The concept of securitization of microfinance is gaining momentum across the world as an effective measure for financing. A large number of MFIs are giving more interest in developing commercial sources of money to finance their development. Other than mobilising deposits and accessing debt and equity, MFIs can utilize securitization to get in touch with capital markets, develop liquidity and provide more money. Securitisation can be an optimistic tool that can enable microfinance institutions (MFIs) to exploit the potential of their broad networks. Securitization makes it possible for the MFI to obtain immediate fund while earning income through supervision of the securitized loan portfolio. Securitisation will facilitate MFIs to handle their capital better and liberated their loan commencing process from the constraints of their balance sheet capability. Securitization enabled MFIs to broaden their borrowing sources, decrease the rate of borrowings, improve return on assets deployed and instruct pricing flexibility on the lending side. On the other hand banks, particularly the new private sector ones, can profit from the organization of microfinance receivable portfolios with advances in priority sector. The end borrower will be the vital beneficiary in the long run since they get ahead of on their operating efficiency and this gain to them. The main focus of this paper is to analyse and estimate whether a bright future for the securitization of microfinance exists in the modern financial world.
Background
In recent years, microfinance has achieved greater significance and is been under the spotlight. The remarkable efforts of its promoters have enabled microfinance activity gone deeper to its optimum efficiency. It is significant to refer to its improvement as ample and profound because there is still much financial stuff that remains unexplored. The recent achievements of the microcredit movement comprises of the declaration by the United Nations making the year 2005 the International Year of Microcredit (UN, 2005) and also the Nobel Peace Prize that was awarded to Yunus and Grameen Bank in 2006 (NF, 2006) who in fact behind implementation of the microfinance concept. A recent research in India has proven that the involvement in a micro savings program resulted in an additional 2% of yearly per capita income in each household. Additionally, utilization was higher in households concerned in the savings program at a rate of 25 basis points for each 1% of additional income. This has to be watched carefully taking into account that more than 20% of the income is spent in food consumption (BERG, 2008: 14). Absolutely, the microfinance boom has decisive mainly on microloans, leaving the financial products like that of insurance, savings and investment, safe and sound. According to (BERG, 2008:19), saving allows poor households to manage to pay for major acquisitions, smooth consumption over time and self insure against income shocks.
The Bank Rakyat of Indonesia (BRI, 2008) serves over more than three million borrowers and about 33 million savers. This throws light at the fact that savers enormously outnumber borrowers and which indeed shows that the poor could save more when a proper instrument is presented with. Moreover, the past information available has shown that the poor do not borrow as they cannot manage to pay for the loans, but for the reason that they are hesitant to debt. According to (Johnston and Morduch, 2007: 14), by approaching this thought further, it can be stated that saving instruments are possibly more competent tools to increase outreach than loans. There are certainly a lot of areas which should be developed before anyone can properly refer microfinance as such and in several ways entirely different than microcredit. Hopefully, the implementation of a proper microfinance structure can assist with the establishment of a more robust economy and poverty reduction.
Securitization: Micro loan
Securitization, the new initiative for funding deserves attention. It is better that microfinance could be securitized in much the same way that credit card debt, home mortgages, and the growing variety of other assets are sold. But its attention to investors will depend on the character and size of loans, and the legal and other major issues related to securitization of loans. It is practical that only when major MFIs are making significantly similar loans and using similar legal frameworks, a true market in securitized micro loans can be contemplated. The experiences of securitization of micro loans receivable in Latin America, India and Bangladesh can be taken into consideration in this relation. Direct securitization of micro loans has influenced a great matter of interest, as micro loans are more relatively homogenous and vastly diversified, in particular connection with other consumer obligations such as mortgage loans and car loans that have been successfully securitized. However, numerous important challenges are need to be overcome to structure a proper micro loan securitization.
1. Commencing risk:
The portfolio of underlying micro loans needs steady replenishment and because of this, the ability of the MFIs to continually originate an adequate volume of microloans is an extreme additional risk.
2. Short maturity of microloans:
Most microloans in general mature in less than a year and in most case feature frequent amortization. In this contest, it means that all but the shortest term microloan securitization will be required to integrate a proper mechanism to overcome or substitute the underlying assets, which to certain extent greatly increases the structuring complexity, non financial risk and administration cost.
3. Role of servicer:
As major successful MFIs create close associations with borrowers; their role in servicing securitized micro loans is a crucial ingredient in the performance of the securitized portfolio. This makes it difficult to describe micro loan securitizations as clean borrower risk. Due to these reasons the performance risk of the MFI servicer is major factor in the overall risk outline and a highly complicated one to measure in the pricing of the risk.
4. Rating problems:
Institutional investors in general will look for and require credit ratings on investment products. In the case of securitizations, as there is no corporate balance sheet to sustain the credit, the rating agencies will be relying on widespread data on the assets being securitized to mould the outcomes of diverse risk and maturity structures.
Cases of microfinance securitization
As securitization of microfinance involves complex constraints, there have been only few application cases of microfinance securitization in international capital markets. The two major cases among them are as follows:
1. Bangladesh Rural Advancement Committee (BRAC)
BRAC securitization was a revolutionary deal with RSA Capital acting as the major coordinator, and FMO (Netherlands), Citibank, N.A. Bangladesh (Citigroup) and KfW (Germany) standing as co arrangers. BRAC is the world's largest NGO and mainly focuses on empowering the poor and poverty alleviation. As contrasting to PCB, in which borrowers have a comparatively steady source of income, BRAC serves low income communities with particularly less collateral availability.
The structure used for the allocation of the securities certainly made them to be rated AAA by the Credit Rating Agency of Bangladesh. BRAC's issuance system involves a unique purpose dependence that has the burden of purchasing the receivables from the originator and providing the certificates for investors in every six months, above a six year period, with a maturity period of a year each. The entire fund accumulated will be more than 12.6 BN Bangladesh Taka (BDT) which is equivalent to US$180 MM. A third of the first sequence of the allocating was acquired by FMO, an additional third by Citibank, N.A backed by assurance of FMO and counter promise of KfW and Citibank, N.A. Bangladesh, and along with other two local banks purchased the remaining one third of the certificates (BRAC, 2006). The structure implemented had the unambiguous target of giving the securities a higher range of liquidity and protection for the investors.
2. ProCredit Bank Bulgaria (PCB)
A milestone business deal was structured indeed by the securitization of €47.8 million of the loan portfolio of ProCredit Bank Bulgaria (PCB), within Bulgaria and internationally. As per (Hagen and Hüttenrauch, 2006) it was been treated as the first true sale securitization in Bulgaria, and in general also the first microloan backed securitization worldwide. PCB is the bank determined in providing major loans to Small and Medium Sized Enterprises (SME). Its shareholders consist mainly of the European Bank for Reconstruction (EBRD) ProCredit Holding AG, a leader in microfinance lending in the world, and International Project Consult (IPC) GmbH, a major front runner in microfinance consultancy services. The commercial paper issued related to this had a rating of BBB by Fitch Ratings, in accordance with further guarantee enhancements provided by the European Investment Fund (EIF) and German KfW (PH and DB, 2006). The positive output of this issuance has established that capital markets can be accessed for MF funding and that international organizations are willing to provide support for the purpose of reducing the risk of the securities.
Stages in Securitization
In the course of securitization of microfinance, there are certain steps, which in together makes the procedures complete. The following are the major steps involved in securitization:
I. Micro lending
Microcredit institutions (MFI) provide major funds to their customers according to their credit policies. This movement is the core of the deal because the receivables generated by the loans are the major source of the cash flow of the securities. The assurance involved in the payments of the loans will be transferred to the securities in the shape of a higher rating. Thus, it is in general certain that MFIs estimate thoroughly the borrowers before sanctioning loan payments so that the credit risk is mitigated.
II. True Sale Transfer
As per the view of regulatory and supervisory sections it is very significant that this crucial step is carried out as a true sale of assets, as contrasting to a guarantee or pledge agreement, because of that the loans are actually shifted to the Special Purpose Vehicle (SPV). Some rulings could possibly restrict MFIs to place or underwrite securities. In this case, if the loans are not appropriately transferred to the SPV and if the MFI is left related with the throw of assets, in a quality entirely different from originator or servicer and if that is the case, legal problems could arise as a result of non compliance to the regulatory frame. However, some discussions are carried out still, on whether the originator is an issuer. At this point, the MFI and the set of arrangers must have firm whether the Originator is becoming the servicer of the loans. It has been considered approving that this happens for 3 major purposes:
a) MFIs are having extra profits for developing this labour;
b) MFIs and borrowers already hold an established relationship;
c) The issue seems to be very difficult for the SPV to track every one of the loans.
III. Enhancements
Investors recognize a higher risk from micro borrowers, with proper knowledge that traditionally the significance and repayment rates of microloans are complimentary. To boost the rating of such securities it is always necessary that the governments provide some kind of protection and the usage of any other kind of insurance available.
IV. Issuing of Securities
The SPV issues variety of securities. To have an additional sort of protection, the total value of the securities issued by the SPV will be lower than the value of the bulky loans termed as Overcollateralization. Additionally, the issuance can consider multiple subordination levels, so each one of them can be embattled to a specific investing group. As there is subordination included, huge cash provisions are necessary.
V. Distribution of Securities
Once all of the procedures are cleared and the traditional sort of securitization is performed, securities will be acquired by investors and generally by the same borrowers of the underlying loans or the low income part of the population. This acquisition can be directly or indirectly, through collective investing schemes or by way of deposit taking MFIs portfolio.
Role of the Rating Agencies
Rating Agencies play a crucial role in securitization issue, as investors seeing the concept as a new tool in the financial will be looking forward at the ratings provided by the agencies for making the safest investment. Major asset backed securities are been rated by international rating agencies to develop their attractiveness to investors and supply a guideline for their pricing. The rating agencies will closely examine the legal structure of the transaction mainly the true sale element, the quality of the securitised asset pool and the capability of the originator to examining the assets. Based on this core analysis and the amount of the credit enhancement and other supporting arrangements the rating of the securities will be determined.
Benefits of Securitization of Microfinance
Developing major true sale securitizations allows MFIs to push apparent of the troublesome regulation of banking institutions as they are not taking deposits. This allows them to focus entirely on intensifying the outreach of their operations, rather than spending much higher time and money in compliance issues. Through securitizations MFIs also grabs the potential opportunity to share the risk of the loan portfolio with other similar investors with maintaining and further increasing their profits. Funding through this structure allows MFIs to reduce the uncertainty of their liabilities in some more effective way than deposit taking institutions. The major advantage of this scheme to investors is the offering of a financial product which enables the poor to save or invest by holding a reasonable rate of return. In addition, due to the government insurance and other enhancements, their savings structure would not be exposed to a high risk.
Securitization of microfinance surely will create an inclusive market which attracts huge savings and there by will develop the flow of liquidity throughout the market, giving an additional impulse to the overall performance of the economy. Given the microfinance sector's enormous development potential, this particular sector will have a higher desire for capital. Securitisation can help MFIs to deal with their balance sheets. They can sell down the originated loans through the securitization way, book profits and initiate more huge loans with the earnings from securitisation. Thus, securitisation will provides the MFIs the flexibility to handle higher intensification with their existing capital. MFIs typically sustain significantly higher operating costs when compared with retail non banking finance companies (NBFCs). For example, although the overheads or average funds deployed ratio for NBFCs is almost 2.0% to 2.5% per annum, it falls between the range of 6% to 14% per annum for MFIs. This higher working structure is mainly because of the small loan size, borrower intensive lending and monitoring operations and wide dispersion of borrowers, among other crucial things.
Constraints of Securitization in Microfinance
The securitization of microfinance has to cover up many constraints and risks. One of the major one is associated to reckless lending. If MFIs recklessly lend to non creditworthy borrowers, there could arise a chance for collapse to repay and the economy would need to face another sub prime crisis like disaster after the entire population. Deficiency of proper regulation and justice structure is another major barrier faced while implementing the proposal of securitization. Thus, it is significant that before enacting a whole set of rules, there is a first implementation on a case by case basis within a painstaking contractual structure. In developing countries the justice system is often lacking in effectiveness and swiftness.
Moral risk can be faced by MFIs which is closely linked to reckless lending. If the government and other insurers pay the investors regardless how bad the loans being securitized are, MFIs will continue to initiate deficient loans and will still get the incoming flow of capital because the investors‟ confidence will not be affected. Another main hindrance for the implementation of the proposal is due to the strict market regulation in certain economies.
In certain countries, MFIs is strictly prohibited from issuing securities. Due to the recent sub prime crisis, investors are not willing to make large investments. In order to raise the level of impact of the scheme it is significant that wealthy investors, such as institutional investors, participate in order to get more funds in circulation. The only way to encourage investor confidence in these kinds of securities is by giving peace of mind.
Summary, Findings & Recommendations
Micro finance has achieved greater importance now all around the world as an effective measure for financing loans, mainly to low income group and there by eradicating poverty to a large extent. Lending and savings instruments have been covered by MFIs even though much more the former than the latter. However, in spite of their importance for the targeted communities, no investment products have been conceived, and the insurance ones have not been widely extended. Many changes are required in order to allow microfinance as the basic tool for empowering the poor and constructing those bridges which could promise MFIs to get access to funds. The investors really have to move away from the predictable view of risk and invest in Microfinance projects with better confidence. Nowadays, investor makes investments only after looking at what the debtor has done so far that can build up a satisfactory level of trust, and there by ensuring that the money is safe. Microfinance actually needs a diverse approach to risk analysis which is not based on the past, but on the major outlook. Another major issue that potential investors must re think is the market dimension of microfinance. Microfinance works as hypermarket kind of businesses: the profit derived from a single contract might not be so attractive, but if we appreciate the potential market for these products which is almost around USD 300 billion, then there exists something to really think about.
On the other hand, not only the investors required to change their attitudes. The MFIs also have to recognize the importance of standardizing measures and come up with appropriate and apparent information. MFIs now have been much more concentrated on doing what traditional banks have not done, while overlooking banking practices that in fact match with the objectives of microfinance by having proper documentation among the clients, or statistics concerning the portfolio performance, or regulations that establish credit analysis processes are all very helpful equipments to scrutinize the operations of various MFIs, while making easier to transfer the concept to potential investors. Certainly, if the significant information is provided to investors in an understandable and standardized manner, it will spare the MFIs from the difficulty of checking the entity to identify its operations. There are still lot of things that remain to be done; governments have to enact proper rules, laws and regulations which make things much easier though safe for investors to invest, for MFIs to broaden their services and sufficient for protecting the safety of the serviced communities.
International foundations and organizations need to support microfinance, by contributions to specific MFIs and by financing projects that encourage combination between the actors of society who can play an active role in fighting and eradicating poverty. Finally, also the entrepreneurial world could become a part of microfinance through Corporate Social Responsibility planning by providing guarantees to the obligations of the micro borrowers to put together up the essential confidence in the market there by making investing in microfinance becomes a necessity. Admittedly, many more elements require action along the way. As long as what is currently done has the purpose of integrating microfinance into the formal financial markets, mainly by building faith and assurance around it and it is much more safer now to state that the financial world is on the right path.
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