MICROCAPITAL.ORG STORY: Braking Securitizations - India's Economic Times Reports That The Reserve Bank of India Proposes To Ask Originating Banks To Hold Loans On Their Balance Sheets For 6 Months To Stem 'Reckless Securitizations' And Suggests That Holding Periods Should Be Tailored For Banks Originating Microfinance Loans

A recent article in India’s Economic Times entitled ‘The Reserve Bank of India may ask banks to hold securitised debt for six months’ [1] by Gaurav Pai noted that the Reserve Bank of India (RBI) [2] may ask Indian banks to retain originated debt on their loan books for six to seven months before selling or securitising those loans to other market players. A securitisation is a financing technique under which loans originated by a bank are sold to another market participant, usually a special purpose vehicle (SPV) for an agreed price. The SPV funds the purchase of the portfolio of loans from the originating bank by issuing debt instruments to investors. These debt instruments are often known as ‘asset backed securities’ as they are typically backed or collateralised by the portfolio of loans.

The RBI’s proposal is consistent with measures recently taken by banking regulators in other jurisdictions to ensure that originators of loans continue to have ‘some skin in the game’ or retain some exposure to the loans before selling them in a securitization. This is to incentivize banks to originate loans that are of good quality and to ensure that they retain a ‘material interest in the performance’ of those loans. The article notes that ‘regulators in both the EU and the US now insist that the originator retain a minimum of 5% of issued securities on his own book, before sale’. The US Treasury is also mandating that ‘originators should have fees or incentives based on actual performance of the pool’ of loans, again an incentive for the originating banks to focus on the credit quality of loans. In Europe, it is reported that ‘banks have also been barred from exposing more than 25 percent of its own funds to a client or group of clients’.

The article notes that ‘securitization deals have come down dramatically’ in recent months, given the ‘regulatory uncertainty’ surrounding such products and the lack of investor appetite for them. Reference was made to the ‘reckless securitisation’ where a ‘loan advanced to pharma major Wockhardt changed hands a number of times in the course of a few days’. When Wockhardt defaulted on its obligations, the debt instruments the Wockhardt loans ‘backed’ became worthless. The RBI hopes that a ‘minimum seasoning’ period whereby the loans will continue to be held on the balance sheet of the originating bank for at least one coupon or interest period would limit the occurence of flagrant on-selling of loans.

Vinod Kothari [3], an India-based practitioner and author on asset-based finance pointed out that there is little difference between what market participants call a ‘securitization’ and a ‘transfer of financial assets’. He added rules on minimum holding periods and regulations should apply to both full-blown securitizations and bilateral transfers of loan assets. The report further added that the seasoning period ‘should be linked to the total asset term’. As an example, the report stated that ‘a six month period may be too short for a housing loan, but too long for a microfinance loan’.

In recent years, the Indian securitisation market has grown to as high as Rs 50,000 crore (approximately USD 10.7 billion) per year with mutual funds and insurers lapping up securities allured by their higher yields. The use of securitization as a fund-raising technique for microfinance institutions and its role in the current credit crisis have been covered in previous Microcapital.Org publications, some of which have been referenced in the Bibliography section below [4] – [11].

By Chinq Yee Chong, Research Assistant

Bibliography

[1] Article in the Economic Times entitled ‘The Reserve Bank of India may ask banks to hold securitised debt for six months’ : http://economictimes.indiatimes.com/articleshow/5147307.cms?flstry=1

[2] Reserve Bank of India (RBI): www.rbi.org.in/

[3] Vinod Kothari: www.vinodkothari.com/

[4] PRESS RELEASE: SKS Microfinance Securitization Receives “Highest Safety” Rating from Credit Analysis & Research

[5] MICROCAPITAL.ORG STORY: CGAP Consultant Deborah Burand Blogs About What Subprime Mortgage Securitizations Can Teach Microfinance Participants About The Sales Of Microfinance Loan Portfolios

[6] MICROCAPITAL STORY: SKS Microfinance Plans to Raise USD 104 Million in Rated Debt

[7] MICROCAPITAL STORY: SKS Microfinance, Share Microfin, and Equitas Microfinance Collaborate with Yes Bank to Securitize a Series of Micro-loans in India that Cumulatively Amount to USD 38.3 Million.

[8] MICROCAPITAL STORY: India’s microfinance sector softens while Indian MFIs Turn to Securitizing Loans to Raise Funds

[9] MICROCAPITAL STORY: Equitas Micro Finance Gets Transaction Securitized and Rated by CRISIL, Structured and Arranged by the Institute for Financial Management and Research

[10] MICROFINANCE PAPER WRAP-UP: Securitization in Microfinance, By Brad Swanson

[11] MICROCAPITAL.ORG STORY: CGAP Microfinance Blog Comments On Case Studies On The Liquidation Of Microfinance Institutions And Highlights Challenges Associated With Retaining Borrower Repayment Incentives In The Midst Of A Deteriorating Loan Portfolio