A microfinance lender has 30% of its book in one state where loan waiver talk is breaking repayment discipline. Stress that state for an 8% default rate with a 60% loss, and show what it does to profit, returns and capital.

The stress cuts pre-tax profit from Rs 200 crore to about Rs 128 crore, ROA from 2.7% to 1.7% and ROE from 15% to 9.6%, and costs about Rs 54 crore of capital after tax. Trouble in 30% of the book removes 36% of profit, and if the bad loans also stop paying interest, profit falls to about Rs 104 crore. Capital holds: equity stays near 20% of loans. The lesson is that a state is a single borrower in disguise, because everyone there stops paying for the same reason on the same day.

Think of a tiffin service whose customers all work in one office building. If that office closes, the service does not lose customers one at a time; it loses them together. Microfinance borrowers in one state share one politics, one monsoon and one rumour, so their repayments move together. A waiver announcement is not a credit event for one borrower; it is a signal to every borrower in the state that paying back may be a mistake. That is why the stress is applied to the whole Rs 1,500 crore at once rather than spread across the Rs 5,000 crore book. Concentration riskExposure to one borrower, sector or place large enough that a single event there moves the whole lender's results. is usually taught as one large borrower; here it is one large geography.

Work it in three lines. 8% of Rs 1,500 crore is Rs 120 crore of loans that stop performing. A loss given defaultThe share of a defaulted loan that is never recovered, after collections, security and write-backs. of 60% means Rs 72 crore of that will not come back, and the lender must provide for it now. Pre-tax profit falls from Rs 200 crore to Rs 128 crore, a 36% drop from trouble in 30% of the book. There is a second, quieter cost. A loan that is not being repaid is not paying interest either. At a 20% yield, Rs 120 crore of non-performing loans stop earning about Rs 24 crore a year, which takes pre-tax profit to about Rs 104 crore if the loans stay bad for a full year.

In a normal year profit after tax is Rs 150 crore: ROA of 2.73% on Rs 5,500 crore of assets and ROE of 15% on Rs 1,000 crore of equity. Under the stress, profit after tax is Rs 96 crore, ROA 1.75% and ROE 9.6%; with the lost interest as well, Rs 78 crore, 1.42% and 7.8%. Capital takes the hit through profit: the after-tax cost of the stress is Rs 54 crore, 5.4% of equity, so Sahbhagi ends the year with about Rs 1,096 crore of equity instead of Rs 1,150 crore. Equity stays near a fifth of the loan book, so at 8% this is a profit event, not a solvency event. It becomes a solvency question only if the stress is much deeper: profit reaches zero when about 22% of the state's book turns bad. Regulators will also look at provision coverage and the capital adequacy ratio, whose current minimum you should confirm from the rules in force.

The loss is survivable; the shape is the problem. The same event in a state holding 10% of the book would cost Rs 24 crore, a sixth of the hit, so the Rs 72 crore is the price of concentration, not of microfinance. Tell the risk head three things. Cap any single state at a share the equity can absorb twice over, and say what that number is. Price loans in the heavy state for the extra risk, or slow growth there until the share falls. And watch collection efficiency in the state weekly, because waiver talk shows up in collections long before it shows up in the accounts. Name the limit of the exercise too: waiver talk spreads to neighbouring states, so the real stress may be wider than one state, and a regulator may ask for provisions beyond what the loss estimate requires.