Securitizations: a tale of promise and caution

Have the lessons from the financial crisis been fully absorbed by the microfinance sector? 

IFMR Capital recently announced its first multi-originator securitization, the first such securitization in microfinance (that I know of).  As compared to previous securitization transactions, which involved loans from only one microfinance institution, this transaction combined 42,000 loans from four microfinance institutions.  This securitization was highly rated by Crisil, one of India's leading ratings firms for microfinance.    

The benefits are clear.  Because of the multi-originator structure, small and medium-sized microfinance institutions can pool their portfolios to reach the size that is needed to access capital markets.  Access to these markets promises cheaper capital and faster growth.  From an investor’s perspective, such deals offer a diversified asset class, comprised of loans from multiple institutions across difference geographies.  Still, there are questions.

Securitizations transfer risk from the originating institution to investors who tend to be better capitalized institutions.  However, there is a danger, as displayed by the sub-prime crisis.  The transfer of risk adds a degree of separation between the loan origination and servicing functions, and the risk bearers.  In the sub-prime crisis, this separation led to insufficient screening of borrowers, and in worst cases, predatory lending.  Chief causes were the lack of appropriate incentive structures within the institutions, and a poor understanding of the real composition of the securities. 

The financial crisis also taught us to be cautious about the benefits of diversification.  On paper, loans that originate from different geographies and institutions seem balanced.  However, when borrowers face common shocks, such as a liquidity crisis in the banking sector, a weakening economy, high unemployment or high food prices, we can see how the asset can become more risky than thought by the rating agencies.

Will microfinance investors be better informed and be able to maintain the oversight required to ensure the quality of the loan portfolio?  This remains to be seen.

It is not necessary that microfinance will follow the sub-prime crisis.  The sector is better prepared, and includes features such as a high-touch lending environment and shorter loan cycles that complement such financial innovations.  If the sector is able to maintain high quality loan portfolios, and securitizations lead to greater outreach and more choices for borrowers, then this is a strong lesson on how financial innovation might actually benefit end-users.