Access to Capital, Inclusive Finance, & Microfinance
Microfinance refers to the providing of basic financial services to the poor, particularly in developing countries, providing underbanked and unbanked populations with access to capital and other financial products (including micro-savings, FX/remittance services, debit and credit cards, and micro-insurance). Also known as Inclusive Finance, Microfinance first came to prominence in the 1980s, although early experiments in microfinance began over 30 years ago in Bangladesh, Brazil, and a few other countries. Most notably, Mohammad Yunus, founder of Grameen Microfinance and winner of the Nobel Peace Prize in 2006, has helped to propel microfinance into the mainstream. Micro-credit is widely regarded as an essential tool for furthering economic development in developing countries and has proven to be one of the most effective and flexible strategies in the fight against global poverty. It is sustainable, and can be implemented upon a massive scale.
Micro-credit, a key area of microfinance, refers to the making of small loans, usually US $200 or less, to poor persons, usually women, in developing economic areas. These loans are made to help those living in poverty establish or expand self-sustaining businesses. The loans help the poor generate and increase income, providing them with stability for their families, opportunities for education, and protection from externalities. Assisting these entrepreneurs found and grow businesses imparts human dignity and social status, transforming them into producers and participants in their society. Although many factors contribute to global poverty, local moneylenders charge rates of interest upwards of 100% perpetuating the state of poverty for the working poor. Micro-credit offers access to cheaper capital and is powerful instrument for self-empowerment, enabling the poor, especially women, to break the cycle of poverty.
Micro-credit loans are typically made to individuals who do not have access to formal financial institutions and who are self-employed, often household-based, entrepreneurs. In rural areas, they are usually small farmers and others who are engaged in small income-generating activities, such as food processing and petty trade. In urban areas, micro-credit recipients are more diverse, and include shopkeepers, service providers, artisans, small manufacturers, and street vendors.
Microfinance Institutions (MFIs) are entities that provide financial services, including such loans, to the very poor assisting this sector of the population. Most MFIs are non-profit institutions, with many MFIs affiliated with faith-based NGOs. Recently, reflecting a maturing of the microfinance industry, certain MFIs have organized themselves as commercial, for-profit institutions.
MFIs, both non-profit and commercial, have proven to engage in microfinance on a profitable basis, with industry average ROEs at 12%. The best microfinance institutions have ROAs that range between 5% and 15%. Loan default rates for micro-credit loans made in developing countries are slightly higher than 1%, besting loan default rates for the largest domestic financial institutions. In addition, several studies have shown that social impact is highly correlated to profitability. With larger scale, lower interest rates, and additional financial products and services, the most profitable MFIs have received the highest social impact scores and metrics, revealing the mutual reinforcement of financial and social returns.
The almost 8,000 MFIs currently service nearly 170 million clients worldwide, equating to $50 billion in assets. This level of service manages to meet approximately 10% of global demand for micro-credit. The total annual demand for micro-credit is estimated at $300 billion, with an estimated annual growth grate of 15% to 30%. In this environment, the largest and most sustainable MFIs are growing at a rate of between 30% and 70% per year, and many smaller institutions are growing at a faster rate.
Traditionally, MFIs have obtained the capital for their lending activities through government grants and private donations. As the microfinance market has grown, these traditional sources of funding have proved to be inadequate to finance the growing demand for micro-credit. Many MFIs now are attempting to obtain capital from financial markets.
Creation Investments is active in evaluating and pursuing investments in the Microfinance space as a means of achieving superior financial and social returns on investment.