PAPER WRAP-UP: Fitch Ratings Report: Microfinance – Testing its Resilience to the Global Financial Crisis by Sandra Hamilton

Written by a team of Fitch Ratings analysts led by Sandra Hamilton, “Microfinance Sector – Testing its Resilience to the Global Financial Crisis, (January 22, 2009),” is a follow up to Fitch’s June 2008 report, “The Microfinance Sector: its Success Could be its Biggest Risk.”  The report looks at the extent to which MFIs are immune to, or insulated from, the global financial crisis.  The June 2008 report highlighted the growing integration of the microfinance industry into the global financial system.  Fitch finds evidence of a positive relationship between the size and level of integration of an MFI and the impact that the financial crisis is having on its business plan, performance, and asset quality.  Fitch outlines the dual impact that the crisis will have on MFIs: a funding or liquidity impact and an economic impact.

Funding and Refinancing Risks
 
The report outlines the main sources of wholesale funding for the MFI sector as: 1) wholesale funding from development finance institutions (DFIs), socially-motivated funders, and to a lesser extent customer deposits and 2) commercially orientated public and private sector funding.  While the first category of funding is usually counter-cyclical, MFIs access to commercial funding has been reduced and become more expensive when it is available.  This has led to increased levels of refinancing risk, although, the level of financing constraints varies by region.  For example, Fitch notes that eastern Europe, central Asia, and the Balkans are experiencing tighter funding constraints than central and Latin America.  Fitch raises the concern that from an operational standpoint, some MFIs may not be prepared to deal with these challenges.
 
Changing Growth Dynamics
 
The short-term nature of microcredit and the cash flow that is generated by repayment is a positive in this environment.  However, as MFIs begin to use their cash flow in order to meet debt obligations, Fitch feels that lower growth scenarios for 2009 are very likely.  High double-digit growth rates which were commonplace in past years, are expected to fall to single-digits or low double-digit growth rates.  Fitch feels that key to the MFIs success is its ability to manage this lower growth, for example, explaining to new or existing customers that new loans are not available due to funding constraints.  This prospect raises yet another risk: one key incentive to the microcredit borrower of repaying a loan is the promise of a larger loan, for better terms, in the future.  If the borrower perceives that this incentive no longer exists, MFIs could incur higher loan defaults.  A higher percentage of non-performing loans in the portfolio would no longer be able to be distorted by rapid loan growth.  A rapidly growing loan portfolio has the ability to distort the ratio of non-performing loans to total loans as the denominator grows from period to period and diminishes the relative significance of the numerator.  Fitch also notes the increased potential for currency-induced credit risk in countries where sharp local currency devaluations could also negatively affect asset quality if loan have been granted in hard currency.
 
Financial Performance
 
Fitch expects that lower lending volumes, higher funding costs, deteriorating asset quality, currency risk, and hedging losses will all negatively affect the financial performance of MFIs.
 
The report speculates that MFIs will use this time of lower growth to tighten lending and liquidity management procedures as well as build capacity.  Additionally, MFIs may choose to refocus on their core lending activities and abandon attempts to diversify into other products such as consumer loans.  Despite all of this, the Fitch report cites one case study, the Bolivian financial crisis of 2000-2002, which indicates that while asset quality and financial performance may initially deteriorate in line with the broader financial system, MFI borrowers tend to bounce back more quickly than borrowers of traditional commercial banks.  This is primarily because microentreprenurs are able to adapt their economic activity more quickly than the traditional commercial bank borrower.  Also, as unemployment levels in the formal economy grow, so does the demand for the non-traditional financial services that MFIs provide.

Similar Posts:

• MICROFINANCE PAPER WRAP-UP: “Predictors of Microfinance Sustainability: Empirical Evidence from Bangladesh,” by Maeenuddin et al
• MICROFINANCE PAPER WRAP-UP: “Impact of Microcredit on Household Consumption and Assets in Nepal;” by Shalik Ram Pokhrel
• MICROFINANCE PAPER WRAP-UP: “Microfinance in India: Issues, Challenges and Opportunities;” by Mohammad Abu Saleh, Zubair Ahmad
• MICROCAPITAL BRIEF: Okra Solar of Nigeria Raises Equity, Debt Totaling $12m to Expand Mesh Grids in Africa, Americas, Asia
• MICROCAPITAL BRIEF: AfDB Seeking $1b for African Climate Risk Insurance Facility (ACRIFA) to Boost Microinsurance for Farms, Livestock Against Drought, Floods