PAPER WRAP-UP: Microfinance Banana Skins 2008: Risk in a Booming Industry, by the Centre for the Study of Financial Innovation (CSFI)

Written by the Centre for the Study of Financial Innovation (CSFI) based on its research sponsored by Citi and the Consultative Group to Assist the Poor (CGAP), released March 2008, 41 pages, available here.

Management and corporate governance standards are the biggest risks faced by microfinance institutions (MFIs) today, while increases in competition and the availability of capital are the fastest-emerging threats to the future of the industry, according to a report by the British think tank CSFI.

The report, entitled Microfinance Banana Skins 2008, ranks both the top 29 risks and top 29 fastest risers based on a survey of practitioners, investors, analysts, and observers focusing on the largest 350 MFIs seen as capable of commercial growth. The greatest risk is deemed to be poor MFI management.

According to the report, “much of the worry about management quality focused on the fact that MFIs tend to be dominated by ‘visionaries’ who are strong on charisma but less so on management skills and strategic flexibility.”

The lack of basic corporate governance concepts at many MFIs is also a concern, especially for investors seeking transparency in their investments.

Other top risks cited by survey respondents include a shortage of competent staff, poor regulation and political interference, controlling costs and managing new technology, increased competition and credit risk, and the potential consequences of unrealistic expectations and mission drift.

Competition, staffing, political interference, and over-funding are seen as the fastest-growing risks to microfinance. Competition and over-funding are both notable because they seem to address some issues while giving rise to others.

The report indicates that the number of lenders is growing by 25 percent a year and that foreign capital investment tripled to USD 4 billion from 2004 to 2006. Industry growth is spurred by relatively low barriers to entry and attractive returns, giving birth to new MFIs, expanding existing MFIs, and inviting traditional commercial entities to get involved in microfinance. In turn, this encourages a distinctly profit-driven mentality, to the detriment of microfinance’s socially responsible ethos. The glut of capital, meanwhile, encourages irresponsible lending that threatens to create large debt burdens or defaults.

On the other hand, a competitive environment is conducive to lower interest rates. This should heighten rate-sensitivity among MFI clients, who currently tend to be rate-indifferent. It would also commit MFIs to greater fiscal discipline, since cost control is one of the major risks named in the survey.

Likewise, an overabundance of capital is surely preferable to a drought. At this point, however, with “too little funding” being named the least of the perceived risks, the discussion swings in the direction of how to react responsibly to overwhelming inflows. Considering its broadening hype, microfinance was originally rooted in ideas of social responsibility, and stakeholders want to ensure that all participants keep that in mind.

The CSFI issued its report with the sponsorship of Citi, a major U.S. financial services company, and the Consultative Group to Assist the Poor (CGAP), a consortium of development agencies that aim to expand financial services to the poor in developing countries. Its data collection effort was supported by the Microfinance Information Exchange (MIX).

By Stephen Son

Additional Resources:

CGAP: Microfinance Banana Skins 2008

Financial Times: “Microfinance urged to raise standards of management and governance”