By Divya Moorthy, CIFD
Childbirth ushers with it a ray of hope and joy for the family. Pregnancy, birth and motherhood, in an environment that respects women, can powerfully affirm women’s rights and social status without jeopardizing their health. The enabling environment for safe motherhood and childbirth depends on the care and attention provided to pregnant women and newborns. Despite various initiatives, the maternal mortality rate (MMR) and infant mortality rate (IMR) in India is alarmingly high at 450 deaths per one lakh live births and 55 deaths per 1000 live births respectively.
Access to finance to acquire improved health care, quality reproductive health services, emergency obstetric and neonatal care and nutrition for the mother and her child is pivotal to addressing the issues of high mortality rates in India.
Centre for Innovative Financial Design (CIFD), IFMR, has developed the ‘Pregnancy Financing’ product that allows poor pregnant women to meet expenses related to child delivery and ante and post-natal care. ‘Pregnancy Financing’ is centered on the premise of Behavioral Collateral; where a particular behavior is treated as collateral for providing financial service. The rationale behind this is:
- Some women belong to the marginalized section of the society and hence would be unable to form groups that can underwrite each individual’s commitment.
- The women are too poor to possess tangible assets that could serve as physical collateral.
Women are encouraged to enroll in this product as early as possible during their pregnancy. Women who take-up the product, save regularly over the course of their pregnancy, with the amount of saving left open for the borrower to decide.
Two weeks prior to delivery, the savings accumulated by the woman is given back to her along with the loan since the savings behavior and not the amount of savings, works as collateral. The underlying principle behind this idea is that if a poor woman can forgo some of her current consumption for savings, then she can also forgo certain part of her consumption in future periods for repaying the loan.
CIFD has entered into collaboration with The Guntur District Cooperative Bank Limited in Andhra Pradesh and The Banswara District Central Cooperative Bank in Rajasthan for offering the pregnancy financing product. As part of the understanding, CIFD will design and develop the product and the associated processes for rolling it out. CIFD will also design the branding and marketing campaign to launch the product. The Bank from its end shall offer the necessary infrastructure and customers, also, it would extend the local level support required for the implementation. The product will be launched during the 2ndweek of August 2010.
What’s your take on the product?
Olympia A. De Castro from IFMR Capital gave us an insight on the correspondent banking model in Brazil that led to some interesting comparison debates with the Indian model. We bring you some highlights of the discussion:
The Growth
According to the Central Bank of Brazil, Correspondent Banking (CB) is “a measure aimed at extending services to bank clients in areas where that bank did not have a branch”. Introduced in the 1970s, the correspondent banking channel has risen in relevance, especially after 1999 when regulatory changes broadened the range of services that could be offered by correspondent banking agents.
As the fifth largest country in the world with a population of 201 million, Brazil has correspondents covering 62 percent of the total number of points of service of the financial system. All of the 5,564 municipalities in Brazil are now reached by the channel, with 25% of the municipalities being served only by correspondents. Between 2000 and 2008, the correspondent banking system grew 85.5 percent while bank branches grew only 16.7 percent, clearly indicating the increasing presence of the channel.
Market Dynamics and Regulation – Aligned Incentives
The significant growth seen in correspondent banking industry in Brazil can be attributed to a unique market dynamic that created aligned incentives between the major stakeholders of the finance industry. In essence, the government, the central bank and the commercial banks were in different ways motivated to allow the correspondent banking model to flourish.
In 2003, Brazil’s newly elected Worker’s Party government needed an effective distribution channel to disburse its social welfare program, Bolsa Familia. The program at that point already reached 68 million benefits, equivalent to R$2.4billion. Transparent and efficient disbursement of this significant government cash transfer program was essential to its success. As of 2009, 1 in 4 households in Brazil receive a monthly G2P i.e. government to person payment. At the same time, the EIU Microscope Report released in 2008 to assess the environment for microfinance in Latin America ranked Brazil at a meagre 14 out of 20. In response to this, the Brazilian Central Bank (BCB) launched a financial inclusion program to improve financial access in the country. As a result, Brazil has seen an improvement of two points due to better regulatory capacity in the most recent 2009 Microscope report where it ranks 24 out of 55 (India was ranked 4).
Similarly commercial banks were in a position to benefit from exploring correspondent banking as a noteworthy business model. Given the years of hyperinflation in the early 90s, banks undertook technology improvements to allow for fast transaction processing. At the same time, banks became the predominant recipients for bill payments, as the public sought quick deposit and use of their rapidly depreciating currency. The resulting considerable increase in foot traffic to branches related to payment business became a strong driver for the need to find a cost effective alternative.
In turn, since the 1990s, regulation around correspondent banking has become more agreeable stimulating significant growth in the industry. From broadening the range of institutions allowed to hire agents, to widening the gamut of services and softening the restrictions over the location of agents, regulation around correspondent banking has been flexible enough to attract strong interest in it as a viable business alternative. Commercial banks are particularly keen on exploring this alternative as it allows for regional expansion and client reach with significantly lower costs. Unlike the rigid legislation of bank-branching, correspondent agents allows for lower security expenses, relatively lax liquidity management and lower labour costs given it does not fall under the domain of the strong branch unions.
Exploring the viability
Brazilian correspondent banks are authorized to offer a wide range of products and services. However, as noted below, bill payment continues to dominate the volume of transactions.
Types of transactions conducted by correspondents
The distribution of product range varies from entity to entity as there are several types of participants in the industry. The main players are the larger banks in the country, Banco do Brasil and Caixa Economica, both wholly-owned by the government, and Bradesco, a private sector bank that entered correspondent banking by partnering with the postal service, each benefiting from the model in different ways.
Bradesco’s Banco Postal seems to be the most profitable with profit per day of US$79 versus an average of 5.2 for the others. Profit margins are also relatively higher at 63% compared to an average of 10.6% for the other agents. Contracts between agent and bank tend to vary with revenue split, capital expenditure and operational expenses being negotiated on a case by case basis.
Banco Postal’s higher margins are arguably explained by its high negotiating power. In July 2009 it effectively increased prices by 60 percent. In addition, the relatively high volume of transactions also adds to its advantages.
Product offering and transaction volume tend to vary by geographic region. In urban areas, bill payments are even a larger share of the number of transactions representing as much as 88 percent of total transactions. Profitability attributed to this product relies on fast rotation of clients and high foot traffic. The below chart shows type of transaction by region:
Evidently, customers in different geographic regions have different needs. However, the dynamics have led to a general urban bias in the expansion of correspondent banking. A snapshot of Brazil’s demographics shows clear differences between the regions, with the South and Southeast region being wealthier and more populous, while the North and Northeast are poorer. Despite some slight improvement, agents tend to favour the wealthier regions of Brazil. Banco Postal especially favours the South and Southeast with roughly 43% of its client located in these regions as of 2004. On the other hand, Caixa, responsible for all Bolsa Familia withdrawal transactions, unsurprisingly shows greater presence in the North and Northeast with roughly 40% of its clients attributed to these regions.
The below chart shows the evolution of the geographic concentration of correspondent banks by region:
Risk Factors
The main risk factors for the industry lie in the fact that the Central Bank of Brazil has an unclear mandate under law to regulate outsourcing. Although the framework for the use of agents is based on the Central Bank’s regulations, its authority ends short of the correspondent agents. As a result Labour Law holds precedence over the Central Bank’s regulation when it comes to correspondent banking. The same applies to other regulatory entities such as the National Health Surveillance Agency which looks over pharmacies and drugstores. As a result, several issues currently threaten the industry, as they pose risks of unviably higher costs and significant disruption in the current agent channels. Specifically, these threats include legal actions from agent employees and branch-bank labour unions demanding higher pay for agents as well as challenges raised on whether pharmacies and drugstores should engage in correspondent banking; currently pharmacies and drugstores account for ~10% of total agents.
Challenges and lessons
When considering if complete financial access is being addressed via the correspondent banking model, it is evident that several challenges remain. First, although Brazil is proud to claim presence of an agent in every municipality, this is still not sufficient as the distance between an agent and a customer in the same municipality many times is too great. Secondly, service offering continues to be dominated by bill payments. Other services such as account opening remains relatively unsuccessful; although incentives have been created for an increase in new accounts a large number of these remain inactive. In addition, credit, a core factor for financial inclusion, remains at a standstill as the right model is yet to be determined. Finally, geographic coverage based on population needs remains limited with a significant urban bias perhaps driven by relatively more attractive profitability.
Conclusions
The corresponding banking system in Brazil has a lot that can be compared to the Indian model. Despite the differences in demographics, there are several points for discussion such as what makes for a conducive regulatory environment, the benefits of a proper credit agency, considerations for credit origination models, potential products and agents to be explored and the technological and training support necessary for an effective and viable correspondent model.
As India refines its agent model and explores the best alternatives to address its financial needs it is worth drawing from the experiences and lessons of its Brazilian counterpart, which although the explosive growth in coverage, remains tasked with a number of challenges.
Sources of data:
1) Gallagher, Terence, “Branchless Banking – Brazil Correspondent Banking Networks”,CGAP, June 2006
2) Kumar, Anjali; Ajai Nair, Adam Parsons, Eduardo Urdapilleta. “Expanding Bank Outreach through Retail Partnerships”, World Bank Working paper N. 85, (June 2006)
3) Branchless Banking and Consumer Protection in Brazil, CGAP, 2009
4) Branchless banking agents in Brazil – Building viable networks, CGAP, 2010
Why is complete financial inclusion such a big challenge? Why cannot financial products that are designed for one set of people be taken to another? Search for answers and you might come up with reasons like, among others, lack of capability of the financial service provider, unviable commercial exercise or even market failure. But there is another perspective to the issue. How many financial service providers have tried to understand what the financially excluded, especially in the rural areas, really want?
“Conducting surveys to identify needs of the target customer is one thing, but seeing the world through the eyes of a rural person throws up some really interesting perspectives”, says K Preethi of InnerWorlds, a design consultancy within the IFMR ecosystem that is helping to design processes, products, organisation and strategies that connect to the experiencesof the rural people by living with them. “When you go to their homes, live with them and see why they take certain decisions that they do, it all falls into place. Any financial inclusion organisation that tries to provide services to the rural people should first understand what they go through in their daily lilves. We bring the context into picture and so help service providers make informed decisions. What works in one place may not work in another. Simple pushing of products in places where it is not accepted will not make sense” she adds.
What is your customer telling you?
“Its completely true!” says Anu Valli of Rural Energy Network Enterprise (RENE), an enterprise that tries to fill supply chain gaps in the rural energy space. “We were establishing a distribution channel to sell energy efficient products in Thanjavur and we started with household cook stoves. People were buying the stoves in Karnataka. When we met them for feedback, they were positive and said that it was good for making rotis. We later realised that what they were actually telling us was that it was good for rotis but not good enough for making rice!” she explains. “This fact was brought out by InnerWorlds who went to live with our customers in Tamilnadu and understand what our stoves meant to them” she adds. Simple things like these miss the eye, but often make a big difference in the impact.
Work by organisations like InnerWorlds can help create access to finance to small businesses in rural India. Several small businesses in rural India face tremendous volatility in revenues due to an uncertain market. This creates enormous constraints for them to access debt, as lenders dislike volatility and seek predictability of cash flows. Understanding the dynamics of the ‘people’ behind the business can address these constraints.
“The Network Enterprises, incubated by IFMR Ventures, are focused on minimising the root cause of revenue volatility for these enterprises. In RENE’s case, the enterprise we are currently serving is the distributor/dealer of energy efficient products. The uncertainty whether the product will sell or not makes the distributor or dealer not “financeable”. We have taken several initiatives to reduce this uncertainty and our tie-up with InnerWorlds is one such effort”, Anu explains.
InnerWorlds is helping RENE evaluate the distributor’s natural capabilities i.e. what they are good at and what they lack. This helps RENE better leverage the distributor’s strengths and provide support wherever he or she lacks. Collectively they are able to serve the market better.
InnerWorlds, through its comprehensive research in rural India, has spent a lot of time with more than 700 households and understood their way of life over several months. It has documented this experience extensively and this database can go a long way in designing products for these households.
Relevance is the key
It is important to understand if a product is relevant and appropriate to the customers. Prof. C. Vijayalakshmi, Research Director, InnerWorlds shares an example. “Loans is a product introduced by many financial service providers. But this service is already being provided to the villagers by the existing social networks and informal lenders. Agreed, they are inefficient but nevertheless, they continue to exist. To compete with this strong informal network, service providers have to understand the psyche of the villagers. Unless we understand “why” a person takes a decision that he has, we will not be able to impact his decision making”.
Financial inclusion is extremely challenging and creating access to finance in rural areas is no mean task. Every institution that works towards this cause is making a laudable effort. But what separates the successful from the unsuccessul ones is the effort taken to understand the wants and needs of the customer and not just focus on dreams of the promoter. Without this understanding of customer perception, no amount of effort put in product designing is justified.
Should it then be beyond ‘Know Your Customer’ – Understand Your Customer?
- By Senthil Kumar Govindararaja, Project Coordinator, IFPRI
International Food Policy Research institute (IFPRI), Washington DC and ICAAP (IKP Centre for Advancement in Agricultural practice) joined together to establish global agricultural knowledge facility through information and communication technology (ICT) in India. The project aims to establish an interactive internet-based platform for facilitating knowledge and experience sharing between the various agri-stakeholders (including men and women farmers, extension agents, agricultural scientists, agro-industries, agri-financing institutions, policymakers and planners).
To kick-start the project, being piloted in Thanjavur and Thiruvarur districts, we visited the locations to understand existing agricultural extension systems in the region, needs and demands of stakeholders in accessing scientific information through various channels. To explore the probable entry points to pilot IFPRI – ICAAP knowledge portal in the locality, we interacted with knowledge intermediaries like extension professionals, KVK (Farm science centre), agricultural research station, civil society organizations, KGFS, farmers associations and small and marginal farming community.
Agriculture scenario at Thanjavur and Thiruvarur districts
Rice and Rice fallow pulses i.e. black gram and green gram and oilseeds i.e. Gingelly, groundnut (Rainfed crop) are the dominant crops in Thanjavur and Thiruvarur districts. Most of the farmers depend on Cauvery water to meet their farming activities. In some of the areas, progressive farmers grow sugarcane and banana by using bore-well water as annual crop.
Recently, the stagnation in growth of rice productivity was noticed in the two districts, caused by various factors like imbalance in fertilizer application, labour scarcity etc. Similarly, even pulses cultivation faces various impediments not least of which would be the lack of scientific methods of production.
Small and marginal farmers are looking at alternate solutions like diversified agriculture, vegetable cultivation and allied activities for livelihood to improve their standard of living.
Few developments at Thanjavur and Thiruvarur districts by various stakeholders
State and central ministries (Agriculture) have launched various schemes to empower farmers in order to realize the profitability in farming. Recently, they launched ATMA (Agricultural Technology Management Agency) in 591 districts in the country, including in Thanjavur and Thiruvarur districts. The agency, a decentralized model where farmers’ issues will be surfaced during meetings and ways to address them would be carved out, aims to integrate all the line departments, research community, farmers association, self-help group and farmers. Additionally, extension professionals organize tours for farmers to visit some of the successful models like organic farming, precision farming etc (Seeing is believing).
Also MSSRF has initiated village resource centre and village knowledge centre that helps rural communities to access information through ICT. They have also launched a mobile van, which travels across different villages to provide farming solutions by way of soil and water testing. In addition, Agricultural research stations i.e. Tamil Nadu Rice Research Station, Soil and Water Management Research Station and Coconut Research station and KVK (Farmers science centre) are trying to bridge gaps between research scientists and farmers.
Discussion at Villamangudi village with agricultural laborers who availed financial services at KGFS
A very unique model for delivery of financial services in rural areas is KGFS. Being at the grassroots level and in touch with the small and marginal farmers, its branches provide a platform for potentially disseminating agricultural scientific knowledge to the local farming community.
Stakeholders Need Assessment
Farmers
- The reality of the rural economy in the districts is one where farmers need not just technology, but information on prices, consumer preferences, markets and trade. They need access to credit and other agricultural market oriented scientific information.
- Their information needs change quickly and requires rapid responses and solutions. Information needs to be complemented by links to markets and other players in the local and global value chains.
- For the poorest households, they don’t necessarily need agricultural development support, but, rather, support for diversified livelihoods in the new rural economy.
Knowledge intermediaries
- Extension agents and subject matter specialist in an ideal world would resemble knowledge brokers. They need to articulate the demand of farmers for knowledge, facilitate linkages between stakeholders with ideas and resources and manage the knowledge process.
- Extension workers lack ability to handhold the stakeholders who are involved in the crop value chain and lack relationship skills with the farming community.
IFPRI-ICAAP will join with above local stakeholders to implement the project and bring the innovative and sustainable model to provide comprehensive advisory services to the small and marginal farmers and link them with the market for profit realization.
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Senthil can be reached at: s.govindarajan [at] cgiar.org
With a vast majority of the Indian population living in the rural hinterland, its economy and growth are linked to developmental efforts. Crucial to this is in ensuring that the fruits of financial inclusion reaches their doorstep. An article in today’s Economic Times, showcases the work of IFMR Trust and KGFS towards this endeavor.
Click here to read the article.
- Bindu Ananth, President IFMR Trust
What is the link between supply chain interventions and access to finance?
The Rural Tourism Network Enterprise (RTNE) has received a lot of attention from the press recently for its work in connecting rural homestays to budget travellers. This is a good time to recap the original hypothesis of RTNE and the link to IFMR’s mission (to ensure that every individual and every enterprise has complete access to financial services).
Several small businesses in rural India, (a rural homestay being a classic example), face tremendous volatility in revenues due to an uncertain market. It is no wonder then that they have enormous constraints accessing debt – lenders dislike volatility and seek predictability of cash flows. There are two ways to go about addressing this:
1. Infuse more equity into each small business so that their ability to withstand revenue shocks and leverage debt increases, or,
2. Minimise the root cause of revenue volatility itself.
We believe that Option 1 is not scaleable given the size of many of these businesses. We have taken the broad direction of Option 2. A company like RTNE reduces the revenue uncertainty to tens of thousands of rural homestays by providing an information and accreditation facility to potential travellers. This provides a steady base of travellers to qualified properties. In this manner, the revenue certainty and ability to leverage debt goes up for every single rural homestay accredited by RTNE.
We believe that this is a promising approach to improve access to debt for small businesses that have market uncertainty.
What do you think?
(Read the RTNE story in Financial Times here and Business Standard here.)
Understanding and channelizing local issues at the grassroots level to policy makers at both regional and national level is both challenging and vital. With a dual objective to create a platform for conducting such local public-private dialogue (PPD) to enhance awareness of issues and assisting in measuring and representing local conditions to inform state and national policy, Centre for Development Finance (CDF) initiated the ‘India Local Economic Environment Project’.
Forming the basis to this project is the PPD process, which is a crucial initial ingredient, involving identification of various stakeholders cutting across diverse functions and their analysis. Somasundaram of CDF explained “We met an array of stakeholders ranging from elected representatives of panchayats, farmers, entrepreneurs who manufacture and sell bronze idol and lamps, vendors in vegetable and fish market, industry practitioners, bankers, NGOs, Government officials etc. Also we got hold of the District Collector and got the list of line department officials who would be of use to this initiative.”
Further to this on 1st July 2010, a one-day workshop was held in Thanjavur, one of the operational areas of the project, where a PPD was conducted. The participants were the horticulture and agriculture officials from Thanjavur district administration, academicians, union chairman of Thanjavur, secretary of chamber of commerce and representatives of – farmers’ association, bronze idol association, flute making and mud-idol association, and Bus owners association.
The participants were divided into groups and were asked to frame a vision statement for Thanjavur in the year 2015 – they identified “Self-sustained Thanjavur” as their vision. Having dealt with the ideal vision, the participants ventured towards identifying obstacles in reaching towards the said vision, some of which were: Non-availability of water inflow for paddy cultivation and non-availability of storage godowns for paddy; Poompuhar not procuring the bronze idols from the manufacturers; Government’s non promotion of agro-based industries; Lack of encouragement in developing temple-based tourism and non-availability of policy for rotation of crops. The existing procedural delay in setting up of business was also pointed out.
The participants realized the need for innovations in agriculture related activities. Also the information shared by the Tamilnadu Agriculture University on the manufacturing of small weeder and selling the same at reasonable cost for the farmers (which is been imported now at higher rate) was quite useful to them.
At the end of the day the participants formed a working group, comprising a healthy mix of private and government representatives, with consent to meet once a month (first meeting on 26th July 2010) for setting up priorities to be carried out to achieve the identified vision.
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Somasundaram, Progam Head – Development Metrics and Lalitha N, Project Manager, of CDF contributed this post.
-By Vineet Sukumar, IFMR Capital
In a recent post, Daniel Rozas and Vinod Kothari have argued that microfinance securitisation does not, in reality, separate ‘pool risk’ from ‘originator risk’ and hence should not be rated very differently from the originator of the portfolio.
Some of the arguments are well reasoned out such as the lack of control over co-mingling of cashflows and lack of regulatory supervision on ‘bilateral assignments’. However, some of the other arguments presented beg greater scrutiny.
Microfinance securitisation has really taken off in the last one-and-a-half years. Prior to that, MFIs, like other financial institutions, sold assets on a bilateral basis to a banks, which were largely incentivized by regulatory benefits. Bilateral assignments still constitute a majority of off-balance sheet transactions. Such deals are opaque, largely unrated and mostly occur in the last quarter of the financial year.Such bilateral deals do not constitute ‘securitisation’. Securitisation is a market-driven transaction, priced against comparable rated benchmarks, tracked by independent agencies and transparent in nature. As such, to tar bilateral deals and market-linked securitisation transactions with the same brush is to do injustice to the tightly structured microfinance securitisation market that has recently developed.
Let us focus on the fundamental question that the authors have raised about microfinance securitisations in this context.
How can assets be rated better than the originator?
The premise of any securitisation is that the underlying assets can be ring-fenced from the originator – cash flows from such assets are pooled into a secure account controlled by a trustee. Further, it is possible to select high quality assets, originated in less risky geographies from borrowers who have historically had good credit history. Third, the assets are not exposed to servicing risk precipitated by a bankruptcy event.
The rationale for a securitisation of assets to have a better rating than that of the originator is that the assets being securitised are of higher credit quality than that of the originator’s own credit quality (which comprises its entire balance sheet).
Vinod Kothari describes securitisation aptly as “the process of de-construction of an entity. If one envisages an entity’s assets as being composed of claims to various cash flows, the process of securitisation would split apart these cash flows into different buckets, classify them, and sell these classified parts to different investors as per their needs. Thus, securitisation breaks the entity into various sub-sets.” Further, he describes receivables securitisation as a way to “originate an instrument which hinges on the quality of the underlying asset. As the issuer is essentially marketing claims on others, the quality of his own commitment becomes irrelevant if the claim on the debtors of the issuer is either market-acceptable or is duly secured. Hence, it allows the issuer to make his own credit-rating insignificant or less-significant, and the intrinsic quality of the asset more critical.”
The arguments in the afore-mentioned article against superior rating of the asset pool are twofold:
(a) Collections are manual, hence co-mingling risk is high and effectively removes ring-fencing (in fact the authors have gone so far as to say that MFIs may pay the investor the scheduled amount regardless of the actual collection) and
(b) if the servicer fails, there is no alternate mechanism to collect from the end-borrowers.
However, in the microfinance securitisation transactions, several structural mitigants have been built in to counter servicer risk.
First, it is mandatory for the MFI to pay the trustee of the SPV on a weekly basis. Hence, the co-mingling risk is reduced to a week’s cash flows. This risk is accounted for while taking into account the rating of the transaction (Please refer to the rating rationales available on IFMR Capital’s Deal Portal)
Second, the MFI maintains a first loss cash collateral from the onset of the transaction. It is difficult to understand why an MFI would make scheduled payments to the trustee despite receiving lower collections (and hence ‘mask’ the true pool performance), while at the same time maintaining a cash collateral – a double whammy! Would it not make better financial sense to let the cash collateral be debited at the end of the transaction?
Third, it is mandatory for MFIs to provide a detailed MIS on collections to the trustee with every payment. The Arranger and the trustee play a key role in in terms of diligence of the MIS. This reduces the risk of fraud.
Fourth, one of the key benefits of the structure is to mitigate the risk of systemic default. The structure provides diversification across branches, geographies, loan types such that the risk of an external shock is minimal. Such diversification can be achieved across multiple originators, where the underlying diversity in a single originator is not sufficient.
Fifth and most important, IFMR Capital’s monitoring and surveillance setup is a critical early warning signal system that has been set up to counter this risk. The monitoring team consists of microfinance professionals with deep experience on the field and strong networks across the sector. The team holds both close relationships with the top management and has indepth knowledge of field operations through these visits. It diagnoses weaknesses in the MFI’s operations and/or systems and provides inputs on corrective measures to the MFI. This continued involvement and diligence by the Arranger post transaction settlement differentiates microfinance securitisation as it is today from securitisation of other asset classes.
In rating microfinance asset backed securitisations, CRISIL has indeed been conservative in its assumptions, due to the limited track record of microfinance securitisations in capital markets. On a more careful analysis of the securitisation structure, the authors of the “Hidden Risks” article should note that the underlying pool of micro-loans securitised, despite their low default rates, have not been assigned a higher rating than that of the originator. After a detailed analysis of default rates of the underlying micro-loan pool, its volatility, the sustainability of the originator and commingling risk, the rating agency arrives at an assessment of base case default rates and the amount of additional credit protection required to achieve the ratings of the senior and junior tranches of securities. The authors’ contention that the rating agency in question “apparently does not understand” the underlying sector and the assets is spurious as CRISIL has assessed more than 140 MFIs over the past eight years and has in fact developed a separate methodology for this sector. CRISIL does not only rate microfinance securitisations, they also provide risk assessments, ratings on bank facilities and debentures. This is accompanied by the arranger, IFMR Capital’s due diligence, monitoring and supervision processes of each MFI that is a potential candidate for securitisation. This is the crux of what goes behind the “P1+ or AAA” rating!
The rating agencies’ approach has been consistent across other retail asset classes such as personal loans, commercial vehicle loans, car loans and small business loans. For instance, Tata Motors executed more than Rs. 2000 crores of rated securitisations in the year 2009. The senior tranches were assigned a AAA rating, while Tata Motors’ senior secured loan rating is at A+. While there is capital markets supervision of retail assets by investors and rating agencies, there is no back up servicer in place for any of these retail loans. What is important in the securitisation of any retail asset is the risk assessment of sustainability of the originator over the life of the underlying asset, a detailed analysis of the underlying pool and a robust monitoring and surveillance system that can monitor triggers that may indicate increasing servicer risk.
So how have the ‘AAA’s’ performed till date?
IFMR Capital has structured, arranged and co- invested in six rated microfinance securitisations comprising a total financing amount of Rs 195 crore
| MFIs |
Type of Deal |
Size (Rs crore) |
Date |
| Equitas Microfinance |
Single-originator |
18 |
March 2009 |
| Equitas Microfinance |
Single-originator |
48 |
November 2009 |
| Sahayata, Satin, Asirvad, Sonata |
Multi-originator |
31 |
January 2010 |
| Grameen Financial Services |
Single-originator |
33 |
March 2010 |
| Sahayata, Satin, Asirvad |
Multi-originator |
34 |
May 2010 |
| Grameen Financial Services |
Single-originator |
31 |
June 2010 |
While this is a drop in the ocean in the context of the entire banking and finance sector, this is important as it signifies a way for high quality microfinance institutions to access debt capital markets, in a framework that builds in tight supervision, and rewards better access at better pricing to those microfinance institutions that are underwriting loans well.
Micro-loan securitisations have shown remarkably strong performance with 0.6% defaults in the underlying pool till date. Four of twelve tranches of securities have been upgraded. However, to maintain this performance, IFMR Capital recognizes that “event risk” and systemic risk such as the originator’s or the arranger’s incentives not being aligned must be carefully considered and incorporated in the design today itself.
The author quotes the example of a political risk event in Krishna district, in which MFIs suffer significant losses in their micro-loan portfolios. However, the largest lenders to MFIs operating in Krishna, have four years later, entirely recovered their dues from this district. This is a promising indicator that recoveries are possible, and that setting up an independent backup servicer that monitors & supervises performance and “steps in” in the worst case, is a probable future reality.
To mitigate systemic risk, the off balance sheet micro-loan securitisations are structured in a manner that the incentives of all the participants are aligned to those of the investors. Securitisation structures “pre- global financial crisis”, by and large did not have sufficient incentives for the originator or the arranger to underwrite and monitor well post sale, this is one of the important lessons we have learnt from this crisis.
Incentivizing the Originator: The MFI or the Originator has to ‘originate wisely’ and ‘collect well’. The investor carries the risk of being sold the riskier assets in the MFI’s portfolio as well as having to depend on the MFI to collect from assets that no longer belong to the MFI.
This risk is mitigated by the MFI retaining the first loss portion of the risk under the pool in the form of cash collateral or an irrevocable bank guarantee. The size of the cash collateral depends primarily on the following factors – historical default rates and their volatility, the extent of co-mingling of cash, an assessment of the originator’s sustainability,and prepayment rates.
The first loss default guarantees in the securitisation transactions till date have been in the range of 10-14% of the transaction size, while the observed default rates on the pools have been less than 0.6%.
The Reserve Bank of India has mandated that the first loss default guarantee is deducted from the Tier I and Tier II capital of the originator. Thus, this provides a powerful incentive for the MFI to ensure that there is no slip-up in its efforts to collect from the underlying pool.
Incentivizing the Arranger: An important risk that is not mentioned in the quoted article is mis-selling. This is even more pertinent for microfinance where there are very few listed organizations, very little public information and very little understanding of how microfinance actually works.
The Arranger in a capital market transaction is best placed to understand the originator and has the responsibility of effectively communicating its strengths and weaknesses to target investors. However, arrangers in debt capital market transactions usually have little involvement with the transaction once the placement is concluded.
However, in each of the microfinance securitisation transactions highlighted above, the Arranger (IFMR Capital) is also an investor in the subordinated tranche of the issuance. The Arranger thus takes the risk of having a junior claim on the asset cash flows. This is a strong incentive for the Arranger to conduct due diligence, monitoring and supervision properly.
IFMR Capital also takes on the responsibility of detailed credit surveillance of the Originator. This is in the form of quarterly visits that cover not only field operations in multiple geographies, but detailed financial analysis and operations review as well. These monitoring and surveillance visits highlight early warning signals well ahead of any potential stress event. Documentation signed with the MFI gives substantial powers to the Arranger to step in and conduct such discretionary audits.
Microfinance securitisation is an important alternative for financing that has opened up to MFIs in India. This permits smaller MFIs to reduce their dependence on a single source of financing, access the capital markets and avail of transparent, market-linked financing, as opposed to opaque, bilateral transactions. These transactions compel the MFI to adhere to the rigor of financial markets, share data, increase external oversight and improve internal systems and processes to meet capital market standards.
Risks in microfinance securitisation are recognised, have been sufficiently highlighted by both the rating agency and the Arranger, are similar to any other asset class securitisation in India and investors are compensated for the risks in the returns on such investments. Perhaps we should devote our energies on strengthening the mitigants instead.
Considered alone, development, finance and management is each a vast field, albeit with substantial overlaps among them. Let me illustrate the overlap by means of an example which has relevance from a historical and contemporary perspective, namely, the central role of finance and management in development.
At the early stages of economic development, agriculture and related activities employ almost all the resources and provide work and livelihood for the entire population. Even today the dominance of agriculture in India and South Asia is evident. The dominant asset and non-labour factor of production, historically for millennia until the emergence of large scale manufacturing and industry, was land. Agriculture, broadly defined to include animal husbandry, with land and labour as primary inputs was the production activity around which all other services, trade, arts and petty manufacturing were organized at early stages of development, if not always. Economy was the idealized self-sufficient village community or small areas reachable with the relatively primitive transport and communications technologies.
Two features of agriculture illustrate the significance of finance, credit and management in development. First, the inputs and their allocation—of land across various crops and of labour across land preparation, irrigation and application of fertilizers prior to sowing—must be committed at the beginning of the crop cycle. Farmer has very limited flexibility to adjust the allocations during the crop cycle in response to weather and demand shocks. Other inputs such as fertilizer, labour for irrigation and weeding, etc., can be adjusted to realised shocks. Second, while most inputs are committed during the crop cycle, the output being subject to additional weather shocks is not known until the harvest is processed and securely stored. Further, the value of the output depends on post-harvest spot prices. Since at best only the joint probability distribution of shocks, prices, etc., and not their actual realisations can be known, the environment of agricultural production is highly uncertain.
The uncertainty and risk of committing land and other inputs in advance of realization of value generates demand for credit to finance the inputs and to sustain the farmer’s consumption during the crop cycle. The length of this cycle varies from a few months for seasonal crops to a year or more for annual and tree crops. Moreover in areas where there is ample rainfall or assured irrigation more than one crop can be raised on the same plot of land. This allows the possibility that the loss of crop in one season could be offset by a bountiful crop in the next. Indeed, in parts of India where Kharif crops could be lost because of floods, the retained moisture and silt from floods could enable more extensive cultivation and higher yields of crops in the following Rabi season. Thus the agricultural risk—ex ante and realized—could could change from year to year due to natural disasters of floods and droughts.
Historically, in addition to credit, risk taking, and risk sharing arrangements have evolved, first in agriculture and then elsewhere as development proceeded, eventually to a specialized and complex financial sector. On the supply side, only those who had enough accumulated resources, social and legal instruments for collecting the principal and interest, and a capacity and taste to bear the default risk, could extend credit. It is no surprise that only landlords with large landholdings and traders in agricultural inputs and outputs had the capacity, desire and ability in adequate combinations to become large players in providing credit. And the demand for credit arose not only for financing the crop cycle but also for covering households in general for variations in cash flows subject to health shocks, demographic events (e.g. births and deaths), social and religious expenditures (marriages, funerals) whose timing and costs are uncertain. Credit is necessary for household consumption smoothing, i.e., to shield their consumption stream from large variations in their income stream. The virtual absence of means of insurance against various risks across families or communities meant that credit was a joint mechanism for inter-temporal resource allocation through borrowing and lending as well as means of insurance against risks. Serving two related but different objectives through the single instrument of credit forced inevitable compromises in the service of each. In other words, a single instrument will almost never achieve two objectives as well as two instruments—one for each objective—could.
Various forms of tenancy developed early on such as share-cropping, fixed produce rent, fixed cash rent to provide a range of arrangements for risk-sharing, each with its own risk and expected return patterns for the landlord and tenant. The attractiveness of each arrangement to individual landlords and potential tenants depended in large part on the sources of risk and covariations (in physical yields per hectare, in spot price per unit of output at harvest, cost and capacity to store harvested output to gain flexibility in the time of its sale, and so on) and the capacity to bear risk and risk preferences. The fact that a landlord (or trader) is often a provider of credit to his/her tenant meant that the landlord and tenant have a bilateral relation with respect to land and credit (whose supplier is the landlord and the tenant is the demander), and labour (whose supplier is the tenant and demander is the landlord). Such simultaneity of bilateral relations across three markets (land, labour and credit) might confer more market power on one of the two parties (usually the landlord or trader) relative to independent pairing in the three markets.
In the case of a trader (who is the supplier of credit, agricultural inputs and marketing service for output) and his agriculturist (who is demander of credit and inputs and supplier of outputs) the situation is analogous. In addition to making a portfolio choice of allocating her land among crops, the cultivator also decides on inputs (e.g., when and how much fertilizer to use), allocates her and her family’s labour between self-employment on her land and supplying it to others, and chooses when and how much to sell her harvests of different crops net of her family consumption, etc. Responsibility for making these decisions makes her a manager of resources. Thus finance and management have been core functions in agriculture at all stages of development, increasing in complexity and specialization as development proceeded.
The post Second World War literature on development was devoted to the analysis of the efficiency and distributional implications of alternative credit, insurance, marketing and other arrangements. While these arrangements may have originated in the historical past in what were then called “underdeveloped” countries, they remain present, if not endemic, in contemporary developing countries. The sophistication of the tools of analysis increased in step with their development in economic theory and econometrics.
It is no accident that historically the interest rate on finance or credit has been the target of attention of religious, literary and secular analysts. Apart from the Islamic prohibition of the charging of interest on loans, fulminations against “usurious” interest rates and characterization of money lenders as heartless “usurers” with no compassion for adverse shocks experienced by borrowers are ubiquitous in almost all religions.
A very early attempt to regulate interest rates is seen in Kautilya’s Arthasastra (commonly dated as a work of 4th century BCE). Kautilya’s sophisticated understanding of the link between interest rate and risk (regulated interest rate steeply rising from a ‘risk free’ 1.5% per month as the transactions financed become riskier and riskier and of legal aspects of liabilities for repayment) in loan transactions in Arthasastra is nothing short of remarkable, leaving aside the privileges to Brahmins and higher castes in rewards and punishments. Appendix I contains an extract from Arthasastra on interest rate regulations. In fact the sophisticated understanding of Kautilya of many aspects of economics and finance including the role of the state (i.e., the King) for provision of irrigation through construction of dams, standardization, weights and measures, preparation of budgets and audits with a clear understanding of income and expenditures, the possibility of corruption by public servants and incentive aspects of payment of adequate salaries for them, import and export taxes, etc., is truly amazing. Appendix II contains brief excerpts from R.P. Kangle’s (1972) translation that include, (i) Pages 90-98 on accounts, audit and definitions of revenues and expenditures, (ii) Pages 98-103 on administrative corruption, (iii) Pages 145-148 on Trade, (iv) pages 162-165 on Customs duties and tolls and (v) finally pages 350-351 on salaries of civil servants.
It is widely believed that the state described by Kautilya is a police state or at least a high centralized state. While there is some evidence in support of such a view, Kangle provides a much more nuanced view that it was a bureaucratic welfare state. Kautilya lists at least twenty departments! Indeed, one can claim that India has been a bureaucratic state for millennia, whether under Mauryas whom Kautilya helped to gain power, Mughals, the British or since independence, though the efficiency of the bureaucracy is another matter altogether. Appendix III contains Kangle’s analysis of Kautilya’s conception of the state.
More than a year ago, I was requested to chair a sub-committee of the Academic Affairs Committee for reviewing the MBA programme of the IFMR Business School and coming up with a vision for its future. The Committee presented the Board with its future vision of the IFMR Business School and a proposal to offer a single integrated, rather than three, Post Graduate Diplomas in management which would be, if not unique, at least have few parallels in the world in its integration of development, finance and management. The Committee’s vision had its academic rationale in the overlap among the disciplines of Finance, Management and Development. This note explains this rationale and illustrates this with the example of a major sector, Agriculture, in which risk taking, credit, finance and management are central. The note also explains the comparative advantage of IFMR Business School in offering an integrated MBA with its proven record of excellent research on finance and development and location in a currently very dynamic developing and emerging market country, India.
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Professor T.N. Srinivasan is Samuel C. Park Jr. Professor of Economics, Yale University and Member, IFMR Business School Board.
T.N. Srinivasan, Samuel C. Park Jr. Professor of Economics, Yale University and Member, IFMR Business School Board.
-By Sucharita Mukherjee
Securitisation of assets by NBFCs came under regulatory purview with draft guidelines being put on the RBI website on June 3rd. With more than 80% of the microfinance market being with NBFC MFIs, this has a strong effect on the microfinance securitisation market. Securitisation has recently come up as a way for small but high quality microfinance institutions (“MFIs”) to tap debt capital markets. Microfinance loans are unique in their nature due to characteristics such as a short one year term, group based credit risk exposure, periodic weekly repayments and very low default rates. The minimum holding period of nine months, as specified in the Draft Securitisation Guidelines, closes the nascent microfinance securitisation market, important not only for the growth of the microfinance sector in a way that reduces systemic risk, but in my view, also for the overall financial inclusion agenda of the country.
There are only three ways in which an MFI can fund itself:
(a) Accepting Deposits;
(b) Bank loans; and
(c) Capital markets.
Accepting deposits as a source of fund is quite rightly not available to MFIs and banks have a strong preference for larger MFIs who are able to absorb large amounts of funding quickly. Banks either lend directly to them or purchase portfolios from them. MFIs (both large and small) represent an essential component of the financial inclusion strategy for us in India and today, they serve more than 20 million clients with over Rs. 17,000 crores of loans However, as it stands, the microfinance sector is highly concentrated, with the top ten MFIs comprising about 75% of the market. As the market expands if growth is restricted only to these ten MFIs, it could present significant servicer concentration risks. In my view small but high quality MFIs are also needed to better serve our diverse populations as well as to address servicer concentration risk concerns. For these smaller MFIs, securitisation represents a very important additional source of capital markets funding, which has been taken away with these new guidelines.
While promoting sound asset quality through capital markets oversight and the involvement of intermediaries such as CRISIL and IFMR Capital, securitisation has also enabled reduction in the cost of financing to MFIs by over 200 basis points and more than one MFI has in turn reduced interest rates to their own clients. The Draft Securitisation Guidelines take an important step forward in ensuring orderly risk transfer from high quality local financial institutions and MFIs to large well-capitalised institutions such as banks and mutual funds, in the capital markets. The minimum retention requirement (MRR) of 5% in the first loss portion, as prescribed in the current draft, ensures that originators retain strong incentives for good due diligence as well as ongoing collection and monitoring. In fact, the microfinance securitisation transactions have seen MRR in the range of 10%. This is much higher than the historical default rate observed in the pools and is substantially higher than the 5% MRR prescribed under the new Draft Securitisation Guidelines.
However, I want to suggest that the minimum holding period (MHP) for one year microfinance loans with periodic weekly instalments (since a majority of microfinance loans are 50 weeks in maturity with weekly repayments) could be specified as the period pertaining to
(a) repayment of 9 instalments or
(b) repayment of 20% of the principal amount of the loan – whichever is larger.
The minimum holding period will then be linked to the tenor, as well as the frequency of repayments of the underlying micro-loans in the same way that the Guidelines make a distinction between bullet repayment loans and amortising loans. Also, a further suggestion would be to bring direct bilateral portfolio assignments under the purview of the Draft Securitisation Guidelines, else, off-balance sheet direct assignment transactions may continue in an unregulated, perhaps under-capitalised fashion.
The size of the microfinance sector is currently small (circa Rs. 17,000 crores) when compared to the combined banking and mainstream NBFC industry. There is much scope for outreach as currently, vast regions and populations of the country are uncovered. To achieve the dual goals of financial inclusion and the design of a stable and efficient financial system for the microfinance sector, the growth and development of high quality small MFIs is a must and deserving of careful regulation.
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[The author is the CEO of IFMR Capital Finance Private Limited]
