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Microfinance securitisation: Impact of client-acquisition strategies and other factors

A number of chinks need to be ironed out during the process of microfinance securitisation. The RBI needs to look into these while finalising its draft guidelines on this subject

The RBI (Reserve Bank of India) has put up the draft guidelines on securitisation on 27th September and it includes guidelines for the "Lock-in Period and Minimum Retention for Securitisation Exposures: To ensure that the originators do not compromise on due diligence of assets generated for the purpose of securitisation, it was proposed in the Annual Policy Statement of April 2009 to stipulate a minimum lock-in period for bank loans before these were securitised. It was also proposed to lay down minimum retention criteria for the originators as another measure to achieve the same objective. Accordingly, it is proposed: that the minimum lock-in period for all types of loans would be one year before these can be securitised; and that the minimum retention by the originators will be 10% of the pool of assets being securitised".i

While the above aspects are important, a few other very important issues unique to microfinance appear to have an impact on securitising microfinance assets and those involved in this doing such deals may want to watch out for these. In other words, there are several peculiarities with regard to microfinance loan assets that need to be carefully considered while engaging in aspects such as securitisation:

a)    Microfinance loan assets tend to be predominantly small in amounts but large in number;
b)    While the transactions are also small, they are however numerous (repetitive) and most often, predominantly cash oriented-this makes it difficult to trace the source as well as end-use;
c)    The geographic diversity is huge in a country like India and these assets tend to be spread over remote rural areas and/or urban slums that make it rather difficult to physically locate them. Therefore, establishing the identity of the microfinance borrower and, hence, the loan asset becomes rather difficult. This is a very critical issue for securitisation; and
d)    While many of the lenders ask for KYC (Know Your Customer) documentation, it must be noted that what is provided is far from accurate. Therefore, it is very easy for an MFI (microfinance institution) to show the same assets for different lenders and redeploy the (surplus) funds in other activities like real estate and the like. Much of this was highlighted, as far back as May 2005, in the (now infamous) paperii  of Thorat and Arunachalam (2005).

Thus, as noted above, these peculiarities can cause serious problems for securitisation of microfinance assets and especially, those who buy these securitised assets must be very careful as there is a good chance that there may be no real persons at all with the associated assets or the assets themselves may have been hypothecated or pledged to other lenders. Also, there are other issues as well which impact securitisation and need to be considered by the RBI—while these are drawn from the present microfinance crisis in the Indian context, they can be adapted and used in other countries/contexts also by other central banks.

Client Acquisition Approaches Used By MFIs: First and foremost, this is a very crucial issue and there are several ways in which this can be done. The various methods and their implications for microfinance 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) Lemons 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 a previous Moneylife articlev . 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 Lemons. 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 prepayments by clients and do not pay back to the institution. This has implications for securitisation. 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 MFIs and related mechanisms whereby field staff cannot come back without collecting client repayment. In a 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 tries and minimises 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 and this again, would have implications for securitisation.

Thus, the above aspects also need to be ascertained during any securitisation deal and here too, I would ask the following critical questions (not exhaustive):

1.    What can be said with regard to the growth pattern of the MFI, whose portfolio is being securitised?
2.    Are systems, practices and procedures at the MFI strong enough to withstand this rapid growth?
3.    Are there any differences between various (MIS, or Management Information Systems, 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?
4.    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 all 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. Three possible strategies could help in alleviating the above problems and ensure a higher degree of safety in securitisation of microfinance 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 the first time as well as large quantum securitisation deals. Third, it also seems necessary to bring in a fair trade kind of certification (or equivalent) 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 microfinance securitisation and I hope that the RBI considers these issues as well when it finalises its draft guidelines.

  iiThorat, Y S P and Ramesh S Arunachalam, (May, 2005), "Regulation And Areas Of Potential Market Failure In Micro-Finance", Paper presented at the NABARD High level policy conference in New Delhi
 iv (a); (b); (c) 

(The writer has over two decades of grassroots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural/urban development and urban poverty alleviation/governance. He has worked extensively in Asia, Africa, North America and Europe with a wide range of stakeholders, from the private sector and academia to governments).


Plan panel distances from poverty line definition

"The affidavit before the court is a factual affidavit in answer to questions asked by the court. Our legal representative will be there in the court (to explain our position), we will abide by what ever the court order," Planning Commission deputy chairman Montek Singh Ahluwalia said

New Delhi: Under attack over the Rs32 per capita per day cut off for poverty line, the Planning Commission on Monday distanced itself from the controversial definition presented to the Supreme Court saying it did not represent its views, reports PTI.

Addressing the media, Planning Commission deputy chairman Montek Singh Ahluwalia also said that these figures were not used for extending benefits to the deprived sections of the population.

"People allege that the Planning Commission is trying to understate poverty which is simply not true...," he said while addressing a joint press conference with rural development minister Jairam Ramesh.

The Planning Commission has come under flak following the affidavit submitted in the Supreme Court, which said that persons consuming items worth more than Rs32 per day in urban areas (Rs26 in rural areas) are not poor.

As per the affidavit, a family of five spending less than Rs4,824 (at June 2011 prices) in urban areas will fall in the BPL (Below Poverty Line) category. The expenditure limit for a family in rural areas has been fixed at Rs3,905.

Mr Ahluwalia had met prime minister Manmohan Singh on Sunday to clarify Planning Commission's view on the controversy.

"The affidavit before the court is a factual affidavit in answer to questions asked by the court. Our legal representative will be there in the court (to explain our position), we will abide by what ever the court order," he said.

By focusing on the daily figures of (Rs32 and Rs26) there was an attempt to embarrass the Planning Commission, he said adding that this was not the criteria for giving benefits.

The Planning Commission and ministry for rural development will form an expert committee which will look into the findings of socio-economic and caste census, which is currently on and is expected to be completed by January 2012, Mr Ramesh said.


GAIL keen to buy ADB stake in Petronet LNG for about Rs614 crore

GAIL, Oil and Natural Gas Corporation, Indian Oil and Bharat Petroleum hold a 12.5% stake each, to restrict the public sector holding in the company at 50%. Gaz de France (GdF) holds 10%. Under the Share Holders' Agreement (SHA), the five have the first right of refusal over ADB stake

New Delhi: The Asian Development Bank plans to sell its 5.2% stake in Petronet LNG, which the state-owned gas utility GAIL India is keen to acquire and may have to pay over Rs600 crore for it, reports PTI.

ADB has offered to sell its 39 million shares or 5.2% stake in Petronet, which is valued at over Rs614 crore at today's trading price of Rs157.85 per share on the BSE, sources privy to the development said.

GAIL, Oil and Natural Gas Corporation, Indian Oil and Bharat Petroleum hold a 12.5% stake each, to restrict the public sector holding in the company at 50%. Gaz de France (GdF) holds 10%. Under the Share Holders' Agreement (SHA), the five have the first right of refusal over ADB stake.

GAIL has proposed to the oil secretary GC Chaturvedi, who is the chairman of Petronet, that it can buy the entire 5.2% stake of ADB. In case other companies are also interested, ADB stake can be split equally among GAIL, IOC, ONGC and BPCL with each buying 1.3% stake.

ADB stake being bought by state firms would turn Petronet into a public sector company with shareholding of state firms rising above current 50%, sources said, adding that GAIL is agreeable to this as it will bring more accountability in running of Petronet.

When contacted, an ADB spokesperson from Manila said: "ADB has held a 5.2% stake in Petronet LNG since 2004.

ADB always looks to exit its equity investments once it believes that the development mission has been accomplished."

ADB had in fact first proposed to exit Petronet in 2008 but the then company CEO Prosad Dasgupta was in favour of a third party like Chevron or the steel baron Lakshmi Mittal's group buying the stake instead of the four promoters.

Sources said Mr Dasgupta had on 29th February in that year written to the then GAIL chairman UD Choubey to say that sale of "even one share" held by ADB to the four promoters or GdF would trigger the takeover code, turn the joint venture into a state-run firm and may result in delisting from the bourses.

ADB and German Development Bank KfW had in 2008 approved a loan of $169 million to Petronet for its expansion projects at Dahej and new terminal at Kochi, but the multilateral lending agency's internal norms prohibit it from having both debt and equity exposure in a company.

"In 2004, ADB had sanctioned $75 million loan to Petronet. But once it took 5.2% stake for less than $8 million, ADB could not disburse the balance due to its internal regulations," a source said.

ADB norms also stipulate it to divest its equity holding in a company three years from the date of the company going public. Petronet's IPO came in 2004 and ADB was supposed to exit Petronet in 2007, but was persuaded to stay on.

Last year, ADB had for the second time offered to quit Petronet and the current move is its third attempt, sources said.

"Since the four promoters and GdF could be seen as entities acting in concert by virtue of the SHA, the purchase of ADB's 5.2% by any one of them will immediately trigger the takeover code-meaning collectively an open offer has to be made for at least 20% shares held by the public," Mr Dasgupta had written in February 2008.

"This would result in the collective holding of the promoters and GdF increasing to 85%. Since a company cannot remain listed if the public holding goes below 25 per cent, the takeover code would require the promoters and GdF to again collectively make an offer for the remaining 15%, leading to delisting of the company," he wrote.


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