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Elisabeth Rhyne: Why are microfinance interest rates so high?

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Elisabeth Rhyne: Why are microfinance interest rates so high?

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May 28, 2010
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Americans often suffer sticker shock when they hear about interest rates charged in international microfinance. At annualized rates above 20 percent, most Americans start getting uncomfortable, and when they hear that in some places annual rates rise as high as 100 percent or even more, their moral outrage beepers start to malfunction. This is unfortunate, because when we are in a state of high outrage, it’s hard to listen.
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When asking “how much is too much?” it is important to reserve judgment long enough to examine the conditions that determine international microfinance interest rates. Here are three factors that international microfinance providers have to consider as they face the hard task of determining what constitutes responsible pricing.
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The arithmetic of tiny loans. Interest rates face an uncompromising arithmetic of three main cost elements, all context-specific. How big are the loans? What is the maximum loan officer caseload? How much are loan officers paid? A lender making $1,000 loans in a dense city market with a labor market that allows modest loan officer salaries can charge a much lower interest rate (think Bolivia, with rates in the 20s) than a lender making $100 loans in the rural parts of a middle income country where loan officers earn a lot (think Mexico with rates in the 60s).
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The need for sustainability to ensure coverage and permanence. Should prices support lender sustainability? Microfinance grew to reach 150 million clients worldwide by pursuing financial sustainability – and profitability — as the ticket to reaching more people permanently without heavy donor dependence. Most of today’s international microfinance providers believe the poor should be treated as clients, not recipients of charity.
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This point does involve moral judgment. Is it more moral to help (a few of) the poor through subsidies or to provide (many of) them with services on a business basis? Answers may differ in different places. The wealthier United States may be able to afford to subsidize the less fortunate, while in the resource-strapped developing world, subsidies are a luxury not available to the masses of the excluded.
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The needs and the existing options of the poor. Many people are surprised to learn that the poor in the developing world lead complex financial lives as they struggle to make their small, often intermittent incomes cover basic needs as well as unusual expenses and opportunities. Poor families are often both savers and borrowers, setting aside money in informal savings clubs, and borrowing from relatives, employers, and local grandees as well as professional moneylenders. While not all moneylenders by any means are the evil loan sharks of legend, they do generally charge rates far in excess of those charged by microlenders.
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Still, it’s fair to ask: can a microloan that tops out at a compound annual rate of say 80 percent inclusive of fees and taxes be a boon to poor borrowers? Client returns to investment are not well documented, but we do know that for short term loans, especially for the kinds of retail and restaurant businesses found in urban microfinance markets, opportunities to leverage an immediate lump sum of cash are often available. At an 80 percent APR, a microfinance client borrowing $500 for three months will pay back $600 – which many clients find to be an acceptable opportunity cost for equipment or stock that will boost a microenterprise’s earning ability or for consumption needs such as school fees or home improvements.
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That said, as interest rates come down and loan terms lengthen, microfinance loans become economically attractive to a wider range of businesses, and support longer term investments.
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In countries such as Mexico where rates are high, market entrants and regulators need to do everything they can to bring rates down. Ultimately, the best means of doing so is to promote competition, which spurs the innovation that brings better products at lower prices.
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The microfinance market in Bolivia provides a good example. In 1992 BancoSol, one of a few small microfinance loan providers at the time, charged an annual rate of 65 percent. Today, in a much more competitive environment, BancoSol and its direct competitors charge much lower rates, in the range of 18 to 22 percent. Worldwide, as microfinance has grown and many more providers have entered the market, a CGAP study found that average interest rates dropped by 2.3 percent per year from 2003 to 2006, with a median rate for profitable MFIs of about 26 percent.
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Ultimately, responsible pricing makes good business sense. With the relatively high cost of acquiring new clients in microfinance, financial service providers survive based on long term customer relationships. Setting a price that allows the client’s business to thrive helps to generate more future business for the financial institution.
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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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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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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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Aravind: How low-cost eye care can be world-class

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India’s revolutionary Aravind Eye Care System has given sight to millions. Thulasiraj Ravilla looks at the ingenious approach that drives its treatment costs down and quality up, and why its methods should trigger a re-think of all human services.  Aravind Eye Care case study is one of the best case studies that can be applied to solve many the problems from education, nutrition, shelter, employment for those living at the bottom of the economic pyramid.

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Microfinance Shows Strong Equity Valuations Despite Crisis

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Microfinance Shows Strong Equity Valuations Despite Crisis

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WASHINGTON, March 3 /PRNewswire-USNewswire/ — Sustained demand for microfinance equity, in the face of the worst financial crisis in decades, continued to propel valuations in this sector higher throughout 2009 and the medium-term outlook remains positive, according to a new report by CGAP, a microfinance group based at the World Bank, and J.P. Morgan.
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“Microfinance institutions encountered the harshest market conditions in more than a decade during 2009, with most showing a clear deterioration in asset quality and profitability,” said Xavier Reille of CGAP, co-author of the report. “And yet most MFIs continued to maintain strong reserve and capitalization levels, and investors continued to show faith in the sector.”
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The CGAP/J.P. Morgan report shows that equity valuations continued to rise across all regions in 2009, with MFIs in the private equity market trading at a median of 2.1 times book value – a 62 percent increase since 2007. Public investors significantly increased their commitments to microfinance last year, and the private sector continued to establish new microfinance equity vehicles, including new funds from Blue Orchard, Triodos, and Developing World Markets.
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“The investor community, both public and private, continues to be interested in microfinance, though we think that they are becoming more selective,” said Nick O’Donohoe, Global Head of Research for J.P. Morgan and co-author of the report.
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The relative youth of the microfinance equity market means there are few established performance benchmarks, making assessments difficult. However, the CGAP/J.P. Morgan report is bridging this gap by drawing on analysis of 200 private equity transactions between 2005 and 2009 and trading information on eight publicly-listed low-income financial institutions to assess the strong performance of the microfinance equity market.
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Indian MFIs are continuing to attract the strongest investor interest, comprising 30% of all microfinance equity transactions in 2009. Indeed, equity valuations for Indian MFIs are trading at nearly six times their book value, or three times the global median, a performance the CGAP/J.P. Morgan analysis suggests is not sustainable over the longer term.
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The strength of MFI equity valuations masks the impact of the global financial crisis on the sector. The CGAP/J.P. Morgan report shows that loan portfolio quality began to deteriorate rapidly after January 2009, with past due loans over 30 days jumping to a median of 4.7 percent from 2.2 percent over the first five months of 2009 although it has moderated since then and thus far remained stable in 2010. The effects of the downturn were far from uniform however, with MFIs in South Asia and South America showing few signs of impact, while others in Eastern Europe and Central Asia particularly were more affected. However, very few MFI failures have been reported and most institutions remain well capitalized with equity ratio unchanged in the 18 to 20% range.
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Judging by the performance of listed low-income financial institutions, the most comparable listed vehicles to MFIs, investors believe the sector will emerge from the crisis in good shape. These stocks have strongly outperformed emerging market banks (as measured by the MSCI Emerging Markets Bank Index) and by the end of 2009, had rebounded to pre-crisis levels or new historical peaks.
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The CGAP/J.P. Morgan report argues that the decline in asset quality at MFIs will likely slow, but not curb, growth in their asset base, while placing a focus on improved risk management. Valuations likely will continue to be underpinned by continuing public and commercial sector demand in the medium-term, further buoyed by local bank acquisitions of MFIs and an expected initial public offering by SKS, India’s largest MFI – in 2010.
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About CGAP
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CGAP (The Consultative Group to Assist the Poor) is the world’s leading resource for the advancement of microfinance. CGAP provides the financial industry, governments and investors with objective information, expert opinion, and innovative solutions to effectively expand access to finance for poor people around the world. More information:  www.cgap.org
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About J.P. Morgan
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J.P. Morgan is the investment banking arm of JPMorgan Chase & Co. (NYSE: JPM), a leading global financial services firm with assets of $2.0 trillion and operations in more than 60 countries. JPMorgan Chase is a leader in investment banking, financial services for consumers, small business and commercial banking, financial transaction processing, asset management and private equity. The firm serves millions of consumers in the United States and many of the world’s most prominent corporate, institutional and government clients under its J.P. Morgan and Chase brands. Information about J.P. Morgan is available at www.jpmorgan.com.
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To Help Haiti (For the long term), End Foreign Aid – WSJ

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While Haiti clearly needs aid and compassion now, the long term prospects will remain weak if not coupled with a rigorous rebuilding and foreign direct investment plan. The Haitian government must work toward building a legislative framework for the protection of human rights and establishment of a robust private sector.
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To Help Haiti, End Foreign Aid

It’s been a week since Port-au-Prince was destroyed by an earthquake. In the days ahead, Haitians will undergo another trauma as rescue efforts struggle, and often fail, to keep pace with unfolding emergencies. After that—and most disastrously of all—will be the arrival of the soldiers of do-goodness, each with his brilliant plan to save Haitians from themselves.
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“Haiti needs a new version of the Marshall Plan—now,” writes Andres Oppenheimer in the Miami Herald, by way of complaining that the hundreds of millions currently being pledged are miserly. Economist Jeffrey Sachs proposes to spend between $10 and $15 billion dollars on a five-year development program. “The obvious way for Washington to cover this new funding,” he writes, “is by introducing special taxes on Wall Street bonuses.” In a New York Times op-ed, former presidents Bill Clinton and George W. Bush profess to want to help Haiti “become its best.” Some job they did of that when they were actually in office.
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All this works to salve the consciences of people whose dimly benign intention is to “do something.” It’s a potential bonanza for the misery professionals of aid agencies and NGOs. And it allows the Jeff Sachses of the world to preen as latter-day saints.
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For actual Haitians, however, just about every conceivable aid scheme beyond immediate humanitarian relief will lead to more poverty, more corruption and less institutional capacity. It will benefit the well-connected at the expense of the truly needy, divert resources from where they are needed most, and crowd out local enterprise. And it will foster the very culture of dependence the country so desperately needs to break.
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How do I know this? It helps to read a 2006 report from the National Academy of Public Administration, usefully titled “Why Foreign Aid to Haiti Failed.” The report summarizes a mass of documents from various aid agencies describing their lengthy records of non-accomplishment in the country.
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Here, for example, is the World Bank—now about to throw another $100 million at Haiti—on what it achieved in the country between 1986 and 2002: “The outcome of World Bank assistance programs is rated unsatisfactory (if not highly so), the institutional development impact, negligible, and the sustainability of the few benefits that have accrued, unlikely.”
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Why was that? The Bank noted that “Haiti has dysfunctional budgetary, financial or procurement systems, making financial and aid management impossible.” It observed that “the government did not exhibit ownership by taking the initiative for formulating and implementing [its] assistance program.” Tellingly, it also acknowledged the “total mismatch between levels of foreign aid and government capacity to absorb it,” another way of saying that the more foreign donors spent on Haiti, the more the funds went astray.
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But this still fails to get at the real problem of aid to Haiti, which has less to do with Haiti than it does with the effects of aid itself. “The countries that have collected the most development aid are also the ones that are in the worst shape,” James Shikwati, a Kenyan economist, told Der Spiegel in 2005. “For God’s sake, please just stop.”
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Take something as seemingly straightforward as food aid. “At some point,” Mr. Shikwati explains, “this corn ends up in the harbor of Mombasa. A portion of the corn often goes directly into the hands of unscrupulous politicians who then pass it on to their own tribe to boost their next election campaign. Another portion of the shipment ends up on the black market where the corn is dumped at extremely low prices. Local farmers may as well put down their hoes right away; no one can compete with the U.N.’s World Food Program.”
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Mr. Sachs has blasted these arguments as “shockingly misguided.” Then again, Mr. Shikwati and others like Kenya’s John Githongo and Zambia’s Dambisa Moyo have had the benefit of seeing first hand how the aid industry wrecked their countries. That the industry typically does so in connivance with the same local governments that have led their people to ruin only serves to help keep those elites in power.
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A better approach recognizes the real humanity of Haitians by treating them—once the immediate tasks of rescue are over—as people capable of making responsible choices. Haiti has some of the weakest property protections in the world, and some of the most burdensome business regulations. In 2007, it received 10 times as much in aid ($701 million) as it did in foreign investment.
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Reversing those figures is a task for Haitians alone, which the world can help by desisting from trying to kill them with kindness. Anything short of that and the hell that has now been visited on this sad country will come to seem like merely its first circle.
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Write to bstephens@wsj.com
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Printed in The Wall Street Journal Europe, page 15
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Private sector goes into development finance

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Private sector goes into development finance

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Published: December 20 2009
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Financial Times
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The first tentative moves by western banks and fund managers into microfinance are gathering momentum. Most of the big banks have set up divisions that provide financial services to low-income clients in emerging markets, particularly to those who have or wish to set up businesses.
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Many specialist fund managers have also entered the arena in recent years, working with providers on the ground to pool large numbers of small investments.
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The infrastructure involved is burdensome and the returns uncertain, but this does not dim the belief of many in the sector that microfinance will outperform in the future.This belief is bolstered by the fact that many businesses and individuals in emerging economies are still starved of capital. Antoinette Koning, of the European Union’s ACP Microfinance Framework Programme, says a survey by her organisation shows that 2.7bn people worldwide are cut off from formal financial services.
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This is despite international state-sponsored funding increasing year after year. “Our last estimate is that $14.8bn has been provided in total,” says Ms Koning. In 2008 alone, $3bn was dispersed.
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“Donor agencies should be seen as a catalyst to attract more private capital so that permanent access to capital is eventually created,” she adds.
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However, in the wake of the credit crisis, western development finance is likely to slow considerably, potentially creating opportunities for the private sector to step into the void.
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Andrew Mold, a senior economist at the Development Centre of the Organisation for Economic Co- operation and Development, says the financing gap is widening. “The World Bank says that in 2009 the developing world needs up to $635bn as a result of the credit crisis,” he says. “In Africa, this will be $30bn-45bn.”
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The priority given to saving the western banking system has meant Africa and parts of Asia have been virtually left to fend for themselves. While 82 per cent of the International Monetary Fund’s resources have gone to European countries, only 1.6 per cent have been allocated to African countries, Mr Mold says.
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This lack of funding for emerging economies is attracting attention at a variety of levels. Friends of Europe, for instance, a prominent Brussels-based think-tank, organised a one-day conference on it this month.
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Giles Merritt, secretary general, says: “The financial crisis is far from over in my view and we need to ensure that the developing world is not wasting the opportunities presented by this crisis.”
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To date, most international public and private-sector initiatives have revolved around extending credit to the poorest areas since this is seen as the best way of achieving returns. However, this model is under attack.
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Graham Wright, programme director at MicroSave India, says: “We don’t give poor people assets by giving them access to debt. Microcredit is standardised and simple, and works for narrow market segments that can repay on a weekly basis. This is just working capital.” He says emerging economies need a range of financial services including, most notably, ones that focus on saving.
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“Imagine if you had to manage all your financial resources just with loans. It would be terribly difficult,” he adds.
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Alternative channels for finance are being created, some of which have the potential to be rolled out across continents.
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Ali Mchumo, managing director of the Dutch-headquartered Common Fund for Commodities, says his organisation allows small-scale farms to deposit their produce in a warehouse, receive a down-payment of 60 per cent of the expected price of the produce and then wait for prices to improve before selling it.
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“This protects the peasant from the cunning of middlemen who want to buy the product as soon as it is harvested, knowing that the peasant needs the money,” says Mr Mchumo. “If he can deposit the produce in a warehouse, he can’t be exploited. The peasant can earn and spend even before the final price is available.”
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This could create a virtuous circle whereby production and expenditure are functions of each other. But there is still a need to create a savings culture in societies where many people are denied access to basic bank accounts and, in any case, do not trust that institutions would treat them fairly.
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Rose Ngugi, a monetary policy committee member of the Central Bank of Kenya, says savers need access to more products, against which they could benchmark returns.
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“Savers don’t have benchmarks such as risk-free assets to decide how to invest,” she says.
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“We should think about capital markets if we want to diversify the basket, and create access to government securities at least.”
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Encouraging formal savings could have a huge impact on disposable incomes.
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A study in Uganda by MicroSave showed that people saving in the informal sector lost 22 per cent of their saved income one way or another. Mr Wright says: “Saving in cows is normal in many places. This has a higher return, but there is a risk factor involved and people really want straightforward security.”
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As well as the capital- limiting effects of the credit crisis, development funding is often not reaching emerging markets because of red tape or inefficiency.
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Paul Baloyi, chief executive of the Development Bank of Southern Africa, says: “Distribution has been problematic for poor countries. There are multiple agencies and well-meaning NGOs, but there is a huge dispersion between committed funds and funds released.”
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This only increases the emphasis on the private sector for increased funding. However, private sector institutions need to create the right products for the right people, rather than looking at the short-term profit motive.
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If they fail, western institutions, which dominate this space, may find they lose out to aggressive competitors, such as China which is leading the charge to harness African assets more productively.
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Microfinance not in the red, despite crisis

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Microfinance not in the red, despite crisis

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Published on : 13 January 2010 – 4:25pm | By Laurens Nijzink
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While major international banks have collapsed in these times of economic crisis, small microfinance institutions are still performing well. Poor women – until recently regarded as totally non-creditworthy – are paying back their loans while large companies fail to meet their repayments. How has micro-finance survived the economic storm?

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Muhammad Yunus, the godfather of microcredit and 2006 Nobel Peace Prize laureate, explained in early 2009 that his Grameen bank had hardly been affected by the financial crisis:

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“The simple reason is that we are anchored in the ‘real’ economy – not investments which exist only on paper. If we lend someone 100 dollars, that represents chickens or a cow. It’s not an imaginary asset.”

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This is a reference to the cause of the global crisis: loans based on fictional values (sub-prime) and convoluted financial constructions.

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Immune
There are, however, places where micro-finance institutions (MFIs) have not proved immune to the global crisis. From 2009, MFIs in Eastern Europe, Russia and the Caucasus, as well as Central America and the Caribbean were affected by the crisis. They became less profitable, there was reduced growth in the number of loans and overdue loans began to pile up. It’s no coincidence that the economies of these regions are more integrated into the global monetary economy, making them more sensitive to adverse economic conditions in the West.

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India
India, on the other hand, seems completely unaffected. In fact MFIs are growing fast, by 100 or 200 percent in recent years and even last year. With more than a billion inhabitants India has an enormous domestic market and its economy is still not all that dependent on international trade. The informal economy, in which most recipients of microcredit operate, is even further removed from global financial developments.
“In India it will take two years before the lower regions of the business community are hit by the global recession, but within two years we will already be seeing signs of recovery,” says Amitabh Kundu, Professor of Economics and micro-credit specialist at Jawaharlal Nehru University in New Delhi. He emphasizes that the Indian government is actively stimulating what they refer to as “inclusive finance”: making financial services available to everyone. As a result, domestic money – both private and public – flows into MFIs, followed by more risk-avoiding foreign money. India has proved successful in attracting commercial funding from abroad. Around 178 million dollars of foreign money was invested in Indian micro-credit schemes in the financial year 2009, more than three times as much as in the previous year.

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Foreign funding
Despite the fact that their budgets have shrunk as a result of the crisis, foreign investment companies (private equity) and investors clearly regard it as advantageous to add microfinance to their portfolios. Returns have been healthy, relatively unaffected by financial developments in the West and they look good in the annual reports. Moreover, Indian microfinance has enormous potential. More than 22 million Indians current have loans from an MFI and rough estimates indicate that another 120 million households are eligible for micro-credit. That translates as a potential market for financial services totalling 50 billion dollars.

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Too soon
But let’s not celebrate too soon. The financial crisis could still penetrate into the microcredit sector: both MFIs and their customers could be affected. The development budgets of western countries are shrinking, if only because they are normally dependent on the donor country’s GNP. This could result in fewer cheap loans to MFIs in the South, and it’s unclear to what extent this can be cushioned by funds like the Bill and Melissa Gates Foundation or the online ender KIVA. This was one reason that, as early as late 2008, Dutch Development Cooperation Minister Bert Koenders announced he was earmarking 15 million euros for a fund to help compensate for dwindling funding for micro-credit.

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Refinancing
From a commercial point of view refinancing MFI loans is a risk. Loans often run for one or two year. New loans are now being granted at higher rates of interest. This is the result of increased currency risks: the chances of exchange rates adversely affecting the lender because of devaluation are greater in times of crisis. Early last year the International Finance Corporation, an affiliate of the World Bank, and the German development bank KfW set aside 500 million dollars to cushion the risks of refinancing. In order to balance their books MFIs will have to concentrate on recovering outstanding credit. This process is already underway in Africa.

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Loans
While major banks were toppling in the West, the damage to credit lenders in less wealthy parts of the world was limited to falling profits and a brake on their growth. However, in some cases, the collection of loans will become more problematic there too. The World Bank has calculated that an additional 65 million people will end up living on less than two dollars a day due to the financial crisis. A number of MFIs show an increase in the number of loans being paid back later or too late.

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Migrant money transfers
The trend is reinforced by a dramatic reduction in migrant money transfers. Their weak position in the Western labour market means migrants are often the first to be laid off during times of economic hardship. As a result they are sending less money back to relatives in their countries of origin.

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Less rosy
At first glance the microfinance sector seems to have been immune to the financial crisis. In 2008 the ten largest microfinance funds grew by 30 percent (while ‘normal’ funds shrank by a fifth). The results for 2009 look a lot less rosy in many regions. Despite a solid basis, the big question in 2010 in whether the sector can continue to stay out of the red in the wake of the global crisis.

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The Problems of Correlation in Financial Risk Management – the Contribution of Micro finance

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In this paper, the authors, Karel Janda and Barbora Svárovská, first introduce microfinance institutions as an alternative investment instrument. They argue (convincingly) that beside socially responsible features of microfinance, there exists also significant portfolio enhancement opportunity in microfinance investments. Then they provide an overview of possible ways how to evaluate the correlation between microfinance related financial instruments and conventional financial market measures of risk and return.

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This paper is available for download at: http://mpra.ub.uni-muenchen.de/19486/1/MPRA_paper_19486.pdf

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