Shantanu Bairagi in Voices, Finance, TOI
March 10, 2023, 4:34 PM IST
An industry that accounts for 30% of India’s GDP is having a tough time getting credit facilities from banks and lending organizations. We’re talking about the MSME category, which consists of 95% of enterprises in India.
Let’s delve deeper into the traditional semantics and how modern-day securitized debt instruments are making a difference.
Lending to MSMEs – The traditional route
The traditional funding methods generally include working capital demand loans, long-term loans, and overdraft facilities. Credit is repaid through various modes like equalized payments with fixed interest rates, etc. Due diligence on the MSME’s financial stability, creditworthiness, and projected cash flow is required for debt funding.
However, banks and other lending institutions have historically had difficulty underwriting credit risk due to information asymmetries such as non-standard and even sometimes unreliable audited financial accounts, limited secondary data sources, fiscal governance, and frequently muddled borders between business owners, managers, and stakeholders.
Thus, to ring-fence, the above lending agencies heavily depend on lending backed by collaterals like mortgage, charge on current assets, share pledge, etc., which have many limitations and scalability issues. Therefore, alternative financing mechanisms like debt securitization can help MSMEs and lenders overcome these challenges.
How does debt securitization work for MSMEs?
Securitization means converting assets into securities. In this process, securities are backed by various assets, such as debt instruments. Here, l loans or receivables are securitized to establish financial securities, commonly known as securitized debt instruments.
Thus, MSME loans can be packaged into loan pools or offered as securitized assets to buyers looking to invest in these asset classes. Securitized debt is an alternate source of funding for MSMEs through the participation of non-traditional lenders like mutual funds, HNIs, family offices, etc.
There are 6 steps for MSMEs to raise funding through debt securitization:
- An MSME approaches a bank or NBFC (referred to as the originator hereon) for a debt.
- The originator issues a loan, and thus an asset in the form of receivables is created in its balance sheet.
- To hold title to the assets that underlie securities, a Special Purpose Vehicle (SPV) is established, which is bankruptcy remote from the originator.
- Current or future assets are sold to the SPV by the asset’s creator or holder.
- The SPV issues – Pass-Through Certificates (PTC) distributed to investors, such as mutual funds, family offices, pension funds, etc. (converting debts to securities).
- The SPV pays the originator for the assets with the money received from the sale of securities.
This way, the receivables that were to be received otherwise in the form of the loan repayment after a certain period have been partially received by the originator from the SPV in the form of the sale of securities.
Current scenario in Indian securitization market
According to a report, “loan securitization volumes in the last quarter of FY2022 increased by more than 50%, totalling more than 50,000 crores. Last fiscal year, a total of ₹1.35 lakh crore in loan assets were securitized, compared to roughly $90,000 crore in 2021.
40% of the total volume came from the traditional retail mortgage-backed securitization (MBS) market. Commercial vehicle (CV; 25%), gold (10%), and two-wheeler (2%) loans continued to be significant asset segments under asset-backed securitization (ABS). The last quarter of fiscal 2022 saw microfinance loans gaining traction, accounting for 10% of the volume, while small-ticket borrowers showed resilience”.
However, this number is still much lower as compared to developed economies, wherein debt securities form 60% of the overall corporate debt market.
The Sarfaesi Act has helped in the securitization of NPAs. To promote the healthy development of the securitization market in India, the RBI developed the RBI Guidelines in 2006 to supervise the securitization of standard assets (i.e., non-stressed assets) by banks, NBFCs, and financial institutions.
Reforms to enforce a regulatory framework and enhance participation
The Indian government has worked diligently to expand the securitization market over the last few years by offering a strong regulatory framework. Increased foreign portfolio investors (FPIs) in securitization deals is another goal of the Indian regulator.
Securitization and direct assignments have undergone significant changes recently, with the help of commercially efficient legal and regulatory frameworks, including:
- Temporary relaxation of the Minimum Holding Period (MHP) and Minimum Retention Requirement (MRR) requirements for NBFC originators in 2020, allowing a larger asset pool to qualify for securitization.
- Framework for securitizing revolving structures.
The key takeaways
The sources of financing accessible to originators play a significant role in their ability to close the MSME credit gap. Broadening the investor base (beyond Banks/NBFCs) in MSME debt participation is key to sustained liquidity and funding accessibility for this sector, which can be achieved with the issuance of securitized debt instruments.
Debt securitization and related governmental reforms can assist small and medium-sized firms in reviving their struggling operations and building a growth momentum with favourable market sentiment.