Microfinance Securitization in Africa

Part two of the series titled, “Unlocking Africa’s MFI cashbox”

The microfinance industry has had its share of crises. The 2010 credit crunch in the Indian state of Andhra Pradesh was the most notable among a slew of MFI failures in Latin America, South Asia and Africa. The key drivers of the Andhra Pradesh crisis were a lack of microfinance regulation, credit bureaus and a unique identification system. Without adequate know-your-customer (KYC) data to assess poor households’ creditworthiness — even for loans of $500 or less — MFIs lent to clients who were already heavily indebted, according to a BBC News report. With no regulatory protection, the borrowers accepted annual interest rates of up to 120%; more than 80 people took their own lives in what the BBC described as a “suicide epidemic.”

Commercial banks fell into trouble, too. Having invested in microloan securities to meet lending targets for government’s protected sectors, they allowed MFIs to transfer principal and interest payments in monthly fixed-amount payments instead of immediate pass-through disbursements. The remaining borrower repayments stayed on the balance sheets of already failing MFIs. Rating agencies, for their part, assigned mismatched ratings to MFIs and their securitized portfolios. In one instance, an MFI with a BBB- rating issued AAA securities.

In the throes of the Great Recession, the 2010 microfinance crisis cast MFIs as little better than traditional financial institutions. Since then, the sector has done much to reverse this fall from grace, and on a global scale. Numerous initiatives now promote technology and sophisticated tools to implement self-imposed standards for corporate governance and social impact. Such improvements have ensured the sector’s continued attractiveness to institutional investors with risk appetites suited to complex structured finance. As of 2016, 127 MIVs globally held $13.5 billion in assets under management and served 400,000 active borrowers.

This level of professionalism has not reached Africa’s MFIs, however. In addition to low liquidity on MFIs’ balance sheets, high operational costs and regulatory restrictions hinder their profitability and keep them from gaining traction. Household borrowers needing smaller amounts cannot cope with interest rates that can top 25%. MSMEs looking to scale up find most Central Banks lending cap stifling. The absence or shallowness of capital markets across sub-Saharan Africa (SSA) has added to these challenges. Legal frameworks limit institutional investors’ ability to diversify risk and omit the possibility of securitizing any asset, let alone microloans. As a result, most MFIs still function on public investments or philanthropy, deprived of the resources held in pension funds, insurance companies, commercial banks and personal bank accounts, under mattresses and in lockboxes.

The securitization of microfinance can provide an infusion of capital for sub-Saharan Africa, as it has across Asia, Eastern Europe and Latin America. Though securitization’s relative impact in those regions has been small, Bangladesh’s initial $180 million issuance amounts to 3,273 percent of Liberia’s $5.5 million MFI loan portfolio for 2019. Securitization can position MFIs to lend in higher volumes to individuals and MSMEs at lower interest rates, and can quicken the flow of resources from commercial banks and other institutional investors into real economic activity. For VSLAs and the economically diverse households and businesses they serve, securitization can also provide a channel for the investment of individual and pooled resources.

Microfinance securitization may benefit from African nations’ growing appetite for greater regional cooperation. The latest such initiative was the creation of the African Continental Free Trade Area in 2019. According to the South Africa–based Trade Law Center, 29 out of 54 signatory states have now ratified the agreement. The securitization of microloans would create an opportunity for smaller countries, like Liberia and Rwanda, to attract capital from institutional and retail investors beyond their borders. As others take steps in that direction, investors of all classes could diversify their portfolios by buying MFI securities in neighboring countries. This could lead to the gradual development of a sub-regional and continental capital market, which would boost trade and economic growth in the real sector as MSMEs continued to grow through greater access to capital.

Comprehensive upgrades are underway across Africa to promote financial inclusion, with support from the World Bank Group and other development partners. These contribute to a suitable environment for microfinance securitization. For instance, authorities in Kenya are working to bring all adult residents into the national identification card and credit reference systems, using biometric data such as fingerprints and facial recognition. The central bank’s National Financial Inclusion Strategy clarifies regulations to allow for mobile credit and the adoption of tiered KYC requirements for banks and non-bank financial institutions. Both measures serve to simplify and expand access to financial services for the mostly undereducated public.

Many African countries, however, lacks the legal and institutional ecosystem to create a secondary market in microloans. So far, in Liberia the nation’s Securities Exchange Commission and Central Securities Depository — established in 2016 — exist only on paper. Putting these entities to work and establishing a credit rating agency would be fundamental to the securitization of any asset, including microloans. A comprehensive legal framework, including proper enforcement mechanisms, would underpin these components and aid in mitigating potential pitfalls of the system. Not surprisingly, countries such as Liberia appear nowhere in PwC’s latest Africa Capital Markets Watch, which reports periodically on trends in financial markets across the continent.

In a market as small, the cost of some institutional arrangements within this ecosystem might outweigh the benefits, at least in the short run. These include independent agencies that would assist MFIs in the expensive and cumbersome task of securitizing their loan portfolios while mitigating risk both before they issue securities and in the event of an MFI default. The domestic and regional markets in sub-Saharan Africa would benefit from having regional bodies fulfill those functions. The Economic Community of West African States (ECOWAS) among other bodies, covering the mostly Anglophone bloc of West African countries, including Liberia, could agree to establish and facilitate initial funding for these entities.

Written by Kennedy Muturi
@kenmuturi5