Banks ask MFIs to replace weak collateral with assets

With a deterioration in the loan portfolio quality of some micro finance institutions, banks have asked MFIs to replace weak collateral with better-quality assets to hedge the risks. This issue is especially pertinent to loan portfolios in Andhra Pradesh.

An MFI executive explained that while lending to non-bank finance companies, banks seek the booked business (loans to borrowers) as primary security. Customer loans are the only asset as a fallback option.

After the events in Andhra Pradesh (political controversy on lending practices, new rules to curb functioning), repayments from MFI borrowers have dipped sharply since October 2010. So, many standard loans have turned into non-performing assets. Only loans which are current – where repayments by MFIs happen on time – are eligible for hypothecation (security or collateral).

A senior executive with an associate bank of State Bank of India said: “Loans which have turned bad have to be taken out of a hypothecation deal. While we do take other assets and guarantees as security from MFIs to cover risks, a hypothecated loan, being the primary source, needs urgent replacement.”

Small micro finance companies will face problems in replacing security cover compared to large MFIs, which have more options to replace assets, he added.

Many MFIs look for securitising part of their portfolio to get funds. Besides getting resources, it also frees capital for finance companies. This has become all the more important when banks are very cautious in giving fresh credit, in the aftermath of the problems in recovery. Securitisation is the process of converting existing assets associated future cash flows into marketable securities. Typically, vehicle, home and corporate loans are pooled and packaged into securities.

The head of structured finance products with a rating agency said there was a drop in recovery in substantial parts of the loan portfolio in Andhra. If so, these would not be available for securitisation in the current financial year.