The Funding of Microfinance Dynamics of the present and the future Gregory Thys

The financing of microfinance On the menu: What is Microfinance / Microcredit? What is Microfinance / Microcredit? The Microfinance Market: a brief overview The Microfinance Market: a brief overview MF Investors: Who? How? Where? Challenges… MF Investors: Who? How? Where? Challenges… Rating Agencies: how do they fit into the picture? Rating Agencies: how do they fit into the picture?

About Microfinance Microfinance provides financial services – including credit, savings, insurance and money transfers – to millions of poor and low-income entrepreneurs Microfinance provides financial services – including credit, savings, insurance and money transfers – to millions of poor and low-income entrepreneurs These services are provided by Microfinance institutions (MFIs) to those who are unserved or underserved by other financial institutions These services are provided by Microfinance institutions (MFIs) to those who are unserved or underserved by other financial institutions Microfinance produces double-bottom-line returns Microfinance produces double-bottom-line returns

Microcredit Is not only about giving small loans to poor people Granted for productive purposes Granted for productive purposes Wealth generating Wealth generating Not collateral-based Not collateral-based  Different lending methodologies: village banking, group lending, individual lending The key factor : if you give a small loan to the right people who invest it in a productive activity they will be able to create an extraordinary value out of this loan.

MF remains tiny yet reports extraordinary growth levels Resilient to Financial Crisis Source: MicroRate, 2012 & CGAP, 2011

High growth brings challenges With such high growth (and easy access to funding) came new challenges With such high growth (and easy access to funding) came new challenges Many MFIs overstretched their systems and controls Many MFIs overstretched their systems and controls Concentrated market competition and multiple borrowing (over indebtedness) Concentrated market competition and multiple borrowing (over indebtedness) Erosion of MFI lending discipline Erosion of MFI lending discipline Governance Challenges Governance Challenges In : 4 countries have experienced a repayment crisis after a period of high growth (aggravated by the financial crisis) Today: Growth tend to slow down, MFIs beef up their systems, controls, transform and professionalize (Strong need for TA). Today: Growth tend to slow down, MFIs beef up their systems, controls, transform and professionalize (Strong need for TA).

Various legal forms of MFIs AdvantagesDisadvantages Unregulated (40%) Experience in serving the poor (women) Know clients and microcredit market No legally accountable owners Weak Management & Staff Generally not allowed to mobilize savings Many have low outreach Transformation to expand outreach by accessing savings & increasing access to financial markets (Many examples worldwide) Regulated MFIs: NBFIs, MF Banks (transformed from NGO) Meet Central Bank Criteria for regulated MFIs Better access to funding sources Ownership transition can be difficult Unqualified staff or Board members for new position Inexperience in mobilizing and intermediating savings Cooperatives & Credit Unions Experience in savings, credit & financial intermediation Know clients and can reach scale/profitability Many have history of poor governance, management & corruption Poor repayment rates Commercial Banks Regulated & supervised; trained and experienced; adequate MIS; FSS; technical skills Downscaling banks often do not know this market (and do not know that they do not know); partner, acquire or sometimes create their own MFI

MFIs by current legal status

Good portfolio Quality and conservative coverage

An overview of MFIs by Region (Median, 2011) IndicatorAFRICAEAPECALACMENASouth Asia Total Total number of borrowers 5,8 millions 15 millions 2,5 millions 18,3 millions 1,7 millions 39,7 millions 83 millions Total number of depositors 18,8 millions 14,8 millions 2,9 millions 16,6 millions 33,04713,8 millions 67 millions N° of reporting MFIs Gross Loan Pf. ($Millions) 2,2 5,08,713,0 5,5 N° of borrowers Average loan $481$431$1896$1027$606$161 Total Staff Source: The MiX

The funding of microfinance Initially funded by Public International Financial Institutions (IFIs) and Aid organizations (through grants, donations and subsidized loans), Microfinance has now outgrown Development Aid Initially funded by Public International Financial Institutions (IFIs) and Aid organizations (through grants, donations and subsidized loans), Microfinance has now outgrown Development Aid Major sources of funding are client deposits, followed by local commercial banks, International investors (MIVs) and International Financial Institutions (IFIs) Major sources of funding are client deposits, followed by local commercial banks, International investors (MIVs) and International Financial Institutions (IFIs) FOCUS on the foreign investments: less than 10% of the funding resources of MFIs FOCUS on the foreign investments: less than 10% of the funding resources of MFIs

The Investor landscape – Foreign Investments (2010 data) DFIs Retail Investors Institutional Investors MFIs MIVs NGO Funds Holding Companies Government & Networks $7,5 Billions* * Source: CGAP, Focus Note n°71, 2011 $3,5 Billions* $1,9 Billions* $4,7 Bln** ** Source: Microrate: 2012

Type of FunderDFIsInstitutional InvestorsRetail Investor % of total foreign funding (2010) 58%27%15% ObservationsNew approaches (Special funds, focus on SME, etc.) Attracted by 3 features: 1.Social Value 2.Perceived attractive risk- adjusted returns 3.Potential decorrelation from other asset classes Small in Volume, but big on social value FutureIncreasing Equity Investments (strengthen capital base or provide start-up capital) As new investors entered the market until 2011, many have been reevaluating their promises and scaling back investments as a result Driven by social performance; are concerned by the responsible growth of the sector Example of FundersIFC, KfW, OPIC, Danida, etc. International Banks, private equity funds, MIVs, etc. Wealthy individuals, MIVs, Kiva.org; MYC4.com;

A typology of MIVs (2011) Financial & Social returns – a dual focus but a double-edged sword.

The MIV Universe Financial Crisis Source: The state of microfinance investment, 2012, MicroRate.

Challenges Fierce competition between MIVs puts pressure on margins Fierce competition between MIVs puts pressure on margins Increasing competition from local commercial banks lending in local currency (but shorter terms) Increasing competition from local commercial banks lending in local currency (but shorter terms) IFIs are “still” crowding out MIVs at the top of the market IFIs are “still” crowding out MIVs at the top of the market Too much funding chasing too few creditworthy MFIs ? Limited absorptive capacity (market saturation and over indebtedness) Too much funding chasing too few creditworthy MFIs ? Limited absorptive capacity (market saturation and over indebtedness) Need for TA and healthier investment infrastructure (regulation, credit bureaus): a role for donors and IFIs Need for TA and healthier investment infrastructure (regulation, credit bureaus): a role for donors and IFIs

Where do MIVs invest? Source: The state of microfinance investment, 2012, MicroRate.

The Investor perspective Diversification & decreasing concentration within the MIV sector in spite of having 45% of all MF assets managed by 5 MIVs Diversification & decreasing concentration within the MIV sector in spite of having 45% of all MF assets managed by 5 MIVs Increased investments in Increased investments inEquity Change in the nature of Change in the nature of debt (VS higher focus of MFIs on savings) Guarantees have declined Guarantees have declined and are likely to disappear

Future prospects Growth back to normal at 13% - unlikely to return to high double-digit growth Growth back to normal at 13% - unlikely to return to high double-digit growth Diversification and decreasing concentration within the MIV sector (more equity (18%), changing nature of debt, decline of the guarantees) Diversification and decreasing concentration within the MIV sector (more equity (18%), changing nature of debt, decline of the guarantees) Institutional Investors (43% of MIVs) focus on financial performance Institutional Investors (43% of MIVs) focus on financial performance Retail Investors are more sensitive to social returns Retail Investors are more sensitive to social returns Big differences between regions and countries (zero growth in ECA (sign of ill-health) but huge growth in Cambodia is of great concern) Big differences between regions and countries (zero growth in ECA (sign of ill-health) but huge growth in Cambodia is of great concern) Sub-Saharan Africa looks promising but does not yet have the right market conditions and is still strongly concentrated in a few countries Sub-Saharan Africa looks promising but does not yet have the right market conditions and is still strongly concentrated in a few countries Source: The state of microfinance investment, 2012, MicroRate.

The MF Rating Agencies 4 rating agencies specialized in Microfinance 4 rating agencies specialized in Microfinance Performance Ratings, not credit ratings Performance Ratings, not credit ratings Social Ratings Social Ratings Institutional Assessments Institutional Assessments MIV Ratings MIV Ratings Initially funded, then co-funded by donors Initially funded, then co-funded by donors Ratings are requested by most MIVs yet high competition has led to overlook ratings in some cases Ratings are requested by most MIVs yet high competition has led to overlook ratings in some cases MIVs still conduct their own due diligence MIVs still conduct their own due diligence Aim at increasing the flow of funding from the developed world towards developing and emerging countries Aim at increasing the flow of funding from the developed world towards developing and emerging countries

The MF Rating Agencies I need someone who speaks the same language Show me you are transparent and pursuing sustainability I would like to attract commercial funding ressources and identifiy my strengths and weaknesses I facilitate the relationship of the MFI with its funders and supporters Rating Agency MFI Investors, donors, regulators The Rating Report L a c k o f r e l i a b l e, o p o r t u n e a n d r e g u l a r i n f o r m a t i o n o n M F I r i s k s a n d p e r f o r m a n c e s

Methodology Source: MicroRate, 2010

MF Banana skins PRACTITIONERSINVESTORS 1. Over-indebtedness (*)1. Corporate Governance (5) 2. Credit Risk (1)2. Over-indebtedness (*) 3. Client Management (*)3. Management Quality (7) 4. Corporate Governance (6)4. Quality of risk management (*) 5. Competition (2)5. Political interference (4) 6. Political Interference (8)6. Regulation (6) 7. Management Quality (9)7. Credit Risk (1) 8. Regulation (*)8. Competition (3) 9. Quality of risk management (*)9. Liquidity (*) 10. Staffing (5)10. Back-office operations

Sources MicroRate Publications – MicroRate Publications – CGAP – Focus Note n°71 CGAP – Focus Note n°71 The Mix Market The Mix Market THANK YOU!