Securitisation of assets by NBFCs came under regulatory purview with draft guidelines being put on the RBI website on June 3rd. With more than 80% of the microfinance market being with NBFC MFIs, this has a strong effect on the microfinance securitisation market. Securitisation has recently come up as a way for small but high quality microfinance institutions (“MFIs”) to tap debt capital markets. Microfinance loans are unique in their nature due to characteristics such as a short one year term, group based credit risk exposure, periodic weekly repayments and very low default rates. The minimum holding period of nine months, as specified in the Draft Securitisation Guidelines, closes the nascent microfinance securitisation market, important not only for the growth of the microfinance sector in a way that reduces systemic risk, but in my view, also for the overall financial inclusion agenda of the country.
There are only three ways in which an MFI can fund itself:
(a) Accepting Deposits;
(b) Bank loans; and
(c) Capital markets.
Accepting deposits as a source of fund is quite rightly not available to MFIs and banks have a strong preference for larger MFIs who are able to absorb large amounts of funding quickly. Banks either lend directly to them or purchase portfolios from them. MFIs (both large and small) represent an essential component of the financial inclusion strategy for us in India and today, they serve more than 20 million clients with over Rs. 17,000 crores of loans However, as it stands, the microfinance sector is highly concentrated, with the top ten MFIs comprising about 75% of the market. As the market expands if growth is restricted only to these ten MFIs, it could present significant servicer concentration risks. In my view small but high quality MFIs are also needed to better serve our diverse populations as well as to address servicer concentration risk concerns. For these smaller MFIs, securitisation represents a very important additional source of capital markets funding, which has been taken away with these new guidelines.
While promoting sound asset quality through capital markets oversight and the involvement of intermediaries such as CRISIL and IFMR Capital, securitisation has also enabled reduction in the cost of financing to MFIs by over 200 basis points and more than one MFI has in turn reduced interest rates to their own clients. The Draft Securitisation Guidelines take an important step forward in ensuring orderly risk transfer from high quality local financial institutions and MFIs to large well-capitalised institutions such as banks and mutual funds, in the capital markets. The minimum retention requirement (MRR) of 5% in the first loss portion, as prescribed in the current draft, ensures that originators retain strong incentives for good due diligence as well as ongoing collection and monitoring. In fact, the microfinance securitisation transactions have seen MRR in the range of 10%. This is much higher than the historical default rate observed in the pools and is substantially higher than the 5% MRR prescribed under the new Draft Securitisation Guidelines.
However, I want to suggest that the minimum holding period (MHP) for one year microfinance loans with periodic weekly instalments (since a majority of microfinance loans are 50 weeks in maturity with weekly repayments) could be specified as the period pertaining to
(a) repayment of 9 instalments or
(b) repayment of 20% of the principal amount of the loan – whichever is larger.
The minimum holding period will then be linked to the tenor, as well as the frequency of repayments of the underlying micro-loans in the same way that the Guidelines make a distinction between bullet repayment loans and amortising loans. Also, a further suggestion would be to bring direct bilateral portfolio assignments under the purview of the Draft Securitisation Guidelines, else, off-balance sheet direct assignment transactions may continue in an unregulated, perhaps under-capitalised fashion.
The size of the microfinance sector is currently small (circa Rs. 17,000 crores) when compared to the combined banking and mainstream NBFC industry. There is much scope for outreach as currently, vast regions and populations of the country are uncovered. To achieve the dual goals of financial inclusion and the design of a stable and efficient financial system for the microfinance sector, the growth and development of high quality small MFIs is a must and deserving of careful regulation.
[The author is the CEO of IFMR Capital Finance Private Limited]