Microfinance Insights Vol. 11: Microfinance and the Global Recession by Microfinance Insights

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Vol.11, Mar/Apr 2009

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Risk & Reward Exploring Risk in Microfinance Critique Why Microfinance Needs Radical Change Politics Interference in Pakistan Commentary Dangers of Leverage

Global Crisis & Microfinance: Tough Times Ahead?

A bimonthly publication from Intellecap

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Inverting the Pyramid 2008 Indian Microfinance: Scaling Against the Odds Inverting the Pyramid, an annual publication by Intellecap, provides insights on the microfinance industry in India. With growth rates of over 80 percent and a miniscule market penetration of less than 10 percent, the sector is constantly witnessing the entry of many more actors seeking business and investment opportunities with ambitions and business plans that surpass historical benchmarks.

Inside Inverting the Pyramid 2008: • Key trends that defined Indian microfinance in 2007-2008 • Demand and supply statistics • Growth and financial performance (sample of 70 top MFIs) • Estimated capital requirements and key trends for 2008-2013 • Financing and business environment opportunities • Priorities for future growth, value and sustainability

2007 and 2008 saw Indian microfinance emerging as a valued asset class with over 40 investors eyeing the market and changing promoter profiles, leading to unparalleled valuations. With turbulent financial markets and shifting priorities, what will the future hold for this industry?

Read Inverting the Pyramid –Indian Microfinance: Scaling Against the Odds to find out more! To purchase your copy, please email publisher@intellecap.net or contact Neha Aggarwal at neha.a@intellecap.net or call +91-40-4030-0200

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Cover Story

Critique

Locked In: Microfinance Needs Radical Change Before its Too Late 23 Milford Bateman

Risk & Reward Risky Business: Can Rating Agencies do More to Protect MFIs During the Crisis 26 Massimo Vita, Ingrid Stokstad Exploring the Contours of Risk in Indian Microfinance Devyani Parameshwar, Karan Sabharwal, Neha Aggarwal

13 From Crisis to Catharsis:

How Microfinance Can Make it Through the Global Recession As the economic downturn spreads across the globe, Yana Watson, a manager at Dalberg, tells us that while the impact of the crisis on MFIs can be anticipated, its outcome is not a foregone conclusion. She shares recommendations for action by microfinance network and institution leaders, as well as public and private investors.

Regular Features News Board

Commentary

The Dangers of Leverage Vinay Nair

Global Viewpoints

Perspectives from Mexico, the Philippines, Nigeria and more

Gauging and Hedging the Upside: The Need for a Publicly Traded MFI Index Bhakti Mirchandani

Islamic Finance Islamic Finance and Microfinance: Lessons for the Global Financial Crisis 34 Zohaib Patel

Politics A Very Political Economy: The Ill-advised Political Interference in Pakistanâ&#x20AC;&#x2122;s Microfinance Sector 36 Roshaneh Zafar

Lenders

Something to Believe In: A Lenderâ&#x20AC;&#x2122;s Perspective in India 37 Alok Prasad

Resources

Interview Remittances Decline as Economies Shrink 39 Gregory Watson

Trends

MFI Experience

Survey

Recommended Readings and Calendar of Events Indicators on the Current Economic Environment Microfinance and the Global Recession

Books

Last Word

Book Excerpt and Book Review Post-Recession Survival: Evolution at Play? Roberto Moro Visconti

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Time is on Our Side: An Indian MFI Offers Advice 41 Suresh Krishna Will the Cambodian Microfinance Sector Survive this Crisis? Mak Vichet

42 44

Prepared for Rain: Nigeria Says Not if, but When Godwin Ehigiamusoe

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readers speak

Features Interview SunEdison & SELCO on Solar

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Survey Product Development, Implementation and Partnerships

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Point/CounterPoint How Many Bottom Lines do MFIs Need?

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From the Editor Microfinance and the Global Economic Crisis TM

Vol. 7, July 2008

Managing Editor Lindsay Clinton Editorial Team Aparajita Agrawal, Jerilene Creado, Ranjit Koshi, Asako Matsukawa, Vibha Mehta Advisory Board Vineet Rai, Wim van der Beek Cover & Page Design ToonPillz Cover Photograph Lucie Debelkova For editorial, contributions, subscriptions, advertisements and other queries, please contact:

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Dear Reader, Recently, I read a quote from Peter Sands, CEO, Standard Chartered Bank, who said, “One of the few truly strong growth industries in the world is the industry of commentating on and analyzing the crisis.” We at Microfinance Insights cannot exempt ourselves from this trend. In this issue, we have jumped into the commentary wholeheartedly, and hope that by doing so, we will better understand how the microfinance industry is being affected and how it can be proactive in preventing or mitigating the effects of this crisis. In our research for the issue, we found that many sector stakeholders believe that we haven’t yet seen the worst of the downturn’s effects. Truth be told, we all lack a complete understanding of its depth and severity, but there does seem to be a general acknowledgement that this is far from over. Borrowers in many regions have felt the squeeze with rising food and energy prices, decreases in remittances, and less availability of loans. MFIs, particularly those that are not permitted to mobilize deposits, have struggled to maintain the liquidity to continue loan cycles without interruption. And, donor funding seems to be evaporating slowly from the system. But, there’s hope, too, that many organizations can survive the storm, and that in doing so, they will benefit greatly when they come out on the other side. Some have hypothesized that when the tempest has calmed, the crisis will have made many institutions stronger, and will have incited regulators to sit up and take a closer look at the microfinance sector. During a conversation several days ago with a major global private equity investor, and one that has made a substantial investment into Indian microfinance, I asked how their investments were faring. “Well, the one thing we feel secure about right now is our microfinance investment.” Indeed, investors are turning to look at microfinance with fresh eyes, as it appears to be one of the safer asset classes in the current environment with a consistently strong underlying macro-economic thesis. This interest was evident this January at a roundtable discussion about microfinance and risk, hosted by Intellecap (the company that publishes this magazine) in partnership with CGAP and Aavishkaar Goodwell, a microfinance private equity firm. No less than 15 major private equity investors showed up to put their ear to the ground on risks and rewards to be found in microfinance. This could be a function of optimism about the sector, or it could simply demonstrate the herd-like mentality among investors who are tracking the trail of several sizeable PE investments made into Indian MFIs. It is probably a bit of both. What struck me, and what always strikes me at these gatherings, is that a group of enterprising women in cotton saris from rural Andhra Pradesh has galvanized a group of 15 investors wearing crisp Brioni suits holstering blackberries to sit around and project whether this sector is worth their time and capital (the latter being more scarce these days). Perhaps microfinance is lucky to sit at this juxtaposition—between concern and curious optimism. The crisis, if handled thoughtfully, could ensure the development of proper regulations and risk management systems, while shepherding in new growth opportunities. Understanding the crisis and its causes will encourage those who are chasing rapid growth and short-term profitability to think longer-term and with a social conscience. In this issue, we have tried to present perspectives from every angle—the MFIs, industry associations/networks, lenders, investors, consultants, academics, and of course, the borrowers. Thinking about the issues we face from each vantage point is important to protect the industry and its people, and to ensure it doesn’t turn out to be another mortgage derivative. We have some great pieces to help you understand the scenario in these turbulent times.

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NEWS BOARD TIAA-CREF Makes US$40m Investment in Microfinance Equity Fund

February 24, 2009 - TIAA-CREF announced a US$40m investment in Developing World Markets Microfinance Equity Fund I. TIAA-CREF joins other investors to form a US$82m fund that aims to alleviate poverty through the provision of equity capital to MFIs around the world which lend to low-income individuals and families. This new investment continues TIAACREF’s commitment that started in 2006 with the creation of a US$100m Global Microfinance Investment Program (GMIP) to invest in selected MFIs worldwide.

World’s First Cell-Phone-Based Carbon Microcredit System

February 24, 2009 - Carbon Manna Unlimited rolled out its mobile-based Carbon Micro Credit system in Kenya. The System employs SMS and unique identifiers to allow millions of families in the developing world to claim on a bi-weekly or monthly basis the carbon offsets they produce by using more efficient cooking methods. Each family can monetize directly its own contribution to mitigating global warming, while also reducing nationwide rates of deforestation and desertification. Each family that cooks more efficiently may claim approximately 3 tons of CO2 offsets per year, which is worth about US$20 - US$35 when sold in Europe on a regulated or voluntary carbon-offset market. The family also saves US$70 - US$150 a year on fuel.

New Social Investing Guidelines for Microfinance

February 23, 2009 - Grameen Foundation released the first ever guidelines designed to help institutional and individual investors rigorously evaluate the social returns on their microfinance investments. The guideline criteria were developed based on Grameen Foundation’s ongoing work with Oikocredit, a leading social investor in microfinance, other fund managers, and MFIs.

Gates Foundation Grants US$12.5m for Mobile Banking February 18, 2009 - The Bill and Melinda

microfinance insights

Gates Foundation announced a US$12.5m for expanding banking opportunities via mobile phones for people living on less than US$2 per day. The Foundation announced the program, Mobile Money for the Unbanked, with the European mobile communications organization GSMA in Spain. The program is expected to support about 20 projects in developing countries, in Africa, Asia and Latin America, and plans to reach 20 million unbanked people with mobile financial services by 2012.

First Microfinance Investment Yielding 5% for Everyday Investors

February 18, 2009 – MicroPlace launched a new investment opportunity that offers a 5% return, a first in the microfinance investment industry for everyday investors. By visiting the MicroPlace website, people can invest as little as US$20 and have the opportunity to earn 5% interest. The investment opportunity listed on MicroPlace is offered by MicroCredit Enterprises, a nonprofit organization committed to reducing poverty by providing small loans to the working poor around the world.

Pakistan Microfinance Network Launches Code of Conduct

February 15, 2009 - Realizing the necessity of consumer protection measures for microfinance clients, Pakistan Microfinance Network (PMN) with the unanimous approval of all of its 20 members launched the Code of Conduct for Consumer Protection, on January 26, 2009. The core values around which the code is structured are transparency, fair practices, dignified treatment, privacy and fair disclosure, governance, and client satisfaction. The code will be translated into all regional languages and distributed to all branches of the signatory organizations.

European Investment Bank Announces US$38bn for MFIs

February 13, 2009 - The European Investment Bank (EIB) has announced a support of EUR30bn (US$38bn) for SMEs over the next three years. It will also provide technical assistance to MFIs. Loans will be given to banks, which will then pass credit on to

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small businesses. The new scheme will encourage financial institutions to loosen the supply of much-needed credit to SMEs. To mitigate the risks taken by banks in lending to businesses, the EIB will take on half of the risk, thus reducing the capital requirements of lending institutions. In addition, the EIB will make technical assistance available to MFIs to help them become more professional and make larger banks less hesitant to lend.

Bahrain Launches First Poor People’s Bank

February 12, 2009 - Bahrain has become the first Gulf Cooperation Council (GCC) state to launch a bank for extending microcredit facilities for the poor. The Ibda’a (Creativity) Bank is a joint venture of Agfund, will support low income Bahrainis with small loans to start their own businesses. The bank with a capital investment of US$5m (Dh18.35m), aims at helping 1,000 Bahrainis in its first year and 5,000 by the end of the second year of operation. The bank’s capital is raised by the Agfund, the Housing Bank and Bahrain’s private sector.

CGAP, J.P. Morgan Establish First Ever Microfinance Equity Investment Benchmarks

February 3, 2009 - To support the development of the microfinance equity market, and to address the lack of reliable market data, CGAP and J.P. Morgan have estab-

NEWS BOARD lished benchmarks to help microfinance investors, managers, and analysts value MFIs. They analyzed two datasets: a sample of 144 private equity (PE) transactions, which represents the largest such dataset gathered to date, and data on 10 publicly traded MFIs and low-income consumer lenders. CGAP and J.P. Morgan found that while publicly listed microfinance lenders have outperformed traditional banks by 250% since 2003, PE valuations for MFIs have varied widely over the past few years. And publicly listed low-income finance institutions (LIFIs) have outperformed their country indices, though over the past 12 months, they have underperformed traditional banks. CGAP and J.P. Morgan also identified five characteristics that differentiate MFIs from traditional banks: a double bottom line that aims for both social and financial returns.

Zurich Financial, WWB Launch Microinsurance Products

January 28, 2009 - Zurich Financial Services Group and Women’s World Banking have developed a program that will make microinsurance products available to women in low-income populations. The global Caregiver program will make insurance available to needy women and will cover expenses related to hospitalizations.

Financial Industry Should Integrate Sustainable Investing Practices

January 28, 2009 - A new report by the IFC, the UN Global Compact, and the Swiss government finds that although the financial industry understands the necessity of developing methodologies and tools that examine environmental issues in the investment process, it is still not standard practice. The 2008 Who Cares Wins report, titled Future Proof?, urges the financial industry to advance efforts to integrate environmental, social, and governance (ESG) issues into mainstream investment decision-making and ownership practices. If they do not, consequences of climate change could fuel another financial crisis, warns the report. www.microfinanceinsights.com

Microcredit Reaches Over 100 Million of the World’s Poorest

January 26, 2009 - Over 106 million of the world’s poorest families received a microloan in 2007, surpassing a goal set in 1997 by the Microcredit Summit Campaign, according to its 2009 State of the Campaign Report. Organizers say that when the goal was originally set in 1997, less than 8 million very poor clients had a microloan. The number has grown by more than 1,300% between 1997 and 2007. In 2007, microloans went to 88 million very poor women. The Campaign counts the world’s poorest as those who live in the bottom half of those living below their nation’s poverty line, or any of the nearly 1 billion people living on less than US$1.25 a day.

European Union Calls for Legislation to Encourage Microcredit

January 20, 2009 - The Economics Committee is calling for the Commission to propose legislation on microcredit schemes in Europe, aiming to remove problems caused by competition and money-laundering rules, to allow for more EU co-funding, to introduce a harmonized regulatory framework for microcredit providers and to raise their profile. In a report drawn up by Zsolt László Becsey, the Economic and Monetary Affairs Committee makes a formal call for the Commission to present a legislative proposal to bring together different measures in a framework to encourage microcredit development in Europe.

First MFI Starts Operating in Liberia

January 23, 2009 - AccessBank Liberia has become the first MFI to receive a banking license in Liberia. AccessBank Liberia is the result of a two-year partnership between IFC and the Government of Liberia. It was established in partnership with Access Holding. The European Investment Bank and African Development Bank are also shareholders in the MFI.

Victims of Collapsed Rwandan Banks/MFIs Seek Help

January 18, 2009 - Disgruntled victims of collapsed MFIs are considering filing their concerns with the Ombudsman’s office. The

Rwandan government provided Frw3bn (US$5.3m) to compensate the former MFIs depositors, and assigned Banques Populaire du Rwanda to disburse the money. In 2006, several MFIs in the country closed down, leaving thousands of Rwandans who had deposited billions of francs in ruin. Fifteen former MFI managers were arrested for defrauding depositors’ after a year-long investigation after the government shut down eight bankrupt MFIs. This was followed by an operation that cracked down on several others increasing the number of the arrested MFI defaulters to 50.

South Korea Provides US$73m in Microcredit, Loan Guarantees

January 15, 2009 - The South Korean government has pledged to provide loans and credit guarantees to the self-employed, including legitimate street vendors. The government is also planning to cater to lower-income individuals who would otherwise have no other source of income. The initiative is in response to the recent economic downturn which is affecting the entrepreneurs who cannot borrow money from banks due to their bad credit status. A total of KRW100b (US$73m) is expected to be earmarked for this measure. Sixteen credit guarantee foundations run by local governments will provide the credit guarantees.

BRAC’s Loan Fund to Expand Microfinance in East Africa

January 6, 2009 - BRAC Bangladesh has raised US$62.6m of debt capital to provide microfinance loans to poor borrowers in Tanzania, Uganda and Southern Sudan. The BRAC Africa Loan Fund will provide long-term, local currency funding that will enable BRAC to reach over 700,000 borrowers through over 200 branches across the three countries. The Fund represents the largest single financing to date of a southern hemisphere development organization expanding into Africa. The Fund intends to explore the development of local operations in at least ten countries over the next decade, including both East and West Africa. n

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commentary

The Dangers of Leverage Credit, according to Professor Muhammad Yunus, is a fundamental human right. However, if not handled with care, the magnification effect inherent in leverage can make it dangerous. One need only look at the current economic spiral to see the result of the provision of credit gone dangerously awry. Credit must be deployed to microfinance borrowers judiciously in order to minimize the risk of nonrepayment, as this would cause lenders, themselves levered, to suffer magnified losses. Vinay Nair, an Executive Director at J.P. Morgan currently on sabbatical, explains that it is imperative to avoid over-leverage to avoid losing control. “Those who cannot remember the past are condemned to repeat it.” - George Santayana, Poet and Philosopher

s the world descends deeper into economic crisis, economic historians have their work cut out for them, positing which current events do or do not resemble those of the past. The microfinance sector cannot wait for their results. The crisis may be ongoing, but the root causes are now past and must be clearly understood. Given how fresh in the mind they are, it makes Mr. Santayana’s maxim all the more important. The nature of this crisis has resulted in deep introspection about everything, from the role of financial services to globalization to capitalism itself. Microfinance should be no exception. Such self-reflection is not a purely academic exercise; it has a clear purpose, requiring us to re-appraise underpinning assumptions. We must be confident of the path we take from here: do we confidently march onwards or should we backtrack and take a new route? Above all, complacency has no place; the purveyors of stock lines--We have survived previous crises and we will survive this one—must not be heeded. Back to Basics Key practitioners in microfinance have already begun to question fundamental assumptions. At a recent conference in London, while presenting findings from his forthcoming book Portfolios of the Poor,1 Professor Jonathan Morduch outlined the financial accounts of the world’s poor. He questioned the widely held assumption that those who live on US$2-a-day have “simple” financial affairs. His results uncover the detailed complexities across the formal and informal financial transactions at the base of the pyramid. Given such striking results, revealed by questioning conventional wisdom, what other underlying assumptions should the industry confront?

microfinance insights

To answer this question, it may help to recap the early stages of the crisis in the United States. Over the last decade, credit was made abundantly available to some of those at the bottom of their pyramid – that is, “sub-prime” borrowers. The inability of these borrowers to sustainably repay their burdensome debts triggered (and catalyzed) widespread losses. Irrespective of whether banks lent too much or people borrowed too much, it is this excessive credit (and now, de-leveraging) that is at the very nub of the issue. In microfinance today, much is made of the dangers of cowboy lenders, falsely dressed up as MFIs, charging excessive interest rates to borrowers. But, given credit has been abundant in recent years, we must now consider a more lurking danger: loans loosely granted to the borrower without due consideration to the risks. The industry should therefore ask ab-initio: is credit good or bad? Professor Yunus’ much-quoted tenet is, “Credit is a fundamental human right.”2 I agree, but with one major caveat: we must recognize the innate dangers (and opportunities) embedded within “credit.” Understanding “Leverage” First, let us take a moment to define the jargon, to ensure that we understand the terms correctly. The provision of credit increases the amount of debt a household or company holds versus their assets or equity. Leverage can therefore be understood as the ratio between debt and equity/ assets. For an individual household, leverage is a comparison of debt to total assets— if a borrower takes out a loan, her debt rises, and her leverage increases. For a company, at its Operating Company (OpCo) level, the same happens as it takes on more debt or if equity falls. It is

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Photo credit: Gabriel Pollard

important to therefore realize that an MFI is impacted by leverage twofold, at the company and household levels. Given leverage is a ratio, it increases as the numerator increases or the denominator falls. So what would happen to the ratio in the event of losses? With losses or a fall in asset values, leverage makes it more difficult to repay debts. This can result in further losses, which in turn, makes it even it more difficult to repay these debts. This is the magnification effect of leverage, and it underlies the innate danger of the circle of leverage (represented in Chart 1). Household Leverage For households, such as those described by Professor Morduch, it is easy to see how loose credit, even if provided with good intentions, can suddenly be the cause of a dangerous and downward spiral. There are a number of risks that are widely recognized that may cause the denominator to decrease. At the January 2009 CGAP/Aavishkaar Goodwell/Intellecap Risk Roundtable in Mumbai, whose preliminaries I contributed to on behalf of JP Morgan’s Social Sector Finance group, many were identified: over-indebtedness due to multiple borrowings, high cost of debt, credit risk, asset liability mismatch, etc. The debate typically focuses on which of these pose the greatest clear and present danger to repayment rates. In my opinion, it almost does not matter–it is the magnification effect of any of these, caused by leverage, which is the greatest threat to households repaying their debts.

Household Debt

Company Debt Leverage = or Total Assets Equity

commentary MFI Leverage It is important to also assess microfinance institution (MFI) or Operating Company (OpCo) leverage. The challenges of OpCo deleveraging are currently felt around the world— one need not look far. America’s US$800bn economic stimulus provided by the government is in part giving companies the equity they need to stabilize and de-leverage. This environment should provide the microfinance sector with salutary lessons. Using India as a case study, we find that many MFIs are moving from a thrift co-operative structure into an NBFC (Non-Banking Financial Company). This is due, in part, to thrifts operating under highly restrictive parameters set by the Reserve Bank of India (RBI), India’s Central Bank. Whilst restrictive to MFIs looking to expand and impact more people’s lives, it cannot be used as an excuse to try to “lever up” and increase size if the motivation is purely for economic interests. In a meeting with a medium-sized Indian MFI in November 2008, the management outlined their expansion plans for becoming an NBFC and increasing leverage from 5:1 to 20:1, accumulating more debt in order to reach new borrowers. To give some context, at the start of 2008, commercial banks in the U.S. had leverage ratios of approximately 10-12 times3 and investment banks of 20-25 times. The MFI’s motivation was purely to gain size and thereby attract increased enterprise valuations from potential investors. It was, in other words, a short-term numbers game bent on increasing the number of borrowers, with no concern for long-term scaling impact.3 Leverage is a tool that can be used to affect very quick growth. However, this leads us back to the magnification effect. Should any of the multiple risks occur, we enter the dangerous cycle and our denominator—our assets and/or equity--shrinks very rapidly. “Only” Liquidity Risk? Also Credit Risk Further analysis from the Risk Roundtable in Mumbai supplies an eerie parallel to the early stages of the downfall of banks and investment banks. The risk survey leading up to the Roundtable found that most respondents, including MFIs, investors and lenders, felt that liquidity risk is the major risk, not risk of credit losses. In the United Kingdom, the crisis faced by Northern Rock in September 2007 www.microfinanceinsights.com

required liquidity support facility from the Bank of England, following their problems in the markets. In other words, it was a crisis first born out of liquidity. But what we have seen, some 12-18 months later, is that liquidity risk is really only the first challenge for lenders. Realized credit losses in their loan portfolios have a much greater effect on the fundamental structure of the institution. What this means, when we return to the root of this issue, is that the OpCo leverage dramatically amplifies the consequences of realized credit portfolio losses.4 So is Credit “bad”? With a better understanding of the dangerous magnification effect of leverage, does this mean that growth of MFIs or microfinance itself must be systematically curtailed? Absolutely not. The provision of credit is not wrong; it just depends on what you do with it. In fact, microfinance can provide the broader banking industry with some notable perspective. Indeed, as bankers return to Banking 101, they can learn from MFIs. Case in point: Grameen America’s recent report of a tremendous 99.5% repayment rate after its first year of business, which has received a considerable amount of coverage in the mainstream financial press, with the Bloomberg newswire running it as one of its top stories in January 2009.5 The key for MFIs is to understand fully the dual dangers of leverage at their OpCo and with their borrowers. Small mistakes and losses can spiral out of control.

So what do we do with it? The key is to sharply minimize losses in the first place. This may seem incredibly obvious; however, it has been systematically obviated around the world. If, for example, a better understanding of the purpose of the loan necessitates providing skills and training to the borrower, it must be done. This can only increase the likelihood of repayment. Loan officers must have better aligned incentivization and compensation, not only for saying “yes” but also for saying “no.” Furthermore, any moves away from the joint-liability group model to a large individual loan without complementary training is, from where I stand, dangerous mission drift. Rather, to help more people and in a deeper way, the move must be to a more consumercentric model from the existing product-centric model. Such visions are being pursued by innovative organizations around the world. One example of this is the Kshetriya Gramin Financial Services (KGFS) initiative in South India, where branches are located in villages (rather than villages periodically visited by MFI officers) offering a range of financial services to suit the needs of “clients,” who are not automatically assumed to be “borrowers.” It is not about just where the profits can be optimized (e.g. insurance, mobile telephony), but where impact can be scaled. This transition will take time but it must happen. Of critical importance is how best to minimize risk and the degree of support to provide to the borrower. As the distinguished Vijay Mahajan, Founder of BASIX, writes: “[In] the familiar debate of ‘minimalist credit’ strategies versus the ‘integrated’ approach

Chart 1: The Leverage Cycle3 Target Leverage

Stronger Balance Sheets

Target Leverage

Increase Balance Weaker Balance Sheets Sheet size

Asset Price Boom

Reduce Balance Sheet size

Asset Price Decline mar/apr 2009

microfinance insights

commentary to microenterprise promotion…there is no one correct approach and the strategy for microenterprise promotion should be contingent on the requirements of the situation, based on a systematic analysis.”6 The consequences of getting this wrong are great, knowing, as we do, that leverage will magnify the consequences. Conclusion The nature of the economic crisis has led to introspection across all aspects of society. Microfinance is no different. We have seen leading practitioners already begin to question fundamental assumptions. Additionally, CGAP and ACCION are in the process of

doing important work in their “Beyond Codes” Steering Committee. Its purpose is to emphasize the importance of a fundamental principle: “Treat customers with dignity and respect.” One of the most critical parts of this is to “prevent over-indebtedness.”7 It is true that credit is a fundamental human right. But there are dangerws embedded within it. We have seen how the broader crisis

has developed, starting with over-indebted borrowers, over-leveraged OpCos and liquidity risks moving to magnified credit losses. We are at a critical juncture in microfinance, but if we move quickly, we can heed Mr. Santayana’s words. The circle can turn vicious very rapidly, so it is imperative to redouble all efforts to ensure that the circle is, instead, virtuous. n

Vinay Nair is an Executive Director at J.P.Morgan. He has been on sabbatical from the firm since August 2008, pursuing philanthropic, travel and research interests in the field of social enterprise, with a focus on microfinance. Vinay was born in India, brought up in Canada & Ireland and lives in London. He can be reached at vinay@nair.com. The opinion’s expressed are the author’s own and do not represent the views of J.P. morgan Chase & Co.

1. Jonathan Morduch. “Meeting the Needs of Low Income Groups: Analysis of a recent study on how they manage their money.” Proceedings of the Managing Risks and Rewards for Institutional Investors in Microfinance: Ensuring Financial Returns while Meeting Global Social Objectives. Grange City Hotel, London.. October 29-30 2008. 2. Counts, Alex. Grameen USA email newsletter. “Should Access to Credit be a Human Right?” December 2008. 3. Greenlaw, David et al. “Leveraged Losses: Lessons from the Mortgage Market Meltdown.” US Monetary Policy Forum Conference. Grange City Hotel, London. 29 February 2009. faculty. chicagogsb.edu/anil.kashyap/research/usmpf2008confdraft.pdf 4. For those interested in understanding the amplification effect of leverage in the US, see Greenlaw, David et al. 5. Grameen USA email newsletter. “Grameen America Expects Dramatic Increase in Microcredit Loans.” 15 February 2009. 6. Mahajan, Vijay. “From microcredit to livelihood finance.” What’s Wrong with Microfinance. Eds. Dichter, Thomas and Malcolm Harper. Practical Action Publishing, 2007. 7. Clark, Heather, Kate McKee, Gabriel Solorzano, eds. “Protecting Microfinance Consumers and Avoiding a Sub-prime Crisis in Microfinance.” Proceedings of the Managing Risks and Rewards for Institutional Investors in Microfinance: Ensuring Financial Returns while Meeting Global Social Objectives. Grange City Hotel, London. October 29-30 2008.

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microfinance insights

mar/apr 2009

cover story

From Crisis to Catharsis: How Microfinance Can Make it Through the Global Recession

Since the advent of the global economic downturn in mid-2007, there has been much discussion regarding what impact, if any, the financial crisis will have on the microfinance sector. Yana Watson of Dalberg Global Development Advisors provides a diagnosis of different impacts on MFIs depending on their capital structure and geography. She contends that while the impact of the crisis can be anticipated, its outcome is not a foregone conclusion. For microfinance to survive and thrive, she shares recommendations for action on the part of microfinance network and institution leaders, as well as public and private investors.

t is only the first quarter of 2009 and it is unclear whether we have seen the entire iceberg of this financial crisis, or merely the tip. Whatever the ultimate scale and scope of the crisis, it seems unlikely that the microfinance sector will emerge entirely unscathed. That said, the impact of the crisis is far from a foregone conclusion. With the right strategies, microfinance institution (MFI) managers and capital providers can survive, and even find means to thrive, despite the global recession. Why this Time is Different Some believe that microfinance is immune to the current meltdown of financial markets, citing its resilience to crises in the 1990s and claiming that balance sheets in the sector are impervious to adverse external economic shocks. But one cannot escape the reality that today’s microfinance is more closely tied to international www.microfinanceinsights.com

capital markets or that this crisis seems unique in both scope and scale. Therefore, it is difficult to ascribe wisdom or rationality to any conclusion that forecasts with certainty a positive outcome for MFIs. History is not necessarily a guide for predicting the outcome of this crisis since microfinance is no longer the uncorrelated market that it was during the downturns of the 1990s. During that period, only a handful of MFIs had even begun to contemplate transforming into regulated deposit-taking banks with access to commercial funding sources. But by the early 2000s -- with Banco Compartamos’ bond issuance; Bank Rakyat Indonesia’s first microfinance IPO; and the emergence of microfinance collateralized debt obligations (CDOs) -- microfinance had burst onto the international capital market. With the United Nations naming 2005 as the Year of Microcredit and Prof. Mohammad

Yunus receiving the Nobel Peace Prize for the work of Grameen Bank, microfinance seemed to emerge as the darling of international development. By 2007, an estimated US$5bn of foreign investment1 had flowed from developed nations into MFIs around the world. As a result, today microfinance is tied to global markets to an unprecedented degree. Unfortunately, those markets are simultaneously experiencing a near-unprecedented degree of turmoil that seems to combine the worst characteristics of downturns in the 1990s. If we look to the Asian crisis, the more widespread of the past proxies available for academic study, we should take note that microfinance suffered most where it was most tied to the formal financial system. In Indonesia, the value of Bank Rakyat Indonesia’s Unit Desa fell by one-quarter to one-half in constant price terms.2 The current downturn shows signs of being both more severe

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microfinance insights

cover story and more all-encompassing than prior crises. Global trade this year is projected to contract for the first time since 1982. Both GDP growth in developing countries and private capital flows to developing countries are projected to fall to roughly half their 2007 levels. With reductions in foreign investment and remittance flows, increases in country risk premiums and local credit spreads, there does not appear to be any safe haven. Critical Dimensions of Country and Capital According to estimates for 2007, there are roughly 10,000 MFIs with a collective asset base of more than US$35bn, serving 66 million clients across the globe.3 MFIs come in all shapes and sizes, with different institutional types, missions, and lending methodologies, in different sociopolitical settings, and subject to different legal and regulatory frameworks. A meaningful diagnosis of the impact of the financial crisis on MFIs requires a segmentation of the sector by the most critical defining dimensions. The sector should be segmented according to the characteristics that are most influential in determining an MFI’s experience during the crisis: country location and capital structure. Country location is a critical factor due to the formative influences of an MFI’s economic and regulatory operating environment. Government can either alleviate or exacerbate the impacts of the financial crisis through central bank lending policies, fiscal stimulus measures, and monetary policies. While there is insufficient space to allow for a full geographic segmentation of MFIs, the following examples highlight the importance of countryspecific impact analysis. East Asia and the Pacific —> In response to liquidity tightening, Korea’s financial regulator deferred implementation of the Basel II framework from January 2009 to 2010. This intervention was designed to keep capital requirements low and thereby ease liquidity. In addition, the government announced it would provide US$100bn won or roughly US$73m in direct loans and guarantees to micro and small business owners unable to otherwise secure financing during the economic downturn. Due to these activist measures, MFIs in Korea should experience relatively lower liquidity pains during the financial crisis.

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Eastern Europe and Central Asia —> Mongolia’s central bank recently decreed that commercial banks maintain minimum capital adequacy ratios of 12% -- a measure that was designed to safeguard customer deposits.6 However, while larger MFIs like XacBank have successfully met the new requirements, it is reasonable to expect that smaller, less well-established MFIs may find this challenging. As such, surviving the credit crunch will likely require severely curtailed growth plans. Latin America and the Caribbean —> In the early days of the crisis, liquidity issues arose in the region at an alarming rate. Problems were compounded by the fact that the region lags in terms of deposit-taking, as only about 18% of microfinance-receiving families had a savings product at the end of 2006, versus 22% on average in Africa and 37% in Asia.7 Certain countries have taken action that may mitigate liquidity issues for MFIs. In Colombia, the government has facilitated capital flows by removing restrictions on foreign lending and lowering interest rates.8 Middle East and North Africa —> As many MFIs in this region operate in highly regulated, insulated financial markets, we can expect less of an impact from the global financial crisis.9 In Tunisia, for example, Enda Inter-Arabe credits strict regulation and exchange controls with mitigating the impact of the crisis. South Asia —> In India, initiatives to increase liquidity and lower foreign exchange risk have done much to ease the impact of the crisis on the microfinance sector. The Central Bank lifted foreign lending restrictions to non-bank financial companies (many of which are MFIs), let the rupee depreciate to slow the outflow of capital, and is providing extra funding to the financial sector.10 Interviewees on both the institution and investment sides of the sector claimed the overall impact of the crisis on the subcontinent had been limited to date, in part to due to proactive government measures such as these. Sub-Saharan Africa —> In Kenya, a key concern of MFIs is repayment as the economy slows. One MFI, Jamii Bora, has seen a rise in nonperforming loans as clients are slipping back into deeper poverty levels due to lower profit margins from their microenterprises. However,

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the implementation in May 2008 of the Kenyan Microfinance Act now enables regulated MFIs to accept client deposits.11 We can expect these deposit-taking MFIs to better withstand repayment volatility. In conjunction with country location, capital structure is the second critical dimension for microfinance sector segmentation. Liability mix will determine the type and degree of MFI risk exposure during the crisis, as different capital sources can be expected to react in distinct and predictable ways. As shown in Figure 1: MFI Funding by Source, microfinance institutions derive capital from three main sources: debt, deposits, and equity. Debt financing in microfinance far exceeds equity, driven by the creation of microfinance investment vehicles (MIVs) and structured debt instruments such as collateralized debt and loan obligations. These instruments have been tailored to the microfinance sector offering first loss junior tranches at higher rates to the risk-leading development banks and safer senior positions with guaranteed returns to commercial investors.12 CGAP’s 2008 MIV survey concluded that there were roughly 90 MIVs with slightly more than US$5bn in assets under management investing in the sector by the end of 2007, representing a nearly 80% increase from 2006.13 Similarly, although equity accounts for a smaller overall slice of sector funding, it too has grown remarkably, given the limited exit options in microfinance and the general uncertainty that surrounds valuation techniques. The potential of microfinance equity was perhaps most famously illustrated by the IPO of the Mexican MFI Banco Compartamos. The IPO involved a secondary offering of 30% of Compartamos’ stock and raised roughly US$450m, yielding investors an IRR of over 100% compounded over 8 years. The Compartamos issue was 13 times oversubscribed.14 Unsurprisingly, the Banana Skins report on types of risk in microfinance published by the Centre for the Study of Financial Innovation (CSFI) in 2007 concluded that capital availability was not a risk to the sector. Today, the times of free-flowing capital appear behind us. As the financial crisis deepens, there is mounting evidence that capital flows are ebbing. Women’s World Banking assembled a US$100m CDO for 14 members late in 2007, but according to CEO Mary Ellen Iskenderian, was unable to bring it to market due to risk aversion that was not commensurate with the underlying asset

cover story quality of the MFIs in question.15 Funding from public investors is also drying up as international financial institutions hit counterparty or country exposure risk ceilings.16 In today’s environment of local currency devaluation and rising repayment rates, lack of capital to manage volatility is a leading concern of most MFIs. Although most MFIs are funded from a mix of sources, the effect of the financial crisis can nonetheless be reasonably anticipated by reflecting upon the primary source of MFI funding. Deposit-based MFIs MFIs that are highly reliant on deposits with relatively little third-party funding are in the lowest risk group. The financial crisis should pose less of a threat to these institutions as they are more protected from refinancing and foreign exchange problems. However, depositbased MFIs will still be challenged by inflation, food and fuel price volatility, and a decrease in remittance flows.17 As local currencies in developing countries lose value, clients will find it increasingly difficult to maintain savings levels. Deposits may decline and non-performing loans may increase as clients require additional capital to cover basic needs. Debt-based MFIs MFIs that depend upon fixed-income investment are at greatest risk during the financial crisis, particularly those with closer ties to international/commercial sources of funding versus local/public sources of funding. In today’s economy, there is less available debt capital and it is offered at higher interest rates. Foreign loans compound the problem by requiring repayment in hard currency at a moment of devalued domestic currencies. Moreover, since local currency funds have suffered significant losses over the past year, they will be increasingly scarce

going forward. In the first quarter of 2008, only 30% of international investments were in local currency,18 leaving MFIs to bear the foreign exchange risk. While there are multiple options for hedging risk, ranging from countervailing foreign exchange deposits to futures and forwards, few MFIs have the institutional know-how or the domestic capital market sophistication to deploy these instruments to full effect. Equity-based MFIs MFIs that are reliant on equity investment will likely find themselves in the middle of the risk range. Historically equity investors have been drawn to microfinance’s low default rates and strong profit margins. As shown in Figure 2, MFIs enjoy higher net interest margins (NIMs) and lower PAR than commercial emerging market institutions. The rising cost of funding precipitated by the financial crisis has begun to compress NIMs, and while some MFIs are passing a portion of these costs through to clients in the form of higher lending rates, many are not.19 If coupled with rising defaults and other expenses, this decrease in top line interest income would put pressure on profit margins and make microfinance less attractive to equity investors. To date, investor interviewees have not witnessed a spike in redemption calls. However, new private equity investments appear to be slowing. As MFI growth slows and earning power wanes, investors anticipate valuation multiples will slide from a median of 1.9x book value in 2008 to closer to 1x book in 2009.20 Implications for Action- MFIs Given the likely impact of the financial crisis on the microfinance sector described above, the logical next question becomes: what can be done to navigate these circumstances as best possible? Anticipating the likely impact of the financial

Figure 2: Relative Interest Margin and Asset Quality, 2007 30%

Net Interest Margin (NIM)1

10%

Portfolio-at-Risk, 90 days

22.0% 20% 5% 10%

6.1%

3.2% 1.4%

MFIs EM banks2 MFIs EM banks2 Source: “Shedding Light on Microfinance Equity Valuation: Past and Present.” JP Morgan and CGAP. February 3 2009. MicroBanking Bulletin. MIX 2007 MFI benchmark data 1. NIM net interest income /average total assets. Median NIM for all MFIs reporting to MBB shown above. 2. EM banks are selection of commercial banks in emerging markets (excl. Asia) covered by JP Morgan.

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Figure 1: MFI Funding by Source, 2007 100% 9.9% 80%

2.5%

15.5%

60%

35.8%

40% 20%

36.2%

Source: MIX 2006-07 MFI benchmark data Note: Equity includes paid-in capital and retained earnings; Other debt includes concessionary loans and compulsory savings

crisis on the microfinance sector is only useful to the degree that it helps identify and prioritize mitigating actions. As mentioned earlier, there are no foregone conclusions to this crisis. How microfinance emerges will depend upon the actions of both MFI managers and capital providers. For microfinance management, whether at the individual MFI level or the network level, there are three recommended actions for successfully navigating the financial crisis: 1. Be ruthlessly demand-driven Much of the published advice to date has focused on the importance of MFIs “sticking to the basics” of microcredit as a means to survive the financial downturn. This may be good advice if credit reflects the demand-profile of clients, but it would be bad advice if that is not the case. Ensuring that product portfolios are an accurate and recent reflection of customer needs, wants and preferences is always critical, but particularly so during times of financial volatility when there is little margin for error. The steps to determining demand begin with a segmentation of the MFI customer base. Understanding customers along descriptive (Who?), behavioral (When? Where? How?) and attitudinal (Why?) dimensions will enable groupings according to shared attributes. Representatives of those groups or segments can then be researched via a variety of means to determine wants, needs and preferences. This customer data can then be mapped to products and services offered by the MFI. Questions to be considered include: • Which products/services best reflect customer wants, needs and preferences? • Which products/services are not well aligned

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microfinance insights

cover story with wants, needs and preferences? • Which wants, needs and preferences are not reflected in the product/service portfolio? • Of the products/services in demand, which are we best suited to provide, given our capabilities and competencies? 2. Shift from seeking scale to ensuring financial sustainability Unsurprisingly in a sector that experienced a global median growth rate of roughly 20% in 2006-07 (reaching as high as 50%+ in some parts of Eastern Europe and Central Asia), the focus in microfinance in recent years has been on scale.21 MFI managers and network leaders have dedicated themselves to reaching a greater number of clients, across urban, peri-urban and rural regions, with a greater number of financial products and services. However in a time of financial downturn, MFIs must temper growth aspirations and focus instead on economic sustainability. One part of sustainability relates to underlying portfolio quality. Much of the sector advice lately has centered on the need for MFIs to actively monitor and manage portfolio quality. Certainly, trends towards lower repayment rates and higher costs of funds make active management of an MFI’s underlying asset quality vital. However, while necessary, this is not sufficient. To ensure sustainability, an MFI must look hard at all the costs associated with providing products and services to different customer segments. In the section above, the MFI addressed questions designed to drive at true demand. Building off these, further questions to pose to ensure economic sustainability include: • Of the products/services that do satisfy demand, which are more/less financially viable? • Of the various customer segments, which are the more/less costly to serve? • How can the MFI streamline products and services to meet the demand of highpriority customer segments in an increasingly economically sustainable way? Tactically, this might require cost analysis by product and customer type, overlaid on an analysis of the true total cost of doing business. To illustrate, let’s take an example of a newlyregulated MFI that has been offering three savings products. After having first established justifiable client demand for the provision of savings products (per the first recommended

microfinance insights

action above), the break-even cost curve would need to be determined and compared to the current cost curve for each product. Backing out from the break-even point, managers can then assess whether the product profile or customer mix needs to be rebalanced (assuming different customer types bear different transaction costs due to differential transaction amounts, etc). Since our example involves savings, the next step would also be to determine the benefit to the business of deposits from a cost-of-funds standpoint, as this is a critical component of total cost. 3. Consider consolidation The financial crisis has put considerable strain on small and mid-sized MFIs’ ability to maintain operations. Peer-to-peer institutional consolidation, although rare in the sector to date, offers one potential means of surviving the storm that warrants exploration. In the context of the credit crunch, the major benefits of consolidation are twofold. First, consolidation can offer a resolution to liquidity problems. As MFIs struggle to find affordable, available sources of funds, merging pools assets and increases MFI attractiveness to capital providers. Consolidation would also likely result in economies of scale and thereby reduce operating expenses. One interviewee reported a nearly two-thirds reduction in cumulative overhead costs following an MFI merger in Latin America. Given the saturation levels of many microfinance markets, industry consolidation is likely. It stands to reason that the evolution of consolidation will follow a similar trajectory to the one taken by traditional banking. First waves of consolidation will likely occur within MFI networks, in a particular province or state. Second waves of consolidation will likely be within regions, across countries that share common currencies and compatible regulatory frameworks. The third and increasingly sophisticated form of consolidation will be across national borders, again likely beginning with MFIs within a single network.22 Recognizing these three phases of consolidation early and positioning to benefit from industry evolution will be a key success factor for all MFIs, but mid-sized MFIs in particular. During the downturn, many mid-sized MFIs will find they are not quite strong enough to absorb economic shocks like their larger counterparts,

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and not quite lean enough to attract acquisition interest like their smaller, niche counterparts. Most of the thinning in the microfinance sector will occur amongst mid-sized players with weaknesses in their operational and financial foundations. These weaknesses, which were previously concealed in the good times of rapid growth, will be exposed by the crisis and in some cases cause institutional failure. To begin assessing the opportunities and risks associated with consolidation, microfinance institutions and networks might begin by: • Mapping the MFI’s market niche (products offered, customers served) within the context of other MFIs in the network and/or market • Quantifying a valuation of the MFI • Identifying the value proposition, strengths and weaknesses of the MFI • Identifying potential synergies from consolidation • Preparing for exploratory conversations Implications for Action - Capital providers Public and private capital providers can each take action in the coming months that supports the microfinance sector and also furthers financial objectives. For public investors, there are three recommended actions, and for private investors, one potential opportunity to be explored. 1. Go where others fear to tread It is now more critical than ever for multilateral and bilateral development financial institutions to take higher-risk positions in order to encourage private capital flows into the sector. Instead of providing financing to the larger, top-tier MFIs who can likely still attract private sector investment interest, development finance institutions should look to support second- and thirdtier MFIs. In recent years, some sector analysts concluded that development institutions were at risk of ‘crowding out’ private investors by investing in larger, more well-established MFIs, often at below-market price points.23 If IFIs were repelling private investors by their actions before, they must now solicit private investors’ interest by leaving lower-risk investment opportunities open, taking first loss positions in structured investments, and seeking to support the capital needs of the relatively under-served second- and third-tier MFIs. 2. Assist as well as invest Next, public investors should increase capacity-

cover story building services provided alongside financial infusions, and develop best practice guides for broader circulation. Institutions and networks interviewed indicated an appetite for strategic and operational support during the downturn. Key areas of need include training in market risk analysis, enhanced credit risk management techniques, and support in strengthening back office informational and financial systems. 3. Be the lender of last resort…in local currency Lastly, public investors should continue to convene shareholders from the private sector to fund emergency liquidity and credit enhancement facilities of the sort that the InterAmerican Development Bank, the World Bank, IFC, and the German development bank KfW have launched. Unlike large banks, MFIs cannot typically obtain government-backed loans as bridge financing during difficult economic times, and so these facilities serve a critical need as lenders of last resort. As Omtrix, fund manager for the IADB’s emergency facility, explains, these facilities are valuable not just in that they provide additional liquidity, but in how they provide that liquidity. The more local currency funds that can be created, the less unhedged currency exposure will be inflicted upon MFIs. For private investors, it is still too early to

say definitively what the performance of debt funds will be in 2009. In a global downturn characterized by depreciating currencies, once marked-to-market, interest rates on loan funds may effectively be much higher to the borrowing MFI and as a result, default rates may rise and decrease overall returns.24 The outcome remains to be seen as MFIs turn increasingly to liquidity from their loan portfolios to service maturing debt obligations. For equity investors, the financial crisis may offer opportunities. 4. Explore opportunities in equity As discussed above, equity is a thin slice of the overall MFI liability structure, but it had recently begun to grow rapidly. There were 24 equity funds by the end of 2008 totaling US$1.5bn under management.25 Since the deepening of the financial crisis, however, investor enthusiasm for microfinance equity deals appears to have become more subdued. Perhaps it should not be. MFIs are hungry for capital and in a climate of uncertainty, will likely offer equity stakes at lower prices. Furthermore, given the general lack of liquidity in the market, MFIs may try to raise more equity finance than is strictly needed out of a desire to build a buffer against repayment volatility. As a result, equity investors may see more, as well as cheaper, deals available. Before successful exits are complete,

it is difficult to predict the performance of these deals. However, there are reasons for optimism. Sector fundamentals are strong. Average asset size of microfinance banks grew by roughly 40% last year, and asset quality remains high with portfolio-at-risk ratios at less than 2% as of February 2009.26 The backbone of the sector is the low-income borrowers and they have been proven to rebound more quickly from financial downturns than commercial bank borrowers. Finally, returns on equity are attractive, as illustrated by a median ROE of about 14% in 2007.27 For all of these reasons, it remains worthwhile to explore equity investments in microfinance. Conclusion It is true that the global recession poses risks to the microfinance sector. However the flip side of risk is opportunity. The crisis can turn into a positive catharsis for those in the microfinance sector that can react nimbly to the seemingly unpredictable global economic environment. By anticipating and proactively responding to the conditions of the financial crisis, MFI managers and capital providers can, to a great extent, manage towards a positive outcome. n

Yana Watson is a Manager in the New York office of Dalberg Global Development Advisors. She leads many of the firm’s engagements in access to finance. Yana has worked with microfinance networks, institutions and investors on strategies for financial sustainability, market entry, product development, technology innovation, back-office management and post-merger integration. Prior to joining Dalberg, Yana worked with the Boston Consulting Group (BCG), VISA International’s emerging markets division, Women’s World Banking and Arthur D. Little. She can be reached at yana.watson@dalberg.com. Dalberg Global Development Advisors is a strategy consulting firm focused on global development with eight offices worldwide. For more information on Dalberg, please visit www.dalberg.com. ACKNOWLEDGEMENTS The author would like to thank the following for providing input to this article: Alex Silva of Omtrix Inc., Bhakti Mirchandani of Unitus Capital, Camilla Nestor of Grameen Foundation, Christina (CJ) Juhasz of Women’s World Banking, Chuck Olson of Deutsche Bank, Geeta Goel of the Michael and Susan Dell Foundation, Hans Dellien of Women’s World Banking, Howard J. Finkelstein, Hugh Sinclair, Ingrid Munro of Jamii Bora, Michael Cracknell of Enda Inter-Arabe, Minh Lai of PlaNet Finance, Monica Brand of ACCION, Rachel McCullough-Sanden of ASA Foundation, Scott J. Budde of TIAA-CREF, Shari Berenbach of The Calvert Foundation, Tomas Miller of the Inter-American Development Bank, Xavier Reille of CGAP, and Zachary Pessin of Distributed Capital. Endnotes: 1. “Foreign Capital Investment in Microfinance.” CGAP Focus Note No. 44. February 2008. 2. Effects on Microfinance of the 1997-1998 Asian Financial Crisis, McGuire and Conroy, November 1998. 3. MixMarket 2007. 4. “East Asia and the Pacific: Navigating the Perfect Storm.” EAP Update. The World Bank. December 2008. 5. JoongAng Daily. “Government Provides Cheap Loans and Guarantees in Response to Recent Economic Downturn.” January 15 2009. 6. “East Asia and the Pacific: Navigating the Perfect Storm.” EAP Update. The World Bank. December 2008. 7. IDB News Release Oct 9 2008. 8. “Optimism Soars in the Andes.” The Banker, Oct 6 2008. 9. Mohammed Khaled, CGAP representative. 10.“Global Financial Crisis: Implications for South Asia” October 21, 2008. 11. Speech by Mrs Jacinta Mwatela, Deputy Governor of the Central Bank of Kenya, at the Stakeholders Forum on the Deposit-Taking Microfinance Regulations issued under the Microfinance Act, Kenya School of Monetary Studies, Nairobi, 12 May 2008. 12. “Microfinance Investment Vehicles.” Credit Suisse, August 4 2008. 13. “The Microfinance Sector: Its Success Could be its Biggest Risk” Fitch Ratings. June 16 2008. 14. Banco Compartamos: Life after the IPO, Harvard Business School, March 2008. 15. “Credit Crunch Derails but Doesn’t Crush Microfinance Market.” ABS Report. Structured Finance News. August 11, 2008. 16. “Microfinance: Testing its Resilience to the Financial Crisis.” Fitch Ratings. January 22 2009. 17. CGAP Virtual Conference: Microfinance and the Financial Crisis, November 2008. 18. CGAP MF Capital Markets Update #25 March-April 2008. 19. “Shedding Light on Microfinance Equity Valuation: Past and Present.” JP Morgan and CGAP. February 3 2009. 20. “Shedding Light on Microfinance Equity Valuation: Past and Present.” JP Morgan and CGAP. February 3 2009. 21. MicroBanking Bulletin 17 Autumn 2008. 22. Special thanks to Hugh Sinclair for sharing his perspectives. 23. Abrams, Julie and Damian von Stauffenberg. “Role Reversal: Are Public Development Institutions Crowding Out Private Investment in Microfinance?” MicroRate 2007. 24. Special thanks to Zac Pessin of Distributed Capital for sharing his perspectives. 25. “Shedding Light on Microfinance Equity Valuation: Past and Present.” JP Morgan and CGAP. February 3, 2009. Ibid. 26. “Microfinance: Testing its Resilience to the Financial Crisis.” Fitch Ratings. January 22 2009. 27. “Shedding Light on Microfinance Equity Valuation: Past and Present.” JP Morgan and CGAP. February 3 2009. For the complete bibliography, please access this article online at http://www.microfinanceinsights.com.

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mar/apr 2009

microfinance insights

global viewpoints

The stalled engine of the global economy has affected people and organizations in very different ways. In this issue, we reached out to a cross section of microfinance stakeholders who have been impacted by the crisis. We spoke to borrowers in Mexico and Nigeria, investors in the Netherlands, and executives in the Philippines and Switzerland to find out more.

A Tale of Two Marias: Borrowers share their stories Some experts feel that the microfinance sector is less prone to the shocks of the global economic crisis because borrowers operate largely in the informal economy, and are less influenced by macro-economic changes; others highlight the need to protect borrowers who are facing increasing economic hardship. We reached out to two borrowers who, by pure coincidence, are both named Maria, and found that their name isn’t the only thing they have in common.

A Preacher’s Prayer Nigeria is Africa’s most populous country and had long struggled with political division, corruption and poor macroeconomic management under military rule. However, with the help of international organizations, the country started on a path to economic reform a few years ago. Large oil and natural gas reserves (which have long-driven growth) led to high revenues in 2008, however, the country’s banking and economic reform program has left it open to the vagaries of the international financial system. Against this background, located in the heart of Nigeria’s capital Abuja, is Target Microfinance Bank. This one-year-old institution has a growing client base and a total loan disbursement of US$165,000. Maria Ibeabuchi, a Target borrower, who is a preacher at the local church and a petty trader, shares her story. Profile

Maria Ibeabuchi Petty trader, Target Microfinance Bank Abuja, Nigeria In the last six months how has the economic situation changed in your community? Ibeabuchi: Oh well, it has not been so easy. However, we are coping with the harsh economic situation in our community. In fact, we are determined to reduce poverty and make wealth for ourselves with the support of Target Microfinance Bank. How have you been personally affected by any changes in the Nigerian economy? Ibeabuchi: Since I am still in the business of selling vegetables, foodstuffs, etc., I try to balance the effects of the economy despite the challenges by making sure that my foodstuffs meet the satisfaction of my customers at reasonable prices.

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Has the loan, or interest levied on your loan changed in the last six months? Ibeabuchi: No, but we still expect interest review on loans to us. What sort of changes have you seen in prices in the last year? Ibeabuchi: The price of goods and services are increasing. We used to buy goods at the rate of fifty naira (US$0.30), but now goes for between N100 to N200 (US$0.60-1.20). What changes have happened in your family in the last six months, as a result of the changing economy? Ibeabuchi: We have had corresponding fulfillment of our heart’s desires and more. Though the economy is hard on us, we still manage to pay school fees and feed our family at least two meals daily.

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Maria: “It hasn’t been easy.”

How has Target Microfinance Bank helped you handle the changing economyic situation? Ibeabuchi: Target Microfinance Bank has helped me a lot in my business. They have helped me to increase my bulk purchase through the loan that was granted to me. I am very happy with Target. I am doing all I can to repay my loan as this will guarantee me another loan maybe with increase amount.

global viewpoints

Making Every Peso Count The Mexican economy is one of the few US$1 trillion economies in the world (based on its Purchasing Power Parity (PPP) GDP figures for 2007) and is largely dependent on trade with the United States and Canada. Its geographic proximity to the origin of the economic crisis makes it more vulnerable to economic flux. And the impact is not centered on urban locations, or the “banked.” As the largest remittance receiving country, the poor are finding it more difficult to make ends meet. Solucion ASEA, operates throughout the country, and lends primarily to groups of 10-50 people (and, at least 80% of each group’s members are women.) Maria Castellanos runs a small business selling household provisions and is also President and Founder of the group ITURBIDE – a group of seven women borrowers. Profile

Maria Amalia Chun Castellanos Borrower, Solucion ASEA Tapachula, Mexico In the last six months, how has the economic situation changed in your community? Castellanos: There have been a lot of changes, but not for good. Our community is dependent upon coffee, and the harvest has not done well this year. Has the loan amount, or interest levied on your loan changed in the last six months? Castellanos: I’ve had to lower the amount of my credit. In the previous cycle I borrowed 6,000 pesos (US$400); in this cycle I lowered the amount to 5,000 pesos (US$330). What sort of changes have you seen in the last year? How have those changes

affected you? Castellanos: I have observed increases in priced of the basic provisions: milk, kidney beans, rice, sugar. Chicken used to cost between 7 and 75 pesos (US$0.50 and US$5) and today it costs 90 pesos (US$6). This affects me because the money I take home has not increased. What changes have happened in your family, as a result of the changing economy? Castellanos: We are cutting back on buying things that are unnecessary, and only purchasing things for our basic needs. Also, my son has lost his job. The company where he used to work is laying off people. How has Solucion ASEA helped you deal with the changing economic situation? Castellanos: Solucion ASEA supports us by offering more flexibility with our payments. A lot of MFIs collect payments

Maria: “The harvest has not done well.”

each week which is too short to meet our cash flow. In our case, the payment is every two weeks. It gives us more time to recover the investment made in our business. Where they could help us more is by lowering the interest rate since it is still a bit higher than other MFIs, like Compartamos. The group is strong enough thanks to the experience we have of working with Solucion ASEA; we are all hard workers and feel that we receive the support we need from Solucion ASEA.

Investing at the Edge: An Investment Manager Speaks Microfinance is experiencing an unprecedented investment boom. The past few years have seen a remarkable increase in global microfinance investments. The stock of foreign capital investment — including debt and equity—more than tripled to US$4bn between 2004 and 2006. The most significant development is the entry of private investors in the microfinance investment space. Forty specialized microfinance investment funds have been established in the past three years. International retail banks, investment banks, pension funds, and private equity funds, are all looking for ways to channel capital into microfinance. Microfinance is proving a very attractive proposition for a growing section of socially responsible investors (SRI). Marilou van Golstein Brouwers, Managing Director at Triodos Investment Management BV, sheds light on the changing face of microfinance during the global recession and predicts investment trends for the coming year. Profile

Marilou van Golstein Brouwers, MD Triodos Investment Management BV The Netherlands In 2008, how did the microfinance investment landscape change and how are your microfinance investments faring? Brouwers: In general, our microfinance investments developed well in 2008. There were www.microfinanceinsights.com

a few MFIs which had to cope with increased PARs [Portfolio At Risk], but these were very much related to country-specific issues. What changed is the supply of capital available to MFIs - both for debt and equity and both from local and foreign sources. In some cases and in some specific regions, you can say that the supply of money has been driving the growth of MFIs. These MFIs now have to change their strategies and look at different growth scenarios.

How are microfinance investors reacting to the global recession? Has the likelihood or type of investing changed? Brouwers: In Europe, we still see a lot of interest with both institutional as well as retail investors. In 2008, our Triodos Fair Share Fund –a fund for Dutch retail investors--increased from EUR36m to EUR60m. We have seen some outflow, but this was always compensated by more inflow in the Fund. As for institutional

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global viewpoints investors; they increasingly see microfinance as an interesting “asset class” to invest in—as part of their alternative portfolio—both because of the social impact and its lower correlation with other asset classes. However, a problem now for some of the institutional investors is that investment in alternatives is usually limited to a certain percentage of their total portfolio. As the rest of the portfolio has decreased in value substantially, the alternatives part, which overall shows more positive returns, is at its limit in percentage terms. This leaves no room, for the time being at least, for further investments. How does microfinance compare to other social investment opportunities in this current economic environment? Brouwers: I think it is a big advantage that MFIs are not listed on stock exchanges. Therefore, the development of “value” of microfinance equity investments is more connected to the real economic development of MFIs. It is less driven by speculation and emotions like fear or greed that often seem to be the basis for development of values for companies listed on the stock exchange. Investments in microfinance show a more stable return than, for example, SRI investments in stock listed companies. Another thing is that MFIs are very much working in the “real economy;” they offer financial services based on real needs of low-income people. Also, in the current economic environment, these needs will not go away. This, in itself, provides

a solid basis for further good development of MFIs. Do you see any similarities between microfinance lending and the sub-prime lending that led to the economic crisis? Brouwers: No. If you look at the reasons behind the current crisis, a lot of it has to do with the fact that increasingly, in recent decades, people have tried to make money out of money through speculation and by creating complex financial products with the promise of a high return. Products with no real value were created, risks were ignored, and fees were simply added up by agents, brokers, and investment bankers. These included sub-prime mortgages, packaged in structured vehicles and sold as CDOs [collateralized debt obligations] with different classes of risk to investors all over the world. As long as investors believed in these products, all seemed well. But this hid reality. Last year it resulted in the “sub-prime crisis.” The balance between the financial world and the real economy has been completely lost. With these products, there was no direct relation anymore between the lender and the borrower. This is completely different with microfinance. Microfinance banks are well connected to the real economy, offering inclusive financial services as an answer to real needs of people. Banks need to go back to their core function; back to being an intermediary between savers and lenders, back to a strong relationship between the client and

his financial institution and back to thorough assessments of how much a client or a business can take as a loan, giving them or the business a chance to develop. Good MFIs are doing just that and they can, in fact, be inspiring examples to the financial sector as a whole. What microfinance investment trends do you foresee over the next 2-3 years? Brouwers: In general, we see the market for socially responsible investments increasing rapidly. There is an increased awareness among investors, and the public in general, that how returns are realized, is as important as what these returns are. We think microfinance will evolve further into a niche investment alternative, appealing to both private individuals as well as institutional investors, seeking social impact and pursuing portfolio diversification. As for the development of the microfinance banks and institutions; we will probably not see the fast growth that we have seen in the last five years. Specifically, MFIs that are completely dependent on (foreign) borrowings may have some problems with refinancing. The microfinance banks that have a strong local depositors’ base will probably continue to develop well. They will need more equity to continue growth. We also see a trend where strong local microfinance banks expand to neighboring countries. This will also provide investment opportunities.

P2P Lending Platforms. Still Going Strong? Online, person-to-person lending platforms like Kiva, MyC4, and Microplace bring millions of individuals across the globe into direct contact with small-scale microfinance borrowers. These platforms have worked not just because they personalize the experience, but also because, in tapping into an individual’s generosity, they open a new line of credit for MFIs, and in some cases, provide a return on “investment.” But how much do people lend in a recession? Is funding drying up? We spoke with Darren Miao of KIVA (www.kiva. org) to find out. Profile

Darren Miao, Microfinance Partnership Manager, East Asia Pacific Region KIVA KIVA is heavily dependent on individual donors in the US, where the recession is having a dramatic effect. How has the economic downturn affected KIVA? Miao: Right now, we have not seen a slowdown in the amount of lending through the Kiva site.

microfinance insights

In fact, we still will run out of loans on our site. Part of this phenomenon is due to re-lending by our existing lenders – once they get repaid by a borrower, they tend to re-loan through Kiva. We have seen a slowdown in new users, but we are not sure if this is a result of the economic downturn, the lack of inventory or some other third-party event. One hypothesis is that because Kiva tends to come out of an individual’s “donation,” it actually is one of the last “discretionary” spending cuts an individual will make.

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Eim Sarin, a Cambodian Borrower connected to KIVA. Photo Credit: Kieran Ball

global viewpoints How has the economic downturn affected MFIs that Kiva supports? Miao: The main effect has been that MFIs have had a harder time accessing funding for their portfolio. Lenders are scaling back their operations and are becoming much more choosy in who they lend money to. Whereas several years ago MFIs were awash with potential funders, now they are finding it a tighter market. The majority of our partners are still able to secure funding, but they would definitely all like to raise more through Kiva. How has the global recession impacted the borrowers KIVA supports? Miao: We don’t actually have that much insight into the individual borrowers. Anecdotal evidence from our partners shows that our borrowers are much more affected by commodity price

shocks – such as the surge in oil prices over the summer – than they are by the credit crunch since they typically do not access financing from traditional sources. As long as the MFI that they work with continues to receive funding, the global recession does not seem to affect our borrowers as much. However, when recession begins to affect the prices of basic commodities, then it really begins to affect the day-to-day lives of our borrowers. Are there any innovative measures you have introduced in your operations to cope with the increasing financial burden? Miao: As a result of the recession, Kiva has had to adopt a tighter budget and be more risk conscious about the type of MFIs we work with. While we still strive to serve the long-tail of the MFI market, currently we are re-evaluating the

risk policies of the organization. One thing we hope to do is help our MFIs deal with the foreign exchange risk associated with KIVA funding. Since we lend and get repaid in US dollars, this obviously can have a significant effect on our MFI partners. We are hoping to develop some sort of solution with our lenders that help mitigate this risk for our partners by the end of the second quarter of 2009. What are your predictions for economic recovery this year? Miao: It’s tough to say – bleak for the most part of the year. I’m sure we will see some weaker MFIs either get taken over or fold. Those that make it through this recession will come out much stronger.

Survivor: Recession—Two MFI Networks Share their Notes During the Asian financial crisis in 1997, clients in the Philippines stopped borrowing from traditional banks with strict lending rules and switched to local lenders specializing in flexible lending strategies. While the traditional banks incurred heavy losses because of the recession, the MFIs profited, expanding operations. Will this global financial crisis bring new challenges for the Philippines microfinance sector? Marlowe O. Baring of SEEDFINANCE in the Philippines tells us how their partner MFIs are preparing to cope. Profile

Marlowe O. Baring Corporate Planning and Marketing Head SEEDFINANCE Corporation, Philippines How has the crisis impacted SEEDFINANCE? Baring: The impact of the global financial crisis is expected to be felt by our partner-MFIs and other MFIs in the country within the first half of 2009. We expect major policy changes on financial service delivery as well as on the funding mechanism from these institutions. Most of SEEDFINANCE’s existing funding partners are government-financing institutions. During the last quarter of 2008, these institutions have shown significant interest in partnering with us by increasing our credit lines and offering new partnerships for MSMEs [micro, small and medium enterprises]. However, SEEDFINANCE is carefully examining those offers in light of the worsening financial crisis vis-a-vis its present capacity to innovate. Have MFIs in the Philippines shut down due to the crisis? Baring: Bank closures in the Philippines reached www.microfinanceinsights.com

an unprecedented high in 2008 affecting P21.6bn (US$456m) worth of customer deposits in a total of 25 padlocked banks. The spate of bank closures, which banking regulators attributed more to mismanagement and unsound banking practices rather than a fallout of the US-centered global financial crisis, exceeded 17 bank failures in 2007 and 11 closures in 2006 (Banko Sentral ng Pilipinas). It is noteworthy that these rural banks also have microfinance services. SEEDFINANCE is closely monitoring its partner-MFIs, especially banks and NGOs. A trend of increasing loan delinquency and liquidity problems at these MFIs were noted in 2008. So far, the cooperatives have not shown negative indicators compared to the other types mentioned above. How have your clients been affected? Baring: Direct SEEDFINANCE clients are the MFIs and these partners only have a general idea of the crisis and not of its depth. End-clients (the micro-entrepreneurs) of SEEDFINANCE directly feel the crunch because of the high inflation rate, increased prices of basic commodities and loss of employment and underemployment. In 2008, there was an unusual withdrawal of sav-

ings deposits and high demands for loans. Loan delinquency is yet to be established. What specific steps has SEEDFINANCE taken to ensure continued investor support? Baring: In 2008, SEEDFINANCE has increased its bottom line and controlled its delinquency. This has maintained the confidence of its investors and creditors to stick with SEEDFINANCE. As mentioned earlier, creditors have increased their credit line offers and partners-MFIs-investors increased their equity investments. These may be taken as indicators of maintaining confidence. What operational changes have you made as a result of the crisis? Baring: Our operational structure is streamlined to cover regional operations (covering 2 or more provinces for 1 portfolio officer.) Marketing is giving more attention to the non-financial or business development services and integrated into the portfolio management responsibilities of staff. This non-financial service is designed and envisioned to build resource-based local communities with economies that are sustained by small and medium entrepreneurs and sup-

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global viewpoints ported/supplied by the numerous micro-entrepreneurs in the locality. Financial products have also been diversified. These include liquidity facility for partner-MFIs and co-financing facility for small enterprise end-clients to its regular loan facility. The liquidity fund, in effect, has a higher interest rate compared to the microfinance regular revolving credit line and has a shorter loan term. On the other hand, SME co-financing has longer loan terms and lower interest rates but has a built-in mechanism of risk sharing with select, established MFI-partners. Partners welcomed the new financial products with enthusiasm. Have you had to limit/review your growth plans for 2009? Baring: On the contrary, an aggressive 2009 ex-

pansion plan that was crafted in the middle of 2008 remains unchanged and is actually being implemented now. With the diversified portfolio and introduction of Business Development Services (BDS) as fee-based income, financial viability is projected to double in 2009. THe BDS for 2009 has been expanded to the microfinance and SME clients of partner-MFIs. Two major components of the BDS are the set up of a micro-economic development (MED) center where market study, market linkage, and product improvement are taken care of, and the set up of the training institute (IM-FREE - Institute of Management in Finance and Rural Economic Empowerment) for knowledge-sharing, skills development and capacity-building for internal and external clients. The MED centre and the IM-FREE are operated through a co-manage-

Baring: “Our partners only have a general idea of the crisis.”

ment scheme (between SEEDFINANCE and the MFI-partner). This necessitates a major marketing shift from purely financial sustainability to double-bottom line of local economic development and organizational sustainability to make SEEDFINANCE a long-term partner of choice.

Playing It Safe

Overlooking a network of microfinance banks takes planning, precision and foresight. The Aga Khan Agency for Microfinance, a Swiss-based organization, does precisely this. Over the past eight years, the Agency has set up microfinance banks across more than nine countries. Each bank operates independently and is managed by the Agency. Microfinance Insights spoke with Jacques Toureille, General Manager to learn more about how the organization’s work is affected by the crisis. Profile

Jacques Toureille, General Manager, Aga Khan Agency for Microfinance How has the global recession affected your organization? Toureille: For us the recession has started to have an effect, but only marginally. As for the future, we can’t say, but obviously we will be more cautious. We had earlier been concerned by the rising price of food. We saw that some people had started to be affected, particularly in cities. Although several of the countries we work in are relatively isolated from these problems, they will inevitably be affected at some point in time. For example in Tajikistan, where we have a microfinance bank, the effects of the crisis has been slow to take hold but is now manifesting itself in the form of reduced liquidity in the market, interest rates have gone up, the currency is under attack to some extent. The population also relies a lot on remittances from people working in Russia. There are those indirect effects, but for the time being, it is not something beyond control. Your funding is largely from deposits, equity and loans and a small portion through grants. How are these being affected by the economic

microfinance insights

crisis? Are you seeing your investors, donors and other partners decrease their interest or commitments? Toureille: We do rely on equity, loans and grants, particularly in areas where regulation does not allow our banks to take deposits. We work with our own funds, provided by His Highness the Aga Khan, and from international organizations such as the IFC, KfW, and others. As of late, some development agencies have told us that their budgets are reduced. Some have refurbished their funding and created liquidity funds. In fact, the IFC has just created one recently. What they have said is that those funds are there to help institutions that are facing problems. My reading of this is that they want to stand behind those institutions that are facing liquidity issues. For example, in parts of Eastern Europe the tension is very high right now. Ukraine is one country that has been affected severely, and they are some good MFIs which are facing difficulties right now. In 2009 is your organization, looking to scale back? Toureille: Not in a significant way. We have some projects in the pipeline and we will see if our partners follow through at the same speed as before. We are being told by certain aid agencies

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that they have reduced budgets, but there is a willingness among international organizations to be ready to help microfinance because they feel it is very important to have strong MFIs in difficult times. Regarding 2009, we are going to be cautious. We are feeling some pressure on our portfolio, and although it is still quite sound, some of our clients are starting to have problems. On the remittance issue, we have been very careful of not lending to people who are heavily dependent on other people to pay their loans. The other area is deposits: we don’t know whether people will continue to have as much money as before. We expect that this is going to be reduced as a source of funding. What we will do obviously is adjust lending activities to our clients. When do you think we will start to see a change in the situation? Toureille: We are all wondering. Nobody knows and it is difficult to say. We are hoping it will be soon, but it is very difficult to know. At this stage we are trying to protect our activities, and wait for better times. n Members of the Microfinance Insights editorial team conducted and compiled these interviews. For perspectives from MFIs on the recession, turn to page 41.

critique

Locked In:

Microfinance Needs Radical Change Before its Too Late The effective collapse in 2008 of the US government-Wall Street-driven model of liberal capitalism is an event of major historical importance. As with the collapse of an earlier wall in 1989 – the Berlin Wall – transition to a new economic model is now required, and is indeed underway. The microfinance industry is in no less a need for radical change. This is because many of the flawed character traits that have ultimately destroyed Wall Street also lie at the heart of the increasingly commercialised microfinance industry. In a very uncomfortable parallel with the spectacular rise of Wall Street’s most hallowed institutions and individuals, now consigned to the grubby margins of business and economic history, careerism, personal greed and the related drive for profit have also blinded the microfinance industry to the fact that microfinance is ultimately destroying the goal of reducing poverty and promoting sustainable economic and social development. Photo credit: Tay Nascimento

www.microfinanceinsights.com

icrofinance emerged in the late 1980s to become the most high-profile intervention against rising poverty in developing countries. According to Grameen Bank founder, Dr Muhammad Yunus, microfinance was going to transform the lives of the poor, and he predicted that in a couple of decades poverty would be completely eliminated. In the 1990s, the growing microfinance industry began to come under the powerful influence of the World Bank and a number of high-profile US-based international NGOs. The result was that many of Wall Street’s core aims, values, and methodologies were extended into microfinance. According to this “new wave” philosophy, microfinance could best eradicate poverty only if microfinance institutions themselves acted as commercially driven businesses. However, the recent collapse of Wall Street’s entire value and operating system, allied to the resulting US-led global economic meltdown this has precipitated, have combined to subject the microfinance industry to serious critical scrutiny for perhaps the very first time. The upshot is that the microfinance industry, like Wall Street itself, stands accused of perpetrating an ongoing economic and moral-ethical disaster. But doesn’t microfinance work? Not really. Consider the situation in Bosnia, one of the international donor community’s supreme examples of “best practice.” The end of the Yugoslav civil war in 1995 saw the international donor community very quickly establish a raft of lavishly financed microfinance institutions in Bosnia, including a couple of dedicated microfinance banks (e.g., Pro-Credit Bank). A little later on, Bosnia’s now foreign-owned commercial banks also discovered the impressive profitability of simple microloans. By the early 2000s, therefore, Bosnia was on a par with Bangladesh

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critique and Bolivia in being effectively saturated with microfinance. The overarching outcome of this saturation, however, has been the progressive informalization and infantilization of the Bosnian economy, now at a very advanced stage. With the overwhelming bulk of microfinance finding its way into the informal sector and into the very tiniest and least sustainable of micro-businesses, and with small and medium enterprise (SME) lending progressively abandoned (especially for start-ups) because of higher risk and lower/ slower profit factors, this debilitating trajectory was inevitable. Tragically, Bosnia’s considerable industrial and technological base – an institutional asset most developing countries are desperately trying to construct – was almost entirely ignored as the starting point for a new generation of relatively technology-intensive microenterprises and SMEs. Because of high interest rates and short repayment periods, microfinance was of no use whatsoever to those many entrepreneurs considering a new venture based upon this extremely valuable knowledge and technology base. But with no other major financial alternatives, as intended, it was therefore made inevitable that almost all such far-sighted projects would be aborted. Bosnia’s industrial base was thus allowed to collapse without even a whimper. All told, the Bosnian economy has been subject to what many Bosnians term “Africanization” (Africanizacija), meaning its programmed descent into unsustainability and likely permanent dependence upon the international donor community (or the EU). But surely lots of new jobs and incomes were created in Bosnia, as the microfinance institutions widely proclaim? Well, no. The microfinance industry everywhere wrongly assumes some kind of Say’s Law operates at the local level, meaning that the unending supply of the simple non-tradable goods and services that poverty-push microenterprises typically provide will automatically call forth the local demand for such items. But real economic life is not like this. Instead, other things being equal, new microenterprises and microenterprise expansions mainly displace existing jobs and income streams in non-client microenterprises. If we cared to look further in Bosnia, we would undoubtedly find that net job and income creation thanks to microfinance has really been quite negligible. In addition, we must reflect upon the fact that very many of the new microfinance-supported microenterprises

microfinance insights

(the clients) collapse after a short period of time. World Bank researchers estimated that 50% of those moving into self-employment in Bosnia between 2002 and 2003 failed within just one year of starting their venture. This is a very worrying development indeed. We know that failure of a microenterprise often necessitates having to repay the original microloan by liquidating family assets - family savings, apartments, family land, and so on – as well as going even further into debt. This is, of course, why failure rates appear to have increased considerably in Bosnia, but repayment rates nevertheless remain impressive. But this also means that very many of the poor individuals who end up failing in their microenterprise venture - now probably the majority – are therefore plunged into even deeper poverty and insecurity than before.

“No-one seems to have considered either the moral implications of expecting the very poorest women in Mexico to effectively underwrite access to microloans for others equally poor, still less to underwrite the Wall Streetstyle financial rewards accruing to those running Compartamos supposedly on their behalf.” Bosnia’s microfinance sector is not, unfortunately, the only one to precipitate such debilitating local impacts. Far from it. Bosnia’s predicament is certainly shared by its Balkan neighbours. And as a recent 2003 UN report

outlined, the globalisation-driven collapse of formal sector employment everywhere (especially public sector employment) has directly resulted in most local economies becoming saturated with poverty-push informal sector microenterprises. Here too the deployment of microfinance may well turn a healthy profit for the microfinance institutions, but almost everywhere the local economy’s functioning and growth potential is being likewise destroyed. In Bangladesh, the microfinance sector very profitably recycles a quite significant percentage of the nation’s valuable savings back into yet more rickshaws, street food sellers, rice huskers and petty traders. At the very same time, potentially growth-oriented, but riskier, SME and larger projects fail to attract any local financial support. In Mexico, too, a new generation of aggressively commercial microfinance banks has very profitably mobilized huge amounts of local savings and commercial funding, but this largesse is also overwhelmingly recycled back into an already bursting-at-the-seams informal sector. Many analysts in Mexico quite rightly express their fear that the accelerating “changarrization” of the economy - a reference to “changarros” or informal microenterprises – is inevitably leading Mexico back to a primitive non-industrial base, and thus back to endemic poverty. By all accounts, many localities and regions in India, Bolivia and in many other developing countries have moved toward emulating this locally destructive scenario. In spite of the worrying evidence that microfinance is actually part of the development

Rickshaws in Dhaka. According to Bateman, Bangladesh recycles a significant percentage of its savings into rickshaws, street food sellers and petty traders, not growth-oriented SMEs. Photo: Nafis Bhai

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critique problem, and not the solution, the microfinance industry has nevertheless shown little or no interest. This attitude very closely emulates Wall Street’s reaction to those raising concerns as to the eventual outcome of its greed and speculative excess. Yet the tide cannot be held back forever. The recent case of Compartamos has helped to highlight more than ever before the potential local destructiveness, as well as moral bankruptcy, of commercialised Wall Street-style microfinance. Originating in an NGO capitalized with significant donor grant funding, Compartamos’ rapid growth since the 1990s was made possible through charging poor Mexican women annual interest rates at times approaching 120%. In an almost perfect parallel with Wall Street’s bogus claims surrounding sub-prime loans - that the commercial banks and others may have erred in extending far too many of them, but they were simply “trying to help America’s homeless poor” - the very high profits realized in Compartamos were similarly justified on the basis that “they would eventually help more Mexicans obtain microloans.” Yet no-one from Compartamos thought to directly ask the poor Mexican women paying ultra-high interest rates if this was what they wanted done with their earnings and reinvestment opportunities forgone. No-one seems to have considered either the moral implications of expecting the very poorest women in Mexico to effectively underwrite access to microloans for others equally poor, still less to underwrite the Wall Street-style financial rewards accruing to those running Compartamos supposedly on their behalf. Moreover, the damaging “changarrization” trend underway in Mexico’s economy is seemingly of no concern to anyone in Compartamos or in the wider microfinance industry. Just as on Wall Street and also regardless of the wider consequences, Compartamos adopted a profitmaximisation strategy largely in order to provide cover for the generous salaries and bonuses the senior staff felt they simply had to reward themselves with, particularly from around 2000 onwards. Such stratospheric financial rewards

then very usefully allowed the lucky recipients to begin to buy into ownership of Compartamos, with an obvious eye to the real bonanza that lay ahead in the form of an IPO. The fifty million dollar windfalls several of the key people in and around Compartamos eventually realised are classic Wall Street outcomes based, not on development impact, but on opportunism and greed. The light at the end of the “commercialised microfinance-as-poverty-reduction” tunnel is actually an oncoming train.

“If microfinance institutions continue to intermediate the bulk of a country’s domestic savings... into the informal sector...then that country will forever remain ‘locked in’ to a state of grinding poverty, marginalization and under-development.” So, finally, what to do? Naturally, abandoning Wall Street-style commercialized microfinance is a start. We then need to learn the real lessons of economic history. As a growing number of development economists point out – notably Cambridge University-based Ha-Joon Chang – today’s rich developed economies, as well as the more recently wealthy East Asian “Tiger” economies, all managed to succeed in sustainably reducing poverty not with microfinance, but with a quite different set of solidarity-driven financial (and other) institutions. Financial cooperatives, specialized development banks, special credit institutes, and social venture capital funds were the principal instruments. Such financial institutions ensured that domestic savings and any other funds (e.g., Marshall Plan funds in post-war Europe) were carefully and efficiently recycled back into growth-oriented SMEs and larger business projects operating in potential growth sectors. This was why many East Asian countries may have started at or near the GDP level of Bangladesh in the 1970s, but they then massively outpaced Bangladesh in terms of

development, growth and poverty reduction. This is why the most successful regional and local economies in Europe - in northern Italy, in the Basque country of northern Spain and in the former West Germany - were able to achieve hugely positive local economic development outcomes compared to just about everywhere else in post-war Europe. Put simply, these local financial institutions were designed to press the key “triggers” we know lie behind sustainable development and poverty reduction – the ability to reap scale and scope economies, develop and/ or use new technologies, incorporate recent innovations, develop productivity-enhancing linkages (vertically and horizontally), quickly evolve efficient organizational routines and build institutional memories, and utilize high-level skills and personnel. Moreover - and it cannot be stressed too much - all of these crucial development “triggers” overwhelmingly occur in public, private and cooperative productive enterprises, not in microenterprises. Lets be clear: if microfinance institutions continue to (very profitably) intermediate the bulk of a country’s domestic savings and any other funds into the exact opposite of the required growth-enhancing projects that we know underpin sustainable poverty reduction – that is, into the informal sector, and so into rickshaws, street food sellers, petty traders, subsistence farms and so on - then that country, region or locality will forever remain “locked in” to a state of grinding poverty, marginalisation and under-development. Unfortunately, this is an “iron law of microfinance.” n

Milford Bateman is a Visiting Professor of Economics at the University of Juraj Dobrila in Pula, Croatia and an economic development consultant.

1. Bateman, Milford. “Deindustrialisation and social disintegration in Bosnia,” in Thomas Dichter and Malcolm Harper (eds), What’s Wrong with Microfinance? London: Practical Action Publishers, 2007. 2. Drezgić, Saša, Zoran Pavlović and Dragoljub Stoyanov. “Using local labour market methodologies to assess the impact of ‘best practise’ microfinance programmes: the case of Bosnia and Herzegovina,” paper presented at the European Association for Comparative Economics Studies (EACES) seminar: “The Role of Microfinance in Promoting Sustainable Development in Southeast Europe.” Great Brioni Island, Croatia, July 5, 2007. 3. Demirgüç-Kunt, Asli, Leora Klapper and Georgios A. Panos. The Origins of Self-Employment. Development Research Group, Washington DC: World Bank, February 2007. 4. Bateman, Milford. “Borderlands and microfinance: impacts of ‘local neoliberalism’” in: Michael Pugh, Neil Cooper and Mandy Turner (eds). Whose Peace? Critical Perspectives on the Political Economy of Peacebuilding. London: Palgrave MacMillan, 2008. 5. UN Human Settlements Programme. The Challenge of Slums: Global report on human settlements. London: Earthscan, 2003. 6. See the contributions by Dave Richardson on the DFN website, June/July, 2007. 7. Chang, Ha-Joon. Bad Samaritans: Rich nations, poor policies and the threat to the developing world. London: Random House, 2007. 8. Chang, Ha-Joon. The East Asian Development Experience – The Miracle, the Crisis, and the Future. London: Zed Press, 2006. 9. Bateman, Milford. “Financial Co-operatives for Sustainable Local Economic and Social Development,” Small Enterprise Development. 18(1): 37–49, 2007.

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risk & reward

Risky Business:

Can Rating Agencies do More to Protect MFIs During the Crisis?

Amidst the ongoing global financial turmoil, the role of credit rating agencies has come under increased scrutiny. The specialized microfinance rating agencies are reacting on two fronts. While actively working to help MFIs identify and quantify the new challenges and risks arising from the global credit crunch, the agencies are concurrently taking action to avoid the pitfalls which beset the mainstream rating industry and to increase transparency in the sector. Massimo Vita, Director of Operations, and Ingrid Stokstad, Financial Analyst, MicroFinanza Rating, share their perspective on the recent criticism targeted at rating agencies for their role in the financial crisis.

t is hard to avoid the blame game, particularly when so many are connected to the downfall. Lax regulatory authorities, overly-zealous mortgage lenders, and profit-craving top executives have all taken their turn in the hot seat concerning the recent global financial turmoil. Within the span of responsibility, credit rating agencies (CRA) have not escaped unscathed. In late 2008, the European Union and the U.S. both moved to investigate CRA practices linked to the current financial crisis. The recent controversy about mainstream CRA has not precluded specialized microfinance rating agencies. As debate over the resilience of microfinance to the global financial crisis rages on, specialized rating agencies are reacting on two fronts. Rating agencies play a central role in gauging the new challenges facing MFIs, particularly those concerning liquidity risk and the changing growth dynamics spurred by funding. The agencies help MFIs identify and quantify the increased liquidity risk exposure they face as a result of the global financial crisis. In particular, the rating analysis focuses in-depth on several issues including the cost and availability of funding (especially to non-deposit taking MFIs), the diversification of funds, currency risk, liquidity reserves and the ability of the MFI to raise financial resources in extreme conditions. Through this exercise, the specialized rating agencies help to push MFIs to define a clear and prudential liquidity strategy. Such strategies should contain elements that define and implement an organizational structure to manage liquidity risk; measure and monitor cash flow requirements (short and long term); define and approve policies to manage liquidity and treasury (by determining alerts and limits to monitor and measure liquidity risk according to the specific features of the institution); avoid deposits or funding liabilities concentration;

microfinance insights

Rating agencies like Microfinanza work to maximize transparency during the rating process. Photo Credit: Matthew Bailey

and finally; develop a reasonable Liquidity Contingency Plan.

â&#x20AC;&#x153;Within the span of responsibility, credit rating agencies (CRA) have not escaped unscathed. In late 2008, the European Union and the U.S. both moved to investigate CRA practices linked to the current financial crisis.â&#x20AC;? The specialized rating agencies have also reacted to the recent criticism of CRA by taking steps to avoid the pitfalls which beset the mainstream rating industry and to increase transparency in the sector. The recent experience of the mainstream CRA has demonstrated that lax rating procedures or conflicts of interest can yield disastrous results on a wide scale. While it is useless to pin the blame for the current crisis on a single actor, it is essential for all stakeholders to take action to avoid future turmoil. Within the microfinance sector, rating agencies must work to minimize conflicts of interest while maximiz-

mar/apr 2009

ing the transparency of the process. Initial progress has been made through the establishment of a Code of Conduct, formulated through a multi-stakeholder effort and signed by the primary microfinance rating agencies. The main objective of the Code of Conduct is to avoid potential conflicts of interest between the rated MFI and the Rating Agency. For example, in order to ensure a completely independent opinion and rating, the Code dictates that Rating Agencies must not be related to an investor and must not provide technical assistance. Further developments such as a review of evaluation frameworks and better coordination to promote healthy competition will also ensure that agencies steer clear of the problems which beset conventional CRA. As microfinance becomes ever more integrated within the formal financial system, the rating agencies will be better positioned to adequately recognize and measure risk and support the sector for sustained and secure expansion and growth.

risk & reward Regional Exposure Levels By nature, the microfinance sector is, in part, shielded from negative impacts of the crisis due to its concentration of clients in the informal sector. Nevertheless, MFI risk exposure in the current financial turmoil is increasing due to the rising integration of microfinance into the formal financial system. Liquidity risks linked to both funding and refinancing, a declining trend in growth scenarios for 2009 and lower lending volumes coupled with higher costs of funding, promise to squeeze margins and profitability across the board. In our observations of rated institutions, MicroFinanza Rating has confirmed these trends, noting that the crisis seems to hit MFIs according to their region (location), funding structure and type of institution. Taking recent experiences from our local offices based in Africa (Kenya), Central Asia (Kyrgyzstan) and Central (Mexico and Nicaragua) and South America (Ecuador), the trends demonstrate that while the regions are variously affected, no sector remains immune to the negative impact of the recent downturn.

“As microfinance becomes ever more integrated within the formal financial system, the rating agencies will be better positioned to adequately recognize and measure risk and support the sector for sustained and secure expansion and growth.” In Latin America, the cooperatives and deposit-taking MFIs have been best positioned to confront the growing liquidity shortages due to their access to member funds. Deposit-taking MFIs, for example, are well-insulated from refinancing risk, even if some remain reliant on external liabilities for portfolio growth and are slightly exposed. On the contrary, non-deposit taking MFIs funded by external sources have experienced increasing financial expenses, delayed disbursements, and cancelled and/or non-renewed credit lines. Needless to say, these MFIs are increasingly worried about meeting refinancing needs when loans from international sources come due in 2009. In Nicaragua and Central America, in particular, many MFIs have a funding structure concentrated in loans

Microfinance rating industry at a glance: • Nearly 1,000 MFIs rated between 1997 and 2007 • Over 18% increase in the demand for ratings in 2007, with 536 assessments undertaken at nearly 450 microfinance institutions • The number of credit ratings grew from 127 in 2006 to 217 in 2007, while the number of social ratings almost doubled. During the same annual period, there was a 35% growth in international investments in MFIs. Source: The Microfinance Rating Outlook Report 2008, written by KPMG Luxembourg

from international sources due to their status as NGOs. These NGO-MFIs are thus in a weaker position if international flows, especially lending from MIVs, are curtailed. Moreover, funds borrowed in foreign currency could prove a challenge as the costs of repayment in hard currency swell due to recently weakened local currencies. In Central Asia, many MFIs are working to initiate refinancing agreements early in case the liquidity situation with investors tightens even further. Concurrently, in South East Asia, Cambodian MFIs face mounting concern over funding availability. While local financing is available, MFIs count on foreign borrowings to support strong portfolio growth. Since the onset of the crisis, funding access has tapered and growth objectives have necessarily been revised. Given the notable growth figures realized in recent years (over 60% in 2006 and 2007), the 20-50% projections for 2009 demonstrate a notable decline. Microfinance in Africa is one of the least developed sectors worldwide. Many institutions remain unregulated and are thus unable to intermediate client deposits. Within the current credit crunch, these institutions are especially affected due to the contraction of external funding liabilities, the main source for portfolio growth. In reaction to shrinking liquidity, some investors have become more stringent with lending requirements, thereby eliminating borderline institutions from eligibility. Our recent experience has shown that MFIs face rising costs of funds, prepayment requests from local funding entities, and even the breakdown of lending agreements as some international investors pull out of discussions in response to their own contracting

liquidity. Importance of Regulation Within the context of the financial turmoil, efficient and effective regulatory norms are necessary to shield MFIs from risk while concurrently enabling the desired growth. In some countries, this calls for reform of the existing regulatory framework. In other countries, although specific microfinance legislation is already in place, more regular monitoring and assessment would make it stronger. In countries where MFIs remain unregulated despite adequate law and policy, other governing bodies such as country associations or networks should work to strengthen MFI capacity to identify and mitigate the increased risk exposure.

“In countries where MFIs remain unregulated despite adequate law and policy, other governing bodies such as country associations or networks should work to strengthen MFI capacity to identify and mitigate the increased risk exposure.” On the other side, an overreaction on the part of regulators could also prove detrimental to the sector. Recent discussions have pointed out the inherent danger of abrupt measures taken by regulators who “might become excessively conservative… Well-intentioned governments may do things to alleviate the crisis effects that hurt financial access in the long run. These might include debt forgiveness programs, soft loan schemes and unsustainably low interest rate caps.” n

Massimo Vita is Director of Operations at MicroFinanza Rating, headquartered in Italy and Ingrid Stokstad is a Financial Analyst based in Nairobi. MicroFinanza Rating is a private and independent rating agency specializing in microfinance, which operates through regional offices worldwide (Ecuador, Kenya, Kyrgyzstan, Mexico and Nicaragua). To know more, please visit www.microfinanzarating.com

1. Hamilton, Sandra et. al. “Microfinance – Testing its Resilience to the Global Financial Crisis.” Fitch Ratings. January 2009. 2. Performance Trends: Cambodia Trends. MIX Market, November 2007.

www.microfinanceinsights.com

mar/apr 2009

microfinance insights

risk & reward

Exploring the Contours of Risk in Indian Microfinance

Given the context of high growth in the industry and the global economic slowdown, Aavishkaar Goodwell, CGAP, and Intellecap organized a day-long round table titled â&#x20AC;&#x153;Exploring the Contours of Risk in Indian Microfinance and Moving Towards Strategic Responsesâ&#x20AC;? on January 15th 2009 in Mumbai. The event was attended by 45 participants, including top management of high growth MFIs, lenders, private equity investors, and microfinance investment vehicles, donors and industry observers such as rating agencies and technical service providers.

ndian microfinance retains an enigmatic hue among students of global microfinance due to its incredible pace of growth, the potential of its market, the participation of commercial lenders and its ability to attract human talent that continues to push the integration of innovation and technology. As is common across sunrise business sectors that boast of such a combination of business potential and human talent, Indian microfinance has also seen an emerging interest from private equity and venture capital. The initial investments by Legatum, Sequoia and JM Financial in partnership with Aavishkaar Goodwell, Unitus and Lok Capital in large MFIs such as SHARE, SKS and Spandana created a sense of euphoria. These investments were followed by aggressive valuations and an increase in interest amongst investors. In the last two years, a total of US$200m in equity investments have flowed to the sector, bringing in a new set of expectations on governance, management, exits, and growth targets. These developments attest to a growing investor confidence in Indian microfinance and its ability to scale, grow and become a robust asset class. The crumbling of the financial markets in the latter half of 2008 and the slowing down of credit supply by Indian commercial banks to the microfinance sector are the first signs of emerging pressure on the bottom lines of microfinance institutions. These developments have compelled industry stakeholders to examine the potential risks that may have gone unnoticed in the early stages of growth. Given the nascence of commercial microfinance and divergent ways in which risks are perceived across industry actors, the organizers felt the need for a closed-door forum for fast growing MFIs and their key stakeholders to discuss risks in the current scenario. The round table was preceded by a survey designed by Intellecap, to elicit the perceptions of risk from across stakeholder groups. Figure 1 shows the top eight risks identified by the MFIs,

microfinance insights

Indian micorfinance has seen increased interest from PE investors that are willing to accept the risks.

lenders, and investors who participated in the survey. As evidenced by discussions at the event, risks do not operate in isolation, but are often inter-linked. For example, Figure 2 illustrates how various risks come together to amplify credit risk. Interestingly while all stakeholders unanimously identified liquidity as the top risk, each

mar/apr 2009

group had otherwise divergent views. MFIs listed external issues such as over-indebtedness of clients and the high cost of debt as their next most significant risks while investors and commercial lenders were more concerned with internal risks such as management and inadequacy of internal controls. The high level of apprehension over liquidity can be attributed to the global financial crisis. An ad-hoc survey conducted at the start of

risk & reward

Figure 1: Top Eight Risks by Stakeholder Group 14

Liquidity Risk

Number of Respondents

MFIs

Risks emerging as a result of high growth

Over indebtedness due to multiple borrowings

Investors

Inadequacies in internal control

Lenders

High cost of debt

6 Credit risk

Political risk Management and Governance

2 0

Top 8 Risks by Stakeholder Groups

the event showed a shift in this perception, with both investors and lenders rating management and governance as a greater risk than liquidity and the high cost of debt. This change in perception is probably due to the recent fraud at Satyam Computer Services Ltd, the IT-outsourcing company that has been called India’s “Enron,” and the easing of pressure on liquidity due to relaxation of monetary policy. Both MFIs and investors discussed how liquidity could impact the ability of MFIs to refinance their clients, leading to a potential rise in the current default rate. Both groups agreed that access to future loans is the incentive for clients to re-pay current loans. Although investors are attracted to the microfinance sector due to the high growth rates it has achieved, they were the only group to identify risks emerging as a result of high growth, as a cause for concern. The perceived risk stems from apprehensions around management capabilities and the robustness of existing systems and technology to manage high growth. However, MFIs believe that equity investors’ affinity for high growth institutions may encourage risky behavior on the part of MFIs, as they have no choice but to sustain high growth despite the Figure 3: Factors influencing high growth

Liquidity Crunch

wth Gro High

High Valuations

www.microfinanceinsights.com

current financial environment in order to attract capital. The liquidity crunch on the one hand and high valuations on the other exert opposing pressures on high growth. Higher valuations push growth targets upwards while the liquidity crunch makes realizing these targets improbable as shown in Figure 3.

5. Expand the definition of “weaker section” under the priority sector norms to include joint liability groups in addition to Self Help Groups Following the event, a group of thirteen NBFC MFIs met at the Intellecap office in Hyderabad to discuss the incorporation of the SRO and form a task force to take further action. n

“The number one collateral is not joint liability or social collateral, but the option to access new loans.”

Presentations made at this event can be viewed at: http://www.24framesdigital.com/ intellecap/150109

- Blaine Stephens, Mix Market

Both MFIs and investors highlighted the need for information sharing between MFIs in the country, emphasizing that both positive and negative information on client behavior should be exchanged to mitigate the risk of over-indebted clients due to lending by multiple MFIs. One of the major outcomes of the event was the commitment by the MFIs present to form a self regulatory organization (SRO) of Non Banking Financial Company (NBFC) MFIs through which they could lobby for regulatory reforms and promote cooperation and information sharing within the industry. The following points were discussed as the initial agenda items to be taken up by the SRO: 1. Create a separate category under the NBFC rules for MFIs 2. Open external commercial borrowings to NBFC MFIs 3. Allow NBFC MFIs to be micro insurance agents and business correspondents 4. Allow NBFC MFIs to mobilise deposits from their customers

Intellecap has also created a report on risk in Indian microfinance which can be accessed by sending a request to: riskroundtable2009@ intellecap.net

Intellecap is the publisher of Microfinance Insights. Intellecap is a social investment advisory firm that works with microfinance institutions and rural businesses in consulting and investment advisory roles. The company’s project experience spans 10 countries. This article was written by Devyani Parameshwar, Senior Associate, and Karan Sabharwal and Neha Aggarwal, Associates at Intellecap. For more information about Intellecap, its work and team members, please visit www.Intellecap.net.

mar/apr 2009

microfinance insights

risk & reward

Gauging and Hedging the Upside The Need for a Publicly Traded MFI Index

Microfinance is a rapidly growing, profitable, socially responsible industry that has outperformed emerging markets financial institutions, emerging markets, and US markets. We can learn much by examining microfinance institution (MFI) resilience during the financial crisis. The time has come for a publicly traded MFI index, writes Bhakti Mirchandani of Unitus Capital, to benchmark and hedge investments in this attractive sector, as well as to provide retail investors with exposure to microfinance through an index fund. Publicly Traded MFIs and the Current Financial Crisis The current financial crisis, which began in July 2007, has adversely affected publicly traded MFI stock price performance, but less than it has adversely affected US financial stocks. Specifically, the average underperformance of MFIs vs. their country indices was 6% vs. 39% for US financial stocks. Moreover, the underperformance of publicly traded MFIs is most pronounced in Mexico, due in part to Mexico’s dependence on US markets and businesses (exports to US represent 25% of Mexican GDP).

“Microfinance’s unique business model mitigates some factors that drivce poor results of Financial Sector SPDR component companies.” Microfinance’s unique business model mitigates some factors that drive poor results of Financial Sector SPDR (an exchange-traded fund of financial service stocks in the S&P 500 index) component companies: • Relatively high microloan rates buffer the financial crisis’ impact via relatively high revenues.

Mirchandani: "The time has come for a publicly traded MFI index." Photo Credit: Bruce Turner

• The low global microfinance penetration of 10% in aggregate loan value and 26% in number of clients allows publicly traded MFIs to focus on the most creditworthy clients and maintain growth. • High barriers to entry, including microfinance

operating experience and a broad distribution network, should preserve microfinance’s nearterm profitability. • Group guarantees on some microfinance products help mitigate the risk to loan collectability. • Strong loan portfolio growth partially offsets

Impact of Financial Crisis (July 2, 2007 - July 7, 2007) MFI

Country

Post July 2, 2007 Stock Proce Performance

Post July 7, 2007 Country Index Performance

Capitec Bank

South Africa (EZA)

-43%

-45%

Bank Rakyat Indonesia

Indonesia (IDDOW)

-33%

-55%

21%

Equity Bank

Differential

Kenya

-2%

N/A

Banco Compartamos

Mexico (EWW.IV)

-73%

-51%

-22%

Financiera Independencia1

Mexico (EWW.IV)

-72%

-47%

-25%

-45%

-50%

-6%

-67%

-28%

-39%

Average MFIs Financial Select Secor SPDR

US (S&P500. GSPC)

1. Financiera Independencia and its country index comparable are as of the first trading day one month post-IPO (Dec 3, 2007)

microfinance insights

mar/apr 2009

risk & reward mild non-performing loan (NPL) increases and loan collectability reduction. • The short durations of microloans reduces the risk of asset-liability mismatch in an environment of increased cost of funding financial institutions; between loan cycles, MFIs can adjust rates or deleverage. In fact, Banco Compartamos’s net margins rose to 65.8% in Q3’08 from 64.9% in Q2 ‘08 as it more than passed on higher interest expenses to clients through higher interest rates. • MFIs currently still appear to have secured credit lines. • MFIs can tap local development agencies or multilateral sources of funds at attractive prices. • Publicly traded MFIs could reduce high dividend payout ratios (from 50% for Compartamos and 35% for Financiera Independencia) to mitigate the impact of restricted access to financing. Despite these mitigating factors, a number of risks to publicly traded MFI earnings and stock price performance remain. First, ongoing financial turmoil has heightened regulatory risk. Increasing regulatory oversight in developed countries may spill over into emerging markets. Other regulatory risks, albeit low, include low interest rate cap imposition and forced directed lending. Second, growth from expansion beyond core microfinance clients poses risks. For example, corporate lending in Bank Rakyat Indonesia has grown from 13.3% of the loan portfolio at the end of 2006 to 17.4% at the end of 2007, and historically, NPLs have increased more for corporate loans than for microloans. Similarly, Banco Compartamos has been increasingly offering consumer credit microloans in urban areas, which it has found to have higher delinquencies and NPLs. Third, microfinance’s exposure to the agricultural sector through lending to farmers could pose a risk given projected increases in farm output for 2009 (4% for grains and 11% for wheat, ac-

cording to the International Grains Council) and the sharp recent decline in commodity prices. Fourth, although publicly traded MFI loan growth remained strong in terms of number of clients and loan size per client through the end of Q3 ’08, it is projected to slow in 2009. Fifth, although asset quality remains relatively high, it is projected to weaken slightly in 2009. Sixth, liquidity risk related to wholesale funding, higher funding costs, and retail deposit contraction is expected in 2009. Thus, although publicly traded MFI financial performance remained sound through the end of Q3 ’08, publicly traded MFI share prices— particularly in Mexico—were adversely affected by the economic downturn and the expectation of weaker financial performance in 2009. Why The Time Has Come for a Publicly Traded MFI Index There are five reasons why a publicly traded MFI index is necessary to catalyze the growth of the microfinance sector. First, many institutional investors (especially the most successful, such as Warren Buffet) focus on sectors that they understand. Having a benchmark, like an industry index, facilitates understanding. A publicly traded MFI index would help current and prospective investors in the 100+ microfinance funds with aggregate assets under management (AUM) of US$5.4bn gauge relative performance, thus increasing their likelihood of maintaining or making new microfinance investments. Second, a publicly traded MFI index would increase accountability and efficiency among microfinance funds as an index-based product could give investors—even retail investors—interest in microfinance exposure a low-cost, passive alternative to higher fee actively-managed microfinance funds. Third, having a registered MFI index would raise the profile and facilitate growth of the sector. Indeed, an index would help to increase awareness among mainstream financial service professionals about MFIs, par-

ticularly the most sophisticated ones. Fourth, such an index could help an investor hedge his/her long investments in MFIs or microfinance funds by shorting the index – known as a paired trade. Such paired trades allow investors to make specific bets on MFI managers or microfinance fund managers while mitigating sector exposure. How the Index has been Constructed The publicly traded MFI index is a weighted composite of the stock prices of five of the seven publicly traded MFIs worldwide. The index is equally weighted by stock dollar value so that each US$1.00 invested in the index is a US$0.20 investment in each of the five index components. This equal dollar weighting prevents the largest MFI(s) by market cap from dominating the index. The index is rebalanced on the last day of each calendar quarter, starting on December 31, 2003, the first calendar quarter-end after the second MFI joined the index. MFIs are added to the index one month post-IPO.

“The publicly traded MFI index is a weighted compostie of the stock prices of five of the seven publicly traded MFIs worldwide. The index is equallyl weighted by stock dollar value so that each US$1 invested in the index is a US$0.20 investment in each of the five index components.” Index Components The publicly traded MFI index includes the following five publicly traded MFIs: Capitec Bank (South Africa), Bank Rakyat Indonesia (Indonesia), Equity Bank (Kenya), Banco Compartamos (Mexico), and Financiera Independencia (Mexico). These five MFIs, tabulated below, all report to microfinance information platform MIX MARKET. The index is therefore more directly comparable to private MFI investments than an index that includes a broader range of

Index Components MFI

Ticker Symbol

Country

Capitec Bank

CPI.ZA

South Africa

02/18/2002

Bank Rakyat Indonesia

BBRI.JK

Indonesia

11/10/2003

Equity Bank Banco Compartamos Financiera Independencia www.microfinanceinsights.com

IPO Date

EBL.KE

Kenya

08/09/2006

COMPARTO.MX

Mexico

04/23/2007

FINDEP.MEX

Mexico

11/01/2007

mar/apr 2009

microfinance insights

risk & reward MF Index vs S&P500, MSCI EMG (EEM), & FI Composite Indices 140 120

MF Index

100

Comparable FI Index

S&P500 Normalized

MSCI EEM Normalized

40 20 0 03/02

09/02

03/03

09/03

03/04

financial institutions that do not self-identify as MFIs. Arman Financial Services Ltd. and S. E. Investments Ltd. (both India) are excluded because they transitioned to microfinance after their IPOs – the former in 2008 vs. 2002; the latter in 2005 vs. 1996. Additional Detail on MFI IPOs • Capitec Bank Holdings (South Africa) – US$27m IPO listed on Johannesburg Stock Exchange. Specifically, it is a retail bank with US$490 average loan/borrower. • Bank Rakyat Indonesia - US$489m IPO: 30% of shares listed on Jakarta Stock Exchange. 59.5% of shares bought by government and 40.5% by the public, of which 55.3% were foreign and 44.7% domestic investors. MSME (micro and small business loan segment) are 82% of total loans. • Equity Bank (Kenya) – US$28m IPO on Nairobi Stock Exchange. Primary shareholders are Britak Investment Company Lt, Africap, and two Equity Bank employees via an ESOP.

09/04

03/05

09/05

03/06

09/06

• Banco Compartamos (Mexico) - US$467m IPO in April 2007 (US$332m international; US$73m Mexican retail) on an initial price/book of 12.8 and in initial price/earnings of 24.2; the IPO was 13 times oversubscribed. ACCION/ IFC/other initial equity stakes of US$6m were worth US$450m at IPO. • Financiera Independencia SA (Mexico) US$265m IPO (including 15% overallotment option) at US$2.24/share on Mexican stock exchange. 65% US/Europe investors and 35% rest of the world. Index Performance The proposed publicly traded MFI index outperforms both S&P500 and MSCI Emerging Markets (EEM) indices. Specifically, US$1.00 invested in the MFI index at its inception on March 18, 2002 (one month after Capitec Bank’s IPO) would yield US$57.95 on January 2, 2009 vs. US$0.81 for a corresponding S&P500 investment. Also, US$1.00 invested in the MFI index on April 25, 2003 (first Friday after MSCI EEM

03/07

09/07

03/08

09/08

Index launch) would yield US$9.45 on January 2, 2009 vs. US$2.33 for an MSCI EEM Index investment. For a closer comparison to the publicly traded MFI index, we created a composite of the stock prices of the largest mainstream financial institution (FI) by market capitalization in each of South Africa, Indonesia, Kenya, and Mexico and the second largest FI in Mexico (corresponding to Capitec Bank, Bank Rakyat Indonesia, Equity Bank, Banco Compartamos, and Financiera Independencia). Specifically, these component FIs are Standard Bank Group Ltd (SBK.SJ), PT Bank Central Asia Tbk (BBCA.IJ), Barclays Bank of Kenya (BCBL.KN), Grupo Financiero Santander SA (SANMEXB.MX) and Grupo Financiero Inbursa SA (GFINBURO.MX). FIs only entered the comparable index once their corresponding MFIs entered the publicly traded MFI index—once their countries were relevant to the microfinance index’s performance. Like the MFI index, the comparable index is equally weighted by stock dollar value and rebalanced

MFI Stock Price Performance Post IPO vs Country Index Performance MFI

Capitec Bank1 Bank Rakyat Indonesia

Country

IPO Date

Post IPO Stock Price Delta1, 2

Post 1 Mo Post IPO Country Index Delta1, 2

Differential

South Africa

02/18/2002

463%

33%

430%

Indonesia

11/10/2003

254%

29%

226%

Kenya

08/09/2006

283%

N/A

Mexico

04/23/2007

-68%

-50%

-18%

Mexico

11/01/2007

-72%

-47%

-25%

172%

-9%

153%

Equity Bank Banco Compartamos Financiera Independencia

Average MFIs

1.Capitec Bank Stock Price as of 11/10/2003, the start date for iShares MSCI South Africa Index 2. Financiera Independencia & its country index as of Dec 3, ‘07 (first trading day 1-month post IPO)

microfinance insights

mar/apr 2009

risk & reward

Publicly Traded MFI Cumulative Trading Volumes $Ms (LTM from January 7, 2009) MFI Institution

Capitec Bank

Country

Trading Volume ($Ms)

Market Capital

Cum. LTM Trading Volume ($Ms)/Market Capital

Volume ($Ms)/Market Cap >30%

South Africa

457

0.1x

Indonesia

2498

1868

1.3x

Yes

Bank Rakyat Indonesia Equity Bank

Kenya

149

1.7x

Yes

Financiera Independencia

Mexico

153

2.3x

Yes

Banco Compartamos

Mexico

500

163

3.1x

Yes

quarterly. In contrast to the microfinance equity index yielding US$57.95 on January 2, 2008 for every US$1.00 invested on March 18, 2002, the comparable index would yield US$4.95. As shown below, the first three MFIs to IPO – Capitec Bank, Bank Rakyat Indonesia, and Equity Bank—have driven much of the index’s outperformance. The first two vastly outperformed their country indices.

“In contrast to the microfinance equity index yielding US$57.95 for every US$1 invested... the comparable index would yield US$4.95.” Index Tradability The MFI index is tradable for two reasons. First, all of the currencies of the index components have sufficiently liquid foreign exchange markets. Second, four of the five publicly traded MFI index components have sufficient relative cumulative last-twelve-month trading volumes (in dollar terms) for inclusion in the index, defined as at least 30% of market capitalization. In other words, the dollar volumes of trades of four of the five MFIs in the index over the past year were at least 30% of the dollar value of the common stock outstanding –the minimum trading velocity for creating an index, according to an industry rule of thumb. As shown in the table below, the four components with sufficient relative volume are Bank Rakyat Indonesia, Equity Bank, Banco Compartamos, and Financiera Independencia. Despite the index’s tradability, its pure commercial potential is limited until more MFI IPOs make a publicly traded MFI index fund a viable product. Indices with fewer than 10 components are too easy for institutional investors to replicate to justify their paying fees to invest in an index fund for pure commercial reasons. Five additional MFIs could IPO as soon www.microfinanceinsights.com

as late 2010—depending on how quickly broader economic conditions improve. However, given microfinance’s mission of poverty alleviation and high profile, socially responsible investors may be willing to invest in a publicly traded MFI index with only five components. Risk Factors Potential investors in publicly traded MFI equity should be aware of the following risks: relatively short track record of cross-border commercial MFI investments; small absolute institution size (small equity cushion); lack of diversification (typical focus on local low-income clients in one particular country/region), and credit and operational risk due to rapid microfinance sector and microfinance institution growth. Other considerations of investing in microfinance institutions include, but are not limited to: • Market risk - interest rate risk, foreign exchange risk, and risks to the local informal sector • Credit risk - loan portfolio quality/ diversification, loan loss provisioning, and credit assessment • Operational risk - people, processes, and procedures • Reputational risk - due to dual commercial and humanitarian aims • Key person risk - depth of talented staff, corporate governance • Liquidity, funding risk, capital adequacy as most MFIs are significantly leveraged • Microfinance institution risk assessment, monitoring, and control systems

• Operating environment - political/economic context, sovereign credit rating, regulatory framework

“The social good of extending access to vital financial services to more working poor should motivate socially responsible capitalists to invest in a publicly traded MFI index fund - even one with only five components.” Conclusion A publicly traded MFI index would add tremendous value today as a benchmark for and hedge against investments in the 10,000+ MFIs and 100+ microfinance funds and raise the sector’s profile, thereby catalyzing its growth. The social good of extending access to vital financial services to more working poor should motivate socially responsible capitalists to invest in a publicly traded MFI index fund – even one with only five components. Amidst market losses, foreclosures, and bankruptcies, we all have less money. It is therefore crucial that we use the money that we do have wisely to do well by doing good. n

Bhakti Mirchandani (bmirchandani@unituscapital.com), Unitus Capital Associate Vice President and formerly Lehman Brothers microfinance specialist, created the Publicly Traded MFI Index. Alexandra Connell (connell.alexandra@gmail.com), also formerly of Lehman Brothers, provided research support.

mar/apr 2009

microfinance insights

islamic finance

Islamic Finance and Microfinance: Lessons for the Global Financial Crisis

As the global financial crisis continues without any clear end in sight, some pundits are starting to question the very basics of the financial system – a free market economy, globalization, deregulation and so on. While the debate may do little to change the way the world spends its money, it certainly raises interest in other financial models, and systems that exist. Islamic finance has emerged relatively unscathed by the ongoing crisis. More specifically, Islamic microfinance, although a nascent subset of microfinance, could prove to be solid ground for MFIs operating in Muslim-majority regions. Zohaib Patel, of Dubai-based Fajr Capital Limited, elaborates.

he unraveling consequences of the global financial crisis has the potential to negatively impact and hamper the commitment to development goals across the world. With pressing needs for government funding to prop up weak banking institutions, in addition to stimuli packages to invigorate aggregate demand in local economies, aid and developmental projects stand to feel the repercussions of the diversion of capital and tightening of credit markets, including the microfinance industry. With over half the world living below subsistence levels, overcoming poverty is fast becoming recognized as a global humanitarian concern requiring a sustainable approach for long-term impact. Institutional development has a key role to play towards the goal of widening the stakeholder base of society and building the participants of the local economy through various channels; ensuring capital flow and distribution throughout society, bringing access to education and health care, stimulating entrepreneurship and developing the enterprise base for employment generation. In addressing poverty alleviation microfinance plays a key and complementary role in building a sustainable infrastructure to support low income households, providing a capital flow mechanism dictated by societal needs above return-maximising objectives. As Martin Luther King noted, “True compassion is more than flinging a coin to a beggar; it is not haphazard and superficial. It comes to see that an edifice which produces beggars needs restructuring.” Shared Values With a historic role as a society builder and enabler, Islamic finance shares a strong affinity with microfinance. “Awqaaf” institutions (charitable trusts) were philanthropically endowed as a principal-preserving, usufruct1 -deliver-

microfinance insights

In this global recession, the structure of Islamic finance holds lessons for microfinance.

ing, society-welfare asset. Initially consisting of donated durable assets (traditionally land and buildings), the trusts have evolved to also comprise endowment funds (adopted during the Turkish Ottoman period) and are used as a socio-economic tool for religious, education and public service provision. Their revenues enable the funding and maintenance of mosques, provision of scholarships, as well as the construction and management of schools, in addition to supporting general public services such as running orphanages, providing water and sanitation, and building hospitals. Understanding Islamic finance requires an understanding of the governing philosophical framework from which it is derived – a religion requiring the financial system to be guided by social responsibility and justice, while enabling a

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free market role. The industry presents an alternative banking paradigm which has yet to reach its full potential, given its young contemporary start in the 1970s. As a result, its historic and natural affinity with microfinance has been slow to develop sponsorship. The first modern Islamic financial institutions (IFI) were a network of village microsaving associations in Egypt and a microsaving association setup in Malaysia to manage pilgrim savings, both established in a 1950s post-colonial setting. In the holistic development and evolution of the industry, Islamic financial institutions are re-engaging with microfinance, as a tool to reach the current “unbanked” masses in Muslimmajority markets and provide banking products and credit market access that also conform to the customer’s religious requirements, primarily

islamic finance relating to the prohibition of interest. Inherent Benefits A key feature of Islamic finance is its intrinsic asset-backed nature and investment orientation in financing, which draws several benefits. Asset-backed transactions provide a direct linkage to the productive real economy, with financing extended on the basis of returngenerating assets. Additionally, where the IFI finances the purchase of real assets on behalf of its client, the IFI has full legal claim and collateral recourse in the event of a default in client repayments. Furthermore, the Islamic finance investment approach of risk/reward sharing aligns the incentives of both parties to the contract. For example, an equity partnership financing shares in the asset’s cash flow generation, allows the client to ensure a sustainable repayment schedule, while ensuring responsible lending on the part of IFIs as a result of rigorous project investment appraisal.

“A key feature of Islamic finance is its intrinsic asset-backed nature and investment orientation in financing, which draws several benefits.” By way of example, equity financing can be applied in home purchase and enterprise financing arrangements. A home purchase can be treated as a joint investment by a speciailized housing-finance MFI, with the terms outlining a “share” buy back scheme to enable the customer to increase their “shareholding” of the home and reduce pre-agreed rental payments to the MFI on the MFI’s shareholding stake. In contrast to a fixed loan, the equity financing enables easy repayment schedules linked to the customer’s cash flow and provides for an affordable access to an asset. Furthermore, the financing arrangement prevents a negative equity situation from forming, and allows the customer to use their “home shares” as collateral for other financing needs. A similar financing approach towards microenterprises entails providing risk-bearing capital to start up community businesses and projects with MFI fund managers in a micro joint venture equity partnership. Finance can be provided to directly purchase fixed assets which can be rented, or sold to the client at a mark-up with deferred payment. The MFI would add further value to the partnership by assisting clients with

business development supervision, networking, and professional and training assistance. Crisis Relevance The principles of Islamic finance hold greater relevance in light of the current global financial crisis in the context of sub-prime mortgage lending. One of the core principles of Islamic finance— the prevention of the sale of debt—would have ensured “line-of-sight” lending that reinforced responsible and prudent financing, maintained lending portfolio asset quality, and prevented the formation of an unsustainable debt bubble. Asset-backed financing would have provided a natural credit constraint and prevented the overleveraging that triggered the crisis. The global recessionary environment will disproportionately impact the poor, with strained direct aid channels, that contribute to both public welfare projects and MFI capital, diverted to local economic recovery packages. In such a context, Islamic microfinance provides flexibility in repayments that are key to maintaining sustainable lending that is fair to borrowers in difficult times. Way Forward The Islamic finance industry has been traditionally led by grassroots demand from retail customers. The development of a suite of Islamic financing alternatives has now enabled the industry to diversify its client base and the services it provides. As a result, microfinance is garnering greater attention within the young Islamic finance industry. The Islamic Development Bank—a triple-A credit rated multilateral organization—has ear-marked microfinance as a strategic imperative in the development framework for the Islamic finance industry to address. The demand for microfinance products requires a supply that Islamic finance has been slow to provide. A sizeable portion of the Muslim-majority countries sit in the bottom-of-the pyramid income category that are left out of conventional financial systems, and require financial

attendance. Access to credit is vital, hampering the progress of micro-entrepreneurs and the growth of income-generating and employmentcreating enterprises. The key to providing services to this group of people is collaboration. Islamic microfinance can learn from existing operating agencies, building on best practices and successful business models with proven operating efficiency, distribution channels, and risk management processes. Furthermore collaboration for technological efficiencies is vital to reduce cost levels that hamper economic viability. For example, building on innovations in mobile payment systems, and internet intermediation, as well as enabling a back-end technology and operations platforms built around the needs of MFIs that would enable the cost savings needed to further push the client reach of MFIs.

“The Islamic finance industry has been traditionally led by grassroots demand from retail customers. The development of a suite of Islamic financing alternatives has now enabled the industry to diversify its client base and the services it provides.” The financial crisis trigger of “sub-prime lending,” however, presents the most looming concern the industry should be wary of. The principles of Islamic finance inherently apply fairness to both parties in the transaction, and can safeguard the interest of the borrower. The industry as a whole needs to ensure lending practices do not follow the path that led to the recent crisis, as the repercussions of a MFI credit crisis would inevitably cause social suffering on a much deeper scale. In conclusion, Islamic microfinance may gather increasing relevance in the current recessionary crisis. The income-generating, asset financing, investment orientation, and cash flow linked repayments provide for an alternative lending model ensuring the sustainability of the borrower in these volatile times. n

Zohaib Patel is an Associate at Fajr Capital Limited, a newly-established Islamic investment company incorporated in the Dubai International Financial Centre. Previously he was an Analyst with HSBC Amanah based in London, and studied Economics at Trinity College, Cambridge.

The views expressed in this article are solely those of the author and do not represent Fajr Capital Limited.

1. The right to enjoy the advantages derivable from the use of an asset that belongs to another, as far as is compatible with the asset not being destroyed or injured.

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mar/apr 2009

microfinance insights

politics

A Very Political Economy: The Ill-advised

Political Interference in Pakistan’s Microfinance Sector In November 2008, Pakistan’s economy was in need of intervention from the IMF to the tune of US$7.6bn, due to huge budget deficits, high inflation (as high as 24% in November) and dwindling foreign exchange reserves. Increasing political and economic instability coupled with the ongoing international economic crisis could potentially be a threat to the country’s microfinance sector. Roshaneh Zafar of Kashf Foundation, one of the largest MFIs in the country, tells us why the government should pay more attention to the sector.

akistan’s economy has been severely impacted by the recent inflation in food prices and the meltdown in the global financial system. Where the impact has been severe overall, the effects have been particularly pronounced at the bottom-of-the-pyramid (BOP). In such challenging economic conditions, the microfinance sector offers hope as it takes financial services to the very doorstep of the BOP. All across South Asia, and the rest of the world, microfinance has traditionally enjoyed stellar recovery rates, in the range of 99%. Such outstanding rates are a testament to the trust-based relationship between clients and microfinace institutions (MFIs). Unlike conventional banks, MFIs lend to low-income clients without any form of collateral. The instrument employed to ensure high recovery rates is the notion of group or peer support, where 5-20 members get together to jointly support each other’s recovery. These networks, with time, become not only transaction points for collecting loans, but also sources of associative strength and learning. For example, Kashf Foundation’s impact assessments have shown that women’s self-confidence and self worth improves as a result of interaction with peer groups. In the past year, the Pakistani economy has faced multiple challenges including an outof-control fiscal deficit, a yawning gap in the balance of payments, a plummeting exchange rate and a very steep inflation in energy and food prices. The Sensitive Price Index (SPI), which measures the weekly cost of living for the BOP, has been increasing at an average rate of 31% over the last six months of 2008.1 The relentless increase in food prices, in particular, has quickly eroded the purchasing power of

low-income households as they tend to spend a larger proportion of their incomes on basic consumption needs. A recent research study carried out by the Kashf Foundation showed that, on average, low-income households are spending 66% of their household income on food. Microfinance institutions (MFIs) offer a rare ray of hope, but they cannot surmount every challenge.

“The biggest threat to the microfinance sector in Pakistan is misguided and myopic intervention by the elected representatives.” In order to truly appreciate the efficacy of microfinance for low-income households, one has to evaluate the sector, especially in the context of a country that lacks social safety nets. Continuous access to loans provides lowincome households with the ability to enhance and diversify their income sources. Research has shown that microfinance households are able to earn 55% more income than non-microfinance households on average, thus allowing such households to pay for better food, better healthcare and better education for themselves and their families. In fact, microfinance clients are seen to spend 20% more on education of their children than non-microfinance households. Demand-oriented savings products can provide low-income households with the opportunity of managing future cash flows, and thus reduce financial vulnerabilities. Currently, Pakistan faces tough challenges on the international and national stage. The biggest threat to the microfinance sector in Pakistan is misguided and myopic intervention by the elected representatives. Such interventions carry the potential to actually wipe out the gains of the

1. Source: www.statpak.gov

microfinance insights

mar/apr 2009

Pakistan’s trucks are not just art canvases, they also keep the economy moving. Photo Credit: Murtaza Imran Ali

decade-long growth in the sector. For example, in certain areas of the Punjab—Pakistan’s most populous province—elected representatives have made statements claiming a general amnesty from micro-loans. Such irresponsible statements have created an environment of poor credit discipline all across the sector. These national-level challenges call for immediate, direct and focused efforts from the economic managers in Pakistan. For microfinance to operate smoothly, it requires certain enabling conditions like political impartiality, rule of law and contract enforcement. In the long run, if the government does not step in and address these issues, we could see a wave of credit indiscipline that could negatively affect the quality and the outreach of the sector, along with the credit-worthiness of low-income borrowers. Moreover, if the microfinance sector is not able to avert this crisis then this will not only lead to a complete drying up of investment capital for the BOP, but will also expose Pakistan to a whole host of economic and social problems: rampant unemployment, hunger, morbidity, and full-scale social unrest. This will only exacerbate the tough economic challenges that Pakistan is presently facing. Credit discipline is, indeed, a public good. Therefore, there is a very strong need for a direct and focused government policy for the protection of the microfinance sector from such irresponsible, ill-advised and myopic political intervention. n

By Roshaneh Zafar, Managing Director of the Kashf Foundation, based in Lahore, Pakistan.

lenders

Something to Believe In: A Lender’s Perspective in India

At a time when liquidity is a major concern of many financial players in the sector, MFIs are even more dependent on steady cash flow via on-lending funds from banks. In this essay, the head of Citi Microfinance Group, India explains the current interplay between microfinance institutions and banks, and speaks about the effects of the credit crunch, inflation and the global recession.

here are moments in history when the world appears to be spinning on its axis more rapidly, almost ready to derail. Starting from around the middle of 2008, we have witnessed and experienced a financial maelstrom that, although conceived in the US, has now sucked in nearly every one of us around the world. As President Clinton commented—rather presciently and with remarkable candor—while addressing the World Bank & International Monetary Fund (IMF) in October of 1995, “These forces [of globalization] have made all our societies more vulnerable to disturbances that once seemed distant but which now directly affect jobs and livelihoods in every nation, from the richest to the poorest.” Thus, the actions of the banker on Wall Street with his head full of Black-Scholes option pricing models and other arcane risk management techniques can and are impacting the lives of, let us say, Rani Makkam, a 35-yearold woman running a petty shop in the outskirts of Chennai, India who has taken 11 micro loans from Working Women’s Forum (WWF), a microfinance institution (MFI). This paper discusses, from a lender’s perspective, the impact of the current financial turmoil on the Indian microfinance sector and, more particularly, the state of interplay between MFIs and banks. CGAP has described the credit crunch, inflation, currency dislocations and global recession as the “four dominoes of the crisis.” In the Indian context, the first two and the last are most relevant. What to Believe in? Bankers have often been accused of—with reason—being fair weather friends. From a banker’s standpoint, of course, as Walter Wriston, the legendary CEO of Citibank once remarked, banking is only about managing risks. Financial crises, typically, tend to have their genesis in money lent badly and used badly. Faced with a situation wherein, notwithstanding the most sophisticated of risk management tools/techniques, the leviathans of global finance have lost hundreds of bilwww.microfinanceinsights.com

In India, microfinance has become a relatively safe haven for equity investments during the downturn. Photo Credit: Joi Ito

lions of dollars, risk management has acquired a completely new meaning. It is a time when bankers are rethinking risk, trying to understand its full spectrum and the likely medium/long term consequences of decisions made.

“The root of the word credit is “credo,” Latin for “I believe.” As bankers now look at extending credit, the core issue is what to believe in?” The root of the word credit is “credo,” Latin for “I believe.” As bankers now look at extending credit, the core issue is what to believe in? The earlier confidence in the risk management tools in their armory has been replaced by an aversion to risk, probably short term, but which has created the so-called liquidity crunch. In fact, the various monetary measures taken by the Reserve Bank of India (RBI), since September 2008, have injected liquidity of ~US$86bn into the Indian banking system. As a result, the interbank call rates, after moving to a high of 19% – 20% in October 2008 have, more recently, stayed well within the official repo1 and reverse repo2 corridor. Another indicator of the comfortable liquidity

position is the value of surplus funds being parked by banks under the liquidity adjustment facility (LAF) reverse window of RBI3 — average of ~US$11bn, in the first week of February 2009. The relaxations made in the external commercial borrowing (ECB) guidelines by the RBI are also expected to enhance foreign exchange liquidity. The “regulatory powder” with the RBI remains dry and further interventions can be made to ensure that liquidity conditions remain benign. Hence, the flow of credit to the microfinance sector can be impacted not by funds availability with banks, but by overall credit concerns and heightened levels of caution. It, however, must also be stated that, in any event, banks in India have to meet their priority sector lending (PSL) quotas—directed lending as prescribed by the RBI—and cannot become too tight fisted. And, as the immediate term “reflexivity” passes, lending decisions, both in terms of risk taking and speed, can be expected to normalize. MF: A Safe Road for Equity? On equity inflows, too, the position appears comfortable. A recent E&Y newsletter (Oct – Dec ‘08) titled “Private Equity in Public” while analyzing private equity (PE) investments by in-

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microfinance insights

lenders PSU* Banks:

Prime Lending Rates (%) Feb-08

Aug-08

Dec-08

Punjab National Bank

12.5

11.5

Canara

12.8

12.5

State Bank of India

12.3

13.8

12.3

Bank of Baroda

12.8

12.5

Bank of India

12.8

12.5

Union

12.8

12.5 * Public sector banks

dustry in the last quarter of 2008 states, “Interestingly, out of a total of 10 deals announced in the Banking and Financial services sector, 5 deals belonged to the microfinance space. Microfinance has emerged as a relatively safe avenue for private equity investors amidst the global downturn.” In value terms, these five deals constitute 44.2% of the total deals done for the Banking & Financial services sector in Q4, 2008. There is also anecdotal evidence to suggest that overseas funds, both social and commercial, continue to actively look for opportunities in the Indian microfinance space and the ability of well run MFIs to attract overseas investors remains strong. Sailing, as all financial institutions are, in choppy waters, the focus of MFIs has to be on building strong balance sheets – capitalization at levels better than the regulatory norms, adequate structural liquidity, provisioning and loan loss reserves as per international standards and operational self sufficiency (OSS) of not under 115%. Coupled with this would be putting in place realistic short/medium term funding plans (ideally, backed by patient, committed investors) and efficient cash/treasury management. Lastly, all growth plans should be based on sanity, not vanity! Sensitive to the Touch: Lending Rates The next issue, highly sensitive from both a borrower’s perspective and politically, is that of pricing. Loans to MFIs have generally been on what could almost be described as soft terms. Tier I MFIs have typically received funding at rates below the prime-lending rate (PLR) of most banks. Even Tier 2 MFIs have usually been able to borrow at rates that would make similar organizations in other sectors salivate. Lending rates of MFIs to their end customers have tended to be relatively high, given the transaction costs inher-

ent in the lending model. But, from a hard, on the ground market perspective, the end customers are accessing credit from the MFIs at rates which are, by and large, not unreasonable.

“Managing business risks is a responsibility which sits squarely with the leadership of the MFIs. In an uncertain environment, this is particularly difficult.” The question is whether there has been an upward movement in the rates over the past six months or so. Market feedback suggests that there was some hardening of rates in the last quarter of 2008. But, with the series of monetary policy measures taken by the RBI and the substantial injection of liquidity, the benchmark PLRs of most banks have trended downwards. In the recent past, major public sector banks have reduced their PLR by 150 – 175 basis points (Bps); major private sector banks have reduced their PLRs by 50 – 100 Bps. The chart below demonstrates that the current PLR of major state owned banks is lower than what it was in February 2008. It is, of course, true that this drop in PLRs may not necessarily have translated into actual lending at lower rates. Higher credit spreads and the general re-pricing of risk by banks is a reality, which practically all borrowers are facing. MFIs, particularly the large, Tier 1 names, such as SKS and Spandana, are now much better capitalized. They have built multiple banking relationships and diversified their funding sources.

They have, to a fair extent, put in place systems, processes and controls to mitigate their operational risk. Their leadership is comprised of seasoned practitioners who have a deep knowledge of the sector. All this is good news. But, the growth in scale and geographical spread is throwing up a whole host of new challenges. The Microfinance “Banana Skins 2008” report by the Center for the Study of Financial Innovation, stated that the “greatest risk facing microfinance is the uneven quality of management at MFIs at a time of rapid change.” Closely linked to this were concerns about corporate governance and staffing. Refinance risk (risk number 28) and macro economic trends (risk number 23) were not seen as high risks. In a survey today, the above risks would, perhaps, move to the top of the list. Riding out the Storm Managing business risks is a responsibility which sits squarely with the leadership of the MFIs. In an uncertain environment, this is particularly difficult. But, as long as they stay with the core lending model; tighten lending norms, as may be required; expand in a paced manner; have properly trained personnel including a strong second line; have adequate controls and MIS; and, keep their banks informed, good news or bad, MFIs can ride out the storm. The banks, in turn, have the responsibility of keeping the credit flowing, and, in operational terms, not letting the MFIs get into a situation of cash flow stress. Finance has been described by Willem Buiter of the London School of Economics as “a scary, inherently unstable, essential activity.” Both banks and MFIs are engaged in this activity, in a synergistic manner, for a sector, which is vital to this country’s socio-economic well being. An open, partnership approach will best serve the interests of all the stakeholders. n

Alok Prasad is the Country Director, Citi Microfinance Group, Citi India. Alok joined Citi in 2001 and was instrumental in building the home equity business in India. Under his leadership, this business emerged as the most successful mortgage business for Citi in the Asia-Pacific region. He is also on the Board of Directors of CitiFinancial India and Citicorp Maruti Finance Limited India. The opinions expressed are the author’s own and do not represent the views of Citi India.

1. Rate at which banks borrow from RBI; in October, 8% 2. Rate at which RBI borrows from banks, in October, 6% 3. LAF is an important monetary policy instrument used by the RBI. It is employed for dealing with day to day liquidity mismatches in the banking system and smoothening volatility in short term money market rates through daily repo and reverse repo auctions.

microfinance insights

mar/apr 2009

remittances

Remittances Decline as Economies Shrink Remittances are an important part of the growth in developing countries around the world. In some Latin American and Caribbean countries (LAC), remittances contribute more than 25% of gross domestic product. But, during recession, remittance amounts decline, tightening economies back home. We spoke to Gregory Watson, Remittance Program Coordinator at the Inter-American Development Bank, to find out more about remittance flows to Latin America during the recession. Microfinance Insights: A recent IDB study showed that remittances actually contributed less to household incomes in 2008. What are the particular challenges currently facing the remittance market in Latin America? How is the recession impacting remittances flows? Mr. Watson: We project that remittances to LAC will have grown by 1.5% in 2008, reaching US$67.5bn. Despite a nominal increase, migrant workers and their families were under great pressure in the last year, as high inflation reduced the contribution remittances made to households in the first three quarters. Adjusted for inflation and exchange rate variations, the IDB estimates that remittances contributed 1.7% less to household incomes in LAC over that period. Remittances to some of the key countries in the region showed negative growth in 2008. Mexico and Brazil, the top two recipient countries, had shown consistent declines in remittance receipts since mid-2007, and this continued in 2008. In August of 2008, the drop in remittances spread to El Salvador and Guatemala, countries where remittance flows represent a significant proportion of GDP, at 18% and 12%, respectively. A number of factors have contributed to this reduction in the contribution of remittances: 1) Inflation: The significant rise in the price of food and fuel makes life more expensive for migrants sending money home. At the same time, these price rises also increase the needs of families dependent on remittances from abroad. 2) Economic downturns: The downturns in the US economy, and more recently in Spain, have made it more difficult for immigrants to find well-paying jobs. 3) Migration Climate: In remittance-sending countries, the migration climate is becoming more restrictive, affecting migrants’ ability to www.microfinanceinsights.com

Photo credit: Card by Macaroni and Glue

send money home. 4) Value of the dollar: Especially during the first three quarters of 2008, many non-dollarized economies in LAC saw their currencies appreciate against the dollar. As a result, the dollars sent home were not going as far as they used to. It is clear that remittance flows will change in concert with global economic reality. However any decline is likely to be modest, because migrant workers have proven their ability to adapt to changing demand for their labor. Focus groups held in 2008 illustrate that LAC immigrants are cutting back on their own consumption, using their savings, moving between job sectors, and even moving from one state to another in order to be able to continue sending money home. The fundamentals of the remittance equation have not changed. There are still some jobs in migrant destination countries that native workers will not fill, and there are still immigrants who will migrate in order to fill them. While there may be a period of dislocation as migrants move to different states, or choose to immigrate to different countries (especially intra-regionally), in the end we do not expect a large decrease in remittances in the medium and long terms. Insights: While remittances are not directly linked to microfinance, the expansion of financial services brings a whole new subset of clients into the industry. What measures are being taken in LAC to convert remittances receivers into microfinance borrowers? Mr. Watson: Actually, there is a very important link between remittances and microfinance. Beyond serving as excellent disbursement channels for remittance transfers, MFIs are key to leveraging remittances to bank the unbanked. Currently, the most pressing issue in LAC and

the rest of the world is to provide remittance recipients and their families with greater access to the formal financial system. A common assumption has been that because remittances are generally cash-to-cash transfers outside the financial system, most remittances are distributed through a retail store or money transmitter licensee, such as a bodega. According to the Multilateral Investment Fund’s (MIF) scorecard on the remittances industry, however, the majority of remittances to LAC (54%) are distributed through a bank, cooperative, credit union, microfinance institution, or other type of deposit institution. Unfortunately, only a very small percentage of remittances transferred through the financial system are currently going into bank accounts. Month after month, about 10 million families across the region pick up their remittances at a financial institution. Most of these institutions, however, serve merely as a licensed distribution agent for an international money transfer operator. In the great majority of cases, they remain uninterested in converting remittance clients into deposit account holders, for reasons such as a perceived lack of profitability of these clients, a shortage of products, legal and regulatory obstacles, poor commitment by management to serving the region’s majority, and cultural assumptions about the poor. Cooperatives, credit unions, popular banks, and MFIs have a better record than banks of attracting remittances into accounts—although there is still significant room for improvement. As a result, an opportunity to put millions of Latin American and Caribbean families on a pathway to credit and participation in the financial system continues to be missed. Yet when the legal, regulatory, and cultural obstacles are overcome, remittance recipients

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microfinance insights

remittances respond to the right products and have been found to be excellent clients. Where institutions (in many cases, MFIs) have made a concerted effort to turn remittance customers into deposit holders, at least 30% of recipients have opened new accounts. Banks such as Banco Agrícola in El Salvador have targeted the needs of remittance recipients with specific products and have enjoyed increased deposits and market share, and numerous other microfinance institutions and credit unions have also successfully served this market. A serious attempt to develop the remittance recipient market through a regionwide conversion program could yield more than three million new clients and an additional US$1bn annually in deposits.

“A serious attempt to develop the remittance recipient market through a region-wide conversion program could yield more than three million new clients and an additional US$1bn annually in deposits.” A recent IDB survey revealed that at least 15% of the more than US$67bn annually in remittances to LAC is used for activities other than consumption. The demand for remittance deposit products is clear; the challenge remains for financial institutions to make a commitment to the market. Attitudes toward “banking the poor,” from upper management to the teller line, must change in order to reach these clients and to develop appropriate products. At the same time, financial education about this market for governments, financial institutions, and remittance recipients is imperative. The actors on the supply side—banks, credit unions, community banks, microfinance institutions, and Money Transfer Operators (MTO)—need substantive education concerning the demand for financial products and outreach strategies. On the demand side, it is of critical importance to educate and raise the level of awareness, currently very low or nonexistent on the part of many remittance recipients, concerning the relationship between finance, employment, and economic activities. Financial institutions can also implement new technologies to reduce the cost of serving these clients, making those accounts more profitable. Firms need to determine as well whether their business models

microfinance insights

are technologically flexible and take advantage of new products such as banking through point of sale terminals, agents, post offices, and technology. For their part, governments need to remove the legal and regulatory obstacles to serving this population. Deep-seated cultural, historical, and regulatory challenges need to be overcome to foster financial inclusion and put these families on a pathway to credit. Towards this end, the MIF is working with a wide variety of institutions and organizations, both public and private, in developed and developing countries to help make the needed changes a reality through more than 35 projects leveraging remittances for microloans, housing and home improvement loans, microinsurance, and other products. The MIF also advances the remittance agenda through, participation in international working groups, direct dialogue with market players and governments, and by sharing its experiences with other institutions such as the World Bank, the Asian Development Bank, the European Bank for Reconstruction and Development, the African Development Bank, the G-8, and the UN. When migrants and their families are brought into the financial system, they will have much greater access to small business loans, housing mortgages, and other financial products. Individual banks will be able to capture a greater percentage of remittances flows and thereby increase their liquidity and national savings. Most importantly, tens of millions of families throughout LAC will become greater stakeholders in their own futures. Insights: What are the most recent technological and product innovations in play in the LAC remittances market? Mr. Watson: In recent years, we have seen the implementation of innovative practices on the disbursement side with financial institutions offering their own remittance products, and the promotion of new links to banking agent networks, card-based systems, and microfinance networks. We have also seen an increase in the interest of banks in leveraging remittances. On the product side, we have seen increasing numbers of financial products linked to remittances that were originally promoted by MIF

projects, such as microloans, housing, and insurance in the marketplace in different countries. Insights: In terms of the LAC market, which geographies are the most active centers for remittances? How does LAC compare to other developing regions? Mr. Watson: About 75% of remittances last year originated in the United States and the rest from Spain, other European Countries, and intra-regionally. This total represents more than the sum of foreign direct investment and official development aid to the region combined. Mexico is the largest regional recipient, receiving over US$24bn in the last year. In many other Latin America and Caribbean countries, remittances, while smaller numerically, represent a significant portion of GDP.

“A recent IDB survey revealed that at least 15% of the more than US$67bn annually in remittances to LAC is used for activities other than consumption.” In comparison with other regions in terms of cost, when the MIF started looking at the issue of remittances in 2000, money transfer operators (MTOs) were criticized for their high prices. At that time, MTOs retained 10% or more of each transaction in the Latin American and Caribbean region as a fee and typically charged at least an additional 5% through an ever-changing system of foreign exchange markups. Years of increasing awareness and competition among MTOs have now reduced the average cost to send US$200 in the region considerably, to 5.6% (US$11), and Latin America has moved from being one of the most expensive remittance markets in the world to being one of the cheapest. Although there is still room for more cost reductions (through, for example, increased transparency, so that customers can more easily compare services), new data clearly show that cost is no longer a major factor in the remittances industry, freeing up significant resources for investment and local development. n

Gregory Watson is the Remittance Program Coordinator, Multilateral Investment Fund at the Inter-American Development Bank.

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mfi experience

Time is on Our Side: An Indian MFI Offers Advice

Grameen Koota, a microfinance institution in Bangalore, India with nearly 150,000 active borrowers, was ranked 19th on the Forbes list of top 50 MFIs in 2007. We asked the organization’s Managing Director to share the tools and tactics Grameen Koota uses to cope with the financial crisis. “Barack Obama says one of his top priorities once he becomes President is closing down Guantanamo Bay. To make sure it closes, he’s going to turn it into a bank.” —Comedian Jay Leno on The Tonight Show

embers of the audience loved Mr. Leno’s joke so much that they didn’t stop applauding that night. Then they went home. And the next morning, there were kids to send to college, homes to buy – and nobody to give them money. Once banking giants began to go belly up, other banks started tightening the screws on their credit taps. Consequently the liquidity in the markets began to dry up. What this means for borrowers is simple – there’s less money, or credit, accessible as loans. With the sub-prime crisis in the US having contributed significantly to the poor image of borrowers, MFIs too are being viewed in the same light – as institutions lending to “nonprime” borrowers. Well-established institutions have roots deep enough in banking soil to be able to draw a steady flow of credit; however, the same cannot be said of smaller and relatively younger MFIs. Having limited access to credit is detrimental to the microfinance model that strongly depends on loan availability to keep clients motivated enough to repay existing debts. As it stands, clients move to progressively larger loans as their credit ratings develop. The clients repay regularly in order to build this credit rating and gain access to larger sums of money through loans. Take away the carrot, and suddenly the structure collapses into a heap of defaults. MFIs have several levers that can be used to maintain the semblance of normalcy, even during crisis mode. Time is one of the most important factors. Extra time equals extra breathing room for the MFI. There are several simple methods that buy an MFI more time —and time, in this case is, indeed, money. Group Formation and Testing Grameen Koota has developed a meticulous process of group creation and sustenance. Groups are compulsorily put through a weeklong training exercise during which time they are taught about microfinance services, eligibility requirements for various schemes and the www.microfinanceinsights.com

repayment method. A Group Recognition Test at the end of seven days determines a basic level of financial competence which then leads to the start of lending/borrowing activity. If the results of the test are unsatisfactory, we give the group is given an extra day of training. No loans can be disbursed until the group has passed this test and has been active for a pre-determined period of time. Even one extra day of training will result in a week’s delay in loan acquisition, because group meetings take place only once a week on a set day and time. This works in the favor of an MFI looking to spread out loan periods so as to hold on to as much working capital as possible. During times of crisis, this is particularly important. However, this tool must be used both tactfully and sparingly. Staggered Lending Additional cushion for an MFI can also be found by staggering loans, i.e., not giving loans to all members of a group at once. When lending is staggered, with a certain number of weeks between the disbursements of loans to each fraction of the group, it brings less financial strain for the MFI. Reasoning with clients also helps in extending these periods. However, once they have agreed to time alterations in loan disbursements, it is up to the MFI to hold up their end of the bargain. Further extensions and deviations from the timeline agreed upon could set off more serious protest. One might argue that halting the enrollment of new borrowers could be a viable solution, but for many MFIs, it is not a good option. Much before the liquidity crunch, employee job roles and incentives were drawn out. Financial incentives are offered to employees based on the number of

During times of low liquidity, some MFIs stagger their lending, making sure not to give loans to all group members at once. Photo credit: Joel Mahon

new clients they are able to draw into the system. Reworking task descriptions and incentive plans would take months. The quicker option would be to balance the pressure. This can be achieved by extending the period between loans for older borrowers (the trust developed with these clients allows an MFI the leeway to do this), so that new borrowers can be serviced. Mobilizing Unused Resources Using idle credit is effective is creating resources for borrowers. Branches with fewer clients have credit that lies unused. These sums can be redirected to branches servicing a larger number of borrowers. Scores of branches have large amounts of money that haven’t entered the lending market yet – mobilizing those resources increases an MFI’s capital flow. While these methods are effective in combating the credit crunch, they are only temporary solutions, not built to withstand long-term liquidity problems. In a longer period of liquidity crisis, MFIs will need to rework business plans, re-configure operational costs and even alter loan timelines. No one hopes for a long term crisis of this kind, but astute business leaders are always prepared with several back up plans and options. It is important to understand that above all, complete transparency with clients is always valued and reaps the greatest returns. n

Mr. Suresh Krishna is the MD, Grameen Financial Services Private Limited. Mr Krishna has worked with Grameen Koota since its inception 10 years ago. He has also observed the nuances of microcredit at various MFIs including SKS, SHARE, ASA and CFTS . Mr Krishna has been trained at Bankakademie, Germany on Microfinance Management and at Harvard Business School, on Strategic Leadership. mar/apr 2009

microfinance insights

mfi experience

Will the Cambodian Microfinance Sector Survive this Crisis?

At the Banking Cambodia conference, held a week before this magazine went to print, many participants pointed to the evaporation of foreign funding as the reason for decreased lending on behalf of microfinance institutions (MFIs). However, they predicted that with an increased focus on savings, the sector would be safe in the year ahead. Although the poor will be impacted indirectly—decreases in income and remittances—most Cambodian MFIs expect the demand for services, particularly savings products, to increase. However, the risk of loan default might increase at a rapid pace, requiring MFIs to manage risk and improve internal control systems. Mak Vichet, Economic Analyst at Amret Microfinance Institution, sheds light on the state of Cambodian microfinance.

he Cambodian microfinance sector has been blessed with high growth over the past few years, both in terms of loans outstanding and number of active borrowers. Eighteen regulated, licensed MFIs and one microfinance provider with a bank charter (ACLEDA Bank) operate in the country, servicing one million Cambodians, with total loans outstanding of US$436.56m as of December 2008, a 65% growth from the same period last year (Figure 1). Portfolio growth has been more rapid than growth in borrowers and therefore loan sizes have steadily increased in most institutions through new product offerings. Most MFIs have introduced loan sizes up to US$10,000. This trend has obviously changed in recent months because of the global financial meltdown. A considerable amount of the loans outstanding has been funded by foreign external debts and the remaining by equity, while the saving balances have remained modest. Consequently, MFIs that need funds to support operational growth mostly rely on foreign commercial borrowings, due to an inability to mobilize resources locally. Due to the crisis, funds have been curtailed, prohibiting development of the Cambodian microfinance sector and dampening

the growth forecasts of all MFIs. A slowdown means people who need money to create new businesses or extend their businesses will be hurt. Amret will cut about 10% out of its forecasted 70% growth rate in 2009. Other MFIs will not expand, while some have expressed pessimistic outlooks on projected operational growth rate. Acleda Bank has experienced a shortage of funds due to the difficulty of collecting savings, and clients withdrew their money due to the global economic crisis. Where have all the Lenders Gone? The liquidity shortage immediately impacts the availability of funding and the increasing cost of capital. Funds from external lenders are tighter, slower and more expensive. Some lenders have cancelled contracts without prior notification and some have agreed to extend the contract but with a higher interest rate. The cost of capital has increased from an average of 7.5% to 9% per annum. Most MFIs concede that they lack funding to support their growth this year. On Voice of America Khmer, the General Manager of Prasac Microfinance Sim Senacheert said that it would

Evolution of of Loan Figure 1: Evolution LoanPortfolio Portfolioand andActive ActiveBorrowers Borrowers 2000000 1800000 1600000 1400000 1200000 1000000 800000 600000 400000 200000 0

Evolution of Loan Portfolio (Amount in Million KHR)

2008

Evolution of Active Borrowers (Number of borrowers) 2007 2006

Source: Cambodian Microfinance Association (CMA) 2008

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be hard to find foreign lenders now. Prasac has already seen a US$10m loan canceled due to the financial crisis. The Trickle Down Effect The downturn of garment exports, tourism, construction, and agriculture, which are four main growth contributors to the Cambodian economy, has affected clients’ small businesses, making them unable to repay loans. Foreign direct investment has dried up, especially in the real estate sector. About 60% of the Cambodian population lives in rural areas and works in agriculture, construction and garment exports. Their income functions as a major source of remittance funds which are used to pay back small loans in rural areas. About 350,000 women work in the garment industry, and send remittances home to support their families in rural areas. An Economic Institute of Cambodia (EIC) research report showed that US$50m of the workers’ salaries in the garment industry supported rural economic activities in 2008. The official figures released by Ministry of Commerce have revealed that the growth in garment exports to the US and European Union have decreased by 2% in 2008 as compared to 2007. While many micro-enterprises will be unaffected by the economic downturn, others may suffer, as posited by the increase in PAR (portfolio at risk) ratio from its lowest rate in 2007 up to 0.33% of loan portfolio in 2008 (see Figure 2). Additionally, because of the liquidity crisis, MFIs have reduced their loan disbursements to clients. This has dulled client confidence in MFIs and their ability to provide finance, which has led to higher default rates because the incentive to pay off an outstanding loan in order to receive a future loan is gone.

mfi experience Switching to Public Savings In December 2007, the National Bank of Cambodia (NBC) issued a new Prakas (announcement) regulating savings mobilization from MFIs that comply with certain requirements. Compliant MFIs will be allowed to collect deposits directly from the public. Many MFIs have already applied and the first licenses are expected to be granted during 2009. Previously, most Cambodian MFIs were not deposit-taking institutions and were allowed to take savings only from their clients but not the public. However, in this environment, clientsâ&#x20AC;&#x2122; incomes have tightened, their purchasing power has gone down while cash needs have gone up, and savings have been difficult to mobilize. With funds drying-up, most MFIs have strategically chosen to mobilize savings from the public to compensate for the lack of funds from external borrowers. MFIs expect to compete with each other fiercely to collect deposits. Amret plans to launch savings products for its current clientele and new clients using its existing network early in 2009 after we receive a Microfinance Deposit-taking Institution (MDI) license from the NBC. Adjust, Adjust The rise in the price of food and agricultural products has resulted in rising inflation. The costs of agricultural inputs, especially fertilizers, diesel and seeds have also risen. Most clients have complained that with the small loan amount, they cannot afford to buy agricultural inputs for their production. Nevertheless, farmers are still trying to expand their agricultural production; with high demand from both the local and regional markets, they are able to sell their products to the market at higher prices. To fulfill the unmet and growing demand in the market, Amret has increased the loan ceiling Sources of for Cambodian Figure 2: funds Sources of funds MFIs for Cambodian MFIs Commercial Borrowing Total Equity Savings

30%

2% 68%

www.microfinanceinsights.com

Figure 3: Evolution of Loan Portfolio and PAR 30 Day Ratio

ACLEDA Bank) Evolution of Loan Portfolio(excluding and PAR 30 Day Ratio (excluding ACLEDA Bank) 1400000

Evolution of Loan Portfolio (Amount in Million KHR)

1200000

PAR Ratio: 0.35% for 2006, 0.18% for 2007 and 0.33% for 2008

1000000 800000 600000 400000 200000 0

2008

2007

2006

Source: CMA 2008; the National Bank of Cambodia 2006 - 2007

for Solidarity Credit (SC) up to KHR1,000,000 (US$250) and Individual Credit (IC) up to KHR 40,000,000 (US$10,000). Additionally, Amret plans to reinforce saving mobilization and expand into the western part of the country to exploit the opportunity created by rising prices of agricultural products and rising income levels. While we increase the loan amount disbursed to rural and SME clients, we will inevitably be confronted with credit defaults from our clients. To mitigate credit risk and keep the PAR low, we have implemented stricter credit polices, strengthened internal control systems, tightened risk management, introduced a reliable MIS system (to stay on track with operational growth), strengthened our staffsâ&#x20AC;&#x2122; capacity to manage loans disbursed, and focused on small loan sizes. We have also set up clear working procedures for our operating staff to select clients, and we have established working procedures for them to scrutinize and analyze cash flow, availability of information and business status. Additionally, we have formulated a policy for designing delegation rights to approve loans to clients ranging from Branch Manager to General Manager based on client profiles, loan sizes, and products. Future of Cambodian MFIs Despite the global economic crisis, Cambodian MFIs are solid and robust. Both loan portfolio and active borrowers are growing at a compelling rate, reaching over US$400m and one million Cambodians respectively. PAR is still under control even though it has increased. In the absence of this crisis, MFIs could grow their loans outstanding more than 100% on average. However, now Cambodian MFIs face

a shortage of external financing from foreign lenders. Thus, they are facing issues of liquidity and growth constraints. On the other hand, the cost of funds will certainly increase and they will most likely be directed towards the biggest and strongest MFIs. To deal with the shortage of funds, Cambodian MFIs will develop and launch more attractive savings products, develop stronger internal control systems, and strengthen credit evaluation risk management systems. Moreover, to mitigate operational risks, the staff involved with credit operations must be trained about the current crisis, encouraging them to respect lending practices, not to engage in aggressive lending tactics, and spend more time doing qualitative and quantitative analysis before making decisions. Above all, all MFIs within the Cambodian Microfinance Association (CMA) have signed an MOU about fair competition that pushes MFIs to facilitate information exchange to avoid client over-indebtedness to mitigate loan default and strengthen portfolio quality. The NBC has drafted a Code of Conduct for Credit Information Sharing Systems and issued a Prakas on the utilization and protection of credit information with the purpose of promoting sound credit activities of all entities participating in the financial system in Cambodia. n

Mak Vichet is an Economic Analyst at Amret Microfinance Institution, Cambodia. You can reach him at vichet@amret.com.kh

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microfinance insights

mfi experience

Prepared for Rain: Nigeria Says Not if, but When Godwin Ehigiamusoe, founder of the microfinance institution, Lift Above Poverty Organization (LAPO) in Nigeria, explains how the Nigerian microfinance sector has been affected thus far, and how the ability of Nigerian MFIs to mobilize savings and deposits are just one way they are holding off the circling storm. Crisis: Not if, but When The international financial system has largely driven the phenomenal growth experienced by the microfinance sector in the past decade. Investors and funders, both social and commercial, have committed huge funds to microfinance in the form of equity, debts, guarantees and other sophisticated financial instruments. In most countries, debt from international financial institutions (IFIs) have emerged as the dominant form of financial instrument for two reasons: the absence of a suitable policy and regulatory environment that supports significant equity participation or investment (in Africa, many countries are still grappling with the process of formulating regulatory and supervisory guidelines), and the lack of suitable credit facilities available for MFIs through local financial institutions.

“Until recently, loans due were usually rolled-over/renewed. Now foreign creditors decline roll-overs frequently. ” In Nigeria, local banks, until recently, lacked sufficient understanding of the dynamics of microfinance and were not enthusiastic about granting credit to MFIs. This development created a funding gap, which IFIs now fill. Not many practitioners are as optimistic as Professor Muhammad Yunus, who noted in October 2008, “The financial crisis has not hit the microfinance system.”1 With a high level of financial penetration of the microfinance sector in developing nations, the point is no longer whether microfinance is at risk of the negative impact of the deepening financial turmoil, but the timing and magnitude of the impact. Fewer Funds, Higher Cost The impact of the financial crisis on MFIs in Nigeria may not be apparent yet, but signs indicate that the sector is unlikely to come out of the current financial meltdown unscratched as it did during the Asian financial crisis. Effects of the financial crisis are direct and indirect. Foremost, the direct impact is on port-

microfinance insights

Funders are reviewing their commitments, and sometimes coming up short. Photo Credit: Michael Dunn

folio financing of retail MFIs. The crisis is bound to create a lack of funding for MFIs, whether commercial or non-profit, both of which have become more dependent on IFIs and investors to fund their ambitious growth plans. For example, consider LAPO’s five-year plan: from 2004 to 2008, we funded most of our work with debts and guarantees provided by foreign financiers. Now, funding commitments and credit lines are being reviewed. Until recently, loans due were usually rolled-over/renewed. Now foreign creditors decline roll-overs frequently. They assure that they will give new loans, however, it has not happened yet. Foreign funders who are willing to provide debt are requesting higher rates. The declining value of Nigeria’s national currency, the naira, has sagged international investment institutions’ confidence in the Nigerian economy. Loans in local currency are no longer available. Potential lenders are putting on-going negotiations for local currency-denominated loans on hold to give them time to observe trends in foreign exchange rate movement. Declining funding not only limits implementation of expansion plans; investment in product development and technology are also severely constrained. The challenge created by the paucity of re-

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financing funds has been complicated by the rising cost of funds. This development could affect the rate of financial returns and institutional sustainability. Investors and funders, in response to the financial crisis, are adjusting interest rates and other charges upward. Foreign currency loans are priced in the range of 8% and 12% per annum as against an average of 7% per annum a few months ago. Rates for local transactions have also moved up, from an average of 17% to range of 21% and 25% per annum. These have combined to raise the average cost of funds for LAPO by 25% in the last three months.

“It is important to note that government sources of funds for MFIs may be adversely affected if the current decline in prices of petroleum in the international market persists.” Another fall-out of the crisis is the reduction in the average loan period. Foreign creditors are now averse to long-term financing, usually appropriate for on-lending purposes. The average loan period has been reduced to one year. This creates an inherent liquidity management challenge.

mfi experience Attempts to raise public funds through the Stock Exchange are unlikely to be successful. Current poor performance of stocks has eroded investors’ confidence in initial public offers (IPOs).

“Oil revenue accounts for over 70% of total government earnings. The government and its agencies are major employers. With over 65% decline in oil revenue, the government’s capacity to meet its obligations to the people will be constrained.” Funding Options for MFIs It is instructive to note that there are a number of funding options open to Nigerian MFIs to deal with the thinning of foreign funds. First, savings mobilization is a vital component of traditional microfinance practices in West Africa. MFIs use savings to finance their portfolios. In addition, Nigeria’s extant microfinance policy and supervisory guidelines allow for deposit mobilization. The response strategy of MFIs consists of the development of innovative savings products and approaches. Most microfinance banks (as regulated MFIs are called in Nigeria) are implementing aggressive deposit mobilization campaigns. Some are developing linkages with numerous informal savings groups and schemes to reach rural savers. LAPO for instance has taken a number of steps to increase the savings balance as a proportion of a borrower’s portfolio from 57% to 80%. Specific strategies adopted include setting up a client relationship unit. Besides implementation of client protection initiatives, the unit initiates and implements incentive systems for deposit mobilization. Several incentives to incite deposit mobilization include public recognition of clients (listing and calling names of savers with very high savings balances at Branch Council meetings),2 size of loans and gifts. Additional voluntary savings products have been added to encourage clients to make regular deposits. An example is “Golden Savings,” a product designed to enable clients to build capital over a specified period. Another financing opportunity for Nigerian institutions is the creation of the Microfinance Development Fund, a N50b (~US$426m) fund

to be administered by the Central Bank of Nigeria (CBN). The Fund is to be established and replenished with contributions of commercial banks and state (regional) governments. Each of the 36 states is expected to contribute 1% of its annual budget to the Fund. Microfinance service providers are required to access fund In addition to this fund, some state governments have established micro-credit schemes as an integral part of their respective poverty alleviation programs. MFIs under these schemes act as implementation agents on behalf of poverty alleviation agencies. They finance their portfolios with funds provided by the government. In most cases, they access funds on commercial terms. It is important to note that government sources of funds for MFIs may be adversely affected if the current decline in prices of petroleum in the international market persists. Governments rely heavily on oil revenue for execution of their development programs. Indirect Effects: Clients and their Businesses Besides the direct effect of reduced funding, the current financial crisis also has indirect effects on MFIs by negatively affecting our clients and their businesses. In Nigeria, as in other developing countries, clients are dominant actors in the informal sector. Clients’ businesses have been negatively impacted for two reasons: the declining price of oil in the international market, and the increasing restriction of credit by commercial banks to businesses. Oil revenue accounts for over 70% of total government earnings. The government and its agencies are major employers. With over 65% decline in oil revenue, the government’s capacity to meet its obligations to the people will be constrained. Also, a reduction in government expenditure weakens peoples’ purchasing power which negatively impacts a client’s business volume. On the credit side, local commercial banks lend with trepidation and have adopted stricter credit guidelines in response to current review of credit lines by IFIs. The real sector, which usually requires long-term loans, is discriminated against in favor of short loans for commerce. IFIs which provided credit lines to local banks are recalling their funds. This development has made Nigerian banks review their credit

guidelines and practices. One of these practices is the tendency to provide short-term facilities to traders and artisans at the expense of manufacturing companies/ industries/agricultural firms that require longterm loans. Since these companies provide a large number of jobs, continued deprivation of needed credit could lead to lay-offs. This will affect the overall purchasing power of Nigerians. Reduced purchasing power will affect the small businesses run by clients. The worsening economic situation affects clients’ absorptive or debt capacity. Lower loan demand means reduced business volume and margins for MFIs. Long-lasting economic recession is a credible threat to loan asset quality of MFIs. Advances to clients and enterprises involved in vulnerable sectors, such as tourism or the export of agricultural produce are at greater risk. Increasing emphasis on deposit mobilization in microfinance is also in jeopardy. Capacity of clients and the general public to make substantial deposits is often limited in a recessed economy.

“Provision of business development services is imperative for clients to make reasonable returns on their investments and meet repayment obligations.” The nature of microfinance may provide some measure of protection against the devastating impact of the current financial meltdown. It is, however, obvious that no segment of the financial system is absolutely immune. Challenges thrown up by the crisis demand improved risk management strategies and innovations. More than ever before, clients will require support. Provision of business development services is imperative for clients to make reasonable returns on their investments and meet repayment obligations. n

Mr. Godwin Ehigiamusoe is the Founder of Lift Above Poverty Organization (LAPO) a microfinance institution in Nigeria.

1. “Microfinance unscathed by financial crisis: Yunus.” Agence France-Presse (AFP). October 2008. 2. A Branch Council is a body of all leaders of credit groups, supervised by a LAPO Branch Office. It meets quarterly.

www.microfinanceinsights.com

mar/apr 2009

microfinance insights

resources

Recommended Readings Microfinance - Testing its Resilience to the Global Financial Crisis Sandra Hamilton Fitch Ratings, 2009 Following up Fitch’s June 2008 report, “The Microfinance Sector: its Success Could be its Biggest Risk,” this latest report examines whether MFIs can survive the global financial crisis and the extent to which they will be affected. The June 2008 report highlighted the growing integration of the microfinance industry into the global financial system. This 2009 report states that as MFIs are increasingly integrated into the global financial markets, their performance sees more noticeable influences of the global financial crisis. The paper also highlights that the crisis will impact MFIs directly by causing liquidity problems and indirectly by slowing down economies. Impact of the Financial Turmoil on MFIs L. Wellen & M. Mulder Triple Jump Fund Management, 2008 Although the microfinance industry in general did not feel significant impacts of financial crises in the past, the current global financial meltdown has brought tough times for most microfinance institutions (MFIs). This is attributed, first to their greater integration within the larger financial markets, and second the overall slowdown of economy itself is suffering a hit due to rising inflation and declining flow of remittances. For the microfinance sector, this implies a possibility that the capital funds will dry up, there will be shorter-term credits, and the demand for microfinance may eventually diminish. The author s have given some suggestions: for MFIs to withstand the crisis, they will have to diversify the sources of their funds have a clear picture of their capital costs, develop a workable liquidity plan, diversify their portfolio, and increase operational efficiency. Impact of the Global Financial Crisis on Microfinance (FDC Briefing Note #6) S. Murphy Foundation for Development Cooperation, 2008 There has been a dearth of international funding as a result of the current global financial crisis. This means that MFIs have to rethink their existing strategy to achieve their revenue and expansion targets. Standard & Poor’s conducted a survey of MFIs, investments banks, microfinance investment funds, microfinance networks, microfinance industry associations and rating agencies to examine the needs of the sector. The paper highlights that industry experts see this phase as a positive development since slower growth will encourage MFIs to improve their operating discipline and enhance infrastructure to meet future expansion demands. It also recommends that MFIs should ensure portfolio diversification; improve risk

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management processes; work closely with international financial institutions, development agencies and investors; and diversify their sources of funding to perform well in the current financial environment. Can Microfinance Reduce Portfolio Volatility? Nicolas Krauss & Ingo Walter, 2008 In recent years, the access to funding by MFIs has been diversified, for example through client deposits, refinancing via interbank deposits and commercial loans, and raising funds in capital markets. This paper analyzes both the market risk associated with microfinance and the relative market risk by comparing MFIs to other potential emerging market investments. It concludes that MFIs seem to be significantly detached from global capital markets, both in absolute and relative terms. However, as the microfinance industry matures, market risk associated with MFIs will increase, although to a lower lesser extent for most other emerging market investments. The Promise and the Peril of Microfinance Institutions in Indonesia Jay K. Rosengard, et al. Bulletin of Indonesian Economic Studies, 2007 After the East Asian financial crisis in 1997, central banks throughout the region introduced regulatory reforms in order to reduce the risk of future bank failures. The paper notes that the results concentrated rather than mitigated banking risks, and decreased the access of low-income households and enterprises to formal financial services. The local, government-owned MFIs have been the worst hit as a result of these reforms. However, this paper sheds light on a few successful cases in the midst of continuous struggle, where government-owned MFIs functioned well and addressed a market failure through extension of their service coverage to areas not served by conventional financial institution. The evident gaps in the financial access of rural Indonesian households and micro-enterprises reveals the pressing need to understand if and how these successful stories can be replicated. The Impact of Capital Structure on the Performance of Microfinance Institutions Anthony Kyereboah-Coleman The Journal of Risk Finance, 2007 The paper reports that refinancing risk is a great concern for many large and smaller donor-driven MFIs. Lower growth may make debt financing more expensive for current borrowers and practically unavailable for the new ones, causing a heavy blow to MFIs. Some financial consolidation will happen as a result of small MFIs converging to cope with the crisis, however, it would be premature to conclude that bigger entities will survive the crisis unscathed.

resources

Mark your Calendar March BRUSSELS, Belgium

Mobile Payments and Commerce* 17th – 18th March 2009 The event is designed for top executives from both the mobile finance industry and commerce industry to formulate the mobile payments, banking and commercial strategy for the future. Topics include business strategies for the sector, cross-border remittance growth, advanced payment services for retail innovation, mobile marketing, and coupon transactions. Sponsor: Informa Telecoms and Media Website: www.mpaymentsconference.com

VIENNA, Austria

2nd Annual Microfinance Forum* 19th – 20th March, 2009 At a time when the financial markets are hitting a down-turn, banks have started to consider closer ties between their microfinance-oriented products and their normal business lines. This conference will bring together leaders from microfinance and the banking sector to discuss the global financial trends and microfinance, industry standards, mobile banking, and more. Sponsor: Uniglobal Research Website: https://www.uniglobalresearch.eu/en/event/2009-66

April KUALA LUMPUR, Malaysia

Mobile Payments & NFC World Summit 2009* 1st – 3rd April, 2009 This two-day event will bring explore the growing business of mobile and near field communication payment services. The conference will address issues such as regulation, business and partnership models, mpayment opportunities and challenges, and banking the unbanked. Sponsor: Neo-edge Website: http://www.neo-edge.com/events/event. php?fld=it&page=it_4&event=MP_and_NFC%20&venue=Kuala_ Lumpur_Malaysia&date=1-2_April_2009

NEW DELHI, India

Moving Beyond Financial Inclusion - Financing the Poor* 29th April, 2009 The theme of this one-day event is the need to shift the sector’s focus from mere inclusion to a more holistic framework that monitors and addresses “outcomes and impact” of products and services. The event will serve as a global platform to showcase endeavours and accomplishments towards understanding and enhancing the outcome and impact of microfinance. Sponsor: Microfinance Connect Website: www.microfinanceconnect.com

SANTIAGO, Chile

22nd WSBI World Congress – Financial Inclusion in a Globalised World: Our Challenge 30th April – 1st May, 2009 In today’s global economy, the challenge facing savings and socially committed retail banks is the development of sustainable innovative solutions in order to continue extending finance to their clients, while remaining efficient and profitable. The Congress will focus on the current economic situation, the successes in financial inclusion, asset-building, and innovation and technology support for efficient delivery of financial services. Sponsor: World Savings Bank Institute Website: http://www.wsbi2009cl.cl/english/acerca.php

May JOHANNESBURG, South Africa

Mobile Money Transfer (MMT) Africa* 5th - 6th May 2009 With accommodating regulatory environments for mobile money, and some of the highest remittances globally, Africa holds great potential for mobile money operators to lower costs, lower value, increase remittances and maximize the contribution to developing countries. This two-day event will bring to light experiences of the MMT ecosystem through interaction with sector stakeholders based around presentations, roundtables, Q&A sessions, and workshops. Sponsor: Clarion Events Website: http://www.mobile-money-transfer.com/africa/

NEW YORK, USA

The Global Microfinance Investment Congress 2009* 19th May – 20th May, 2009 In an era of increased economic uncertainty, microfinance remains a powerful and growing sector. But as the market matures, it raises new questions about future investment strategies and sources of finance. This event will bring together key players from the investment and banking community with microfinance networks and funds. Sponsor: American Conference Institute and PlaNet Finance Website: http://www.microfinancecongress.com

MUNICH, Germany

Off-Grid Power Conference – Focus 2009: Micro-Finance 28th May, 2009 This annual international conference will focus on power supply in developing countries and will bring together private companies, international organizations with a focus on development and infrastructure, NGOs, and entrepreneurs focused on rural electrification. The focus this year will also be on MFIs operating in the renewable energy space, and on exploring synergies between the industry and off-grid power supply. Sponsor: PSE AG Website: http://www.off-grid-conference.org/cms/front_content. php

* Indicates a Microfinance Insights recommended event www.microfinanceinsights.com

mar/apr 2009

microfinance insights

trends

Microfinance Market Indicators Statistics and indicators related to the effects of the global recession around the world, selected and compiled by the editorial team. Rising Costs and Risks

Food Price Shocks

Higher Inflation Faced by Developing Countries

Higher Inflation Faced by Developing Countries1

6 4 2

Jan-08

Nov-07

Jul-07

Sep-07

May-07

Jan-07

Mar-07

Nov-06

Jul-06

Sep-06

May-06

Jan-06

Mar-06

Nov-05

Jul-05

Sep-05

May-05

Jan-05

0 Mar-05

Headlineinflation inflation Headline

FoodFood priceprice hikes hikes (%) (%)

Developing countries OECD Countries

27 25 23 21 19 17 15 13 11 9 7 5 3 1 -1

Commodityprice priceindices indices(2000=100) (2000=100) Commodity

350.0

Energy

325.0

Grains

300.0

Food

275.0

Agriculture

% depreciation between Sept.15-Oct.30 % depreciation between Sept.15-Oct.30 2008

Urban Population

LAC

SSA

EAP

MENA

Slowing Growth in Remittances Among Developing Countries2

Declining Investment Growth in Low Income Countries1

2008

250.0 225.0 200.0 175.0 150.0 100.0 2007

2009

The Break-Down: Remittance flows to South Asia will slow sharply from over 16% growth in 2008 to zero growth in 2009, while flows to the Middle East and North Africa are expected to decline by nearly 7%.

125.0 2006

2008

Currency Depreciation Against the Dollar

11.7

11.6

6.3 3.8

High MENA income countries

12.3

By the Numbers 130-155m people Is the estimated increase of global poverty due to higher food prices1

7.0

4.5% Expected decline in GDP growth in developing countries for 20091

4.7

EAP

LAC

SSA

ECA

microfinance insights

mar/apr 2009

2009

Low-income countries have less access to international capital markets. The slowdown will affect them mainly through indirect mechanisms, including slower global growth, lower commodity prices, slackening remittance receipts, and partial scale back in aid flows.

Currency Depreciation Against the Dollar1

MFIs that borrow in foreign currency will face not only rising interest rates, but also costs of having to pay in hard currency with recently weakened local currencies. Declines in MFIsâ&#x20AC;&#x2122; net income from foreign exchange losses were cited in the 7%-43% range in the past few years.

Rural Population

ECA

Headline inflation is a measurement of price inflation that takes into account all types of inflation that an economy can experience. It is more useful for the typical household because it reflects changes in the cost of living.

RisingCommodity Commodity Price forfor LowLow andand Middle Rising PriceIndices Indices Middle Income IncomeCountries Countries1

Food Price Shocks1

1/3 Of developing countries are running current account deficits in excess of 10% of GDP1 Mexico, India and China Are the largest recipients of remittances2

trends Macroeconomic Indicators Declining Real GDP Growth1

Real GDP, percentage change

Capital In/Out Flows

e- estimate, f- forecast

Rising Unemployment Rates Rising Unemployment Rates

Rising Unemployment Rates3 MENA MENA ECA ECA SSA SSA LAC LAC High income High income countries countries SA SA EAP EAP

Rate (%) Rate Rate (%)(%)

9.75 9.75 9.25 9.25 8.75 8.75 8.25 8.25 7.75 7.75 7.25 7.25 6.75 6.75 6.25 6.25 5.75 5.75 5.25 5.25 4.75 4.75 4.25 4.25

2007 2007

2008 2008

2009f 2009f

EAP (East Asia and Pacific) ECA (Eastern Europe and Central Asia) LAC (Latin America and Caribbean) MENA (Middle East and North Africa) SA (South Asia) East Asian* Economic Recovery SSA (Sub Saharan Africa)from the 1997/98

US$600m5 To be launched in a “Microfinance Enhancement Facility” by IFC and KfW to support MFIs during the economic crisis US$42bn5 In donor contributions will come through International Development Association (IDA) over the next 3 years to support the world’s poorest countries US$35bn6 For lending to developing country partners from the World Bank Group’s International Bank for Reconstruction and Development (IBRD). This is an increase from last year’s US$13.5bn India’s investment deals (November 2008)6: • US$75m (INR336Cr) in SKS • US$19.6m (INR94Cr) in Ujjivan Financial Services • US$20m (INR100Cr) in Spandana US$1.2m5 Equity share in ParaLife, a Swiss microinsurance holding company, by ACCION International US$3m5 Investment into Leapfrog Investments, a Mauritius-based microinsurance fund, by ACCION International 20% 5 Growth decrease in The Bill & Melinda Gates Foundation expansion plan 24%5 Cut in total spending by Paul G. Allen Family Foundation, the charitable arm of the Microsoft co-founder US$30bn7 Worth of IPOs have been cancelled in emerging markets this year Private debt flows to the banking sector declined dramatically (comparing January through September 2008 with the same period in 2007)1: • US$13.2bn in Kazakhstan • US$6.6bn in Russia • US$3.7bn in South Africa • US$3.1bn in Turkey US$72bn1 Decrease in bond issuance by developing countries over 2008, down from a high of just over US$170bn at mid-2007 Stock Price Comparisons Between Compartamos, Equity Bank and BRI (2006-08) 2006 (end of period)

Banking Crisis

East Asian* Economic Recovery from the 1997/98 Banking Crisis4

year on year (%)

7.69

GDP growth

Inflation rate

2008 (end of period)

US$3.19

US$1.83

Equity Bank9

US$1.71

US$1.9

US$2.23

Bank Rakyat Indonesia (Persero) Tbk PT8

US$0.44

US$0.58

US$0.38

5.97

6.98 4.84

3.18

1990-1996

Compartamos Banco8

2007 (end of period)

1997-2001

2.97

2001-2006

* Includes Hong Kong, China; Indonesia Korea; Malaysia; PRC; Singapore; and Thailand.

www.microfinanceinsights.com

Sources 1. Adapted from: The World Bank. “Global Economic Prospectus: Commodities at the Crossroads 2009,” 2009. 2. Adapted from: The World Bank. http://web.worldbank.org/WBSITE/EXTERNAL/NEWS 3. Adapted from: ILO. “Global Employment Trends 2009,” January 2009. 4. Adapted from: Adams, Charles. “Emerging East Asian Banking Systems Ten Years after the 1997/98 Crisis.” ADB, May 2008. 5. Adapted from: MicroCapital & Symbiotics 6. Press releases from: www.sksindia.com, www.ujjivan.com, www.spandanaindia.com 7. The World Bank. “The Unfolding Crisis: Implications for Financial Systems and Their Oversight,” October 2008. 8. Reuters Stocks. http://www.reuters.com/finance/stocks 9. BusinessWeek Companies. http://investing.businessweek.com/businessweek/research/ stocks/snapshot/snapshot.asp

mar/apr 2009

microfinance insights

survey

Microfinance and the Global Recession How closely correlated is microfinance to traditional asset classes? In this issue’s survey we asked MFIs and investors to share their perspectives on the effects of the global recession on their operations – from strategic changes to risk assessment. We also tried to gauge some of their expectations and analyze the most effective ways to keep their heads above water. The survey drew on responses from 120 microfinance institutions and 41 investors from all over the world. We put together some of the most compelling highlights from our survey on these pages. The complete Microfinance and Global Recession Survey Report will be sent to subscribers and will be available online at www.microfinanceinsights.com.

Survey Sample Overview

Types of MFIs in the Survey Sample

Types of Investors in the Survey Sample

Types of MFIs

Types of Investors NGO-MFI

5% 10%

Microfinance Investment Vehicle

11%

Bank 13%

Other

16% 52%

NBFC

39%

Cooperative/Credit Union

17%

Multi-lateral or Bilateral Institution Mainstream Investor with Social Portfolio

13%

Consultancy 24%

Investor Risk-Return Profiles

Aggressive 10%

Conservative 26%

Moderate 64%

Foundation

MFI Perspective Operational Changes in MFIs Over the Last 12 Months

Effect of the Recession on MFIs

45 35 30

Deposit taking MFIs

Non-deposit taking MFIs

25 20 15 10 5 0 Less availability More requests Higher defaults of funding from customers for loans

Lower repayment rates

Change in MFI Funding Mix Over the Last 12 Months

MFI respondents %%ofof MFI respondents

% of% MFI respondents of MFI respondents

Operational Changes in MFIs Over the Last 12 Months

Deposit taking MFIs Non-deposit taking MFIs

15 10 5 0

Increase Decrease Decrease Reduce Increase Increase Decrease Stop interest loan size lending staff size lending loan size interest lending rates rate

Facts & Figures • 76% of MFIs responded that deposits have increased as more clients are putting money in for the future. • 61% of MFIs have noticed a decrease in the amount and frequency of remittance inflows.

Type of funding

Most MFI respondents (%)

Change

Debt

20%

Increase

• 63% of MFIs have had difficulty in raising funding during the economic crisis.

Retained Earnings

17%

Increase

• 30% of MFIs state their investors are changing demands as a result of the economic crisis and MFIs are trying to improve portfolio management and communication as a result.

Equity

15%

Increase

• 85% of MFIs have not needed to change their business model or target customer in any way as a result of the global recession.

Soft/Below Market Loans

22%

No change

Grants

21%

No change

Quasi Equity

18%

Decrease

microfinance insights

mar/apr 2009

• 41% of MFIs have found that their bad debt expense has increased as a result of the crisis.

• MFIs are devoting resources towards risk management and deposit mobilization. The 3 strategies rated the most helpful to protect MFIs and borrowers from the effects of the global recession in the future are: • Improved management and internal governance • Improved portfolio quality and delinquency management • Diversification of funding sources

survey

Global Recession’s Effect on Client Issues MFIs Issues MFIsHave HaveFaced Faced While While Raising FundsStrategic Changes MFIs Have Strategic ChangesofMFIs Made as a Result of the R Global Recession's Effect on Client Repayment Rates Repayment Rates Raising Funds Made as a Result the Have Recession 37%

41%

33%

41% 32% 27%

34% % of MFI respondents

% of MFI respondents

49% Deposit taking MFIs Non-deposit taking MFIs 22% 17% 10% 13%

12%

Foreign exchange risk

High return expectations

none

1-5%

5-15%

>15%

Higher Stricter loan interest rates terms

% of clients missing payments % of clients missing payments

21%

Modified Reduced growth plan operating downwards costs

Reduced Introduced individual fee-based lending products

Banks and investors have more stringent policies and credit appraisals.

Investor Perspective Investor Risk Assesment of MFI Investments

Changes in Investor Strategy Changes in Investor Towards MFIs Strategy Towards MFIs

33%

40%

31%

% of investor respondents

Not linked 69%

Not sure

25%

17%

20%

10%

15% 10% 5%

0% There is a variation from country to country, with Tighter Greater due Increase CoA shift to some countries being more closely tied to themonitoring ater duemonitoring diligence of MFI investments of Increase potential Ainvestments shift Co-investing rate to moremore established, largerEAP MFIs ECA diligence of inMFI ininterest interest investesglobal system when compared to others. of MFI in- potential rate ing tablished, vestments MFI investments

What do Investors Think? • 45% of investors have seen bad debt expense increase among the MFIs they work with

• Investors have noted that for those MFIs that lack the ability to raise capital, there has been a downward revision of growth forecasts and tighter monitoring to maintain portfolio quality. This will lead to greater competition and “survival of the fittest.”

www.microfinanceinsights.com

OECD

EAP :

East Asia and Pacific

ECA :

Eastern Europe and Central Asia

LAC :

SSA

larger MFIs

Investors Changing the Geographic Allocation of their MFI Investment

% of MFI respondents % of investors

• 36% of investors stated that investment return time lines are getting longer due to the recession

LAC MENA

Investors want more information for effective investment decisions.

• 54% of investors have had difficulty raising funds during the economic crisis • 81% of investors have not reduced portfolio allocation towards MFI investments as a result of the recession

Least Risky

30%

% of investors

Tightly linked

23%

Most Risky

35%

Loosely linked

Investor Risk Assessment of MFI Investments

% of investors % of investors

Investor Poll: How closely linked are MFIs to the

Investor Poll: How Closely are MFIs global market? Linked to the Global Market?

Investors Changing the Geographic Allocation of their MFI Investment Increase

Decrease

No change

20 15

SA : SSA :

Latin American and Caribbean South Asia Sub-Saharan Africa

OECD :

OECD Countries

MENA :

Middle East and North Africa

10 5 0 EAP

ECA

LAC

MENA

SSA

mar/apr 2009

OECD l

microfinance insights

books

Understanding the Dynamics of Microfinance Microfinance: Emerging Trends and Challenges, the product of a 2007 conference organized by the Columbia Business School, is a clear account of the diversification of the microfinance space in the last three decades, the emergence of commercial microfinance, and the promises it holds for the future. The book brings together perspectives from five different authors and is edited by Suresh Sundaresan, Chase Manhattan Bank Professor of Economics and Finance, Columbia University.

he microfinance sector has remained an important source for providing finance to under-served, marginalized sections of society. A new paradigm of “commercial microfinance” is slowly developing, with commercial banks entering the space and MFIs transforming themselves into for-profit entities from non-profit ones, and raising money from equity and debt capital markets. Therefore, commercial microfinance has emerged to serve the dual objective of serving the poor and providing handsome returns for investors. The book “Microfinance: Emerging Trends and Challenges” captures this transformation and addresses relevant policy questions by drawing on the work of select microfinance practitioners in a series of papers. The authors address issues such as the integration of capital markets with microfinance, technological innovations such as the use of mobile phone technology, the impact of targeting women for microloans or “gender empowerment,” and regulatory challenges and emerging opportunities. While recognizing the continuing role played by NGOs and government-mandated programs (such as rural banks) that have dominated microfinance for so long, one can clearly observe the increasing inter-linkages being developed between the microfinance sector and the capital markets, particularly as large MFIs secure a greater proportion of international capital funding. The authors trace this development back to the partnership between Blue Orchard and Developing World Markets (DWM) in 2004, to create the first ever collateralized debt obligation (CDO).1 Brad Swanson, Partner, DWM, and the author of the chapter “The role of International Capital Markets in Microfinance” explores these developments and highlights the accompanying challenges. Ray Rahman and Saif Shah Mohammed,

Co-founders, MR Analytics, explain in significant detail the securitization techniques used to create debt and equity financing for MFIs in the chapter “Securitization and Microcredit-backed Securities” using the example of the BRAC securitization2 deal to highlight innovative ways of tapping into the capital markets. The chapter addresses the rationale behind this transaction deal, with BRAC as the servicer, and Eastern Bank Limited (EBL) as the trustee. It highlights the key political considerations and the role of the Bangladesh Bank and the Securities and Exchange Commission (SEC) in the acceptance of the securitization concept. The chapter also provides a thorough analysis of the securitization process, mentioning the key data and logistical constraints, and also draws on learnings from the performance of the securitization process so far—particularly relevant now that many firms are swearing off of CDOs because of their role in the sub-prime crisis.

“This friction [caused by excluding men from microfinance groups] could actually lead to a ‘disempowering’ effect on women, causing a lower quality and quantity of health and education in a family.” In the chapter “Cellphones for Delivering Microloans” Anand Shrivastav, founder of SUVIDHA Starnet3 reveals how mobile phone technology has been used to deliver loans as low as US$20 in India. He also details some of the leading mobile-commerce (m-commerce) players in India like JiGrahak, FINO, A Little World and Mchek and touches upon SUVIDHA’s micropayment product, Beam. While Shrivastav is quick to respond to some of the cynical remarks often raised about technology platforms, he also takes a critical look into how the industry

1. Collateralized debt obligations (CDOs) are a type of asset-backed security (ABS) and structured credit product. With the advent of the 2007-2008 credit crunch, it became clear that CDOs, like all ABSes, suffer from a fundamental flaw that causes all tranches to be high risk for investors.. 2. BRAC Microcredit Securitization Series 1 is the world’s first securitization of microcredit receivables and the first microcredit backed security (MCBS) investment. 3. Suvidha is a mobile transaction service provider to banks and mobile customers.

microfinance insights

mar/apr 2009

is growing and identifies the challenges it will face in the future. Going by the disproportionately large number of women borrowers in the sector, it is only logical for a book on the emerging trends in microfinance to look at gender empowerment. This chapter, however, has a twist. “Gender Empowerment in Microfinance” by Beatriz Armendariz, Economics Professor, at Harvard University and Nigel Roome, Daniel Janssen Chair, Solvay Business School, explores the possibility that the sector’s focus on loaning to women could backfire by creating a fractious family environment because of the exclusion of men. This friction could actually lead to a “disempowering” effect on women, causing a lower quality and quantity of health and education in a family. The authors conclude that the lack of significant evidence on the impact of gender empowerment on the quality and level of social and economic development calls for more research. Overall, the book is a valuable resource that traces the changes in the microfinance sector from its origin until now. Those with intermediate knowledge of the sector will be able to dive into some of the more intricate and delicate circumstances that frame the current progress of the sector. The book will serve as a good reference point for future debate in these areas. n Ordering Information Microfinance: Emerging Trends and Challenges By: Suresh Sundaresan, ed Published by: Edward Elgar Publishing, January 2009, Hardcover Pages: 144 ISBN-10 / ASIN: 1847209203 ISBN-13 / EAN: 9781847209207 Price: US$100

books

Creating a Sound Environment:

Legal Protections and Credit Registries Book Excerpt: Banking the Poor: Measuring Banking Access in 54 Economies This issue’s book excerpt explores how banking services are rendered to millions of poor people in developing countries and how these services can be more inclusive. The book draws on responses to questions in surveys undertaken in central banks and leading commercial banks in 54 countries, largely in Africa. It explores associations between countries’ banking policies and practices and their levels of financial access, measured in terms of the number of bank accounts per thousand adults. The following excerpt underlines the need for a sound institutional environment with a transparent credit information system to moderate credit risks associated with banks. It also highlights that competition within the banking sector can translate into increased access to financial services for the poor by curtailing collateral requirements.

egulations Can Increase Access Banks’ loan procedures, terms, and conditions matter for business borrowers, but the broader institutional environment for lending matters for creditors. The soundness of that environment therefore affects access to finance. The degree to which creditors can credibly enforce contracts and the availability of information on current and prospective borrowers both play important roles in reducing credit risks for banks. Better legal protections enable lenders to offer entrepreneurs money on better terms, and creditors’ rights are associated with higher ratios of private credit to GDP. Stronger creditors’ rights are also associated with longer loan terms and lower interest rates. We found that the strength of legal protections for creditors is associated with higher ratios of private credit to GDP, higher shares of bank borrowing in firms’ financing structure, and higher percentages of firms with access to loans from commercial banks. Systems that facilitate the sharing of credit information are equally important. Well-functioning credit information systems improve banks’ knowledge of applicants’ characteristics and permit more accurate predictions of the probability

of repayment. Credit information also increases repayment incentives for borrowers (Jappelli and Pagano 2002b; Padilla and Pagano 1997; Jappelli and Pagano 1993). An abundance of empirical evidence supports the links between credit information and financial access. The presence of credit registries is associated with a higher ratio of private credit to GDP. In countries with no registries, firms perceive higher financing constraints; while in countries where private credit registries are present, firms perceive lower financing constraints and have a higher share of bank borrowing in their financing structure (Djankov, McLeish, and Shleifer 2007). Our results corroborate the earlier findings. The use of credit registries (public or private) is associated across countries with more private credit to GDP and a larger percentage of firms with access to commercial bank loans. The presence of credit registries is associated with lower financing constraints for small and micro firms as well. (This makes sense, because small and micro firms are the most opaque.) Finally, the level of competition in the banking sector, measured by the top three banks’ share of banking sector assets, also affects financial access

for enterprises, particularly in low income countries and countries with underdeveloped financial and institutional infrastructure. Competition in these countries has been associated with more credit for the private sector, and lower levels of collateral requirements. This is because banks’ scope for extracting rent through collateralization decreases with competitive pressure and leads to a higher share of domestic credit being made available to enterprises (Beck, DemirgucKunt, and Maksimovic 2004; Hainz 2003). In the sample of 54 economies studied here, competition among banks is significantly and positively associated with domestic private credit, but not with the number of bank accounts per 1,000 adults. In other words, it increases private credit but not bank access. n Ordering Information Banking the Poor: Measuring Banking Access in 54 Economies Published by: World Bank Publications, December, 2008, paperback Pages: 150 ISBN: 082137754X Price: $13.00, £23.50

Banks’ Flexibility Concerning Collateral for Business Startup Loans Thailand

Ethiopia

Philippines

Tanzania

Niger

Singapore

Niger

Pakistan

Cameroon

Vietnam

South Africa

Kenya

Swaziland

Mauritius

Cambodia

Congo

Mali

Nepal

Lesotho

Chad

Sierra Leone

Sudan

Burundi

Lao PDR

Angola

Senegal

Zambia

Sri Lanka

Malaysia

Malawi

India

Gambia

Bangladesh

Botswana

0.6

Mozambique

0.8

El Salvador

Average scores of sample banks on collateral flexibility index, by country

Burkina Faso

Collateral Acceptibility Index

1.2

0.4 0.2 0

Collateral Flexibility Index Less Flexible More Flexible Note: The collateral flexibility index is an equally weighted index of the sum of reponses concerning the acceptability of various types of assets as collateral for a business startup loan. The asset types are: cash and liquid assets, land, house with title, house without title, equipment, livestock, inventory, accounts receivable, and other. Higher scores indicate a wider range of acceptable collateral. Source: Getting Finance database.

www.microfinanceinsights.com

mar/apr 2009

microfinance insights

last word

Post-Recession Survival: Evolution at Play? In the past few years, multiple microfinance funding options have emerged. Among them are the once popular Collateralized Debt/Loan Obligations, a financial structuring model heavily used by bankers prior to the US economic crisis. With the recent downturn, some of these funding models have lost favor with the microfinance and investment community. Where should microfinance institutions look for funding, and who will survive the meltdown? Corporate Finance Professor Roberto Moro Visconti discusses his thoughts.

nternational intermediaries who invested in microfinance institutions (MFIs) in underdeveloped countries before the current dramatic global financial crisis are now forced to reconsider their investment policy. This is mainly due to the domestic problems of the investors and especially of their shareholders, represented by Western banks and institutions (endowment or pension funds, foundations, governmental agencies for development, etc.), as well as private households. The increasing liquidity constraints and erosion of capital adequacy (due to the write off of toxic assets) are forcing many institutions to de-leverage and sell their assets.

“The main casualties in the microfinance funding situation during this economic crisis are the structured products that were being used to raise capital, such as Collateralized Debt or Loan Obligations.” This forced process, driven in many cases by a dramatic struggle for survival, might concern MFIs in developing countries, even if they are somewhat insulated from the global volatility strongly affecting the international financial markets. Developing countries not fully integrated with international markets seem less affected. Because of some of the sector’s intrinsic characteristics, such as closeness to clients and limited risk and exposure, microfinance tends to behave in an anti-cyclical manner, providing a shelter against recession. This holds true even in situations where foreign support to donor-driven NGOs or partially-dependent microfinance banks is slowing down and collection of international capital is harder and more expensive. The main casualties in the microfinance funding situation during this economic crisis are the structured products that were being used to raise capital, such as Collateralized Debt or

Loan Obligations (CDOs/CLOs). According to experts such as Mary Ellen Iskenderian of Women’s World Banking and Robert Annibale of Citigroup, the CDO structure which recently became a very important low cost funding source for MFIs is most likely to stop. The people and institutions working on CDOs are no longer available, as the whole financing technique has been completely discredited and therefore is about to be substituted by other sources of funding, in particular, domestic finance from local financial institutions in local currencies. The complicated derivatives are not trusted as much anymore. The evolving funding structure of MFIs should quickly replace the CDO “hole” with alternative sources of funds. The cost of capital is increasing since capital itself is difficult to find. In the process developing countries might get neglected simply because Western institutions are too worried about their domestic problems. Bigger and more stable MFIs that are able to collect local deposits and issue unsophisticated forms of debt must adapt to a liability substitution that, albeit painful, should allow them to survive. Leveraged MFIs with an insufficient capital adequacy, however, are likely to struggle for survival, showing in the best case a severe reduction in their growth. If we compare the beginning of 2009 with the fall of 2008, we are already seeing signs that the volatility in the international stock markets is decreasing. However, it is still not yet fully understood how much longer or deeper the recession is going to hit the real economy (production, consumption, trade employment). When the psychological panic selling is over, surviving MFIs will be stronger and better placed. International private equity players are likely to review their investment policy, but the extent of this greatly depends on their personal problems. Leveraged Buy Out (LBO) funds are suffering

1. See www.microcapital.org/microcapital-story-how-far-will-the-credit-crunch-affect-the-microfinance-industry

microfinance insights

mar/apr 2009

much more than venture capitalists because they have a consistently higher leverage and the exit from their investments has become longer and much less profitable as a result of company evaluations halving.

“Long term investors have to be more patient than ever and keep hard at it; early and unplanned exits from investments destroy value, especially in countries where secondary markets are non-existent.” In comparing the impact of the recession in rich Western countries versus poor and underdeveloped countries, the first and most obvious consideration is that at the very bottom of the pyramid there is not much wealth to be destroyed. However, we would do well to consider that the poor have no parachutes or safety nets and little, if any, shelter against adversities. Long term investors have to be more patient than ever and keep hard at it; early and unplanned exits from investments (fire sales) destroy value, especially in countries where secondary markets are non-existent. Disinvestments and de-leveraging can have severe drawbacks, especially on MFIs with ambitious growth plans; even if their plans are now unrealistic, they cannot suddenly decrease beyond break even. In hard and confusing times, it pays to be small, flexible and simple. Only the fattest and the fittest of MFIs will survive this Darwinian selection. n

Roberto Moro Visconti is a Professor of Corporate Finance at the Catholic University of the Sacred Heart, in Milan, Italy, a chartered accountant and a financial consultant. He can be reached at roberto.morovisconti@morovisconti.it

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A bimonthly publication from Intellecap

Volume 10 - Connections & Partnerships From water to education, health care to clean energy, there are numerous products and services that MFIs can offer to the communities they work with. This issue takes a critical look at how these services stack up in the move towards greater financial inclusion. Includes an interview with Harish Hande, Founder, SELCO India; an article on how MFIs can utilize carbon credits from MicroEnergy Credits; a perspective from Green Microfinance, and more.

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Volume 9 - The African Landscape With over 300 million people in need of financial services, over 20 large MFIs, and a growing appetite for investment, there has never been a better time to take a closer look at microfinance in Africa. In this issue, read an overview of the African microfinance landscape from Women’s World Banking (WWB), a commentary from Wagane Diouf, Managing Director of Mecene Investments, interviews with James Mwangi, CEO of Equity Bank, and Ingrid Munro, Founder of Jamii Bora, and more!

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Mitigating Risk Subprime Crisis and Microfinance

MAINSTREAMING Are We Ready for Takeoﬀ?

A publication by Intellecap

Volume 7 - Mainstreaming: Are We Ready for Takeoff? There are numerous signs of the sector’s move into the mainstream: MFIs are shedding their NGO skins to become regulated entities; commercial banks are scaling down to reach a segment once thought “unbankable,” and mainstream investors are pushing money at the sector. All the while, traditionalists shout, “What about mission?” The July 2008 issue focuses on this move from niche to mainsteam.

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Volume 6 - Focus on Human Resources This volume draws from global perspectives to highlight ways to solve issues related to recruitment practices, staff training and incentive systems. Inside you’ll find a provocative commentary on the Forbes Top 50 MFIs List and international voices from Pakistan to Bolivia and Tanzania to Tunisia.

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Interview Jean-Philippe de Schrevel BlueOrchard

Commentary Commercialization of Microfinance: Barbarians at the Gate?

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