MICROFINANCE PAPER WRAP-UP: Microfinance: Ready For its Big Leap? By John Engen

The cover story of the February, 2009 issue of US Banker was entitled, “Microfinance: Ready for its Big Leap?” In it, author John Engen lays out his expectations that a hybrid funding approach will arrive in microfinance sector – one that meshes government, non-profit, and business ethos in pursuit of a “double bottom line” that measures success both with respect to social benefits and financial returns. However, Mr. Engen argues that to attract more funding from private investors, MFIs need further adjustments in both their business practices and ideologies. While such adjustments may be controversial and draw criticism at present, in the long term the changes should induce competition in the sector, and so the theory goes, be beneficial. The real question then is: are MFIs ready for such a big leap? The full text is available at:

http://www.americanbanker.com/usb_article.html?id=20090126JLCSNV6Y&pagenum=1&numpages=3

MFIs need outside investors

The global microfinance market counts an estimated 30 billion USD in small-business loans outstanding, and is exhibiting double digit annual growth. However, as most MFIs do not accept deposits, many are unable to meet market needs as the global demand for loans far outstrips their traditional capital sources – governments, philanthropies, and non-governmental organizations. A December 2007 report by Deutsche Bank estimates that only10 percent of potential borrowers get loans globally, due mostly to the funding limitations of MFIs. However, the same study also predicts that outside investments will grow tenfold by 2015, to 20 billion USD.

For-profit investors are alternative sources for MFIs

Investors’ interest in microfinance comes from several sources. First, more MFIs are offering fee-based services with established corollaries in the commercial banking sector, such as check cashing and facilitating remittances. Second, according to a recent study from CGAP, an independent resource for microfinance information, the average return on assets of 344 MFIs was 2.8 percent – about half of what a profitable pre-crisis bank would have earned – while MFIs’ returns on equity are usually higher than those in the traditional banking system. Such respectable numbers, especially when combined with the philanthropic aspects, have caught investors’ attention. Major banks, including: JPMorgan Chase, Citigroup, HSBC, and Deutsche Bank, have begun providing services through, or small amounts of capital to, MFIs. Such cooperation also provides banks access to market segments where they do not have an existing presence, hence advancing their emerging markets strategies.

Meanwhile, individual investors have likewise shown a willingness to put money into MFIs, purchasing both equity shares and microfinance loan backed securities, the latter drawing additional interest from specialized funds such as Microvest and Blue Orchard. Finally, more aggressive direct investments are on the rise. Sequoia Capital, the same venture capital firm that helped bankroll internet giant Google’s startup, has invested 11 million USD in SKS, an Indian non-banking finance company. In 2007, London-based private equity firm Helios Investors LP paid 175 million USD for a 25 percent stake in Equity Bank, a Kenyan MFI intent on expanding its reach and competing with larger banks.

Can microfinance purists live with securitization?

Potential for ideological conflict exists between traditional MFIs and profit-seeking players who have more stringent expectations regarding the returns on their investments. That is, microfinance has traditionally measured success more in social terms than the bottom line. Many MFIs regard microfinancing as a means to an end – to solve problems like poverty, subpar health care, and lack of educational access. On the contrary, achieving a certain profit level is a major, if not the only, end for most investors. Furthermore, some investors urge efficiency-enhancing operational changes in the microfinance sector. For instance, rapid organizational growth has sparked talk of consolidation. These investors believe that consolidation would shorten the learning curve in new markets and add efficiency to MFIs. However, the notion clashes with the local roots of many MFIs, making mergers unlikely. Meanwhile, greater scrutiny from outside investors has highlighted the need for better performance measurement, as it is often contended that a lack of quantitative knowledge about the long-term returns of microfinance outfits makes it difficult to assess objectives and place investments.

Therefore, if MFIs intend to obtain sizable private sector support they will need to at least address these concerns, and potentially adjust their business models. Investors also have claimed that profits do not compromise the social mission of MFIs per se, rather, the key is finding investors who keep an eye on the receiving entity’s social mission. However, many disagree with this logic and contend that as MFIs reach deeper into the for-profit capital pool, more and more investors will seek to simply maximize profits, potentially at the expense of social goals.

The tension was revealed when Banco Compartamos, a Mexican MFI, raised 467 million USD in a partial IPO that valued the company at 1.5 billion USD. Subsequent operations aroused controversy when it was revealed that Banco Compartamos had charged 100 percent interest on some loans, which according to critics amounted to earning unreasonable profits on the backs of poor to win investors’ money. Yet, supporters of the deal including the heads of some other MFIs applaud it as a model for future growth. They argue that ingesting capital into the market helps foster competition, which in some nations has brought lending rates that once were 100 percent down to less than 30 percent. The drop is considerable when compared to the going rates for loans in the informal sector, where many entrepreneurs are forced to turn when MFIs cannot meet their needs.

So the question remains: are MFIs ready for a big leap?

By Yanni Hao

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