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Due to increase in the capital inflow avenues for the MFIs, MFI rating agencies have come into being. These rating agencies rate the MFIs based on certain parameters and do not rate the securitized loan portfolio per se, however the MFI rating could be taken as good proxy for rating of the structured security. Given all the above facts point to note is that per se the micro-lending area is not regulated.

Lessons from the Sub-Prime Lending Crisis

The problem with sub-prime crisis was not structured finance instruments per se, but the way these securities were not tracked, not properly rated, not properly analyzed etc. in short, were mismanaged. In sub-prime lending the institutions that granted these loans promptly sold them on – the securitization process – to other institutions, which sold them on to others, and so on again and again, those who suffered losses were the ultimate holders. There were so many of them, all over the world, that no one knows where the losses were being borne.

Sans the purpose of the loan and amount of loan into consideration, the profile of clients served by sub-prime lending and microfinance is similar. Microfinance serves people who do not have formal access to any credit and are charged interest rates higher (approx. effective interest rate of 24% due to high transaction costs) as compared to the normal banked entity. As opposed to a sub-prime lending deal in microfinance there is no collateral in most cases.

MFIs have an incentive of freeing up more capital and expanding their reach by selling of the portfolio and transferring the risk to the investor. There are default clauses in the securitization deal, but as the security would change multiple hands the situation would be no different as compared to the sub-prime crisis. The situation would go from bad to worse if multiple banks and MFIs proliferate in the same geographical area (possibility of cross borrowing across financial institutions). Issues in microfinance portfolio securitization would not affect the financial markets but would surely not augur well for the low income group people as financial resources would dry up! It is important to note that an essential ingredient for successful microfinance is trust.

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* Contributed by: -
Raghavendra Badaskar,
PGP II,
T. A. Pai Management Institute, Manipal.