Microfinance: safe on the outside but risky on the inside?

As we reported before, experts warned that the microfinance sector was growing fast.

M.S. Sriram, a faculty at the Centre for Public Policy at the Indian Institute of Management Bangalore, found that the sector was growing “at a frenzied pace”. “The sector is showing signs of overheating, and many are predicting a 2010-like bubble building,” he found in a 2016 report on finance in India.

While the reports on farmers’ suicide continue, questions arise about the stability of the Indian microfinance sector.

In April 2019, the average long term rating for microfinance institutions by ICRA, a credit rating agency, was BBB, just one rating above junk status. ICRA describes their BBB rating as being “considered to have [a] moderate degree of safety regarding timely servicing of financial obligations”. But when looking at the balance sheet of microfinance institutes, this risk is not always apparent.

Keeping it off the books

A new and growing trend to secure funding, is the securitisation of loans according to ICRA in their Special Comment on the microfinance sector from April 2019. “Securitisation has always been an important funding tool for NBFC-MFIs, but the dependence was particularly high during the second half of fiscal 2019. In FY2018 and H1 FY2019, securitisation contributed to only 18 – 20% of the overall disbursements. However, this number leapfrogged to 37% and estimated 50% in Q3 FY2019 and Q4 FY 2019 respectively.”

So funding is increasingly secured through securitisation and the number of microfinance institutes using securitisation is also on the rise, ICRA reports. “ICRA has also noted a sharp increase in the number of NBFC-MFIs taking part in the securitisation market in FY2019. 43 entities raised funds through the securitisation route in FY2019 (as opposed to only 24 such entities in FY 2018).”

Securitisation is the process of bundling outstanding loans and selling these bundles, aka securities, to investors. This means that outstanding loans disappear from the balance sheet and credit is added.

Through this method, the risk associated with microfinance loans to poor people is pushed back, but only on paper. On the balance sheet, defaults are booked at the end of the maturity date of the security (sorry for the technical terms). So when a farmer defaults, the loss is not booked at that time, but when the security expires. This can be months or years later.

Especially the smaller MFIs are having difficulty acquiring new funds according to ICRA, which is reporting an increase in securitisation. The ICRA report Indian Microfinance Sector from December 2019 states, “[s]ecuritisation remains a prominent funding tool propelling the growth of NBFC-MFIs”.

On December 2017, 17 percent of the loan portfolio of all NBFC-MFIs was kept off the books; about 27 percent through securitisation.

Recent defaults in seven microfinance securitisation transactions with an “initial rating predominantly in the ‘A’ category” have highlighted the need for greater caution in evaluating the microfinance loan securitisation, according to India Ratings and Research,” as reported by BloombergQuint.

The fact that the overall long-term ratings of microfinance institutes by ICRA just being above junk status, combined with 17 percent of the outstanding loan portfolio of NBFC-MFIs being invisible on the books (a growing trend), questions the stability of the sector and could indicate another credit crisis like in 2010 when massive numbers of people defaulted on their loan.

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Article by Anrike Visser.
Picture by Abhaya Balaji.

This article was developed with the support of the Money Trail Project (www.money-trail.org).