Microfinance – Banking on the Poor

Dec 2008
Geneva, Switzerland , December, 15 2008 - As the global financial system buckles, microfinance institutions continue to grow on the back of their record for low risk and solid returns.

Microfinance gives small-scale financial services such as loans, savings, insurance and money transfer to poor customers who would otherwise not have access to banking services. Microcredit, an important component of microfinance, involves offering very small loans to poor clients without any collateral and often without any written contract.

First championed by the Nobel laureate Muhammad Yunus in Bangladesh, microfinance has gained a reputation for near-zero default rates and a stable rate of return over the long term for investors. These returns are estimated at about 6% a year, with the best-performing funds returning three or four times that amount.

Healthy and stable returns, combined with the feel-good factor of supporting a social cause, mean microfinance is of increasing interest for investors. Microfinance institutions have traditionally relied on clients' savings, donors, aid agencies and commercial borrowing for funding. But new sources of funding have emerged in the past two or three years. These include socially responsible investment funds, venture capital funds with a social cause, private equity funds, multinational banks and capital markets, according to the Consultative Group to Assist the Poor (CGAP), a leading advocate of microfinance.

Asia accounts for 70% of the global market for microfinance, with India having the largest number of clients followed by Bangladesh, according to Micro Banking Bulletin, a non-profit organisation that tracks microfinance institutions. In India, microfinance institutions have government-facilitated access to finance from banks. Domestic banks are required to set aside 40% of investible funds for the priority sector, which includes microcredit organisations. The target for foreign banks operating in India is at 32%.

Recently, multinational banks have started rolling out funding schemes for microfinance institutions, though their exposure remains a small fraction of their overall business and most of them list microfinance in their sustainability programmes. Emerging markets bank Standard Chartered, for example, in May had an outstanding microfinance portfolio of $180m; its total assets on December 31 2007 were $329bn.

Impact of recession

Despite the trouble in global financial markets, investors continue to put money into Asian microfinance. A $40m fund aimed at financing start-ups in microfinance was launched in October by the India-based Institute for Financial Management & Research Trust, supported by a group of investors including India's Icici Bank. In May, ASA International of Bangladesh, ranked number one on the Forbes list of top 50 microfinance institutions, raised $125m in funding – the largest ever by a microfinance institution – through private equity firm Catalyst Microfinance Investors.

Abhijit Ray, vice-president at microfinance consulting firm Unitus, in India, says: “Large and well-managed microfinance institutions have not been affected much by the credit crisis.” Grameen Bank has enjoyed excess liquidity since 2006 on the back of savings deposits by its clients. Similarly, Indonesia's BRI Desa – one of the largest microfinance institutions in the world – has 10 savings clients for each borrower, according to CGAP.

Industry sources say that as other investment options are shrinking, private equity and venture capital funds will turn their attention to microfinance. “Microfinance offers low-risk investment. Uncertainty of capital markets is driving investors to microfinance,” says Siddharth Sharma, director of IntelleCash, a Mumbai-based microfinance consulting firm.

If the global financial crisis worsens, leading to severe tightening of credit by commercial banks or high interest rates, microfinance institutions may have to scale down their ambitious expansion plans and find alternative ways to raise money. But many remain confident of securing finance from outside investors. “We are looking at several alternatives such as capital markets, bond issuance, securitisation and structured debt funding to diversify our sources of funding,” says Shiva Narain, chief financial officer of Spandana, a microfinance institution in Hyderabad, South India.

SKS Microfinance, the largest microfinance institution in India, entered into a $44m financing deal with Citibank in May last year. Under the deal Citibank agreed to buy SKS's loans and share the credit risk. The company is thought to be mulling going public, although the current volatility in global stock markets could delay its plans.

Mobile boom

For now, SKS is following the example of the Grameen group and diversifying into new business ventures. It has joined forces with India's largest mobile phone operator, Airtel, to provide mobile phones to its 2.4 million members, half of whom will be first-time mobile phone customers. Mobile banking should follow soon.

SKS has also been working with IT companies Microsoft, Wipro, Tulip, HCL and Compulink to develop a new IT infrastructure that will help it expand its outreach and reduce costs.

In Bangladesh, Grameen Shakti, a subsidiary of Grameen Bank, has used microcredit to sell domestic solar power systems to more than 100,000 homes that otherwise would have no access to electricity. Grameen Shakti has a target of covering one million homes by 2015.

Innovation will be key to the survival and growth of microfinance institutions during the downturn. Currently, there are no signs of large banks scaling back their microfinance operations. In fact, some of them continue to expand their microfinance portfolios. In early October, New York-based Citigroup announced the opening of two micro-credit firms in China's Hubei province after regulators approved its application. London headquartered HSBC and Standard Chartered entered the Chinese microfinance sector last year.

Standard Chartered, which committed to setting up a $500m microfinance facility over five years as part of Clinton Global Initiative in 2006, announced funding of $5m to two microfinance institutions – Buro and Shakti Foundation – in Bangladesh in August. In May, Standard Chartered collaborated with International Finance Corporation to increase its microcredit reach. Under the deal, IFC has invested $45m in credit-linked notes issued by Microfinance Institutional Loans for Asia and Africa, a special-purpose vehicle set up by Standard Chartered Bank to facilitate microfinance lending.

Standard Chartered says: “Microfinance is a commercial opportunity which has the potential to make a real contribution to broadening social inclusion. Improving access to finance will not only aid development and reduce poverty but also open up new markets and opportunities as more people become financially independent.”

While large banks such as Citigroup, Standard Chartered, HSBC and Deutsche Bank cite their microfinance funding as part of their sustainability programmes, local banks are looking at microfinance as simply safe business, given the high returns. Bank of the Philippines Islands, for example, decided to expand its microfinance business after it reported a 30% drop in its revenues in the nine months ending September 2008. The bank will form a mobile microfinance bank in partnership with Globe Telecom, the second largest telecommunications firm in the Philippines.

Diverse sources of funding and a sustainable business model mean the microfinance sector is well placed to withstand upheavals in the global financial markets. And the trend of banks and private investors putting more funds into the sector looks set to continue.

Microfinance at a glance
  • By 2010, investors will put an estimated $20bn into microfinance institutions worldwide.
  • The volume of microfinance loans grew from $4bn in 2001 to $25bn in 2006.
  • Since 2004, foreign funding of microfinance has doubled to $4.4bn .
  • Estimated funding gap – the extra amount needed to make microfinance services available to the world's three billion poor: $250bn .
  • Estimated number of microcredit borrowers worldwide: 152 million .
  • Worldwide there are more than seven savings accounts for each loan account.
Sources: Deutsche Bank report “Microfinance: an emerging opportunity”, December 2007; and the Consultative Group to Assist the Poor.

Range of returns

Organisations on the Forbes 2007 list of top microfinance institutions report eye-popping returns on assets. Top performers were: Banco Compartamos of Mexico (23.2% ), FONDEP Microcredit of Morocco (19.2%), Banco Do Nordeste of Brazil (17.2%) and ASA of Bangladesh (14.4%).

Consultative Group to Assist the Poor reports that fixed-income microfinance funds yield an average 5.8% .

MicroBanking Bulletin reports that 63 of the world's top microfinance institutions had an average rate of return of 2.5% , after adjusting for inflation and after taking out subsidies

Source : WBCSD

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