IIFL Finance Ltd Management Discussions.

INDIAN ECONOMY OVERVIEW

Indian GDP growth has been on a declining trend in recent quarters - falling from 8.1% in Q4FY18 to 4.7% in Q3FY20. The largest factor contributing to this has been the slowdown in consumption, which makes up approximately 60% of the Indian economy. Private Final Consumption Expenditure (PFCE) grew by just 3.1% in Q1FY20, 5.0% in Q2FY20 and 5.9% in Q3FY20.

Just as some green shoots had started appearing, the entire world was struck with the massive impact of the contagious COVID-19 virus. Almost all the major economies of the world have gone through some form of lockdown or social distancing. The lockdown in India has severely impacted the economic growth in the fourth quarter of FY20. Indian economy grew by 3.1% in Q4FY20 and the full year FY20 GDP growth now stands at 4.2% (Source: MoSPI), weakest since the financial crisis hit more than a decade back. The lower growth rate will lead to reduced income which is expected to further reduce demand and affect the recovery in FY21. The dip in demand and lockdown has severely hit retail, tourism, hospitality, aviation, real estate and construction sectors. Also, the reduced oil prices around the world and subsequent lower demand has affected the petroleum and diesel and industries.

To mitigate the negative impact of the pandemic and the lockdown, the Government of India along with the Reserve Bank of India (RBI) has released a stimulus package of Rs 20 trillion, which is approximately 10% of GDP. The package includes additional liquidity to sectors like NBFC and MSME, government guarantees on lending by banks, greater allocation to social spending schemes like MNREGA, direct bank transfers, free foodgrains for the poor, etc. Earlier, RBI had lowered the benchmark repo rate to its lowest ever level of 4.0%. Also, the RBI announced a moratorium of another three months from June 01, 2020 1 to August 31, 2020 from the earlier 3 months on repayment of term loans and interest on working capital, taking the total period of applicability of the moratorium period to 6 months.

The shape of the post-pandemic recovery curve depends upon the length of time for which economic activity is subdued, and damage caused by it. The growth is expected to be affected in the first half of FY21, and thereafter to pick up pace in the second half. According to Fitch, Indias GDP is expected to grow to 0.8% in FY21. This reduced growth is mainly on account of reduced consumer spending and contraction in investments.

INDUSTRY STRUCTURE AND DEVELOPMENTS NBFC

Since the last decade, the NBFC sector has held critical importance in the Indian Financial Services sector. The main objective of NBFCs has been serving the underserved segment of the Indian economy such as MSME, microfinance and other retail segments. Over the past few years NBFCs have undergone a significant transformation and today they form an important component of Indias financial system. NBFCs are harnessing technology to reinvent traditional business models and offer loans in a faster, customised and more convenient way to the underbanked population of India. NBFCs especially those catering to the urban and rural poor namely NBFC-MFIs and Asset Finance Companies have a complimentary role in the financial inclusion agenda of the country.

Most NBFCs leverage alternative and technology-driven credit appraisal methodologies to ascertain the credit worthiness of prospective borrowers. This differentiated and unique approach allows them to meet loan requirements of individuals and businesses left traditionally underserved by banks. With the introduction of e-KYC and digital loan agreements making borrowing an instant and hassle-free experience, NBFC lenders are already offering the right financial products to consumers and small businesses in a customised manner. The use of technology to optimise business processes also keeps cost overheads to a minimum, enabling credit to be availed at highly competitive interest rates.

Moreover, NBFCs often have deep regional reach, which they leverage to build robust relationships with their target customer bases. Many new-age NBFCs have started investing in analytics and AI capabilities to connect to their customers in a hyper-personalised manner to serve their credit needs better.

It was a clear indication during the Budgets in July 2019 and February 2020, that the financial services sector, being the backbone of the economy, would be a focus area to boost the economy and investor confidence. For the NBFC sector, the limit to be eligible for debt recovery under the SARFAESI Act, 2002 has been proposed to be reduced from Rs 5 billion to asset size of? 1 billion or loan size from existing Rs 10 million to Rs 5 million. Secondly, the Factoring Regulation Act, 2011 has been proposed to be amended so as to enable the NBFCs to extend invoice financing to the micro, small and medium enterprises (MSMEs) through the Trade Receivables Discounting System (TReDS), thereby enhancing their economic and financial sustainability.

NBFCs (including HFCs) outstanding AUM stood at 27.3 trillion as at FY19. From FY14-FY19, it grew at a CAGR of 17%. The NBFC sector (including HFCs) are expected to post an AUM growth of 6-8% in FY20, as compared to 13% in FY19 (Source: CRISIL). Slow economic growth on account of pre-existing macroeconomic factors, COVID-19 lockdown impact, rising borrowing cost and constrained funding access are some of the reasons behind the moderated growth rate. However, NBFCs with largely retail granular portfolio are having lesser difficulty in accessing funds. These retail focused NBFCs, as they have a de-risked portfolio, are facing lesser challenge as compared to wholesale focused NBFCs.

NBFCs are also adapting to the changing environment and resetting their business model such as shift of funding for wholesale class assets to alternative investment fund (AIF) and de-risking of loan book.

On the Non-performing asset (NPA) front, the GNPA ratio for NBFC sector rose marginally from 6.1% as on March, 2019 to 6.3% as on September, 2019. These delinguencies are expected to rise by another 30 to 150 basis points (bps) by March, 2020 (Source: CRISIL). The NNPA ratio stood at a steady 3.4% as on both the periods (Source: RBI).

Similarly, in case of SCBs, the GNPA ratio remained unchanged at 9.3% in September, 2019 as compared to March, 2019. However, NNPA ratio declined moderately as of September, 2019 indicating an increase in provisioning as compared to March, 2019.

The RBI has now notified that non-residents will have unrestricted access to all 5,10 and 30 year sovereign bonds from FY21. This opens up the opportunity to tap the foreign savings and should help fund our budget deficit. A more exploration of the bond market will be important for banks and NBFCs in India from a liquidity perspective. The mutual fund AMCs also significantly lend to the NBFC sector. The mutual fund industry garnered over Rs 86 billion through systematic investment plans in the month of March 2020, a rise of 7% from the year-ago period, even as the broader market witnessed heavy volatility amid concerns over the impact of corona virus pandemic.

Liquidity Updates

Since 2019 though, this segment has faced few difficulties due to the liquidity crisis on account of failure of an infrastructure finance company. Banks tightened their credit flows and this liquidity squeeze reduced the pace of acceleration of credit as entities chose to focus on asset- liability management over AUM growth. Also, Mutual Funds (MFs) witnessed a fall in NBFC exposure due to liquidity concerns and reduction in sectoral exposure limit by SEBI in NBFC from 25% to 20%. As a result of which share ofAMC- MFs in outstanding borrowings fell from 33.0% in Jun-2018 to 25.9% in Sep-2019 for NBFCs, and from 33.1% in Jun- 2018 to 26.7% in Sep-2019 for HFCs. Alternatively, NBFCs and HFCs have resorted to banks for their funding needs via term loans, securitisation and assignment.

However, NBFCs with a solid and sound business model as well as proven teams have successfully maintained asset quality levels and driven profitability in these challenging times. The focus in FY20 was more on managing the existing loans.

In order to encourage bank lending to NBFCs, the RBI announced in August 2019 that banks can have an exposure of up to 20% of their Tier 1 capital to a single NBFC as compared to the 15% limit earlier, which enabled to increase credit flow as bank funding to NBFCs grew by 30% Y-o-Y. At the same time, the regulator also eased the priority sector lending (PSL) norms by allowing banks to provide funds to NBFCs for on-lending to agriculture up to 1 million, MSMEs up to Rs 2 million and housing up to Rs 2 million per borrower to be classified as priority sector lending. Also, to ensure that public sector banks lend further to NBFCs, the government of India has allowed the sale of BBB+ rated pooled securities to banks (Eg: Partial credit guarantee scheme). These provisions would allow NBFCs to further improve liquidity.

Liquidity Risk Management Framework

Further to counter future liquidity risk in the sector, RBI introduced a new liquidity risk management framework. Under the new framework, non-deposit taking NBFCs with asset size of more than Rs 100 billion and all deposit taking NBFCs will have to maintain a liquidity coverage ratio (LCR) requirement of 50% by December 01,2020 and progressively increase it to 100% by December, 2024. Similarly, nondeposit taking NBFCs with asset size between Rs 50 billion and Rs 100 billion would be required to have a minimum LCR of 30% by December 01, 2020. This might have produced short-term pain in the industry but its an excellent longterm measure to protect the sector from externalities, boost confidence in robustness of the sector, lower cost of funds for NBFCs (due to lower risk perception) and improve the overall risk management frameworks across the industry.

Off-Shore funding/ECBs

The offshore funding route in FY20 has enabled better- placed NBFCs to further diversify funding sources enabling them to capture relative funding-cost benefits and exploit growth opportunities. In H1FY20, companies raised over? 1.4 trillion through external commercial borrowings (ECBs) and foreign currency convertible bonds (FCCBs) (Source: SBI). NBFCs accounted for a 45% of all ECB issuances in H1FY20 out of the above amount. On a y-o-y basis, NBFC fund-raising through the ECB route increased by 80% during the period.

COVID-19 Impact

Banks as well as NBFCs are facing a downside impact on the business due to the COVID-19 pandemic outbreak and the resultant lockdown. However, the Gold loan segment is expected to perform well despite the slowdown mainly due to increased requirement for working capital and bridge finance for small businesses, traders, shopkeepers and households. Also, a reducing LTV on account of rising gold prices is an added advantage. The housing loan segment is also expected be the least affected after gold because majority of the borrowers are salaried and collections are through auto-debit instructions. However, affordable housing loans could face difficulties because of higher proportion of self-employed borrowers, whose income streams have been affected by the lockdown. Similar impact may be witnessed for vehicle loans segment, since reduced traffic may lead to lower income for fleet owners. The outreach of MFI segment is also affected since collection of repayments involves visit to households. However, the three (now six) month moratorium given by RBI has helped NBFCs to manage delinquencies better. This will also ensure adequate liquidity and working capital balance for individual borrowers and MSMEs across the country.

Fresh loan disbursements in the short term will be low and is expected to remain muted in the medium term as well. Digitised lending as well as online top-up and renewal of loans in case of products such as gold loans is the solution to a considerable extent for the slowdown in the sector since it has no physical contact, and hence zero health risk. The lower cost of on boarding and the reduced turnaround time of digitised loans also led to a lower operating cost of loan disbursement for banks and NBFCs. Fintechs can help in the process to offer end-to-end loan digitisation in collaboration with NBFCs.

Going Forward

On the business front, NBFCs will have to leverage technology heavily to keep costs and Non-Performing Assets (NPAs) low. NBFCs also need to have stricter underwriting practices and closely monitor client repayment. The most significant driver of growth will be the ability to create innovative products, delivered efficiently through the use of technology.

On the COVID-19 impact, the six month moratorium on term loan repayments given by RBI will not result in any revenue (Interest income) loss for lending banks and NBFCs as borrowers opting for deferment will either have to extend their tenure else increase the quantum of EMIs. This will ensure continuity of vital businesses and thereby ensure gradual recovery in FY21. With a well-equipped business continuity and contingency plan, NBFCs can quickly bounce back post the corona virus outbreak slows down. NBFCs with proper planning can overcome the impact of this disruption in the second half of FY21, and continue its successful growth trajectory.

Housing Finance

HFCs are specialised lending institutions which, along with SCBs, are the main providers of housing finance. Housing finance is the second-largest portfolio after infrastructure for NBFC. Several NBFCs have shifted focus to secured lending post global slowdown in 2008-09, when delinguencies on unsecured loans soared. The shift in focus can be gauged from the fact that a large number of players started full-fledged housing finance divisions as a result of which loan outstanding of HFCs accelerated. The change in focus to secured assets helped de-risk the loan books of NBFCs and HFCs and resulted in continuous improvement in asset quality.

The home loan segment in India grew over the years mainly on account of increasing demand from Tier 2 and 3 cities, rising disposable income, interest rate subventions and fiscal incentives on housing loans. HFCs grew at a CAGR of 20% from FY13 to H1FY19. In H2FY19, it grew at 8% YoY due to liquidity constraints (Source: CRISIL). The book growth in FY20 is expected to be ~2% (Source: Brickworks).

However, Indias housing finance sector has remained relatively underpenetrated compared to its peers as evident by the low mortgage-to-GDP ratio of less than 15% in FY19 as shown below. This shows the potential India holds for the mortgage market in the future. The growth is likely to be driven by factors such as young population, nuclear families, urbanisation and rising income levels.

While growth in Tier 1 centres has almost stagnated, the overall housing sector is being driven largely by growth in Tier 2 and 3 centres.

Going Forward

Though the impact of COVID-19 has affected the housing sector, it is expected to pick up in the second half of FY21. The affordable housing space, which accounts for roughly 15% of the overall portfolio of HFCs, is generating good interest in banks, and co-lending in this space will also provide required impetus to drive growth, given the government push towards affordable housing. Opportunities in the construction of affordable housing units will remain strong over the coming years, driven by Prime Minister Narendra Modis Pradhan Mantri Awas Yojana (Urban) [PMAY(U)] initiative. Also, on the liquidity front, with the fall in traditional borrowing routes, HFCs have begun to obtain a large portion of their funding through the securitisation route.

Micro Finance

In India, microfinance has fuelled the efforts of rural development, women empowerment and wealth generation by providing small scale savings, credit, insurance and other financial services to poor and low income households. One of the most important features of Micro Finance is aiding the process of attaining financial inclusion in India. They serve as a supplement to banks. There is a huge gap in demand and supply in micro credit in India and that a large part of gap is serviced by informal sources including money lenders. This represents an attractive business opportunity for MFIs in India.

Microfinance industry grew by 24% y-o-y as on December, 2019 with total loan portfolio standing at Rs 2.11 trillion. Nonbanking financial company - microfinance institutions (NBFC-MFIs) are the second largest provider of micro-credit with a loan amount outstanding of Rs 0.66 trillion (Source: MFIN report).

Government initiatives for the NBFC, HFC & MFI Segments

In order to boost liquidity, Bank credit to registered NBFCs via on-lending towards agriculture, MSMEs and housing sector up to prescribed limits will be treated as priority sector loans from April, 2020 onwards. The move is expected to boost credit disbursement in the targeted segment like agriculture, MSME and housing sector. Also, The RBI in March, 2020 mentioned that the bank credit to registered NBFCs (other than MFIs) and HFCs for on-lending will be allowed up to an overall limit of 5.0% of individual banks total priority sector lending. Banks will compute the eligible portfolio under on-lending mechanism by averaging across four quarters, to determine adherence to the prescribed cap.

In order to cater to the needs of MSMEs, the government has proposed to set up an Infrastructure Task Force that will invest around Rs 1 trillion to help restructure MSMEs and deploy these funds for the next 5 years across the industry. The government has also launched a stressed asset fund of Rs 50 billion for domestic MSMEs to sustain business and ensure availability of funds. Also, a Government-sponsored Fund of Funds (FoF) is set up to support crowd funding from Venture capital and private equity firms in the MSME sector. Under the Interest Subvention Scheme for MSMEs, 3.5 billion has been allocated under Union Budget 2019-20 for 2% interest subvention for all GST registered MSMEs, on fresh or incremental loans.

For the housing sector, in November, 2019 government allocated Rs 100 billion to set up AIFs for revival of stalled housing projects. Also, in the Budget 2020, the Union government extended the benefit of availing additional deduction of up to Rs 0.15 million for interest paid on loans for affordable houses by an additional one year till March 31,2021.

To counter the COVID-19 impact, the government has announced measures worth Rs 750 billion for NBFCs and MFIs as part of the governments economic rescue package of Rs 20 trillion. The Government allocated Rs 300 billion to buy investment-grade debt of NBFCs, HFCs and MFIs. The second measure is a partial guarantee scheme worth Rs 450 billion on primary market paper sold by NBFCs.

OPPORTUNITIES

Co-lending

One of the key obstacles currently India faces is how to covert liquidity from risk-averse PSBs into credit to fund the consumption growth. One of the most prominent way is to lend to NBFCs via co-lending. Co-lending is a very encouraging way of spreading risk, wherein the entire loan is not on the NBFCs balance sheet and the banks also do not lend to the NBFC but to the borrowers directly. The government had ushered a slew of schemes such as colending, partial guarantee and onward lending last year. However, the full potential of these schemes are yet to be explored by a wider set of NBFCs. The main advantage to NBFCs is getting access to a new set of customers and cheaper funding sources. Co-lending is expected to create considerable amount of synergy for the sector.

Increasing Consumerism

Over the years, retail borrowing in India has evolved a lot. As a result of which a paradigm psychological shift has been observed in consumers borrowing behaviour. Feisure has become an essential component of Indian urban and semiurban lifestyles and hence they are willing to take loans for instant gratification. This change resulted in a significant rise in demand for personal credit. The earlier aspirational ideology of savings has given way to consumerism. This has given boost to unsecured lending such as personal loans and credit cards across the country. Though there is economic slowdown in the economy, personal loans and credit cards continued to grow. Credit card outstanding grew at 41% in December, 2019 compared with 32% a year ago. Personal loans grew at 28% as on December, 2019 compared with 34 % in the same period last year. The volume of origination in personal loan category increased by 134% Y-o-Y. (Source: TransUnion CIBIL). With the rapid evolution over the last decade of consumer mind-set from a savings-focused and debt-averse country to a more consumption-focused, leveraged economy, the future for personal credit in India is very bright.

Partnership with Fintechs

NBFCs have better access to credit market due to its existing large customer pool. NBFCs also have a robust credit underwriting, risk management and collection process in place. Fintechs on the other hand with the use of their new-age technologies and digital tools such as Al, machine learning, and data analytics extend customised working capital solutions to the retail segment in India. They offer superior customer experience through new-age underwriting models, seamless partner integration and real-time loan decisions. Moreover, they also have access to crowd funding. NBFCs can serve the niche segments in partnerships with fintechs. This will lead increased synergies between NBFCs and fintechs.

Underserved MSME segment

There is still a large unbanked population in India who doesnt have access to formal banking channels. MSME contribute significantly to Indias Gross Domestic Product and this is a sector where there is huge potential for growth but limited access to funds from traditional banks and Financial Institutions. The Government of India has outlined a plan to increase the sectors GDP contribution to 50% from 29% (FY19), in order to achieve the USD 5 trillion target that it has set for its economy. NBFCs with wide coverage and deep penetration in rural India can play a pivotal role in serving these areas by partnering with various players in BFSI and consumption space with innovative products like Micro ATM, Cash deposit/collection, selling home appliances, bundling insurance life and health.

According to a BizFund report, only 16% of MSMEs in India receive formal credit leaving more than 80% of these companies under-financed or financed through informal sources. Informal credit ends up being much more expensive than formal debt making it difficult for MSMEs to address accumulated debt burden. The World Bank estimates the current credit gap for MSMEs in India to be at USD 380 billion. With continued digitisation efforts and improved regulatory norms for data security and protection, this credit gap needs to be addressed by NBFCs in collaboration with fintechs. According to CRISIL, the NBFC financed MSME segment is expected to grow at a CAGR of 12-13% in FY20 and FY21.

There is a huge demand for online credit from buyers, especially for mid- to high-ticket size items. Digitally focused NBFCs have effectively leveraged e-commerce platforms by offering instant credit with their innovative analytics-driven underwriting models. Also, many banks and NBFCs offer zero-cost EMI have captured a significant market share in this segment with a growing proportion of gross merchandise sales on e-commerce platforms happening through EMIs. The Indian E-commerce industry has been on an upward growth trajectory and is expected to surpass the US to become the second largest E-commerce market in the world by 2034. In future e-commerce industry is expected to attract more customers from tier 2 and 3 cities. Also, a large number of selling partners on e-commerce websites have working capital needs during demand spikes.

NBFCs with the help of process automation, analytical tools, Al etc can explore this growing market opportunity in the form of non-collateralised loans. Through its Digital India campaign the Government of India is aiming to create a trillion dollar online economy by 2025.

Growth of Digital Financial Services and tech enabled lending

Technology-driven financial services or digital financial inclusion is one of the crucial ways to serve lower-income customers in India. Digital tools have fostered speedier and more inclusive growth by dramatically reducing financial service providers costs and making services more convenient and accessible for users, especially low-income subscribers in remote locations. Internet penetration in India grew from just 4% in 2007 to 34% in 2017, registering a CAGR of 24% between 2007 and 2017. Rural internet subscriber base stood at 227.01 million and rural India penetration was 25% in FY19. Internet penetration in rural India is expected to grow as high as 45% by 2021. Urban internet subscriber base stood at 409.72 million and its penetration was 98% per cent in FY19 (Source: IBEF). Digital financial payments delivered via internet and mobile phones coupled with the rising credit demand are a huge opportunity for NBFCs and fintechs to expand their credit outreach.

Gold loan demand

Indias gold loan market is expected to reach Rs 4,617 billion by 2022 at a five-year compounded annual growth rate of 13.4% (Source: KPMG).

FY19 and FY20 saw gold loan companies aggressively expanding their branch network especially across the northern and eastern states, which was relatively underpenetrated till 2018. Though due to the COVID-19 pandemic impact the AUM growth has hit a roadblock in March, 2020 and is expected to be muted till second quarter of FY21, companies are expected to focus more on optimising their existing asset utilisation and leveraging their existing branch infrastructure to maximise the branch-level AUM and customer outreach in FY21. The main revolution in FY20 has been the onset of online and digital models in the gold loan space. Services such as verification of gold at the customers doorstep have opened up an untapped market among digitally enabled customers. NBFCs are expected to capture this market faster with quick decision making, faster adoption and better outreach as compared to banks.

More Involvement of Private Sector

The financial sector in India has a very low credit exposure as compared to other developing countries. Indias credit- to-GDP level is 51% as compared to 70% in Brazil and 136% in Malaysia. In developing countries, state banks generally comprise the minority rather than the majority of market credit share: closer to 20% versus ~70% currently in India. This trend has taken hold despite the fact that Indias gross domestic savings rate, at nearly 30% of GDR is in line with peer countries. The savings are sufficient, but the system doesnt use them effectively. In order to grow the economy at a faster rate, credit will have to grow at a faster pace while maintaining good credit quality and avoiding excessive risk taking.

Low banking credit penetration points towards a large area without access to PSB banking services, often dependent on informal sources of credit. Government initiatives for financial inclusion and the steady rise of digitisation are expected to create analytics, operational and business synergies for NBFCs and MFIs that can then capture these markets through operationally efficient and cost-effective models.

THREATS

> Sudden regulatory changes or increase in regulatory scrutiny/restrictions may affect the manner in which the current products or services are produced or delivered

> With rapid changes in technology and innovations, companies need to increase its attention towards innovation objectives alongside business growth objectives. With increasing performance expectations related to quality, timings and cost, technological upkeep is very important to keep in line with competitors, especially new competitors that are "born digital" and with a low-cost base for their operations. The risk of disruptive innovations enabled by new and emerging technologies is always present.

> NBFCs are facing stiff competition from new-age FinTechs which have been capturing a greater market share with their technology-heavy low-cost operating models and by setting new standards for customer experience.

> Uncertainty in the global markets, owing to slow growth in the advanced economies and increased strain in certain emerging economies can result in

volatile capital inflows and currency fluctuations. Increased restrictions on migration and global trade could hurt productivity and incomes and take an immediate toll on market sentiment. In Indian context, slow implementation of regulatory reforms and lack of consensus on important legislations can further delay growth.

> Notable risks to global economy include a possible shift towards inward-looking policies and protectionism, a sharper than expected tightening in global financial conditions that could interact with balance sheet weaknesses in parts of the euro area and in some emerging market economies, increased geopolitical tensions, and more trade tensions in the global market

COMPANY OVERVIEW

IIFL Finance Limited (formerly IIFL Holdings Limited) is a leading player in the Indian financial services space. IIFL offers Gold loans, Business loans, Home loans and Microfinance loans through its wide network of branches.

Promoted by first generation entrepreneurs, Mr. Nirmal Jain and Mr. R. Venkataraman, IIFL is backed by number of marguee institutional investors including Fairfax Group and CDC Group Pic. The Company is led by highly qualified and experienced management team who promote a culture of growth, entrepreneurship and innovation among the huge talent pool of more than 18,500 people. IIFL Finance has a strong geographic footprint in India with more than 2,350 business locations.

Founded in 1995 as a research firm, IIFL has consistently innovated, reinvented and adapted itself to the dynamic business environment without losing focus on its domain of financial services. Today, IIFL has diversified into a full range of financial services, serving over 4 million customers across various business segments. IIFLs strong presence across various customer segments (retail and corporate) and wide network encompassing branches, online and mobile platforms help in catering to the financial credit needs of aspiring and growing India.

Group Re-organisation

The re-organisation of IIFL Group was effected from May 13, 2019. Pursuant to the same, IIFL Wealth Management Limited and IIFL Securities Limited were demerged from IIFL Holdings Limited. Consequent to IIFL Finance Limited (earlier known as IIFL Holdings Limited) receiving registration as a Non-Banking Financial Company from the Reserve Bank of India (RBI), India Infoline Finance Limited, subsidiary of the Company, was merged with IIFL Finance Limited with effect from March 30, 2020.

Financial Performance and Operations Review

The Company has continued to diversify its portfolio with a range of products comprising of home loan, business loan, gold loan, micro finance, real estate finance and capital market finance. During the year, AUM has grown by 9%* Y-o-Y to Rs 379.5 billion. Our total comprehensive income has grown 8%** Y-o-Y to Rs 7.6 billion (post non-controlling interest).

Liquidity has been stable for us despite the COVID-19 pandemic impacting the last month of FY20. We raised long-term loans to the tune of Rs 45.5 billion in Q4FY20, out of which Rs 5.2 billion was raised post March 20, 2020 when the lockdown was initiated. A total of Rs 94.0 billion longterm loans were raised in FY20. Out of the above, Rs 28.6 billion was raised via the Companys maiden medium term note (MTN) programme issue, via the external commercial borrowing route.

We were also able to assign/securitise assets to the tune of Rs 130.0 billion in FY20. The acceptance of IIFL Finances granular retail loan book portfolio across investors is a testimony of its strong underwriting capabilities and strong portfolio quality. Our exposure to commercial paper is now zero. We have undrawn credit lines of Rs 35 billion as of March 31, 2020. We manage our Asset Liability Mismatch diligently and conservatively, with surplus in all buckets.

Consolidated GNPAs and NNPAs, recognised as per RBIs prudential norms and provisioned as per Expected Credit Loss (ECL) method prescribed in IndAS, stood at 2.31% and 0.97% of loans respectively. Under Expected Credit Loss provisioning under IndAS, provisioning coverage on NPAs stood at 128%, including standard asset coverage and COVID-19 additional provision. The same, excluding Covid provision of Rs 2,820 million, stood at 88%.

* Excludes CV business AUM of 39.1 billion in FY19. The business was divested in Q4FY19.

** in FY20, excluding onetime COVID-19 additional provision ( 2.1 billion net of tax), exceptional items of reversal of deferred tax asset reversal of Rs 500 million. Provision for Tax for Q4FY20 includes reinstatement of deferred tax reversal of 494 million post merger. Corresponding impact has been taken in the previous year. In FY19, excluding exceptional items of gain on slump sale of CV business ( 940 million net of tax), goodwill write off ( 107 million).

The primary drivers of our AUM growth were gold loans, which grew by 47% YoY, Micro-finance loans, which grew by 49% YoY and small ticket home loans which grew by a modest 2% YoY. Our synergistic segments of commercial real estate and Capital Market loans have a declining share in our portfolio.

In home loans, our focus continued to remain primarily on Swaraj loans which are small-ticket loans in affordable home segment to both salaried and self-employed sections with average ticket size of 1.3 million. Swaraj loans accounted for 39% of our home loan disbursements in FY20. Our Swaraj product is especially designed to support the informal income segment in fulfilling their dream of owning a house.

As on March 31,2020, we had over 11,000 approved housing projects, up nearly 1.2x from over 9,000 approved projects a year ago. 53% of home loans were made through these approved projects. We expect that this approach will reduce our operating and credit costs going forward.

IIFL Home Finance has been a significant player in PMAY- CLSS. Till date it has benefited over 38,300 customers and disbursed subsidies of more than Rs 9 billion

In the near term, we plan to leverage our existing branches more and undertake further innovations in our digital processes to grow a granular book and ensure healthy portfolio quality. Retail loans, including consumer loans and small business finance constitute about 88% of our loan book.

Another strong characteristic of our loan book is the large proportion of loans that are compliant with RBIs priority sector lending norms. About 63% of our Home loan, 48% of Business Loans and nearly all of our MFI loans are PSL compliant. In aggregate, nearly 43% of our loans are PSL compliant.

The large share of retail and PSL compliant loans are of significant value in the current environment where we can sell-down these loans to raise long-term resources. The share of loans sold down was 26% of total AUM as on March 31,2020.

NIM on Balance Sheet assets for FY20 stood at 6.4% and NIM on assigned assets for FY20 stood at 5.8%

Medium and high yielding assets currently constitute 53% of our AUM. These include Micro-finance loans, small ticket MSME loans, Gold loans, and Construction Finance loans. The other half of AUM consists of relatively low yielding assets including home loans, LAP and capital market loans.

83% of our AUM comprises loans that are secured and about 17% of loans are unsecured. We believe our AUM mix is well balanced.

We currently have 2,377 branches, primarily for our HFC, Gold and Micro-finance businesses.

Return on assets for FY20 was at 2.2% and return on equity at 16.9%. Return on equity for FY19 was at 17.5%. It has majorly decreased in FY20 due to a modest TCI growth at 8% as compared to net worth growth of 9% YoY.

We have continued our focus on digitisation encompassing every aspect of customer loan journey. We have focused on backend process digitisation through multiple innovations as well as partnerships, helping us achieve process efficiencies. IIFL Loans app had 622,000 downloads as at March 2020, with 145K average active users at any point of time. The application has received 1000+ positive reviews on iOS and 1500+ reviews on Android. In analytics, we continue to drive the use of credit scores and automated decisioning across products, and strengthened our risk mitigation processes by developing and deploying behavioural, collection and fraud score-cards. There is continued focus on cross-sell and win-back, with our analytically driven Gold Loan win- back generating strong volumes for both Gold business as well as group-wide products.

‘Excludes exceptional items

SEGMENT-WISE PERFORMANCE Gold Loan

The organised gold loan market in India consists of only 35% of the overall Indian Gold loan market. It is expected to reach Rs 4,617 billion at a CAGR of 13.4% by 2022 (Source: KPMG). Two-thirds of Indias gold demand comes from villages, where jewellery is traditionally used for investment. India, along with China, is among the worlds largest gold consumer.

NBFCs have been a major driving force behind the growth of the organised gold loan market given their extensive network, faster turnaround time and the ability to serve non-bankable customers. A better economic environment will also drive funding needs of small businesses, which will further boost demand for gold loans.

Business Overview

IIFL Finance offers loan against gold jewellery to small businessmen, vendors, traders, farmers and salaried people at competitive rates, minimum documentation and fast turnaround time. The Company follows a strong verification process and our officers are experienced, certified and trained in asset quality practices. Further, the gold ornaments pledged with us are safely stored in fireproof and burglary-proof vaults in our gold loan branches, which are under electronic surveillance at all times.

FY20 Under Review

The companys major focus was to increase profitability and operational efficiency along with tightening of our risk framework. It is because of our continued investments in digitisation that helped us in providing enhanced customer experience and reduced turnaround time. We also laid strong emphasis on collections and resolutions resulting in negligible losses. Our gold loan AUM grew at a healthy rate of47% y-o-y in FY20.

Outlook

We expect gold loan industry to exhibit moderate growth in FY21 despite the COVID-19 pandemic impact. We are we well placed to capitalise on this existing opportunity. We also plan to reap on the benefits of digital capabilities built during the past year and bring in cost optimisation by going completely paperless.

MSME & Others

Traditionally, SMEs have remained a financially unorganised sector. The operations and ownership of such businesses have remained confined to the family or a small group of associates. The credit gap in the SME segment has been very high in India. MSME sector accounts for 29% of Indias GDP as on FY19, the MSME sector comprises 63.3 million enterprises and employs nearly 110 million of Indias population across rural and urban areas (Source: Pwc Report). Given its contribution to the economy, the sector is a critical growth engine for the 2024 milestone. With increasing synergy between banks and NBFCs on account of co-origination, assignment etc., the future remains very positive to explore the MSME lending space.

Business Overview

Under business loans, IIFL offers various products such as - small ticket Insta loans, cash flow backed business loans and loans against POS Swipes. Our focus is to create a significant position in the rapidly growing low ticket and high yielding MSME segment. We have been providing financial solutions to MSMEs by using technology as an enabler and deliver faster turnaround time to ensure customer satisfaction. We have also e-integrated with all our partners for seamless end-to-end process.

FY20 Under Review

The Company continued to leverage its customised product offerings like Emergency personal loan during lockdown under Covid-19 scheme, Scheme against GST return to help people who are regular in filing GST returns, funding to retailers against POS swipe machines to encourage digital medium of payment and strengthened its sales as well as support team. Investments in technology and partnerships during the year have helped in achieving operating efficiency. As a part of robust risk framework and to achieve operational efficiency, strong and prudent credit underwriting practices were balanced with instant inprincipal decision and automated disbursements based on analytical scorecards.

Outlook

The company will continue to target the under-served MSME segment that lack adequate financial facilities due to small loan ticket sizes, difficulties in credit evaluation, distribution etc while focusing on proprietary underwriting methods. We will focus on enhancing customer experiences by providing seamless and integrated services throughout the customer life-cycle.

Mortgage Loans

A burgeoning middle class, rising disposable income and support from the government in terms of interest rate subsidy as well as tax reliefs have increased the affordability of homes in Asias third-largest economy. The current government has viewed housing as the core of its economic policy and announced various schemes and policies to increase home ownership. It has been realised that in addition to its social aspects, housing is also a key driver of economic growth with its ability to create employment and its linkages to multiple other sectors. The home loans segment in India, the largest business segment for NBFCs (incl. HFCs), grew by ~2% in FY20 (Source: Brickworks).

Business Overview

The company provides loans for purchase of residential property, home construction, home improvement, and plot loans. It also offers a range of loans backed by mortgage of residential or commercial properties to small & medium enterprises for working capital requirements, business use, purchase of commercial property and other similar purposes. IIFL has in place a robust platform to undertake necessary checks regarding the borrowers credit background, and to conduct legal and technical security evaluation. It leverages on external as well as internal appraisal of properties, including valuations by international property consultants for large mortgage loans.

FY20 Under Review

IIFL believes in "Housing for all" mission of the government and is actively participating in their initiatives - mainly the credit linked subsidy scheme. The company is also looking forward to build associations with various state housing boards as a key loan partner for affordable housing projects.

The company has expanded its reach in Tier 2 areas and plans to leverage group company network of 1000+ touch points to increase our presence. The company has also started sourcing all its Home loans to salaried customers through tablet and in the coming year all home loans will be sourced digitally.

Outlook

Despite the slowdown caused by the COVID-19 pandemic, it is expected that businesses will pick up in the second half of FY21. Co-lending and securitization are going to remain the catalyst of the next fiscal to boost home loan growth trajectory. HFCs are expected to grow at 6% in FY21 (Source: India Ratings). Government measures such as partial credit guarantee scheme, onward lending etc. will improve liquidity and enable NBFCs (incl. HFCs) to better manage their asset-liability profile. The company expects the growth to sustain by focusing on affordable housing, investments in technological infrastructure and prudent risk management.

Microfinance

With a significant portion of its population in the low- income band, India represents a huge opportunity for the microfinance sector. Though government schemes and established financial institutions have enhanced access to microcredit for nearly two third of the Indian population living in rural areas, only 34% of the districts with microfinance presence contribute 80% of the portfolio (Source: PwC). This shows the significant geographic concentration of MFIs within a few districts of the country and indicates the potential for achieving higher microfinance penetration.

Business Overview

IIFL Finance offers micro loans, credit linked insurance, group based savings accounts to empower communities. It consists of high-yielding granular portfolio dominated by Self Help Groups (SHGs) of women for income generating activities.

FY20 Under Review

IIFL Finance MFI segment continued its growth trajectory in FY20 with a healthy AUM growth of 49% y-o-y. The focus was more on increasing on efficiency and productivity by leveraging the existing branch outreach. We opened less number of branches as compared to past years and focused more on increasing customer base across all the branches. We crossed 1.5 million customer mark with a branch strength of 561 in 17 states as of March 31,2020.

Outlook

The MFI segment is expected to slowly pick up pace with the lockdown being relaxed in many parts of the nation in the first quarter of FY21. This segment is a very crucial component in India to achieve its goal of financial inclusion. Microfinance market in India remains substantially underpenetrated as compared to top markets globally. The Company will be focusing on geographies which still relatively low concentration of microfinance, by leveraging our existing branch networks.

RISK MANAGEMENT & GOVERNANCE

Risk management is a key element of IIFLs business strategy and is integrated seamlessly across all of its business operations. The objective of IIFLs risk management process is to optimise the risk-return equation and ensure meticulous compliance with all extant laws, rules, and regulations applicable to all its business activities.

IIFL seeks to foster a strong and disciplined risk management culture across all of its business activities and at all levels of employees. IIFL takes a holistic view of risk management and undertakes an enterprise-wide risk management approach under the Enterprise Risk Management (ERM) Framework. IIFL believes that ERM provides a sound foundation to ensure that the risk-taking activities across the Company are in line with the business strategy, the risk appetite approved by the Board and regulatory requirements.

The Company operates primarily in the financial services space. IIFL Finance Limited is an NBFC registered with RBI, and the housing finance subsidiary namely India Infoline Housing Finance Limited is registered with National Housing Bank.

Your company adopts the three lines-of-defence model wherein management control at the business entity level is the first line of defence in risk management. Various risk control and compliance oversight functions, established by the management are the second line of defence. Finally, the third line comprises the internal audit/ assurance function.

The compliance function forms a critical part of the Companys operations. IIFLs experienced compliance and audit and risk management teams play a vital role in ensuring that rules and regulations are strictly followed in all processes, not just in letter but also in spirit. The risk management discipline is centrally initiated but implemented at across the Company. Each of the main businesses viz. NBFC, HFC and MFI, have a dedicated risk management teams in place.

IIFL has adopted digital initiatives in all its key businesses, starting with loans and credit as well as customer service, internal operations and HR. Digitisation helps in growing business faster and to achieve critical mass and further grow exponentially using Do-It-Yourself model in a seamless manner with the cutting edge technology with minimum physical infrastructure and manpower. Digitisation ensures less human intervention and superior customer service. Moreover, technology vastly eliminates the scope for any fraud, omission, and commission of errors.

The diversified financial services at IIFL are exposed to various risks that are either inherent to the business or exposed to the changes in external environment. In order to maintain financial soundness of the Company, it seeks to promote a strong risk culture throughout the organisation. All major risk classes viz Credit Risk, Liquidity Risk, Finance Risk, Fraud Risk, Business Risk and Reputational Risk are managed via well-defined risk management processes. It is this strong risk culture that enables operational throughput even during times of Covid-19 pandemic. Additionally, we would continue to strengthen our risk infrastructure based on our learnings during the lockdown.

Risk Risk Response Strategies
Credit, Liquidity and Finance Risk • IIFL has a separate multi-level Credit and Investment Committee, consisting of Directors of the Board / Head of the Departments, for IIFL Finance Limited and India Infoline Housing Finance Limited, to consider medium to large credit proposals. However, smaller proposals are decided at appropriate level as per the approval matrix.
• The Group has in place Risk Management Committee and Asset Liability Management Committee (ALCO), consisting of Directors and senior officials. They regularly meet and review the policies, systems, controls, and positions of the financing business. The Risk Management Committee reviews the risk management processes, covering credit and underwriting controls, operations, technology and compliance risks.
• Also in place are product specific lending policies, credit approval committees and regular monitoring of exposures.
• In the housing finance business, every policy and procedure is approved jointly by CEO, CRO and policy head in consultation with concerned functional heads.
Technology Risk • Management periodically reviews various technology risks such as protecting sensitive customer data, identity theft, cybercrimes, data leakage, business continuity, access controls, etc.
• Company has put in processes, systems and tools for ensuring vigilant monitoring, audit logging and suspicious activity reporting.
• Audit logs are reviewed for any anomalies and pattern deviations on a periodic basis
• Company has implemented tools for mitigating various security risks - restriction of tool access, mobile device management and secured internet access.
Risk Risk Response Strategies
Compliance Risk • The Company has a full-fledged compliance department manned by knowledgeable and well- experienced professionals in compliance, corporate, legal and audit functions. The department guides the businesses/support functions on all regulatory compliances and monitors implementation of extant regulations/circulars, ensuring all the regulatory compliances, governance and reporting of the Company.
• The Company has implemented business-specific Compliance Manuals, limit monitoring systems and AML/ KYC policies.
• In the year, compliance with corporate acts, including Companies Act, RBI-NBFC regulations, NHB-HFC regulations and so on was verified by independent secretarial auditors on the holding company and major subsidiaries, during the year. Their reports and recommendations were considered by the Board and necessary implementations have been initiated.
• The compliance requirements across various service points have been communicated comprehensively to all through compliance manuals and circulars. To ensure complete involvement in the compliance process, reporting processes have been instituted by heads of all businesses/ zones/area offices and departments, through submission of quarterly compliance reports. The compilations of these reports are reviewed by the Audit Committee/Board and are also submitted to regulatory authorities, periodically. Besides, the internal auditors verify the compliances as part of their audit process.

HUMAN RESOURCES

IIFLs human resource department is aligned with business strategy, implement digital solutions, and build a strong culture of transparency and service orientation within the organisation. The Company continued to put in place people-friendly policies and practices in the past year and continues to focus on adopting best practices for its HR policies.

Strong Management Team

The Company continues to attract professional and experienced talent from various sectors including, BFSI, Technology, Software and Start-ups. This has created a transparent, meritocratic and performance driven culture. With the right leadership at the helm, we are able to attract and create a professional team driven by a sense of purpose.

Training & Development

Technology led interventions form the core of our employee, channel and customer learning journeys at IIFL. Through ‘MoneyVersity - our Learning Experience Platform, we have been able to enhance our stakeholder learning experience, beyond proprietary learning content, but also get them exposed to a larger and wider access to national and international content of quality. Learning now is not just limited to pure functional or technical content, but extends beyond to areas such as Covid -19 Impact, Health & Wellness, Leadership stories and Insights, Women centric specific learning events, Motivational videos, Sales Enables, Personality Development etc. This is powered through leveraging the capability of Artificial Intelligence, thereby positioning learning as a truly enjoyable, timely and need based solution. Learning Industry recognition received from Tata Institute of Social Science (TISS) for our Best Digital On The Job Training program, hold as accredited validations for our unique learning digitization efforts.

Fast Track Career Path

In line with our meritocratic culture we have introduced the Role Elevation Panel Process to fast track careers of high- performers through a fair and transparent panel process. This has encouraged employees to perform their best and grow rapidly in their career within the organisation.

Special fast track program was formulated for the recognised high potential employees. These include program towards honing their skills and competencies, special learning and development initiatives which will enable them to meet their career aspirations within the organisation.

Employee Engagement

IIFL believes in engaging its work force and grooming them to become leaders of tomorrow. We have participated and received certification by "Great Place to work" survey that studies the work culture. According to GPTW survey a great workplace culture is a High-Trust, High-Performance Culture. A great workplace is one where employees TRUST the people they work for, take PRIDE in what they do, and ENJOY (Camaraderie) the Company of the people they work with. Such organisations are characterised by great leadership, consistent employee experience, and sustainable financial performance.

The certification represents the most definitive employer- of-choice and workplace quality recognition that any organisation can receive

We also use Workplace as a creative and robust communication platform that serves multipurpose as employees are able to communicate business information, posts relevant articles news and photographs, conduct polls and surveys to actively engage on this platform which proves to be a quicker and interesting way of communication

Monthly, Quarterly and Annual Rewards and Recognition programs are conducted to not only appreciate the exemplary contributions of performing employees, but also to make it aspirational for the others to leverage their potential.

Other engaging events like sports, cultural and festive celebrations, contests, etc. are regularly conducted which enable employees to de-stress, improve team bonding and bring about a new spurt of exuberance within the employees.

Encouraging Performance

IIFL, as an organisation, holds performance and potential to determine employee growth and promotions. Individual Performance Measures (IPMs) for employees is IIFLs very own way of setting expectations across clearly demarcated parameters. Thereafter an effective feedback mechanism from time to time helps the employees to improve their skills. This helps in alignment of the organisational objectives and employees personal goals. An effective PMS helped Company in recognition and rewarding peoples performance.

Technology Enablement

The Company uses Adrenalin as a one stop employee interface for all their human resources related requirements. This system is easily accessible 24X7 through intranet and as a mobile app.

Apart the yearly survey regular connect with employees is enabled via adoption of an AI Bot to chat with employees during their service completion years in the organisation to understand their work experience , seek their feedback and suggestions, with an aim of creating a more conducive work environment.

Management Connect

Considering the importance of management interaction, our Chairman has a periodic live connect session "Ask Nirmal" with all employees through Facebook @ Work. During this session the management discusses the Company overview, goals and future plans, opportunities and challenges etc. The sessions are also opened to live questions from employees which are answered by the management. These sessions have enabled all employees to be aligned with the Companys vision, get clarification or bring to the managements notice any concerns and helped enhance management connect across hierarchy. The Top 10 Performing employees across all business are announced on this forum by the Chairman for their significant contributions during the previous month.

Business Heads too conduct regular Town halls @Workplace which enables them to connect with all their employees at one go and set their business expectations. This is apart from their frequent interactions with their team during the monthly and quarterly reviews. Business suggestions are accepted from all the employees and the feasibility of these suggestions are discussed during the Town hall

As on March 31,2020 the Company has a strong workforce of 18,569 employees.

INTERNAL CONTROLS

The Companys internal audit is conducted as per the Annual Audit Plan approved by the Audit Committee. The scope of internal audit covers all aspects of business including regular front-end and back-end operations and internal compliances. It lays emphasis to check on process controls, measures undertaken by the Company to monitor risk and to check on leakages or frauds. The Company has invested in ensuring that its internal audit and control systems are adequate and commensurate with the nature of business, regulatory prescriptions and the size of its operations. Moreover, the Company is ISO/IEC 27001:2013 certified and also implemented effective information security processes reinforcing our commitment to provide robust and secure technology for all our customers.

The internal control system is supplemented by concurrent and internal audits, as well as special audits and regular reviews by the management. For Company-wide internal audits, the Company has distributed the audit of major businesses to separate top audit firms to have wider and heterogeneous verification approach and inputs, and derive larger value from the audit process. In this regard, the Company has in place KPMG for NBFC, HFC and MFI businesses.

The Company has put in place enhanced risk based supervision systems and ensures continuous monitoring. The Company has an internal team of audit professionals at its head office in Mumbai, supported by regional teams at zonal offices. The Company has in place separate internal audit teams dedicated for major business verticals i.e., NBFC, HFC and MFI. The internal team undertakes special situation audits and follows up on implementation of internal auditors recommendations and action taken reports. In addition, the Company complies with several specific audits mandated by regulatory authorities such as SEBI / Exchanges / Depositories, and the reports are periodically submitted to the regulators.

The Board/Audit Committee reviews the overall risk management framework and the adequacy of internal controls instituted by the management team. The Audit Committee reviews major instances of fraud on a quarterly basis and actions are taken on the same. It also focuses on the implementation of the necessary systems and controls to strengthen the system and prevent such recurrence. The internal processes have been designed to ensure adequate checks and balances, regulatory compliances at every stage. Internal audit team carries out a risk-based audit of these processes to provide assurance on the adequacy and effectiveness of internal controls for prevention, detection, reporting and remediation of frauds.

INTERNAL FINANCIAL CONTROLS

The Company has in place adequate internal controls with reference to financial statements and operations and the same are operating effectively. The Internal Auditors tested the design and effectiveness of the key controls and no material weaknesses were observed in their examination. Further, Statutory Auditors verified the systems and processes and confirmed that the Internal Financial Controls system over financial reporting are adequate and such controls are operating effectively.

OUTLOOK

The outlook for Indian economy remains optimistic in the long run as compared to the global economy, which is expected to contract. The output loss on account of the health emergency and related containment measures is mainly expected to impact the first half of the FY21. If the pandemic subsides and domestic demand picks up in the second half, growth trajectory can be resumed in the second half of FY21, restoring back consumer and investor confidence. The weakness in global growth rules out the possibility of pick up in Indian exports and the government will have to rely on internal consumption and investment to drive growth. That said, weak global growth should keep commodity prices in check which in turn will keep domestic inflation and current account deficit under control. Survival and resumption of MSMEs is of utmost importance for growth revival. The angst against Chinas handling of the overall pandemic also offers a big opportunity to India in terms of becoming the manufacturing hub for market leaders in electronics and communications.

Our company in past few years has made substantial investments in people, processes and technology and continues to focus on delivering steady performance. We are cognisant of the changes in the financial services sector and well prepared to overcome challenges and sustain performance.

For IIFL Finance Limited
(Formerly known as IIFL Holdings Limited)
Nirmal Jain
Date: June 07, 2020 Chairman
Place: Mumbai (DIN: 00010535)