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Building Microfinance Into an Asset Class

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The $44 billion global microfinance industry got a boost recently as private equity investor BlueOrchard attracted $195 million to a new fund aimed at helping microfinance lenders modernize their organizations, improve governance and risk management, and develop into fully-fledged financial institutions.

The knock-on effect is that as the industry as a whole becomes more standardized, with stronger, regulated and rated institutions, this should attract more investment and help turn microfinance into a recognized asset class, which in turn is good news for small businesses both in the US and globally that benefit from microfinance lending.

Although the US microfinance industry is viewed quite differently from global lenders geared at the very poor, as Anne Field pointed out in her blog in March, some of the biggest US microfinance lenders, including ACCION and Kiva, have operations worldwide. And most global microfinance institutions focus on small business lending as well as lending to individuals.

One of the biggest difference is in loan size: microfinance loans in the US range from $500 to $35000, and the average is $7000, according to statistics from the Association for Enterprise Opportunity. In comparison, BlueOrchard’s average loan size is $1650.

The microfinance industry in the US is becoming ever-more important to small businesses and entrepreneurs, with loan applications at US firms having increased 66 percent over the past two years, according to research by the Aspen Institute. However, lending growth from MFIs has not kept pace, leaving many small businesses to search for other sources of funding.

As microfinance as a whole becomes more of a standard asset class for investors and more investment flows into the market, this would allow MFIs to boost lending–and help out both US and global small businesses and entrepreneurs.

However, in order to take that next step, microfinance lenders must improve corporate governance and risk management to become regulated banks, according to Jean-Philippe de Schrevel, CEO of BlueOrchard Investments. This would allow them to raise more money from local institutions and not-for-profit groups–emulating the US microfinance model.

Microfinance has typically seen lower default rates than traditional bank lending. BlueOrchard cites a repayment rate of 97 percent, and Kiva of more than 98 percent. But MFIs are dealing with the outcome of the crisis like any other lenders, hence the need for improved risk management and governance, so that strong track record is maintained and more mainstream investors feel confident in the longer-term strength of the business model.

The BlueOrchard fund is targeting an internal rate of return of 20 percent. A number of other microfinance funds managers are expected to launch funds on a similar scale–including Finance In Motion and Incofin.

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