The Securitisation of Microcredit by SKS Microfinance since

2009 – A Critical Analysis

Summary

The aim of this assignment is to analyse the Indian MFI SKS’s recent activity as the originator of

securitised microcredit, with reference to two academic papers on the broader topic of

securitisation within microfinance. The two reference papers chosen are as follows:

I. The Microfinance Collaterized Debt Obligation: a Modern Robin Hood? (Byström, 2006)

II. The Financialization of Micro-Credit (Aitken, 2013)

Byström’s paper was selected as it offers developed analysis of the potential benefits to the

Microfinance industry from Securitisation, whilst also highlighting the risks associated. Due to the

paper being published in 2006 (before the growth in Microfinance securitised products), it provides

a purely theoretical argument; hinting at some of the potential risks that could follow this

mechanism but with no description of the scale or consequences.

Aitken’s piece takes a more empirical approach, looking at the expansion of and the problems

associated with microcredit securitisation in recent years. Having being written after the 2008 Global

Financial Crisis and the 2010 Andhra Pradesh crisis, it effectively underlines some of the risks these

events uncovered. The study also looks in depth at the MIVs and recent IPOs alongside

securitisation; however this assignment will only focus on its analysis of securitisation.

Section 1: SKS microfinance’s involvement in securitisation

The case study of focus is the Indian MFI, SKS’s involvement as the originator of securitised

microcredit since 2009. Analysis of the case study begins in 2009, because this allows for the

examination of the successes of Securitisation within microfinance post-financial crisis.

SKS microfinance has undertaken quite some transformation since its beginnings in 1998 as a non-

profit NGO. Registered on the Bombay Stock Exchange (BSE) and 10.2% owned by the Private Equity

firm West bridge Capital, one would be allowed to argue that SKS has been a victim of mission drift.

However the firms commercialisation has increased SKS’s outreach with the MFI growing into not

only India’s largest MFIs but one of its most influential companies (Mcgregor, 2008), currently

serving 5.5 million clients (down from the 2010 figure of 7.3 million (Anon, 2010)). Despite suffering

substantially from the Andhra Pradesh crisis in 2010 where its share price dropped from 1366 to

56.66, it has since enjoyed a modest recovery which it’s CFO (Raj, 2010) generously described as

“one of the fastest turnarounds in the Indian financial services sector”. This has been in large part

due to the support of the capital markets in particular the use of securitisation; with the organisation

having undertaken thirteen separate securitisations so far this fiscal year taking the total raised to

1,816.26 crore bettering last year’s securitisation total of 1400.9 crore (Anon, 2014). The successive

rounds of securitisations have allowed SKS to grow its lending book, whilst raising much needed

capital in order to cover it’s written off loans (see Table 2).

The mechanism of focus, securitisation refers to the act of the issuance of securities directly backed

by a pool of usually loans or bonds (Byström, 2006). In this context it pools together a large number

of microfinance loans which are then used as collateral for securities issued by the originating firm.

These securities are then sold on to an external investor allowing the originating MFI to transfer its

credit risk onto a third party. As MFI’s are also able to gain payment for an asset immediately (from

the purchaser of the CDO) instead of waiting till the loan is repaid, they do not have to wait to issue

further loans allowing them to grow at an accelerated pace. This enables them to fill some of the

large excess demand believed to be existent in the market, whilst not directly building up large

amounts of risk; however as was seen in the 2008 Global Financial crisis and the 2010 Andhra

Pradesh crisis can encourage the originator to over lend raising the question of moral hazard.

Section 2: Paper Analysis

Byström’s paper intends to highlight the vast potential the securitisation of microcredit offers (in

particular CDOs), stating the ways in which the area can grow in order to meet the excess demand

for the product. It also cites the many potential complications to the growth of securitised

microcredit, such as the poor infrastructural framework in India that could hinder the development

of the asset.

Byström’s work uses the example of the relative successes enjoyed by similar assets and suggests

the potential characteristics of a Microfinance CDO (MiCDO) could lead to MiCDOs becoming

popular within the market. Due to the lack of empirical data relating to this area in 2006, Byström

was forced to use a hypothetical case in South Asia (including India), based on real life data to

scrutinise the potential benefits of a MiCDO. The study uses simple data analysis, calculating the

expected returns from the three separate tranches to be sold to external investors. The details of

these tranches can be seen in table 1 where it is shown that tranching can lead to the creation of

assets with vastly different risk profiles attracting investors with varied risk appetites. Hence the

clear limitation of this paper is that its findings are not based on real life data or examples, due to

the time at which it was written.

Looking at who stands to gain from securitisation, Byström states that the MFI would benefit via the

fee it receives for loan origination. The micro-lender is set to benefit from securitisation as it is

assumed that there is a large amount of excess demand in the Microfinance market (based on the

World Bank’s estimate in 2005 that MFI’s only meet 4% of world-wide demand (Wardle, 2005)). It is

also mentioned how the increased competiveness in the market, catalysed by outside investment

could lead to lower borrowing rates for lenders. This assumption of wide scale excess demand

supports the need for rapid expansion; however it fails to fully recognise the risks of accelerated

growth to both the MFI and the micro-lenders. These risks were uncovered during the 2010 Andhra

Pradesh crisis where over lending led to indebtedness for both the MFIs and their clients.

Aitken’s paper on the other hand aims to reveal how the “financialization” of Micro-credit has

already been accomplished through MFIs closer relationships with capital markets, whilst

highlighting the various risks that the in-organic expansion of micro-credit possesses. This study

portrays a more pessimistic outlook on the expansion of microfinance and securitisation, arguing

that a commercialised micro-finance sector should not be viewed as an end.

The study uses previous examples as its sole mechanism of analysis choosing not to analyse data on

the matter. Despite this Aitken’s work does provide some salient cases to highlight the recent

growth of securitisation within microfinance whilst raising the various risks associated by drawing

parallels between the growth of microfinance securitisation and the securitisation of sub-prime

mortgages which led to the 2008 Global Financial Crisis. In reference to the 2008 Financial Crisis,

Aitken also outlines how Indian MFIs and intermediaries are trying to learn from the mistakes of the

crisis; one of the techniques used is forcing the MFI and the intermediary to own a significant share

of the security to ensure that they are incentivised to lend responsibly.

The paper ultimately finds the ‘financialization’ of the microfinance industry to have ambiguous

benefits but is certain to add significant risks to the sector, which could be detrimental to the

stability of microfinance. Aitken therefore feels that the securitisation of microcredit should be

slowed in order to avoid another crisis like the sort that occurred in Andhra Pradesh. This view is

understandable however his analysis is one sided in parts and ignores some of the benefits of

securitisation as mentioned in the Byström paper such as geographical expansion. Finally Aitken

points to the fact that MFIs have been forced to become more reliant on the capital markets (in

particular securitisation) since the Andhra Pradesh crisis because of the increased difficulty in

attracting investment. Therefore capital markets could be interpreted as a lifeline for the

commercial microfinance industry allowing for Keynesian reconstruction, because without it these

firms would need to shrink dramatically in size.

Section 3: The use of securitisation by SKS microfinance

It can be said that Byström correctly predicted the expansion of securitised microcredit, with SKS

and other MFIs such as Equitas becoming highly active in the field. However he did not foresee the

dangers associated with the rapid expansion of a relatively infant commercialised microcredit

industry. These pitfalls were observed during the Andhra Pradesh crisis where a mix of the Andhra

Pradesh governments new regulations (tougher lending requirements and a ban on multiple lending)

and SKS’s prior lax due diligence in lending led to SKS’s loan book declining from $1.2bn to $50mn

and 30,000 jobs being cut (Pandey, 2013). Conversely this crisis can only in small part be accredited

to securitisation and since 2010 SKS has shown signs of modest recovery having been forced to

diversify away from Andra Pradesh (Rao, 2012), by growing its loan book in 15 other Indian states

which has to be seen as a positive step to expanding the industry.

Byström certainly did not envisage microcredit CDOs being used in response to a crisis, however it

could be argued that if SKS used securitised products in greater quantity as opposed to its IPO and

the sale of equity stakes as a means of raising capital, then SKS would not have suffered as greatly

from the Andhra Pradesh crisis, due to the potential aversion of large write off fees in 2012 (see

table 2). This stems from the previously mentioned benefit of securitisation as a mechanism of

shifting the credit risk off its loan book onto a third party, allowing SKS to obtain capital and grow its

loan portfolio, whilst not being exposed to credit risk. Having said this securitisation can encourage

originators to lend more recklessly, connoting that increased securitisation by SKS pre-crisis would

have created increased write offs and larger deprivation. However these losses would have been

borne by the wealthy purchasers of the securitised products meaning that this could have just been,

taking from the rich west and giving to the Indian poor. Looking towards the new wave of

securitisations after the 2010 crisis could the influx of extra capital just lead to another period of

over-lending followed by a crash, this time more similar in character (but not scale) to the 2008

Global Financial Crisis? Only time will tell, however history provides a pessimistic outlook.

Aitken’s cynical opinion of the mechanism largely originates from this tendency of securitisation to

lead to crises. The paper states that MFIs have achieved their goal of commercialisation, drawing

upon SKS’s increased ‘financialization’ and the risks this created, eventually leading to a major crisis

in 2010. The paper also reveals the added danger of securitisation, in bringing SKS’s impoverished

clients into contact with the risks associated with capital markets, such as instability and over-

extended credit. This implies that SKS should cut its activity within securitisation, yet their increased

capacity to lend should surely not be viewed as a negative if in principle one believes in the powers

of wide-scale microfinance; after all securitisation has allowed SKS to increase its geographical

locations to avoid market saturation.

In accordance with this, Aitken’s statement that microfinance cannot be viewed as a solution to

poverty, suggests that he is justifiably sceptical about the product and its inorganic expansion. The

negative implications of the growth of this industry and over-indebtedness have been cast into the

spotlight recently following the occurrence of multiple suicides following SKS’s over lending and

harsh collection techniques, and if this field is to expand there are inevitably large risk which have to

be contained.

Section 4: Proposed natural experiment

Due to the recent emergence of securitisation within the field of microcredit, the majority of the

solutions to the problems mentioned in this assignment remain unknown. Most importantly the

following hypothesis: “Does securitisation help to achieve sustained economic growth within the

Indian microfinance sector?” stays unanswered. Once a convincing answer to this problem is found

other MFIs can make a more substantiated decision as to whether and to what extent they utilise

securitisation.

As securitisation has been used in large quantities within microfinance during the past five years, a

natural experiment using current and future dates could be conducted to test the above hypothesis.

The key difficulty with this study would be finding suitable control and treatment groups because

the majority of commercialised Indian MFI’s are now participating in the field of securitisation and

no two MFIs can be said to be identical. However from the basis of this article, SKS post 2010 could

be used as a treatment group for this study, with the treatment being the colossal fall in its share

price in 2010, forcing it to become more reliant on securitisation. The ideal control group in this

instance would be another Indian MFI of similar stature who does not use securitisation, however

one simply does not exist. Nonetheless one could analyse SKS’s performance in Tamil Nadu (a state

which SKS recently expanded into), comparing their successes with the use of securitisation to

Madura a major longstanding on-profit MFI in the state. Econometrically controlling for the

differences in characteristics between these two MFIs it may be possible to conduct a fairly accurate

study on the subject testing this hypothesis.

Another key problem with a study is how to measure the performance of an MFI. The Financial Self

Sufficiency (FSS) measure could be utilised in order to measure the financial performance of both

SKS and Madura in the state of Tamil Nadu, however this measure fails to incorporate the social

impact of the MFIs in focus.

Conclusion

From the above analysis it can be said that the benefits of securitisation within Microcredit remain

ambiguous, however it has been shown to be a useful tool in aiding SKS microfinance’s recovery

from the Andhra Pradesh crisis. The vast potential Byström showed this product to hold should also

not be ignored in fear of invoking a future crisis, because standing idle will simply not tackle the

excess demand and will not serve the citizens credit needs. After all should the rational choice of

willing lenders not be respected, especially with micro-lenders being educated on the process of

repayments? However the harsh sales tactics used by SKS representatives prior to the 2010 crisis

should be avoided at all costs in order to prevent micro lenders from being forced to exhibit

anomalous behaviour (Thaler , 1980).

Taking this into account, if one feels that the capital markets remain the key to the expansion of the

microfinance industry then the characteristic of securitisation of shifting risks onto the wealthier

investor arguably makes it the preferable instrument on offer. Hence this writer feels that the

answer to the problem lies in the further regulation of securitisation and on the lending practices of

MFIs. This has to be conducted in a cautious and drawn out manner in order to avoid a reoccurrence

of the Andhra Pradesh crisis however if done successfully could lead to the mechanism fuelling

sustainable accelerated growth of the microfinance industry.

Appendix

Table 1: Expected MiCDO tranche losses and Moody’s credit ratings (from Moody’s Idealized Loss Rate Table) for various first - and second-loss tranche thicknesses. The MiCDO is made up of three tranches (equity, mezzanine and senior) and it is assumed to contain 50 identical and independent $1 mi llion MFI-loans, each with an expected loss of 5%(Byström, 2006).

Table 2: SKS Income statement 2009-2012 (Pandey, 2013)

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