Securitization and the Challenges Faced in Microfinance

This paper describes securitization, the challenges that banks face in microfinance transactions and the mitigating solutions that ICICI Bank has adopted.The paper states that securitization:

• Is a process through which homogeneous illiquid financial assets are pooled and repackaged into marketable securities;
• Ensures that repayment of the securities issued to investors is dependent wholly upon the securitized assets;
• Involves:
  • Isolation and evaluation of risks,
  • Allocation of risks to various participants in the transaction,
  • Mitigating risks through credit enhancement structures,
  • Pricing the residual risk borne by the originator;
• Deals with various asset classes;
• Is an efficient and cost-effective resource raising mechanism that integrates illiquid underlying assets with capital markets;
• Serves as a balance sheet management tool for originators through which they can identify hidden values, hedge asset-liability mismatch, currency, commodity and interest rate risks, and enhance return on capital and equity;
• Helps banks to reduce their regulatory and economic capital requirements.

The paper then describes the challenges that banks face in microfinance transactions, and the mitigating solutions that ICICI Bank adopts. These include the mitigation of:

• Credit risk of underlying obligors through First Loss Deficiency Guarantees;
• Prepayment risk of underlying obligors by taking indemnities from the originating entities;
• Creation of appropriate rights on the underlying cash flow variables by obtaining No Objection certificates from such lenders holding charge on the portfolio being securitized.