RBI’s proposed securitisation guidelines: Will microfinance entities be able to bear the blow?

By Vinod Kothari,

Microfinance Focus , June 08, 2010 : On 3rd June 2010, the RBI (Reserve Bank of India) posted on its website proposed guidelines for securitisation by non-banking finance companies. Before this, the RBI had come with similar draft guidelines for securitisation by banks on 19th April, 2010.

The background of the guidelines is similar attempts internationally by financial regulators. Regulations have been concerned post the subprime crisis with the allegations that banks and financial intermediaries had a strong motivation to originate assets of substandard quality and sell them down to investors through securitisation. While the risks of the originating banks were limited, banks could sweep high amount of excess spreads as these assets were originated at high rates of interest. This, in essence, is what might have happened during the subprime crisis. As such, as a reaction, regulators all over the world have been busy fixing rules for securitisation business. The European Union was among the first ones to lay down such rules by amending the Capital Requirements Directives requiring retention of 5% of the total value of the securitized exposure. The US regulators are on the verge of laying down similar rules through the Financial Regulatory Reform Bill, recently assented to by the Congress.

Essence of the RBI’s requirements:

Essentially, the RBI would require, once the new guidelines are implemented, two things – a minimum holding period (MHP), and a minimum retention (MR).

The MHP requirement in short is that a receivable or a loan will not be sold unless it is held with the originator for a certain minimum period. In other words, a loan will have to stay on the books of the seller for the MHP before it can be sold. The present proposal is that for loans having a tenure upto 24 months, the MHP will be 9 months, and for the loans having an original term of more than 24 months, it will be 12 months.

The MR requirement is that originator will continue to hold a first loss piece, that is, subordinated portion, of the portfolio, with a minimum risk of 5% in case of loans of upto 24 months’ maturity, and 10% in case of loans with above 24 months’ maturity.

Currently, the RBI’s guidelines on securitisation are not applicable to so-called “direct sell-downs” or “direct assignments”, that is, one bank or NBFC selling its portfolio to another. In  the proposed guidelines, the same rules will be applicable to  both securitisations and direct assignments.

MFIs in India and securitisations:

Microfinance institutions in India are currently using securitisation or portfolio sales as one of the predominant methods of funding. MFIs need significant levels of leverage given their pressing need to grow volumes. Apart from typical bank lines of credit, MFIs either engage in proper securitisation transactions through SPVs, or engage in portfolio sales selling chunks of microfinance receivables to banks. It is a marriage of mutual convenience – for the MFIs, it helps them to tap funding in addition to the bank credit that anyway is exploited to the hilt, and for the  banks that buy up the portfolios, it helps them to find a convenient way of building priority sector loans, at rates which are much more attractive than self-generated books, and with default rates which are far lower than the farm loans that the banks would have originated themselves.

MFIs and RBI’s proposed guidelines:

The RBI’s proposed securitisation guidelines have surely not been drafted keeping in view microfinance sector, which itself is regrettably surprising. If the guidelines seek to lay down a minimum holding period of 9 months before a loan could be sold out, which microfinance loan in the country has an effective life of more than 9 months? Microfinance loans typically have an original maturity of 10 to 11 months, but have  a natural tendency to get prepaid within 9-10 months as the borrower typically pays off the tail of the remaining and takes a new loan.  So, imposing a requirement that a loan cannot be sold off before 9 months of origination is virtually to write a rule that no microfinance loan can ever be sold at all. Note that the requirement does not have to do with the date that the borrower came on the books of the MFI – it concerns the origination of the loan, taking each loan independently. In other words, a repeat loan to a borrower will be taken as a new loan.

Effectively, this prescription closes down the securitisation/portfolio sale window for MFIs completely, leaving MFIs with only one source of leverage – bank borrowings. If bank borrowings seldom allows MFIs to leverage beyond 3-4 times of their net worth, this effectively puts brakes on the growth engine of microfinance.

Could that have the intent? In an environment where inclusive growth is more necessary than ever before in the past, the Apex bank of the country could have meant to guillotine the securitisation window of MFIs. If not, then it becomes an interesting question to ask – how is it that the regulators could pen down the draft of a regulation completely oblivious of the MFI sector?

MFIs surely do not have the option of not growing. Every one having the slightest understanding of the MFI sector knows that microfinance is like a bicycle that has to keep running  – if it stops, it falls. Hence, anything that has the effect of curbing the growth of the microfinance sector will amount to putting a be-or-not-be question before the MFIs.

More bad proposals:

The securitisation guidelines have more “bad” proposals for the MFI sector – without any discussion at all, and surely enough without any serious understanding of the rationale for the restriction, the guidelines propose that revolving securitisation and synthetic securitisation are not permitted in India. So far, there was no such prescription. In fact, there has not been a single revolving securitisation in India, but that is not because it was not permitted. It was never prohibited. The regulations now seek to prohibit the same – without citing any reason. There is no comparable proposal in international regulations. Basel II proposals have expressed concerns about the liquidity risk in revolving transactions, but that simply imposes additional capital requirements for the off-balance sheet risk in revolving transactions. There is surely no proposal to prohibit either revolving transactions or synthetic transactions.

In fact, this author has consistently been holding the view that the right funding technique, given the short age of a microfinance loan, is revolving securitisation and synthetic securitisation. This is exactly what the RBI proposes to deny, for reasons completely unknown.

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About the Author :

Vinod Kothari

Mr. Vinod Kothari, based in Kolkata, India is internationally recognised as an author, trainer and expert on securitisation, asset-based finance, credit derivatives and derivatives accounting. He offers about 20 training courses every year on credit risk, securitisation and credit derivatives all over the World. For more information Visit Author`s website: http://www.vinodkothari.com .

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