by Jaclyn Berfond - Risks -

MICROFINANCE PAPER WRAP-UP: Microfinance Banana Skins 2009: Confronting Crisis and Change by David Lascelles and Sam Mendelson

Written by David Lascelles and Sam Mendelson, released in June 2009 as publication number 85 of the Centre for the Study of Financial Innovation (CSFI), sponsored by Citi Foundation and the Consultative Group to Assist the Poor (CGAP), 52 pages, available at: http://www.cgap.org/gm/document-1.9.35203/Microfinance%20Banana%20Skins%202009.pdf

The Microfinance Banana Skins 2009 survey explores the risks, or “Banana Skins,” facing the microfinance industry at a time when the global financial crisis has raised new and unfamiliar challenges. The report, the second in the series, describes the risks seen by an international sample of practitioners, investors, regulators and observers of the sector. The survey was conducted in April and May 2009 and is based on 430 responses from 82 countries and multinational institutions.

The key finding of the survey is that the economic crisis has completely transformed perceptions of the microfinance risk landscape. MFIs, their investors, and regulators are now focusing on credit risk, liquidity, and global economic trends, in contrast to the top three concerns from 2008 – management quality, corporate governance, and inappropriate regulation.

Of the 25 risks ranked, the top five Banana Skins identified this year include:

  1. Credit Risk. Rising from the number 10 spot in the 2008 survey, the emergence of credit risk – the risk of loss when loans are not repaid – as the top Banana Skin is representative of the new challenges facing the industry in the wake of the financial crisis. In the past, the microfinance industry was known for its excellent repayment record, but a combination of stressful economic conditions – economic slowdown, rising unemployment, and volatile commodity prices – and structural change within the industry – where competition among MFIs has led to an erosion of standards, including a shift from group lending to riskier individual lending – has greatly increased concern about default and loan loss. Credit risk was in the top five risks identified by all respondent categories, and dominated geographical responses – excepting Africa and Asia.
  2. Liquidity. Having enough cash available to make loans and meet deposit withdrawals is today seen as one of the most significant risks to the sector, rising from number 20 in last year’s survey. With banks already cutting lines because of the credit crunch, and the fear that depositors could lose confidence and pull out, liquidity risk could affect MFIs’ business prospects and financial strength. The risk was geographically widespread, and ranked high among all respondent categories.
  3. Macro-economic Trends. Many respondents said that MFIs could no longer claim to be insulated from shocks in the “real economy,” a sharp change in attitude from the last survey when macro-economic trends were ranked number 23. Respondents saw microfinance being hit by rising unemployment, worsening bad debts, falling remittances, and declining investor and depositor confidence. Respondents from all regions – except Asia – put this risk in their top five, with practitioners and investors most concerned.
  4. Management Quality. Concern about management quality fell from the number 1 position in the 2008 survey, both because it was overtaken by more urgent risks and because there was the perception of progress due to an influx of talent and a drive to raise quality. Of note, respondents in Africa still ranked management quality as the number 1 risk.
  5. Refinancing. One of the top concerns for investors, refinancing risk addresses the danger that MFIs may not be able to renew their base funding from investors or donors because of changes in their circumstances or the stresses of the economic crisis. Investor nervousness is a direct consequence of mounting financial pressures on MFIs: the growth of loan delinquency and operating losses, the slowdown in new business, and worries about liquidity. If funding dries up, MFIs’ prospects could get even worse, and there is a real concern that these risks could exacerbate one other.

Other top risks identified include too little funding (6), corporate governance (7), foreign currency (8), competition (9), and political interference (10). Depositor confidence (21), back office operations (22), ownership (23), product development (24), and too much funding (25) were seen as the least important risks facing the industry.

The final part of the survey asked how prepared MFIs were to handle these risks. Only 5 percent of respondents thought they were well prepared, and 13 percent thought they were poorly prepared. This is a more negative result than the 2008 survey when 27 percent said “well” and only 5 percent said “poorly”.  While many respondents thought that MFIs had been lulled by good times into thinking that the global economic crisis would not affect them, some respondents stressed the traditional resilience of the microfinance in facing these challenges. This sentiment was echoed by CGAP’s CEO Elizabeth Littlefield who said; “This year’s Banana Skins survey highlights cracks and fissures in microfinance that have surfaced with the global economic crisis. But, the sector is basically healthy, with strong fundamentals and a solid, reliable, and growing client base. Tackling immediate concerns about credit risk and liquidity is important, but remaining focused on longer term issues of strong management, governance, and asset and liability management capacity remains crucial for the future.”

The authors of the Microfinance Banana Skins 2009 survey, however, summed up the tone of the report as “ominous.”

By Jaclyn Berfond, Research Assistant

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