RBI, Securitisation and Micro-finance – at loggerheads?

Learning lessons from the far reaching consequences of securitisation of sub-prime debt in the US, the Reserve Bank of India has come out with a bunch of regulations, which clearly indicate that ‘caution’ will be the way forward in future. RBI’s June 2010 guidelines for NBFCs stipulate a Minimum Holding Period (MHP) of 9 months before the loans can be sold off for loans maturing within 24 months and an MHP of 12 months for loans maturing after 24 months. In addition, the NBFC must retain a minimum of 5% (for loans maturing within 24 months) or 10% (for loans maturing within 24 months) of the book value of loans being securitised – and in the equity tranche in case there are tranches. In issuing these regulations, the RBI has addressed the most common criticism of the sub-prime crisis – that NBFCs did not perform due diligence, since they were going to sell off the loans anyway. The minimum holding period and minimum retention requirements have ensured that the NBFCs are a significant stakeholder in the loans they are securitising. Also the RBI has implicitly acknowledged the failure or inability of credit rating agencies to properly rate such instruments. Any rating done after 9 or 12 months is likely to be more accurate than a rating done immediately after disbursement of the loans. The reaction to these guidelines has been muted considering the events of the last 2 years. However, the microfinance sector has seen red in these new guidelines. Since the last few years, securitisation was becoming a preferred method of fundraising by micro-finance institutions. However these new guidelines are likely to act as a deterrent to the growth of securitisation in the micro-finance sector as most micro-finance institutions are registered as NBFCs. Micro-finance loans are of short duration and often get prepaid with 9 – 10 months. The borrower typically pays off the remaining tail and gets a new loan. Hence, the guidelines with a holding period of 9 months largely hamper the securitisation route for MFIs. Micro-finance is growing rapidly in India on the back of good returns but concerns have been raised at the fast pace and whether due diligence is being maintained – similar to the situation of fast paced growth of high return sub-prime lending in the US. Also, micro-finance still being a relatively new phenomenon with not enough historical data, ratings provided by agencies are likely to be less accurate. In such a situation, RBI’s cautious approach to securitisation is the right step forward even if it means a slight slow-down in the rapid pace of growth of micro-finance.