All the employees of the company are equipped with smart phones. The employees mark their attendance through their mobile, apply for leaves, tours and tour claims through mobile app only. This has smoothened the processes and reduced the time to settle the claims. This is also environmental friendly as a lot of paper is being saved in printing.

The company has hired some senior people from reputed companies who are expert in their area of activity. With professionals at the top and fully motivated team at the field, the company is bound to grow in the future.

CAUTIONARY STATEMENT

The Management Discussion and Analysis report containing statements used for describing the Companys objectives, projections, estimates, expectation or predictions are ‘forward looking in nature. These statements are within the meaning of applicable securities laws and regulations. Though, Company has undertaken necessary assessment and analysis to make assumptions on the future expectations on business development it does not guarantee the fulfillment of same. Various risks and unknown factors could cause differences in the actual developments from our expectations. The key factors that can impact our assumptions include macro-economic developments in the country, state of capital markets, changes in the Governmental regulations, taxes, laws and other statues, and other incidental factors. The Company undertakes no obligation to publicly revise any forward looking statements to reflect future/likely events or circumstances.