Ramesh S Arunachalam
Rural Finance Practitioner
I was recently talking to a very good friend who understands equity and related matters rather well. I was curious to pick his brains on the “famous” securitisation mechanism and here’s what we came up with regard to securitisation in micro-finance…Read on…
A couple of very important aspects unique to micro-finance appear to have an impact on securitising micro-finance assets and those involved in this doing such deals may want to watch out for the following issues. I pose these as questions to ask and while these are drawn from the present micro-finance crisis in the Indian context, they can be adapted and used in other countries as well…
Client Acquisition Approaches Used By MFI: First and foremost, this is a very crucial issue and as I noted in an earlier post, there are several ways in which this can be done. The various methods and their implications for micro-finance securitisation are given below:
So, I would ask the following key questions here (not exhaustive):
· How has the MFI, whose portfolio is being securitised, acquired its clients?
· Do the client acquisition strategies adopted by the MFI pose any problems for securitisation? If yes, what safeguards need to be built into the deal to mitigate the risks?
Frauds and Internal Control Failures in Portfolio: A second issue is the aspect of growth pattern of the MFI whose assets are being securitised and whether there could be frauds and internal control failures due to this. MFIs that have grown very, very fast could have a significant proportion of (Akerloff’s) lemon’s in their portfolio because of the rapid pace of their growth which may have undermined, stressed and/or sheared existing systems. Examples of the kind of frauds and control failures that could exist are given here in an older post. Click here for the same. The implications of such kinds of frauds and control failures for securitisation are given below:
Loan Disbursement Related Frauds: The most common ones are: ghost or non-existent clients and staff giving loans to themselves (through non-existent clients) - the securitised portfolio in such cases could have a significant proportion of Akerloff lemon’s. It goes without saying that such a portfolio would constitute a very serious credit risk. Further, sometimes, the staff indulge the clients and get them higher than required loans and take the remaining (excess) loan amount from clients – here too, there would be a serious credit risk as most often such staff either migrate or leave and the clients are thereafter unwilling to pay back the portion of loans not used by themselves (rather taken by the staff). Sometimes, staff have collected some extra fees upfront and again, there could be a credit risk as clients may not be able to or want to pay back, given that some “corruption” charge has been paid already by them. In a few MFIs in India, I have found that while incentive systems based on loan disbursement do not exist on paper, they actually operate on the ground. That needs to be ascertained during any securitisation deal.
Loan Repayment Related Frauds: A very common occurrence here is that staff retain regular and/or pre-payments by clients and do not pay back to the institution. This could result in a significant loss for the securitiser. Further, in a few MFIs in India, I have found that while incentive systems based on loan repayment do not exist formally on paper, they actually operate on the ground through different means including ZERO PAR POLICY of MFI and related mechanisms where by field staff cannot come back without collecting client repayment. In few cases, I have seen staff even being given loans and/or having to pay large delinquent amounts from their personal resources. When this is the case, after some time, it is only natural that the staff try and minimize their personal losses and hence, they talk and act very tough on the ground with clients…resulting in what is often called today as coercive repayment recovery…this problem gets even more exacerbated when loan disbursement is supply led…
The above aspects also need to be ascertained during any securitisation deal…
Here too, I would ask the following critical questions (not exhaustive):
· What can be said with regard to the growth pattern of the MFI, whose portfolio is being securitised?
· Are systems, practices and procedures at the MFI strong enough to withstand this rapid growth?
· Are there any differences between various (MIS, internal audit etc) intended systems, procedures and practices (as they exist on paper) and the implementation on the ground (realised systems in operation)? Is it likely to have caused loan disbursement and/or loan repayment frauds and control failures? If yes, what are the implications for future repayments?
· Does the growth pattern of the MFI, whose portfolio is to be securitised, suggest that growth has come from offering supply led (multiple) loans to shared JLGs and clients? Could this growth have caused high levels of indebtedness in the clients whose portfolio is being securitised?
Thus, the questions under both aspects given above, certainly need to be asked during a securitisation deal…as they have implications concerning the nature of the obligor(s) on whom cash flows are dependent… and ability to estimate the cash flows from the assets being securitised as well as payment frequency and the propensity to prepay or make delayed payment…
Suggested Strategies: Three possible strategies could help in alleviating the above problems and ensure a higher degree of safety in securitisation of micro-finance assets. First, stakeholders need to be aware of the critical issues such as those mentioned above and constantly keep asking questions as part of a securitisation deal. Second, it seems like an appropriate strategy and well worth the cost, for securitisers, to commission small sample studies by unrelated third parties (with no conflict of interest) – especially, for first time as well as large quantum securitisation deals. Third, it also seems necessary to bring in a fair trade kind of certification (like Liz Rhyne has been saying) and permit securitisation only if the relevant MFI associations (and/or regulators) certify that the concerned MFI is indeed practicing ethical lending practices (defined appropriately)…that will go a long way towards eliminating the above problems in securitisation and get the incentives right for micro-finance securitisation…
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