Part three of the series titled, “Unlocking Africa’s MFI cashbox”
Sharon Stieber, former vice president of structured transactions at Fannie Mae, put forward the idea of an independent guaranteeing agency in 2007. In an article for the MIT journal, Innovations: Technology, Governance, Globalization, she proposed that such an entity could play a role similar to that of Fannie Mae and Freddie Mac in the U.S. housing market. Her proposal was not specific to any region but could be applied to sub-Saharan Africa. In Stieber’s scenario, the agency would oversee the pooling of loan portfolios from one or several MFIs operating in the region, as well as the preparation of legal documentation and all necessary disclosures pertaining to the portfolios, and the cash flow structuring, modeling and fulfillment of transactions between investors and loan servicers through the Special Purpose Vehicles (SPV). The agency would also obtain credit ratings for the MFIs and securities, structure and sell the securities, and act as trustee and custodian of all documentation pertaining to them.
The Regional MSME Investment Fund for Sub-Saharan Africa (REGMIFA) is leading the way in that direction. The organization acts as a multilayered fund attracting public and private investment in MSMEs. Endorsed at a Group of Eight summit in 2007, the fund offers shares to development finance institutions (DFIs), international finance institutions and aid agencies, all of which share a measure of risk and underwrite the senior and subordinated debt notes offered to private investors. As of September 2019, REGMIFA partnered with 49 MFIs in 19 SSA countries, had reached 176,890 borrowers and had a total loan portfolio of about $127 million.
Africa’s sub-regional blocs could create bodies similar to REGMIFA to attract resources from homegrown DFIs, institutions and retail investors. If such an agency was established in the region, it could help MFIs in Africa avoid the prohibitive cost of individual securitization processes and the burden of coordinating complex tasks beyond their core function. Like REGMIFA, the agency could mitigate foreign exchange risk and employ subordination for credit enhancement. The fund itself would need to be over-collateralized to provide added assurance for investors.
An ECOWAS/COMESA or SADC guarantee agency could help MFIs meet global standards for corporate governance, financial management and social impact. The agency’s technical assistance could include mandatory, phased investments in the technology needed for loan origination and servicing, financial reporting and disclosures, and cybersecurity. The heightened professionalism of MFI operations would afford the guarantor access to credible reporting for display on its web portal, over which regional investors would feel a shared sense of ownership.
Financial institutions across sub-Saharan Africa have sufficient resources to underwrite this scheme, beginning with the African Development Bank and the African Export-Import Bank, which could headline the list of equity investors. Ecobank, United Bank for Africa and other leading commercial banks could subscribe to the senior and subordinated debt notes. A plethora of insurance companies, pension funds and high-income individuals could join them, following the REGMIFA model. VSLA apex bodies — unregulated associations that represent VSLAs in their dealings with financial sector regulators — could help pool funds from interested members to meet the minimum investments for the debt tranches. The guarantee agency could then leverage existing linkages between commercial banks and mobile money platforms to disburse cash flows to VSLA investors. The agency could further accommodate VSLAs by incorporating a tiered-investor KYC arrangement, now globally recognized as appropriate for providing financial services to clients at various income levels.
As securitization gains traction across sub-Saharan Africa, the potential risks will rise. Borrowers’ over indebtedness, resulting defaults and MFI failures, and institutional investors’ overexposure to weak micro lenders could create a domestic and regional domino effect akin to the case of Andhra Pradesh. In a 2010 article describing the risks of microfinance securitization from the Indian state’s perspective, consultants Daniel Rozas and Vinod Kothari recommend installing mitigating systemic elements, including strong MFI regulatory oversight, credit reference and national identification systems for KYC data collection, and robust consumer protection.
Rozas and Kothari also recommend that legal frameworks for securitization treat microloans as distinct from other underlying assets because the typical MFI is the most viable servicer of its own portfolio. In their research, they found that an SPV pooling mortgages could retain a new loan servicer without default risks resulting from an originator’s terminated involvement, but hazarding such sudden changes to a portfolio of microloans could imperil the value of the issued securities. Borrowers would perceive the changes as signaling a creditor’s imminent failure. Or they could simply lose commitment to pay, in the absence of a familiar servicer, and stop paying their debts.
Sub-Saharan Africa could establish a regional receivership entity for failing MFIs as a safeguard against these pitfalls. Under receivership, an MFI would continue servicing its performing loans pending its sale or the transfer of those loans to a more profitable competitor. This would seek to protect the cash flows to investors from borrowers in good standing. SSA countries could create an environment for competing regional credit rating agencies to assess diverse financial institutions and instruments, including those in the microfinance sector.
The African Union, ECOWAS and other regional economic communities have the political tools to effect such major advancements across the continent. Their convening power has already brought African leaders together to agree on regional and continental frameworks for political and economic governance. The establishment of guarantee and receivership agencies by ECOWAS seems the next logical step and could set the pace for the continent’s investment in a sophisticated, integrated capital market, providing the legal and regulatory structures to accommodate microfinance securitization and cross-border investment.
Elevating financial inclusion as a prominent feature in all aspects of this microfinance securitization effort could do much to brand it as credible and sustainable. Sub-regional and continental efforts to set consumer protection standards could complement domestic financial literacy programs to build consumer confidence and whet the appetites of borrowers and retail investors alike. Both groups include a young, mobile-first generation and the traditional, dominant MFI clientele: rural African women who barely have the power to charge their simple cellphones, let alone catch a web signal. An evenhanded, seamless improvement of digital and in-person user experiences could secure MFIs the loyalty of customers who have shied-away from the complexity and expense of formal finance.
These regional policy developments could trigger more robust efforts to standardize cybersecurity infrastructure and risk management procedures to guard against fraud, system failures and data theft. For the SSA microfinance sector, which up to this point has functioned on manual, antiquated systems, this would be a major leap forward.
In sub-Saharan Africa, elements already exist to build a viable ecosystem that supports securitization of microfinance. Mobile money has turned Kenya into a mostly cashless society; 83% of the population has access to a digital wallet with M-Pesa or Airtel app. The technology has picked up steam across West Africa, with Ghana and Liberia leading the region at 38.9% and 20.8%, respectively. Pension funds, insurance companies and commercial banks with significant reserves need new avenues for investment. By subscribing to grassroots financial networks such as VSLAs, high- and low-income earners alike have expressed an appetite to invest in their local communities, not just borrow from them. MFIs, primed with a higher risk appetite than traditional banks, can serve as a conduit between Africans and their financial service providers, offering avenues to improve living standards and increase investment returns.
The end of the lockbox tradition will be bittersweet. It is hard to let go of the comfort and camaraderie of informal financial transactions with people one knows and trusts. Thus, the transition will be slow, as policy decisions on the continent take months and years, and cultural shifts longer. For now, many African women still snuggle their bills in the rolls of their shukas; some still hide money under their mattresses; and rural chama clubs still congregate, keys in hand, at the mud huts of their cash custodians to conduct the next round of transactions. But cash management is gradually going mobile, and with the advent of microfinance securitization, the ever-dynamic Africans will do with their chama investments what they have done with their other small-business pursuits.
Written by Kennedy Muturi @kenmuturi5