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Monthly Archives: April 2010

The rich get richer, the poor get richer, the New York Times gets outraged

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A great article below in response to the NYT article from last week. One thing not mentioned is that not-for-profit MFIs charge similar, if not higher, rates of interest as do for-profits. Thus, the “complaints” lobbied against the for-profits should be brought against the not-for-profits, if not more so. However, all players are significantly better for clients than local moneylenders!

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The rich get richer, the poor get richer, the New York Times gets outraged

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by Don Watkins on 4/23/10
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Look out world: the rich are getting richer by helping the poor get richer. The New York Times warns us that “Big Banks Draw Profits From Microloans to Poor.”
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According to the Times, “Drawn by the prospect of hefty profits from even the smallest of loans, a raft of banks and financial institutions now dominate the field, with some charging interest rates of 100 percent or more.” Now critics of these companies are complaining that the reputation of microloans will be “tarnished by new investors seeking profits on the backs of the poor…”
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But profits aren’t made on anyone’s backs. They are made by creating value and are a sign of mutual gain. Nike profits by making great shoes. Amazon.com profits by running a quality online bookstore. McDonald’s profits by serving delicious food to anyone willing to spend a few bucks. They all profit by making us better off (otherwise we would patronize their competitors). Well, microloan companies profit by providing the poor with a service they desperately need at prices they willingly pay.
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No, suggests the Times, those prices aren’t paid willingly: the poor are taking those loans because they are “too inexperienced and too harried to understand what they are being charged.” But the only example the Times can dredge up to illustrate this point is a Mexican entrepreneur who used microloans to successfully expand her t-shirt factory five times over, and who can now pick up the phone and get a fresh infusion of cash for her business within the span of a day. That’s not a scandal–that’s inspiring.
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Microloan companies deserve their profits and have a moral right to every penny they can earn through voluntary trade. To succeed, they have to be willing to accept the risks inherent in making small loans to incredibly poor people in incredibly poor countries that don’t exactly regard property rights as sacrosanct. Indeed, the Times article itself grudgingly admits that these facts probably account for the relatively high interest rates microloans often carry.
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While the Times treats news of industry profits as a shocking revelation, the only thing shocking is its shock. Why else would companies be willing to brave the vicissitudes of shyster governments and deliver capital to tiny businesses at a moment’s notice but for the profit motive?
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Opponents of microloan companies have an answer to that. The Times quotes economist Muhammad Yunus: “Microcredit should be seen as an opportunity to help people get out of poverty in a business way, but not as an opportunity to make money out of poor people.” Read that sentence again, because what it denounces is viewing the poor as traders rather than charity cases.
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Profit is a benevolent force that creates a harmony of interests among all producers, rich or poor–and any attempt to reduce industry profits can accomplish only one thing: to reduce the poor’s access to capital and prevent microloan companies from reaping the rewards they’ve earned.
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Counting the world’s unbanked – McKinsey Quarterly

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Counting the world’s unbanked

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MARCH 2010: Alberto Chaia, Tony Goland, and Robert Schiff
Source: Social Sector Practice

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Fully 2.5 billion of the world’s adults don’t use banks or microfinance institutions to save or borrow money, but unserved doesn’t mean unservable.
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Fully 2.5 billion of the world’s adults don’t use formal banks or semiformal microfinance institutions to save or borrow money, our research finds. Nearly 2.2 billion of these unserved adults live in Africa, Asia, Latin America, and the Middle East. Unserved, however, does not mean unservable. The microfinance movement, for example, has long helped expand credit use among the world’s poor—reaching more than 150 million clients in 2008 alone.1 Similarly, we find that of the approximately 1.2 billion adults in Africa, Asia, and the Middle East who use formal or semiformal credit or savings products, about 800 million live on less than $5 a day (Exhibit 1). Large unserved populations represent opportunities for institutions that are able to offer an innovative range of high-quality, affordable financial products and services. Moreover, with the right financial education and support to make good choices, lower-income consumers will benefit from credit, savings, insurance, and payments products that help them invest in economic opportunities, better manage their money, reduce risks, and plan for the future.
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http://www.mckinseyquarterly.com/Nonprofit/Performance/Counting_the_worlds_unbanked_2552#
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S&P upgrades ratings of Mexico’s Banco Compartamos

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S&P upgrades ratings of Mexico’s Banco Compartamos

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Microfinance Monitor, April 16, 2010: Ratings agency Standard and Poor’s has upgraded the Mexican microfinance bank Banco Compartamos’s long and short-term ratings to ‘mxAA‘ and ‘mxA-1+’, respectively.
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The upgraded ratings reflect Compartamos’ capacity to maintain its financial profile, based on its asset quality and profitability, which surpasses those reported by the main participants of the Mexican financial sector, said a press release from S&P.
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In addition, the ratings for the local bank bonds (COMPART 09) were also upgraded to ‘mxAA’ and ‘mxA-1+’, with a ‘Stable’ outlook. The stable outlook reflects the bank’s financial profile, which it has been able to sustain despite a continued and complex economic environment, said the statement.
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“Even more positive ratings action could occur in the case that Compartamos were to diversify even further its revenue streams and if its financing sources allow the Bank to have more stable financing sources,” the statement added.
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10 Determinants of Interest Rates in Microfinance

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10 Determinants of Interest Rates in Microfinance

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April 17, 2010 by Fehmeen
Source: lormet.com
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While the necessity of charging interest on microcredit has been widely accepted, there seems to be plenty of disagreement over the level of interest rate charged by microfinance providers because the factors that go into these calculations are not well known. We often hear about high transaction costs and cost of funds in microfinance as justifications of high interest rates, but there is more to it than that. This post shares some of these causes.
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Determinant 1: Cost of Funds

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A large portion of an MFI’s funds are sourced from commercial banks (a 2006 MIX Publication) and the cost of these funds is the market interest rate. In fact, this financial expense, combined with the fees paid on such loans and deposits taken from the public, account for 23% of the interest rate charged by profitable microfinance providers (2010 MIX Publication).
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Determinant 2: Operating Expense

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Personnel and administrative expenses form the largest component (62%) of interest rates charged by sustainable microfinance providers, as per the report mentioned earlier. According to an ADB publication, high transaction costs are associated with disseminating and recovering a large number of small-sized loans, often to clients in geographically dispersed areas with poor infrastructure and security conditions. However, this cost can be reduced by introducing certain technology-related solutions, such as mobile banking, ASP infrastructure model and an MIS customized for microfinance.
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Determinant 3: Contingency Reserves (Provision for Bad Debt)

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‘Provisions for bad debt’ is often a regulatory requirement for bank-led MFIs but other types of MFIs realize the importance of creating an emergency fund to provide a cushion against the risk of loan defaults. As a result, ‘portfolio losses’ account for 6% of interest rates charged by successful microfinance providers, according to data provided by Microfinance Information Exchange.
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Determinant 4: Tax expenses

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Since MFIs often operate in the form of banks, they are subject to business taxes that are often higher than those levied for other businesses. Even though an MFI’s business tax expense is factored into the interest rate calculations by 2%, clients have to pay sales tax on their borrowings as additional fees.
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Determinant 5: Profits

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The profit motivation of microfinance providers is vital for many reasons and it’s only logical that profits form a part of interest rate charged on microloans. The tricky part is ensuring that the returns generated are reasonable and not indicative of greed, as in the case of Bank Compartamos.
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Determinant 6: Credit Rating of Client

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The credit ratings associated with individual and group clients will determine whether a risk-premium is charged on interest rates to off-set the risk of default and maintain the risk-adjusted return to investors.
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Determinant 7: Inflation Levels

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Under the Fisher Effect, inflation erodes the equity levels of an MFI’s lender. As a result, microfinance providers need to raise nominal interest rates to ensure the real value of funds remains the same over time.
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Determinant 8: Higher Competition

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While greater competition among MFIs in many countries has lowered interest rates, a recent study by Financial Access Initiative shows the opposite to be true in Uganda. Greater competition has encouraged MFIs to serve ‘niches characterized by smaller scale loans’ and higher interest rate spreads. In other words, poorer clients in remote areas are targeted with comparatively higher interest rates on smaller loan sizes. Ironically, this partially serves the purpose of microfinance.

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Determinants 9 & 10: Other Factors Impacting the Interest Rate

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Two less definitive factors that impact interest rates, in the opinion of Ruth Goodwin-Groen, are:
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* Management Competence: by tweaking the business process to improve efficiencies, or altering the product design of microloans, managers can lower their operating costs and hence, interest rates.
* Financial Literacy of Clients: if clients understand the actual costs they incur, they perform better comparison shopping and negotiate lower interest rates.
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If you can think of any other factors, please be sure to share them. Alternatively, if you liked this article, you may like to read up on other areas in microfinance theory.
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What Makes The Microfinance Sector Attractive to PE Investors? – WSJ.com

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What Makes The Microfinance Sector Attractive to PE Investors? – WSJ.com

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April 5, 2010, 10:30 AM

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By Durga Raghunath

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Reader Discussion: Inspired by a report describing the attractiveness of the Banking and Financial Services Sector for the PE Investor, Mentors this week will discuss the universals that make a sector attractive.

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In a recently published report, credit venture intelligence, three articles comprehensively lay out the attractiveness of microfinance as an investment sector.

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File photo of women are seen gathered and exchanging money in a micro-finance group in Andhra Pradesh, India. Sanjit Das for The Wall Street Journal

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Samir Bali, Partner at Ernst and Young India writes that partnerships with local vendors including postal departments, the establishment of a credit information bureau and RBI’s revision of mobile banking have collectively led to the massive growth of the sector. Scale, fiscal controls and access to easy transactions mark these initiatives. Mr Bali clearly states that fundamental challenges still remain.

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  • Multiple Borrowings where customers borrow multiple times to refinance existing loans results in non performing assets.
  • The lack of a regulatory framework that will not only ensure orderly growth but allow service expansion
  • Lack of standardized customer information
  • End-of-finance monitoring which will let lenders know where the borrower is using the money

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In this context, Sasha Mirchandani, Prashant Choksey and Anil Joshi make the case for a broader acceptance of the utility of interpreting the semantics of microfinance as “Reaching those excluded from formal financial services”. As a market definition this then includes the geographically isolated as much as the socially and economically excluded.

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“Microfinance is a sector that has opportunities for all investors” said Arun Natarajan, MD and CEO of Venture Intelligence. “The first two stages required smaller, sector specific investors but now it has moved to classic PE territory”, he said.

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In an earlier post Sanjay Anandaram argues for smaller funds in small economies; he says small startups typically do not require large capital infusion at early stages. In contrast, Microfinance becomes a target for constant investment as it requires regular capital infusion – more access, means more loans which then means greater capital adequacy to meet RBI guidelines and better infrastructure. Engineering Construction, according to Mr Natarajan, could also be another example of a sector constantly needing equity to even sit on the bidder’s table. The perfect setting for Private Equity and Venture Capital Investments.

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The outlook for microfinance investment 2010

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The outlook for microfinance investment 2010

Thursday, April 1, 2010, 16:25

http://www.microfinancefocus.com/news/2010/04/01/special-report-is-the-crisis-over-the-outlook-for-microfinance-investment-2010/

By Matthew Fuchs

Microfinance Focus , April 1, 2010 : After a challenging year, 2010 has begun on an optimistic note for microfinance investors. Some fund managers have declared that the recovery has begun, albeit a gradual one. Dr. Armand Vardanyan, Fund Manager, Dual Return Vision Microfinance Fund, has stated that MFIs are recovering, despite some isolated incidents, with an improving outlook for growth and profitability.

Echoing this sentiment, Alesha Wagle, Senior Portfolio Analyst, MicroCredit Enterprises, expects the overall investment climate for microfinance to improve in 2010. Christian Speckhardt, CIO at responsAbility AG also agrees, expecting MFI demand for credit to increase by 10-15% by year-end.

Certainly, the news so far has been good, with major funds reporting positive results for January and February, ending a trend of negative returns in Q4 2009. These funds performed well in 2009, but the impact of the challenging economic conditions was clear, with returns down significantly compared to previous years. For example, the SMX 50, an index conducted by Symbiotics tracking the performance of major Luxembourg-registered funds, shows returns for FY-2009 at 3.08%, down from 5.95% in 2008 and 6.33% in 2007. This was in-line with the CGAP 2009 MIV Survey estimates, which forecast returns to fall below 3.5% in 2009. Reasons identified by the survey for reduced returns included high proportions of liquid assets in fund portfolios, increased provisions against loan-losses and higher costs for currency hedging due to volatility in Forex markets. Any discussion of the outlook for the microfinance needs to consider these factors, how they impacted investment performance in 2009, and what implications these have for the investment outlook this year.

Will investment conditions improve in 2010? Examining the underlying fundamentals

Liquidity

Liquid assets refer to the proportion of fund that is uninvested, that is the different between the total assets and microfinance portfolio. Usually taking the form of cash (although other non-microfinance assets may be included), a liquidity buffer is desirable to guard against cashflow shortages. But as unproductive capital in the sense it is not invested in loans to MFIs or equity, if liquidity positions become to large they can place a drag on returns. For example, if a fund has 30% in liquid assets compared to 10% a year ago, 20% less of a fund is being put to use (even if the microfinance portfolio is the same size or even larger then it was). This situation can result when fund growth, for example through new contribution, out-paces the rate of investment. This is the situation which many microfinance funds are currently dealing with.

Increased demand for funds will help ease excess liquidity, which by the end of 2008 were around 20% for Luxembourg-domiciled MIVs according to the CGAP 2009 MIV Survey. Liquid assets such as cash as a percentage of total fund volume increased significantly from 2008 to 2009 for two major Luxembourg funds — responsAbility Global Microfinance Fund (rAGMF) and Dexia Microcredit Fund (DMCF), This decreased slightly in January in response to slowing investment and a lack of significant fund inflows in Q4-2009 (see table below).

Table 1: Cash and Liquidity positions as % of Total Assets
Year DMCF rAGMF
2010 (Jan.) 27% 28%
2009 (Jan.) 14% 18%
2008 (Sept.) 11% 10%

Source: Monthly fund reports.

A similar trend can be seen in the percentage of non-microfinance portfolio funds (MFPF) of Luxembourg funds as tracked by Symbiotics, which suggests a high level of liquidity. While total assets of the SMX50 index leveled off in H2-2009, there has been no indication that investor interest in microfinance has declined, as fund managers are upbeat in their expectations for attracting new funds in 2010. The CGAP 2009 MIV Benchmark Survey estimated that total assets would grow 26%, which would bring total MIV assets to $8.5 billion. If total assets were to grow at a similar rate in 2010, liquid assets could actually increase, putting further pressure on fund returns.

Source: Symbiotics

Portfolio quality and loan-loss provisioning

Loan-loss provisioning is the expense that has to be set aside to cover losses from bad loans, whether through defaults or renegotiation of terms, such as extension of repayment period or interest rate concessions. Initially, financial performance remained strong throughout most of 2008, maintaining confidence that MFIs were well position to weather the downturn. According to the SYM50 — an index by Symbiotics tracking the performance of 50 large MFIs — Portfolio at Risk (PAR) spiked dramatically in December 2008, peaking at over 5% in October 2009. This in turn directly affected financial performance, with Return on Equity (ROE) falling steeply at the same time.

In response, MFIs generally slowed the growth of their loan portfolios to concentrate on maintaining portfolio quality. However, weakening portfolio has forced some fund managers to take provisions against troubled loans in H2-2009, as revealed by publicly available monthly fund reports. Except for two cases, it was specified that these provisions were made for loans to troubled MFIs in Nicaragua, and Bosnia and Herzegovina. These countries have been affected by repayment crises which have undermined the phenomenal growth that was key to making these countries investment hotspots in the first place. A recently-released report from CGAP, Growth Vulnerabilities in Microfinance, examines these and two other repayment crises in Morocco and Pakistan.

The report reaches an important conclusion — while the economic downturn was a “contextual factor”, the repayment crises resulted primarily from underlying issues stemming from rapid growth and aggravated in these instances, by local anti-microfinance factions (such as the No Pago movement in north Nicaragua). According to the report, during this rapid growth four key vulnerabilities emerged: concentration of lending within specific areas, multiple borrowing leading to high levels of client over-indebtedness, overstretched MFI capacity and loss of lending discipline.

These crises are ongoing and will continue to be problematic in 2010. Therefore further loan loss provisioning remains a possibility.

Addressing the issues that caused the repayment crisis will take concerted action at a local, regional and national level. Suggestions the CGAP report makes include overhauling MFIs operations to refocus attention on portfolio quality through improving portfolio quality monitoring, client satisfaction assessment and developing credit bureaus and strengthening existing ones. Rebuilding the sector and restoring confidence will take time, possibly years, ruling out a quick recovery. As the report points out, the experience of Bolivia, which was affected by a repayment crisis in 1999, demonstrates that such events can lead to development of a stronger and more sustainable microfinance sector in the longer term.

However, microfinance has changed significantly since then. For example, investors, rather then donors, are primary funders of the sector. As a young investment sector, these repayment crises are the first to truly test the current microfinance investment model. And despite a drop in performance, the sector has handled the challenging conditions well, with no funds reporting any serious financial problems due to the repayment crises. Regardless, it will probably prompt a review of risk management strategies and encourage further portfolio diversification. Hopefully, this experience will also enable investors to detect signs of stress earlier so that action can be taken to help prevent future repayment crises from developing.

Equity investments – boom or bubble?

Equity investments in the sector are increasing in importance for the sector, with equity as a proportion of all MIV assets growing by 47% from $987 million in 2007 to US$ 1.45 billion in 2008, representing 24% of MIV investments according to the CGAP MIV Survey. Part of this growth is due to the increase in specialist microfinance private equity funds, with 13 in 2008 representing $257 million. And this figure does not include the equity investments of Development Finance Institutions (DFIs), such as the IFC and EBRD, specialist vehicles established by pension funds, or mainstream venture capital and private equity firms.

An interesting finding of the report was that despite an unprecedented drop in asset quality, and a simultaneous decrease in profitability, MFI equity valuations continued to rise. It concludes that net income growth, rather then profitability, are the key drivers of valuations as investors seek MFIs with high growth prospects. While this trend occurred across all regions, the highest multiples were in Asia, with price-to-book value multiples of 5x, well above the global median of 2.1x.

Table 2: Microfinance Private Equity Transactions:

Price-to-Book-Value
2005 2006 2007 2008 2009
Africa 0.9 1.2 1.6 1.8 NA
Asia 1.7 2 5.1 2.9 5
ECA 1.8 1.3 1 2.1 2.2
LAC 1.4 1.2 1.1 1.2 1.3

NA indicates fewer then five deals

Source: CGAP Microfinance Global Evaluation Survey 2010.

The main contributor to this high figures has been the rapidly expanding Indian market, where valuations have reached 5.9x. This in turn reflects the large influx of capital, which VCCEdge estimates to be around US$80 million, representing 40% of all private equity deals in India.

The CGAP report argues, the price-to-book multiples for Indian MFIs stood at 5.9x price-to-book, or nearly three times the global median, which are difficult to justify and are a cause for concern. It argues that excess capital flows behind these capital flows come from investors motivated by short-term gains. The report even draws parallels with the dot.com bubble, alluding that an equity bubble may be also developing in the Indian MFI equity market.

This influx of capital will probably increase this year in anticipation of the much vaunted IPO from SKS Microfinance — India’s largest MFI. This may be not only from investors seeking to profit from not just this IPO but also from subsequent IPOs that are expected to follow, and is likely drive up valuations further, reinforcing a bubble mentality. At the same time it may encourage investors to look further afield to less competitive microfinance markets in northern India where markets are less penetrated and valuations may be lower. Certainly, this will be a situation that will need close monitoring, as 2010 looks set to be both a landmark year and critical turning point for the microfinance equity market in India.

Regional Outlook: An uneven recovery in 2010?

BlueOrchard’s observation on the current state of the microfinance sector echoes that of the economic outlook. In the DMCF’s January report, the fund manager stated that although most regions were coming out of recession, some regions remain under significant pressure — especially Eastern Europe and Central America. Christian Speckhardt from responsAbility, supports this view also, stating that although there is a noticeable improvement in credit quality overall, risk metrics in Eastern Europe and Central America are likely to continue rising slightly.

According to Mr. Speckhardt, loans in local currencies will become more common in 2010, which will open up more opportunities in Sub-Saharan Africa. Armand Vardanyan, Fund Manager of the Vision Microfinance Dual Return Fund, also foresees increased opportunities in Africa and Asia throughout the year.

Asia and Sub-Saharan Africa (SSA), despite having several fast growing microfinance markets occupy still occupy a small share of fund portfolios compared to Eastern Europe and Central Asia (ECA) and Latin American and the Caribbean (LAC) (Table 3). South Asia share has been growing consistently since 2006, and is expected to have had a record year of growth due in large part to the rapidly expanding Indian market. With a large unserved market, particularly in the north, India is expected to continue to be one of the fastest growing markets in 2010. However at present, most investment is concentrated in MFIs based in the south, fueling concerns that this inflow of capital could encourage the development of a debt bubble in the southern states. Based upon analysis of lending levels in Andra Pradesh and Karnataka, a recent article argues that a bubble has already formed (see Daniel Rozas’ Is there a Microfinance Bubble in South India?). According to the article, this leaves the entire sector in India vulnerable to a spark which could ignite a repayments crisis — whether a sudden drop in economic growth or a populist movement, for example, the author argues.

Coupled with the possibility that an equity bubble is also forming, such a crisis would be a double blow not only to the Indian microfinance sector but could also undermine the emerging MFI equity market. The isolated repayment crisis in the town of Kolar, near Bangalore, demonstrated that the risk is real. Lessons from the current repayment crises in Nicaragua and elsewhere suggests that concerted action should be taken to guard against a similar crisis in India, starting with addressing client-over indebtedness resulting from multiple borrowing. Despite this risk, which will require close monitoring over the next 2-3 years, 2010 is likely to be another standout year for Indian microfinance investment. This inflow is likely to have reduce the gap between South Asia and East Asia/Pacific (EAP) as a share of total portfolio allocation in 2009.

Regardless, EAP will continue to be an important region for investment in Asia, with the region boosting two large, well established microfinance sectors — the Philippines and Indonesia. However, the main draw for investors has been the much smaller but booming market in Cambodia. According to the IFC, lending from MFIs has increased 55% annually between 2006-2008, with total outstanding loans of US$440 million YE-2008. In 2009 the sector continued to grow, with data from the Cambodian Microfinance Association showing that outstanding loans of member MFIs grew by 13% between Q4 2008/09, from US$437 million to US$ 493 million.[1]

Sub-Saharan Africa (SSA) has not enjoyed the same inflow that Asia is attracting, growing steadily but maintaining a portfolio share of between 6-7% of the total MIV asset pool according CGAP 2009 MIV survey figures. But as a share of major globally active Luxembourg funds, it is often much smaller, between 1-3%, according to available fund reports. This reflects in part continuing dominance of donors in the region, who provide 74% of funding to microfinance in SSA — the largest share of any region according to the CGAP 2009 Funder Survey. As noted by the Microscope 2009 report, commissioned by the IDB, CAF and IFC, the investment climate in the region has been limited by comparatively high political and economic risk as well as weak financial sectors. Another important factor has been the shortage of commercially orientated, investment-worthy MFIs, as is reflected in the region’s comparatively low ROE (Table 3).

Table 3: Return on Equity (ROE) by Region
Year Global SSA EAP ECA LAC MENA SA
2008 5.68% -0.73% 12.57% 3.17% 7.63% 4.56% 2.99%

Source: MIX Market (adjusted data).

However the influence donors has had a major benefit for African microfinance. The implementation of progressive regulatory regimes in SSA is due in large part to the political influence of donors and DFIs, the Microscope report argues, with the region poling first in regulation and supervision rankings. This has in turn fostered the growth of regulated NBFIs, many of whom are able to collect deposits. As a result the region has become a pioneer in mobile banking, with a range of initiatives launched in 2008. All of which bodes well for the future of microfinance investment in SSA, which is likely to grow in importance. However, growth will be more gradual compared to SA and EAP, as growth will be limited to an extent by the region’s smaller and less concentrated markets.

And despite exhibiting greater stability over the last decade, political risk in SSA will continue to be an important consideration. Guarantees have potential to address this issue, as demonstrate by two recent investments. In one, Incofin invested in the equity of FINCA Congo with the aid of a guarantee from the Belgian government. In the second, Terrafina together with BRS, ADA and Cordaid, acted as guarantors to facilitate loans to four Ethiopian MFIs from local commercial banks. Donors and DFIs such as the IFC or KfW could play an important role in boosting commercial investment in African MFIs. It will be interesting to see if guarantees play a more prominent role in 2010.

MENA, which weathered the recession well, has solid growth expectations in 2010. However, the region’s small and immature microfinance markets currently limit the scope for significant expansion in investment opportunities. Furthermore, Morocco, MENA’s most developed microfinance market, is still repairing the damage from the repayment crisis, so growth in that country may stagnate or even contract. Therefore, portfolio allocations to the region are likely to remain unchanged at around 1%.

2010 – a year of consolidation

Christian Speckhardt from responsAbility sums up the mood well when he described 2010 as a year of “transition and maturity” for microfinance. For the sector 2009 represented a turning point for microfinance with conditions which tested strength of the microfinance model. On the whole the sector has has done well, but it has also brought to the surface underlying issues the industry needs to address as it matures — adequate risk management and balancing of growth with operational sustainability. With growth expected to slow in 2010, this will the sector a chance to consolidate the gains made in recent years by focusing on addressing these issues.

Likewise, microfinance investors will also adjust to this new climate. While MFI demand for debt is expected to recover in 2010, it is likely to remain lower then pre-crisis levels. This may mean that if fundraising remains strong, funds may find it difficult to lower fund liquidity, which may in turn maintain pressure on fund returns.

Equity investments will continue to growth in importance during 2010, centered around the high growth market in India. While 2010 is likely to another standout year for equity investment in India, with signs of a valuation bubble developing the situation will have to be monitored closely.

In 2010 investment in Asia and Sub-Sahara is likely to increase as investors seek to further increase fund diversification and take advantage of growing opportunities in these regions. Investment in the more established regions, Europe and Central Asia and Latin America and Caribbean, may grow more slowly and possibly decline as a percentage of microfinance portfolio allocations.

How to Tell Good MFIs from Bad MFIs

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An excellent article below which enumerates the difficulty of using an interest rate only to determine “good” vs “bad”. This article also illustrates well the value of the for-profit model, driving higher financial and social returns. This seems like a contradiction in terms, but the empirical evidence begs the question of superior social impact for not-for-profits in the sector. … PLEASE READ THE ENTIRE ARTICLE …

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How to Tell Good MFIs from Bad MFIs

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by Richard Rosenberg: Tuesday, March 16, 2010

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Most of us working in microfinance want microloan clients to be paying interest rates that are as low as possible. While we have the same vision, there is disagreement about how to determine whether an interest rate is an appropriate one.

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Some people, including Mohammed Yunus, are worried about the growing commercialization of microfinance, including the entry of profit-motivated owners and managers.  They are concerned, reasonably enough, about possible “mission drift,” especially in the form of interest rates rising to (or staying at) excessive levels. In his book and in many presentations, Professor Yunus offers a straightforward formula for judging MFIs and their objectives:

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• If you’re a real microlender who cares about the poor, then your interest margin (the difference between the rate you charge when lending to your clients and the rate you have to pay when you borrow from your funding sources) should be no more than 10%. That’s the “green zone” where true microlenders operate.
• If your interest margin is 10-15%, a big warning sign is flashing because you’re in the yellow zone.
• Anything above 15% is the red zone, where you’ve left true microcredit behind and joined the loan sharks.

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Unfortunately, when you look at the evidence, this appealingly direct formula turns out to be pretty far off the mark.

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To begin with the conceptual problem, the formula doesn’t allow enough room for legitimate differences in administrative costs among MFIs. For an MFI that makes especially small loans or serves a sparse rural clientele, administrative costs will inevitably be a higher percentage of loan portfolio, and the lion’s share of the interest rate spread goes to cover those costs. Application of the proposed formula could actually discourage outreach by such MFIs to poorer clients.

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But concepts aside, how does the formula match up against actual MFI experience? It turns out that this formula would place most of the world’s MFIs in the red zone—the average interest rate spread for MIX MFIs in 2008 was over 20%.  But to be fair to Prof. Yunus, that shouldn’t end the discussion.  After all, maybe plenty of the MFIs in the MIX are charging their borrowers rates that are way too high.

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Now let’s test the green-yellow-red formula against a group of Grameen-approved MFIs. Christoph Kneiding and I analyzed MIX data on Grameen along with several dozen MFIs that received support from the Grameen Foundation and reported to MIX. In 2007, for instance, 33 MFIs (representing about two-thirds of the Grameen Foundation recipients) reported to the MIX.  The only one in the green zone that year (interest spread below 10%) was Grameen Bank itself. Seven were in the yellow warning zone (10-15%). All the other 25 were up in the red zone (above 15%) and most of them way up in the red zone (between 30 and 55%). The three preceding years looked pretty much the same.

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The proportion of Grameen affiliates in the red zone was about the same as the worldwide proportion: for instance, 75% of all MIX MFIs were in the red zone in 2008, according to a new study by Adrian Gonzalez of MIX. NGOs were more likely to be in the red zone than for-profit MFIs, suggesting that interest spreads may be driven more by the higher costs of smaller loans than by profit maximization objectives. (Average loan size in NGOs is about a third of what it is in for-profit MFIs.)

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Has the Grameen Foundation has been fooled into working with a bunch of red-zone partner MFIs that are wolves in sheep’s clothing? Far from it. The Grameen partner MFIs that look so terrible on the green-yellow-red test actually appear quite strong—in fact, well above average—on indicators normally thought to be associated with commitment to the poor, such as average loan size.  Nor do they appear to be inefficient: they average considerably lower on cost per borrower than the other MFIs in their countries.

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It’s disappointing that simple formulas can’t help much when it comes to appraising things like mission drift or fairness of interest rates. It takes a more complex analysis (see, for example, the CGAP papers on microcredit interest rates and Banco Compartamos).  I hope we see a lot more MFI-by-MFI analysis, in which the reasonableness of interest rates is judged by the reasonableness of the costs and profits that produce those interest rates. We all want to see MFIs charging clients rates that are as low as possible, so we need analytic tools that can do a credible job of separating the sheep from the goats in that regard.

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