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A great WSJ article on myths behind microfinance and the viability of the business model in addressing sustainable and profitable methods in eleviating poverty and inclusive finance.

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http://online.wsj.com/article/SB125203953484285845.html?mod=googlenews_wsj

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By SUYASH RAI and SONA VARMA

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The power of finance to transform the lives of the poor is not well understood. Despite recent articles that raise concerns about microfinance, the evidence at large shows that successful microfinance institutions (and their list is growing) have managed to implement service delivery mechanisms that meet the needs of the poor, at a lower cost than most accessible alternatives. The work of these institutions, and a number of well-researched reports, shed light on the economic lives of the poor and the way the poor manage their finances.* These reports use detailed surveys, interviews and robust analytical techniques to improve our understanding of the impact of financial services on poverty.

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Suyash Rai.

Drawing on this body of evidence helps counter a number of popularly held misconceptions about role of finance in the lives of the poor. The following noteworthy misconceptions are worth highlighting:

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The poor are not creditworthy: The recent financial crisis has given a bad name to ‘sub-prime’ borrowers in general, and often the terms ‘poor’ and ‘sub-prime’ are used interchangeably and equated with ‘lack of creditworthiness’. As research on the crisis is pouring in, we are learning that the real causes probably had more to do with the mechanisms of service provision and inadequate regulation. Moreover, the micro credit experience of the last three decades decisively challenges this perception, showing that if suitable mechanisms are used, the poor can be as creditworthy as the rich. The poor’s lack of collateral can be overcome with joint liability within a group of borrowers, and this has resulted in very high repayment rates in micro credit over the last three decades. Micro finance institutions have consistently reported repayments upwards of 95% in a number of developing countries.

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Sona Varma

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Finance falls lower in the ‘hierarchy’ of needs for the poor, below health, education etc: Finance should ideally fall out of any such hierarchical ordering of ‘inputs’ into a household, because it is a cross-cutting tool that helps households’ wellbeing across several dimensions. For example, even someone living just on government support can benefit from a sound payment system that ensures timely delivery of cash or a savings facility that provides a safe option to save. Empirical research shows that the poor use many financial instruments frequently, but due to absence and unsuitability of formal mechanisms, they have to rely mainly on unreliable informal service providers.

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Credit is the only financial service required by the poor: Most people equate financial service provision with the provision of credit. Studies clearly show that the poor need a range of services such as a) risk mitigation mechanisms, for example insurance, to protect against exogenous shocks; b) savings facilities to smooth consumption and get reasonable returns even on small amounts; and c) investment/risk management mechanisms that allow for wealth creation and diversification of risk. A number of successful initiatives, such as those providing micro insurance or small ticket investments in mutual funds, re-affirm the hypothesis that the poor demand and can benefit from the same wide range of financial services that are routinely provided for the rich.

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“Given the complexity in their financial lives, the poor are very sophisticated in their use of financial instruments.”

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The poor are not sophisticated in using financial services, so access to finance may end up damaging their livelihoods: On the contrary, research on the use of financial services by the poor shows that given the complexity in their financial lives, the poor are very sophisticated in their use of financial instruments. Due to the absence of well-designed formal services, they end up creating a complex mesh of informal financial mechanisms around their lives. It seems this is the only way they can meet multiple needs using informal instruments. For example, financial diaries of the poor show how they creatively use a variety of loan sources to deal with the irregularity in their incomes and expenditures. Research also shows quite convincingly that on an average the chronic poor, i.e. those who fail to move out of poverty, do take initiatives to change their conditions. Failure to move out of poverty is primarily because of lack of access to capital and relevant networks. The recent evaluation of a micro credit program in India shows how entrepreneurial households consistently use credit to start successful new businesses or improve the profitability of existing businesses.

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Finance can help poor households optimize severely constrained resources across their lifetime. Like the rich, the poor also need to use finance responsibly to ensure that they avoid over-indebtedness and other problematic outcomes. Similarly, financial service providers need to focus on reducing delivery costs while ensuring high quality services that reflect a good understanding of client needs. This often ups the ante in terms of the work that goes into offering a useful suite of financial services for the poor. But the rewards can be immense.

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* A report by the World Bank titled “Moving out of Poverty” presents results of research on the processes of falling into and coming out of poverty. Similarly, “Portfolios of the Poor: How the world’s poor live on $2 a day”, a book by leading researchers in the area of access to finance, presents analysis of households’ financial behaviors in three developing countries, documented using rigorous methodologies. A recent paper from researchers at MIT presents the results of evaluation of a microfinance operation in Hyderabad, India, the first ever randomised evaluation of micro credit

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—Suyash Rai is Senior Manager and Sona Varma is Senior Advisor with IFMR Trust, a private trust with the mission of ensuring complete access to financial services for individuals and enterprises in India.

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

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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).

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 — 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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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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July 22, 2009: Banco Compartamos, the Mexican microfinance bank, on Tuesday announced its second quarter results which show net profit rose 31.3% totaling 327 million pesos ($24.7 million), up from 249 million pesos recorded in the corresponding quarter of 2008, in a statement filed with the Mexican Stock Exchange.
The bank’s active clients reached 1,317,472 or a 40.1% increase compared to 2008 and its total loan portfolio reached 6,729 million pesos or a 40.4% increase compared to second quarter in 2008.
Earnings per share or EPS, excluding shares repurchased, reached 0.79 peso versus 0.58 peso in second quarter of 2008, representing 35.2% growth. Equity to assets was at 40.1%, while ROAE reached 41.3%.
Carlos Danel, the Bank’s Executive Vice President, said despite a challenging macroeconomic environment, the bank said it achieved 40.4% growth in the total loan portfolio driven by a 40.1% growth in the number of active clients being served with 1,841 more employees than a year ago. “Another important aspect of our strategy is to improve efficiency; to achieve this, we implemented a key measure of using our existing infrastructure, therefore, during 2Q09, we did not grow the number of offices, thus focusing on controlling costs. This was not only evidence of our commitment to gain efficiencies but also to grow in a manner that is aggressive yet controlled,” he said.
Tha bank’s statement said both rating agencies, Standard & Poor’s and Fitch Ratings, affirmed counterparty credit ratings of Compartamos at ‘mxAA-’ / ‘mxA-1′ and ‘AA-(mex)’ / ‘F1+(mex)’, respectively. The outlook remains stable and the total number of employees reached 7,130, a 34.8% growth.
The ratio of non-performing loans rose to 2.26%, from 1.38% a year earlier which was better than the general banking sector. Danel was confident to reach 2009 goals too. “With half of the year behind us, we are on track to fulfill our goals for 2009,” he said.
Earlier this week, the bank raised $500 million pesos through the public issuance of bonds in the local debt capital markets for a tenor of 3 years. The bonds obtained a credit rating from Standard & Poors of “mxAA-” and “AA- (mex)” from Fitch Ratings.
Banco Compartamos, S.A., is the largest lender to microbusiness owners in Latin America. Established in 1990 and headquartered in Mexico City, Compartamos provides small loans to low-income individuals and business owners, such as craft manufacturers, food vendors and other small businesses. Banco Compartamos’ shares began trading on the Mexican Stock Exchange on April 25, 2007. It is in the process of establishing a 6-billion pesos bond program to issue long-term debt over the next five years.

Walk, don’t run
Jul 9th 2009
The Economist

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In a guest article Justin Lin, the chief economist at the World Bank, argues that low-income countries need to make small, local banks the mainstay of their financial systems

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FIXING finance is easier if you have a clear idea what it is for. What matters most is setting up a financial sector that can serve the competitive sectors of an economy. In many poorer countries, that means focusing on activities dominated by small-scale manufacturing, farming and services firms. The size and sophistication of financial institutions and markets in the developed world are not appropriate in low-income markets. Small local banks are the best entities for providing financial services to the enterprises and households that are most important in terms of comparative advantage—be they asparagus farmers in Peru, cut-flower companies in Kenya or garment factories in Bangladesh.
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The experiences of countries such as Japan, South Korea and China are telling. Those countries managed to avoid financial crises for long stretches of their development as they evolved from low-income to middle- and high-income countries. It helped greatly that they adhered to simple banking systems (rather than rushing to develop their stockmarkets and integrate into international financial networks) and did not liberalise their capital accounts until they became more advanced. The experience of the United States is also instructive. Hulking national banks and equity markets become important only when a country becomes more advanced and when large capital-intensive firms dominate the economy. The rise of the New York Stock Exchange occurred only after the creation of large-scale industrial firms at the close of the 19th century. For the early labour-intensive phase of America’s economic development, local banks were dominant.

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Governments and the international financial institutions that help them should resist the temptation to strive for “modern” stockmarkets in the early stages of a country’s development. Efforts to create African stockmarkets, for example, have not yet borne much fruit. There are relatively few listed shares in the stockmarkets of sub-Saharan countries. Excluding South Africa, the annual value of traded shares relative to GDP in Africa is below 5% (see chart). In Latin America and the Caribbean the figure is less than 10%; in the former communist countries of Europe and Central Asia it is less than 15%. The comparable figure in 2007 was 79% in Denmark, 207% in Spain and 378% in Britain.
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Stockmarkets are unlikely to be a major force in poor countries in the near future. Microfinance companies and other non-bank financial institutions will play a more important role in financing poor households. And stockmarkets are not the best conduit for providing finance to the small- and medium-sized businesses that characterise the early stages of countries’ economic development. Instead, the banks will be much more critical when it comes to financing companies.
But gigantic banks are not the way to go. In Africa and other parts of the developing world, relatively large foreign banks that were set up in the colonial era have long played a role. But these institutions tend to serve relatively wealthy customers. Smaller domestic banks are much better suited to providing finance to the small businesses that dominate the manufacturing, farming and services sectors in developing countries. There is evidence to suggest that growth is faster in countries where these kinds of banks have larger market shares, in part because of improved financing for just these kind of enterprises.

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It is true that bigger banks can exploit economies of scope and scale that make them more diversified, thus enhancing systemic stability. But local banks are stable in a different way. In America the country’s 7,630 community banks have so far been only mildly affected by the financial crisis as they have continued to deal with the same small, local clients that they have had for years.
Governments in low-income countries should recognise the strategic importance of small, private domestic banks. They should also carry out some fundamental reforms. On the demand side of the equation, entrepreneurs in developing economies need to be able to signal more easily that they are creditworthy.

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Sustained efforts to improve credit and collateral registries offer large pay-offs. Credit registries enable first-time entrepreneurs to document their personal credit histories and share them with lenders. Collateral registries enable lenders to verify that assets such as property and vehicles have not already been pledged by the borrower to secure past loans. Transparent and efficient court procedures allow lenders to seize collateral in the event of loan defaults.

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Step changes
On the supply side, underachieving banks, be they large or small, should be rooted out through merger or liquidation. In many developing countries, supervisory authorities find it difficult to intervene and dispose of troubled banks’ assets quickly. Supervisors in some countries face legal challenges from the owners of such banks, sometimes long after they have left office. All this impedes the efficient exit and entry of institutions that make for a vibrant local banking sector. Failing local banks should be acquired by stronger local banks or liquidated if no such purchaser can be found. After liquidations well-capitalised new banks should be allowed to enter the sector.

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Facilitating the creation of new local banks and improving the methods for intervening to deal with troubled banks will encourage competition and provide healthier incentives. That will help banks promote the private-sector-led growth that will be crucial to recovery from the current financial crisis. Leave the developed markets to worry about how to reform their highly evolved financial systems. To make sustained progress in lifting the weight of the extreme poverty that will remain after the crisis has subsided, low-income countries need to make their financial institutions small and simple.

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CHENNAI: Venture capitalists/PE (private equity) funds are now looking at investing in micro in India. According to industry observers, around Rs 1,000 crore is expected to be invested by venture capitalists/PE funds in the Indian micro finance space (MFIs) this year. In fact, of the 50 private equity deals worth $1 billion in banking and finance in the last 18 months, MFIs alone accounted for 20 deals amounting to $200 million. There are some funds like Aavishkaar and Bellwether Microfinance Fund that primarily invest in MFIs in India.

“Apart from MFI focused funds, other venture capitalists and PE funds who consider opportunities in the space are now adding micro finance to their portfolio,” says Mona Kachhwaha, director, Bellwether.

According to Sameer Mehta, director, Atlas Advisory, “Many venture capitalists are excited about investing in this space now. Many MFIs especially south-based ones have the right professionals and processes in place.”

Early stage investors are keen to enter this space. “We are actively looking at the MFI space and if there is a suitable opportunity, we would invest in this sector,” says Harish Gandhi, executive director, Canaan Partners. The venture fund does early stage investment and primarily focuses in healthcare and technology.

“While each investor has set certain benchmarks, the IRRs (internal rate of returns, which is used to measure and compare the profitability of investments) in the MFI space is 25%-30%,” says Vineet Rai, chief executive officer, Aavishkar. The company recently pumped in equity financing of Rs 45 million into Suryoday Microfinance, a Pune-based NBFC.

Many MFIs have also demonstrated scalability of the business and also boast of a good management structure, essential elements for VC/PE funding. “Micro finance is a high growth sector and there is also a social angle to the business. Plus, investors also have an opportunity for exit,” says Arjun Muralidharan, chief executive officer, Grama Vidiyal.

The Wall Street Journal posted 2009 YTD results for several fund categories.  While microfinance was not named here, it would rank in the top half of investment returns for 2009, and is a clear winner for 2008 (with an exception of the black swan fund).  Click on the link below to see the chart.

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http://online.wsj.com/article/SB10001424052970203872404574264303869260752.html#mod=djemITP

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The first half of 2009 has been a whirlwind of events: unprecedented government efforts to rescue a financial system on the brink, skyrocketing unemployment, dismal corporate earnings and a housing market plagued by defaults and foreclosures.

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Yet even as all those detrimental factors played out, the market started staging a comeback in March. According to Lipper, the average Standard & Poor’s 500-stock index fund gained 15.7% during the second quarter and is now up 3% through June 30.

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