By Tor Jansson (2003)
http://www.iadb.org/sds/doc/financing%5Fmicrofinance.pdf
Abstract
In a 2003 study of Latin American microfinance, Jansson argues that MFIs have outgrown the funding ability of donor agencies. As more MFIs transform into financial institutions with other capitalization options, donor funds will become less necessary. Jansson discusses the differences in funding alternatives and approaches between non-profit microfinance institutions, those transformed into supervised and licensed financial MFIs, and mainstream financial institutions.
Jansson then outlines present and potential future funding objectives and obstacles for MFI investors, including mutual funds from industrialized countries, specialized funds, and donor agencies. He concludes by identifying ways in which donor agencies can continue to positively influence the growth of microfinance:
- Provide seed equity for MFIs in the transformation process
- Provide credit enhancement/guarantees to new bond issues
- Invest in global microfinance securitizations
- Positively influence microfinance regulations and policy by leveraging access to government within donor institution
- Provide a foreign exchange facility, allowing creditors to lend in foreign currency and MFIs to borrow in local currency, thus opening the flow of commercial investment into MFIs
Summary
MFIs that operate as non-profits obtain funding from donors, retained earnings, some public financial institutions, and, at times, commercial banks. However, this can be quite limited. In order to access funding through deposits as well as capital markets instruments, MFIs seek transformation into licensed and supervised financial institutions (FIs).
While a debt/equity ratio of 1:1 is typical for nonprofits providing microcredit, conventional banks and other FIs typically operate at 10 times this amount of leverage. For instance, when Mexican MFI Compartamos transformed from an NGO to a licensed and supervised FI in 2001, its debt/equity ratio increased by more than 10 times in one year, from 0.14 to 1.5.
Microloans are short-term in nature, though the tenor is increasing due to the presence of repeat clients and the possibility of opening up the mortgage loan market. Compiling data from transformed MFIs from Bolivia, El Salvador, Paraguay, and Peru, Jansson demonstrates a shift away from mostly long-term subsidized borrowing toward short-term deposits. Thus, assets are growing in maturity, while liabilities are still short-term, indicating a potential maturity mismatch. This situation is spurring a move into capital markets to seek medium-term funding.
- Mibanco (Peru), Compartamos (Mexico), FinAmerica (Colombia) all issued bonds to domestic investors with 2-3 year maturity.
- Other capital markets instruments, such as securitization, are on the horizon but in many cases would require the pooling of microfinance portfolios to meet minimum issuance size of roughly $25MM. Legal frameworks will be an obstacle in this process, however, since in many Latin American countries legislation requires individual transfer and debtor notifications for each loan, making transactions unwieldy.
The equity ownership of MFIs generally includes the original NGO, multi- or bi-lateral donors, semi-commercial specialized funds, and other NGOs. Normally however, the original NGO maintains a controlling stake, directly or indirectly. For example in Compartamos, of 33 individuals who owned 30% of the shares as of 2003, more than half were Compartamos employees, providing an example of how the original NGO maintains control.
Commercial investors and private individuals who usually participate in equity ownership of financial institutions are rarely present in MFIs. As MFIs increase their leverage with transformation into licensed and supervised institutions, more private sector for-profit involvement may take place, but this has yet to be seen.
Finally, Jansson analyzes the perspective of different types of investors with respect to emerging market MFIs:
Mutual Funds
While there are 40 socially responsible mutual funds in the US, Canada, UK, and Australia holding $2.9 billion at year end 2001, only 3.6% of these assets were invested in emerging markets. These funds have avoided emerging markets for several reasons:
- Requirements to invest in publicly traded securities and lack of investment vehicles
- Lack of country intelligence
- Lack of social impact measurements
- Lack of emerging markets experience
- Inadequate risk/return profile
Specialized Funds
The main shareholders of specialized microfinance funds are multi- and bi-lateral donor agencies. Because of their desire for social impact, they have a higher risk tolerance than average commercial investors but share many of the same concerns:- Dearth of social impact indicators to prove to investors what the actual impact is
- Foreign exchange risk
- Adverse local regulations such as double taxation and the necessity to transfer foreign currency loans to reserves of central bank, raising the cost of the transaction
- Lack of industry statistics and transparency (mainstream ratings firms are only just beginning to review microfinance)
- Sometimes undercut by subsidized funds from donors directly to MFIs
Donor Agencies
- Donor role is diminishing as licensed and supervised MFIs can find financing in other forms
- Donor agencies should concentrate their energy on those institutions that are still non-profit and to those in transition, where commercial investors are unwilling to take on the risk of funding
- To avoid crowding out the private sector, donor agencies should not provided conventional loans to transformed MFIs, but instead should focus on providing loan funds to nonprofit institutions that don't have access to social or commercial investors