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Monthly Archives: August 2009

Froth at the Bottom of the Pyramid – Economist

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In their most recent issue, the Economist included an article “Froth at the Bottom of the Pyramid” that summarized the recent Wall Street Journal article on microfinance and the subsequent responses. It’s a very even-handed review and a healthy reminder that not all microfinance organizations are created equally.

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You can find the article here: http://www.economist.com/businessfinance/displaystory.cfm?story_id=14298996

Why There’s No Credit Crisis in Microfinance

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Why There’s No Credit Crisis in Microfinance – Harvard Business

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Click Here for Original Article

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3:02 PM Tuesday August 25, 2009
by Vikram Akula

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A recent article in the Wall Street Journal would have you believe there is a credit crisis brewing in Indian microfinance — that microfinance institutions are indiscriminately over-lending as they seek to maximize profits. But the article’s assertion was based on a small sample of data that’s not representative of the larger industry. An overload of debt among a few individuals, in one slum, in one city, in one state of India hardly constitutes a bubble. It also misrepresents the nature of microfinance in India today.

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Here are just a few of the facts:

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Repayment rates in India remain solid. Microfinance institutions in India, which serve 22 million clients, have consistent repayments rates of 95% and above — payments that clients could not make if they were not generating regular income, given the weekly collection schedules most microfinance institutions follow. The Microfinance Information Exchange (MIX), a Washington-based nonprofit, reports that the average repayment rate of leading MFIs in India — which have the largest share of clients — is 98%. My own institution, SKS, which serves more than five million clients spread across 70,000 villages and slums of India, has a 99% repayment rate. In tens of thousands of villages and slums across India, millions of microfinance customers are thriving and climbing steadily out of poverty — as shown by a number of independent studies. One in particular, by Karuna Krishnaswamy, suggests that borrowers from multiple microfinance organizations have an equal or lower arrears rate than single-borrowing peers in the same branches. The slum in Karnataka that the Journal article focused on is an aberration in the industry.

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Microfinance borrowers go through a rigorous approval process. The process of approving microfinance loans is completely different from the lax system in the U.S. for approving the mortgages that led to the subprime crisis. Leading microfinance institutions like SKS follow a strict procedure to ensure loans can be comfortably repaid. We require potential members to take three hours of financial literacy training and pass a test indicating they understand interest rates, loan installments, and other product features. We also make small loans exclusively for income-generating activities, not for consumption. We lend only to women, who are known to be more careful with their use of loans than men, and who borrow in interdependent groups of five. Yes, some microfinance institutions — particularly new entrants — may violate these norms. But to extrapolate from the exceptions a sweeping generalization about the entire sector is at best unbalanced; at worst, irresponsible.

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In lieu of credit scores, borrowers prove their reliability over time. The Journal article cites, as cause for concern, that the “average Indian household debt from microfinance lenders almost quintupled between 2004 and 2009, to about $135 from $27.” But the piece failed to point out the underlying reason for this number surge: microfinance institutions deliberately start with small loan sizes and increase them year-on-year as a borrower demonstrates credit worthiness. This gradual increase in loans is a substitute for the lack of a credit score among the poor — something that this neglected and largely undocumented segment of the population does not have. It is a standard practice in the microfinance model pioneered by Nobel Prize winner Muhammad Yunus. Moreover, even at $135, microfinance institutions are still lending well below the typical credit need of a poor household in India, which is $400 (based on survey data from an independent study commissioned by the government’s Small Industries Development Bank of India). These data suggest that, on average, there is no over-lending issue for the sector.

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Microfinance isn’t perfect, and like any fledgling, high-growth sector it’s going to experience growing pains. But we’re taking steps to ease those pains while upholding ethical and transparent lending practices. About 220 microfinance institutions that are members of the industry association Sa-Dhan have signed a voluntary code of conduct. The leading MFIs are also working to create a microfinance credit bureau that would help mitigate credit risk.

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The sector’s rapid growth has been fueled in part by commercial interests. But there’s a lot of merit to the commercial approach. In a decade, SKS has reached millions of poor people at a pace unimaginable not long ago, and we’re now pioneering other ways to use our extensive network to give people access to other products and services they need, such as water filters, solar lamps, and mobile phones. Such scale would have taken far longer if the industry were funded solely by more limited philanthropic funds and grants — and in the meantime, another generation would have slipped into the grinding cycle of poverty.

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Vikram Akula is the chairperson and founder of SKS Microfinance, an organization that offers microloans, insurance, and other services to impoverished people in India. He is the author of the forthcoming book A Fistful of Rice (February 2010).

The Case For Private Equity Investment in Microfinance

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A good write up from a third party on the case for PE in Microfinance.
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Click Here for the Article
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Much has been accomplished since the early days of modern microfinance when NGOs and organizations such as Grameen Bank started lending to industrious, but poor, communities in Bangladesh. The sector now touches well over 100 million people worldwide and boasts a total loan portfolio in excess of US$40bn. Although significant growth was originally catalyzed by grant-led initiatives, such scale would likely not have been possible without the participation of commercial capital. In fact, with billions of individuals still lacking access to basic financial services, representing an estimated demand of US$300bn in loans, the future role of commercial capital will be even more critical. The reality is that it is impossible for microfinance to achieve its full potential without the participation of private equity and debt investment. Quite simply, there is nowhere near enough grant capital available to meet the funding requirements of the world’s microfinance institutions (MFIs) as they continue to scale.

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A role for grant capital in microfinance, however, still exists. Indeed, there are many initiatives that simply fail to offer much potential for a commercial return, but are still critical to the continued development of the sector. These include programs for conducting social impact analysis or the development of microfinance products for “ultra-poor” clientele. In this respect, both commercial and grant capital can work hand-in-hand as the sector continues to evolve and bring more of the world’s poor into the formal economy.

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Private equity in microfinance is mostly invested in the form of early stage start-up or growth capital. This type of investing is very different from the large-cap private equity techniques employed in the developed world, where investee companies are often over-leveraged and streamlined in the pursuit of a short-term exit and return on capital. In contrast, private equity in microfinance often serves to strengthen balance sheets, not to weaken them, and the greater corporate governance requirements of such investors inevitably results in stronger organizations. An increasing flow of this type of capital will not only allow the sector to scale, but will also lead to greater accountability and transparency.

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As an emerging sector within the global financial services landscape, microfinance stands to substantially benefit from the increased participation of private equity investors. Through the provision of risk capital, such investors will actively support new business models and lending methodologies. With this in mind, consider the interesting parallel of the positive role played by private equity in other emerging sectors, where it has often resulted in the financing of hundreds of innovative young companies. Not only have these companies generated attractive returns on equity, but many have also contributed considerable social value by improving productivity, health, and access to information, not to mention the many new employment opportunities they have brought to the market. Examples include technology, telecommunications, biotechnology and, most recently, clean technology, all sectors that would not have achieved the same level of success without the risk capital, strategic support and commercial networks that private equity investors provide.

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While the volume of private equity invested in microfinance to date has barely scratched the surface of the sector’s requirements, there are already a number of examples of the positive role that this capital has played. In India, a series of notable investments has provided the foundation for increased outreach, greater geographic diversity, the introduction of new products and improved mechanisms to attract and retain high quality talent. Over the past two years, the five largest MFIs in the country have been the beneficiaries of approximately US$180m in private equity investment, which has helped them to grow their combined active client bases from 2.2 million to over 4.7 million, a compound annual growth rate of 45%. Four of these organizations are now serving well over a million active clients each. Furthermore, numerous new business models have been launched as a direct result of investor support. Of particular note are the branchless banking technologies currently enabling millions of previously unbanked individuals to efficiently access deposit accounts, government disbursals, insurance products, and even secure payment platforms.

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Despite the positive impacts of such investments, some still criticize private equity backed MFIs for their rapid growth rates. This is potentially a valid concern, but prudent investors will always seek to temper such growth with conservativism, since a default-ridden loan portfolio is of limited value no matter how large it is. This ensures that the interests of private capital are aligned with those of the recipients of MFI credit – both parties benefit from growing a quality loan portfolio, promoting greater operational efficiencies and technological sophistication, and ultimately from accessing public capital markets. These benefits all serve to lower the operating costs of the MFI, therefore resulting in a lower cost of capital and more efficient service for the end client.

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As we reflect on the evolution of the microfinance sector from its origins in 19th century Germany*, and its subsequent development in South Asia, it is clear that an increasing participation of private capital has already stimulated greater competition amongst for-profit MFIs. This will ultimately lead to lower interest rates, a higher quality of service, and a greater diversity of products. Further private equity investment will be a key factor in enabling the sector to reach the billions of unserved clients who still live outside the formal financial system. It will also help more MFIs take a number of important steps towards better serving this market by securing banking licenses (enabling cheaper funding through deposits and a much needed saving tool for their clients), attracting world class talent and accessing cheaper capital markets. As we have seen, private equity and grant capital are far from being mutually exclusive and can actually co-exist. Grants have already realized many valuable developments, and in the future it is likely that this type of capital will also address many more important issues such as the measurement of microfinance’s social impact, the best way to serve the poorest of the poor, how to increase financial literacy, and how best to deliver complementary services like healthcare and education. Each of these is very valuable, not only for the clients concerned but also for society at large, strengthening the sector overall and thereby complementing the ongoing efforts of private equity investors.

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* Raiffeisen Banks were founded in 1846 in rural Germany and are early examples of microfinance institutions. Many of them are still in operation today, functioning as co-operatives or savings banks.

For Global Investors, Microfinance Funds Pay Off – WSJ

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For Global Investors, ‘Microfinance’ Funds Pay Off — So Far

Wall Street Journal, August 13, 2009

By ROB COPELAND

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Investing in funds that make small loans to third-world borrowers has been lucrative the past 12 months. But the weak global economy has some investors worried about trouble ahead.

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The $30 billion industry, partly made up by small lenders on the ground financed by bigger microfinance investment funds, has been expanding its lending at a 40% to 50% annual pace over the past five years, according to the Consultative Group to Assist the Poor, a research institute hosted at the World Bank.

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Those microfinance funds have returned 4.47% for investors the past 12 months, according to a benchmark index, compared with a 22% loss by the Standard & Poor’s 500-stock index.

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While the inflow of funds from the Western world has allowed lending to boom to small borrowers in poor countries — from India to Bosnia to the Ukraine — it’s also sparked worries that too much money is chasing too few loans.
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“As soon as we reach a certain limit, we will see more [loan] defaults,” said Jacques Grivel of the Luxembourg-based $100 million Finethic fund, which invests in microfinance world-wide.

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Already more than 100 investment funds are focused on microfinance, typically accepting money from targeted individuals or institutions, usually with a minimum of $10,000. The funds then buy the bonds or stocks of small, local banks in mostly third-world countries. These banks then lend money to tiny entrepreneurs at annual interest rates up to 50%.

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Not everyone is persuaded the industry is hitting a barrier. They argue that the business is still in its infancy, and $30 billion of loans is a drop in the bucket compared with the needs.

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Bob Annibale, head of a Citigroup unit that advises local microfinance lenders, said his clients are “aware of what’s happening in their markets and the challenges.” They have halved their lending pace, and are taking a harder look at potential borrowers, he said.

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Meantime, fund managers, spurred by the surge in investor interest, are launching new funds. Dexia Bank’s $500 million Micro-Credit Fund has added $100 million in the past year and MicroVest Capital Management, a Bethesda, Md.-based company, is starting a new fund this fall.

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Alex Hartzler, a Harrisburg, Pa., entrepreneur, put $750,000 into funds run by MicroVest. “This has outperformed everything else I’ve had,” he said. Microvest’s first fund has averaged 8% annual returns since 2003, according to the fund manager.

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Microfinance is largely unregulated, and lending standards remain relatively opaque. Since most U.S.-based funds aren’t registered investment companies, they aren’t subject to Securities and Exchange Commission oversight.

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It’s tough to get solid data about loan performance at microfinance firms. According to the Consultative Group to Assist the Poor, the accepted default rate is around 2%. By comparison, a U.S. subprime-mortgage default rate is closer to 30% for loans 90 days past due or in foreclosure.

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However, the International Association of Microfinance Investors, which attempted to verify the 2% default rate this month, said the rate could actually already be much higher, since bookkeeping by many local lenders is incomplete.

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Gustavo Moron, business manager for Financiera Edyficar, a small Peruvian bank that specializes in lending to small-business owners, said he’s being pinched between stiff competition and the flailing economy. In cities like Cusco, at the foot of the Andes Mountains, Mr. Moron is slashing monthly interest rates to 1% from 3% to salvage repayments from taxi drivers, artisans and tour guides who aren’t making money because of weak international tourism.

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As returns are shrinking, he finds himself taking chances he hasn’t before. “We’re loaning to people we wouldn’t have two years ago,” Mr. Moron said in a phone interview from Lima.

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Microcredit may not work wonders but it does help the entrepreneurial poor – Economist

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A partial marvel

Jul 16th 2009
From The Economist print edition
Microcredit may not work wonders but it does help the entrepreneurial poor
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MICROCREDIT looks like a miracle. It involves providing unsecured small loans to poor people in developing countries whom most banks would turn away. Yet these small borrowers almost always repay their loans (and the fairly steep interest charges) on time, which suggests that they find productive uses for the money. The industry’s backers make some big claims as a result: Mohammad Yunus, the founder of Grameen Bank in Bangladesh and the father of microfinance, reckons that 5% of Grameen Bank’s clients exit poverty each year. Yet economists point out that there are surprisingly few credible estimates of the extent to which microcredit actually reduces poverty.

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This would not matter too much if all microfinance funding were raised via the market (as an increasing proportion is). As long as investors were satisfied with their returns, there would be no cause for concern. Yet despite growing interest from private investors, 53% of the $11.7 billion that was committed to the microfinance industry in 2008 still came at below-market rates from aid agencies, multilateral banks and other donors. Given that there are other things that aid money could be spent on, and that the rationale for subsidising microcredit is its effectiveness as an anti-poverty tool, it is important for donors to know whether it has the advertised effects.

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Measuring the impact of microcredit is complicated by the fact that the counterfactual—what would have happened to a person who borrowed from a microlender if he had not done so—cannot easily be tested. Many early studies compared borrowers with non-borrowers. But if borrowers are in any case more entrepreneurial than those who do not borrow, such comparisons are likely to overstate hugely the effect of microcredit.

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Worries of this nature are not mere nitpicking. One study surveyed 1,800 families in rural Bangladesh and found that an impressive 62% of school-age sons of those who borrowed from Grameen Bank were in school, compared with 34% of the sons of non-borrowers. Advocates argued that this showed that microcredit helped increase school enrolment. But a comparison with people of similar backgrounds in villages without access to microcredit showed that the difference was because people who were already more likely to have children in school were also those who signed up for microcredit. Even comparisons between areas with and without microcredit may be misleading, because microlenders naturally choose to work in areas where their prospects of success are the greatest.

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The pervasiveness of these self-selection issues has led researchers to devise experiments that allow them to ensure that participation in a programme is determined essentially by chance. Two new papers* apply this idea to measure the effect of access to microcredit. Researchers from the Poverty Action Lab at the Massachusetts Institute of Technology (MIT) worked with an Indian microfinance firm to ensure that 52 randomly chosen slums in the city of Hyderabad were given access to microfinance, while 52 other slums, which were equally suitable and where the lender was also keen to expand, were denied it. This allowed the researchers to see clearly the effect of microcredit on an entire community. Dean Karlan of Yale University and Jonathan Zinman of Dartmouth College carried out a similar exercise in the Philippines, this time at the level of the individual borrower. They tweaked the credit-scoring software of a microfinance firm so that only a random subset of people with marginal credit histories were accepted as clients. These clients could then be compared with those who sought credit but were denied it.

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Broadly speaking, neither study found that microcredit reduced poverty. There was no effect on average household consumption, at least within a year to 18 months of the experiment. The study in the Philippines also measured the probability of being under the poverty line and the quality of food that people ate, and again found no effects. Microcredit may not even be the most useful financial service for the majority of poor people. Only one in five loans in the Hyderabad study actually led to the creation of a new business. Providing people with safe places to store their (small) savings may help them more in the long run.
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Small and perfectly formed?

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That said, microcredit did have discernible effects. In India, people in the slums that had access to microcredit were more likely to cut down on things like tobacco and alcohol in favour of durable goods (particularly items such as pushcarts or cooking pans that are used heavily by traders and food-stall owners). One reason average consumption failed to increase may therefore be that more people were diverting some of their own income into starting or expanding their businesses. Microcredit clearly allowed more people to overcome the barrier posed by start-up costs. The MIT researchers found that as many as one-third more businesses had opened in slums which had a microcredit branch. This may mean that even though there was no measurable impact on poverty during the study period, there may well be some over a longer time-frame as these businesses prosper.

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Tiny loans are unlikely to be enough to allow these businesses to grow to an efficient scale, of course. But the role of microcredit in allowing people to signal their creditworthiness is valuable, especially if their success makes banks more willing to lend them larger sums and leads to even more economic activity. By being willing to take a risk on entrepreneurial sorts who lack any other way to start a business, microcredit may help reduce poverty in the long run, even if its short-run effects are negligible.

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Hans Rosling’s new insights on poverty

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If you are not familiar with researcher Hans Rosling. He is a brilliant statistician who uses an amazing data tool to show how countries are pulling themselves out of poverty. This is a good taste of his style and conclusions while also demonstrating Dollar Street, comparing households of varying income levels worldwide. His data and technology is publicly available at gapminder.org.

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