By Marc de Sousa-Shields and Cheryl Frankiewicz (December, 2004)
http://www.esglobal.com/pdf/Financing%20Microfinance%20Institutions.pdf
Abstract
De Sousa-Shields and Frankiewicz present a comprehensive overview on financing of the microfinance sector in developing countries in order to understand its potential to access greater commercial capital. They conclude:
- Non-commercial capital should not favor supporting non-profit MFIs over commercial entities
- Domestic capital is almost always a preferable source for MFIs to international capital
- Public and private MFI funds should invest in the next generation of MFIs
- MFIs should dramatically advance and manage deposits from the public
Summary The analysis is based on literature review, interviews with 15 MFIs and more than 20 leading microfinance financing stakeholders and investment decision-makers. Additionally, the authors conducted a roundtable consultation with microfinance financing experts. The report begins by describing the capital needs of a business as predicted by the lifecycle model and compares it to that of microfinance. Among the authors' conclusions are:
- Non-commercial capital has been the main form of early risk capital and remains an important source of funds even as MFIs mature.
- Some mature and profitable MFIs prefer not to access commercial capital. Similarly, other features of fast-growing industries (such as mergers, acquisitions and failures) are missing in the microfinance sector, probably because of existing barriers caused by non-profit behavior.
The authors analyze the most common types of investors and look at their asset allocation strategies to define the type of investors that could be able or willing to invest in MFIs. They conclude:
- Asset allocation strategies and regulation dramatically limit the universe of possible private sector investments in MFIs, even before the quality of the asset is discussed.
- MFI investors must be highly risk tolerant, particularly patient, able to absorb high transaction costs. Internationally, high net worth individuals who are socially responsible investors with an interest in emerging markets and community investments meet the profile. Similarly, socially responsible institutional investors could be attracted to MFI investments, but may have greater concerns about complying with fiduciary responsibilities.
- Local investors (i.e., high net worth individuals) are more likely to participate since they do not face added risks inherent to international investment and have a clearer idea of local economic risks. Local institutional investors could be interested if guarantee programs are in place for low transaction cost and widely available instruments, such as bond issues.
- Key to access for local investors will be addressing information gaps about microfinance.
The authors look into non-commercial capital, which has had a significant impact and influence on MFI financing patterns. They conclude:
- The relative abundance of non-commercial funding for successful and high profile MFIs has serious implications for supporting the 'next generation' of successful MFIs. This concentration could also be harmful for competition and sector vitality, and hence interest from private sector investors. It is surprising that public sources have favored larger, regulated institutions, given that they are the primary source of industry 'risk capital' and should be financing younger institutions.
- While commercial MFIs may be on the rise, the majority of them have grown from non-profit institutions that historically received the bulk of public and private funding support. Non-commercial funding allocation may thus be reinforcing the sector's mission-driven ethos, which is at odds with many of the preconditions to attract private capital.
The authors discusses the influence of non-commercial capital in microfinance and point out the limitations on non-commercial capital models as they affect access to private capital. They argue:
- Commercial capital is key to sustain existing MFIs, but also to contribute to a new market dynamic that offers the most potential to serve the greatest number of people with permanent microfinance services
- Seeking profits maximizes growth, while non-profit business models rarely maximize profits.
- Risking one's own capital and that of others improves financial performance.
- Non-profit ownership is a source of commercial investor concern and seeking non-commercial capital reinforces impulses and instincts that make access to commercial capital more difficult.
- The entry of commercial capital to microfinance will not cause mission-drift, but will create a market dynamic supportive of innovation and growth.
The authors analyze the challenges that MFIs face to attract commercial capital, including:
- Domestic deposits and domestic debt are ultimately the most desirable forms of capital from a cost and liquidity management perspective. Over the long run, domestic capital is preferred to international because the exposure to foreign exchange risk can be very expensive. Additionally, social investment funds may be very limited in terms of types and maturities.
- Regulatory issues are clearly critical for deposits, as well as understanding the marketplace and liquidity management issues.
- Although debt is generally more expensive than deposits, it will remain a cornerstone to MFI funding in the transition to private capital. A critical development would be the creation of networks of local debt sources for MFIs that supply short term portfolio growth capital and longer term balance sheet maintenance. Also, guarantee programs would play an important role in developing access.
- The lack of private equity available for microfinance is partly the result of pickiness among current MFI owners and partly the result of factors beyond the control of the sector. Key to increase the attractiveness of MFI shares is to first create or improve conditions that will provide investors some means of withdrawing income from their investments. That is to abandon the non-profit mentality and get comfortable with the idea that the low-income market is a proven market and offers investors a solid, long-term, profitable alternative to other financial services niches.
The authors' recommendations on specific financing sources are:
- Savings MFIs should dramatically advance in their capacity to mobilize deposits.
- Debt Support the development of debt networks by generating information and dissemination, improved collateral arrangements, guarantee programs and strategic regulatory changes and tax advantages.
- Equity Court profit-driven, private sector investors as potential owners of MFIs. Seek to create a more liquid market for MFI shares by encouraging dividend payments and access to formal capital markets.
- International Social Investment Funds Support international social funds to explicitly leverage domestic capital for MFIs.
- Other non-commercial funders Limit non-commercial funding to early-stage MFI development or to reach new MFI markets. Ensure that leveraging private capital is an explicit goal. Continue to strengthen credit bureaus, sector associations and investment laws that affect access to private capi