Building Financial Systems for the Poor

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GLOBAL TRENDS IN GLOBAL TRENDS IN MICROFINANCE: MICROFINANCE:

COMMERCIALIZATION AND COMMERCIALIZATION AND FOREIGN INVESTMENTFOREIGN INVESTMENT

Baku, AzerbaijanMay 27, 2006

Olga Tomilova, CGAP-MFC Central Asia Microfinance Center

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CGAP – Consultative Group to Assist the Poor

Microfinance Consortium of 31 public and private development agencies working together to expand access to financial services for the poor in developing countries.

Resource center and standard setting body for the entire microfinance industry.

CGAP serves four groups of clients: development agencies, financial institutions including microfinance institutions (MFIs), government policymakers and regulators, and other service providers, such as auditors and rating agencies.

Specialized services: advisory services, training, research and development, consensus building on standards, and information dissemination.

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MF and Access to Finance

MF has made a relatively rapid impact, has achieved significant outreach, and can become sustainable within relatively short period of time

Access to finance enhances growth and helps reduce poverty

MF is now a real industry

BUT:

Big differences between regions (LAC, SA, ECA, MENA), and between countries

2 billion people still lack access to formal financial services

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Global providers of microfinance services

Postal Banks51%

Commercial Banks

2%

NGOs/NBFI5%

COOPs6%

Rural Banks17%

Ag & State Banks19%

Source: CGAP, 2004

750 million accounts in “social” financial institutions, many likely to be poor

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Financial System

Financial Services for the PoorMicrofinanceFinancial Services for the Poor

Microfinance is melting into financial sector

Unregulated MFIs report to national credit

bureaus(Turkey, Peru)

Commercial banks move into MF

MFIs are audited and comply with the IFRS

12 rating agencies rate MFIs

(Standard & Poor’s, Moody’s)

MFI bank issues VISA credit cards (Paraguay)

50 countries discuss and implement

microfinance policies

MFI clients access international ATM

networks(Dominican Republic)

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Each country’s model is different

• Stage of financial sector development

• Existence of infrastructure

• Population density

• Levels of poverty

• Competition

Commercial BanksState Banks

Co-ops

Postal Banks

Rural Banks

Self-Help Groups

Credit Unions Financial NGOs

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Access points are multiplying

Loan Service Agent

PC Kiosk

CLIENTS

Traders and Processors

Point-of-SaleNetworks

Lottery Agent

Self-Help Groups

ATMs

Leveraging existing + new infrastructure to offer multiple access points

State Banks

Commercial Banks

MFIs

9Lower level of engagement

Bank provides front or back office functions

Sharing / Renting facilities

Wholesale lending

Bank buys MFI portfolioand / or contracts MFI operations

Bank creates loan service company

Higher level of engagement

Sogebank, HaitiCreated loan service company Sogesol in 2000

Jammal Trust Bank and Credit Libanais, LebanonHave equity stake in Ameen, a CHF microfinance program

ICICI Bank, IndiaContracts microfinance operations with self-help groups and MFIs

Raffeissen Bank, BosniaLends to multiple MFIs in Bosnia

Garanti Bankasi, TurkeyProvides front office functions through branchnetwork to Maya Enterprise for Microfinance

Microfinance Bank, GeorgiaRents space in its offices to Constanta, a local NGO

Bank invests equity in MFI

Using a range of risk in their engagements

MFI- Bank partnerships taking off

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Pioneer, breakout, consolidation and maturity?

GrameenProdem

~10,000MFIs

M&AFailures

Formal FIs

Top-tier NGO/MFIs

Most efficient, effective, client service oriented institutions will prevail and have access to funding sources

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Downscaling

Downscaling: A bank or other formal financial institution expands its services to work with clients traditionally served, if at all, only by MFIs. Such an expansion can mean serving microfinance clients in one or many financial areas

History: First “multi-global” operations financed by IDB in early 1990s. EBRD adapted and applied the concept in Russia and other NIS countries. Approach is again becoming popular (IFC/Accion, WWB)

Significance LAC: 27 out of top 32 MFIs in LAC are commercial institutions, RoA for this group: 4.8%. Examples: Banco del Trabajo and Banco del Crédito (Peru), Banco Caja Social (Colombia), Financiera Vision (Paraguay)

Significance ECA: Russia, Kazakhstan and Ukraine – 137,000 borrowers, $ 712 m LPF; commercial banks and greenfield banks have highest growth rates in the region

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Downscaling in ECA – Portfolio $

  Dec-02 Dec-03 Dec-04Performance

(Dec02-Dec04)

Share in Total (Dec03)

Share in Total (Dec04)

Kazakhstan 73.39 148.99 251.02 +242% 33% 35%

Ukraine 29.64 55.51 104.59 +253% 12% 15%

Russia 173.49 228.98 307.79 +77% 50% 43%

Kyrgyzstan 0.57 2.59 11.3 +1882% 1% 2%

TOTAL 277.09 436.07 674.7 +145%    

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High Relevance of Banks in ECA

5563

3

60

26

8

5

45

96

20

74

94

20

0.9

0.4

0.75

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0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

EAP EECA LAC MENA Africa S Asia

Percentage

Non-Profit

OTHER

CU/COOP

NBFI/Bank

% Borrowers by Type of MFI 2002

Source: MIX Database

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Downscaling – Summary

Downscaling model is one (but increasingly important) element in sensible approach to access to finance

Secured lending and credit bureaus will make positive impact

Commercial banks unlikely to reach the poorest segments of potential retail customers

Commercial banks unlikely to solve rural finance dilemma

Other (complementary) approaches: -Greenfield banks -CUs-Upgrading NGOs-Linking (cooperation between MFIs and Banks)

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Downscaling – Summary

Access to Finance and especially downscaling can and should be integral part of successful regional development strategy

Government support is needed to ensure conducive environment for investment and growth of financial services industry

Don’t subsidize interest rates, don’t cap interest rates

Subsidize TA

Don’t build monopolies, enhance competition

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Predictions

Multiplying points of service allows exponential growth

Technology and infrastructure are key drivers to scale

Commercial and state banks will become core providers

Major consolidation of MFIs will occur through buy outs by banks, mergers, partnerships, and wind-downs

Domestic sources of funds will become even more important (savings, commercial debt)

Donors will focus on frontier markets (very poor and rural)

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FOREIGN INVESTMENT IN FOREIGN INVESTMENT IN MICROFINANCEMICROFINANCE

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CGAP Foreign Investors Survey

Survey of 54 foreign microfinance investors conducted by CGAP, MIX and ADA (June – September 2004) Purpose – ascertain legal structures, investment focus and history, availability of uncommitted funds, and financial performance Data on “direct” investments in 505 MFIs and “indirect” investments in 25 MF funds Amount of foreign investments (disbursed and committed):

$1.2 billion – direct $611 million - indirect

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Where is the Foreign Investment Going?

Foreign investment in MFIs takes the form of: Equity Debt Guarantees

Only regulated MFIs are legally structured to receive all three forms of investments – non-regulated cannot receive equity investments Among 505 MFIs surveyed, 166, or 33% are regulated institutions Heavy concentration of foreign investment in certain regions – 87% in Latin America and Eastern Europe/Central Asia

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Where is the Foreign Investment Going?

By instrument: Debt – 69% Equity – 24% Guarantees – 8%

By legal status – 82% to regulated MFIs By size of investment – 89% over $1 million By suppliers – nearly half of all investment is provided by four IFIs: IFC, EBRD, KfW and USAID’s Development Credit Authority Two thirds of investment is provided by 6 of 54 funds

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Are Foreign Investments Competing to Find MFIs to Invest in?

Numerous anecdotal suggestions that investors are not finding it easy to place funds in MFIs that meet their standards Tendency for multiple investors to invest in a single MFI – for example, 20 out 54 funded Banco Solidario (Ecuador), 15 funded Confianza (Peru), and 11 funded Fundacion Nieberowski (Nicaragua) The reason is not small investment amounts, but rather excess of supply over demand from suitable MFIs, i.e. those that meet the investors’ quality and risk profile Instances of a single investor funding the same institution through several indirect channels

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Why MFIs Seek Foreign Investment

Motivating factor % of respondents rating factor as “extremely important” and “important”

36 Regulated 112 Unregulated

Lower interest rate 86% 78%

Easier collateral requirements 69% 72%

Investor’s willingness to negotiate

69% 66%

Length of loan 61% 66%

Speed of disbursement 56% 65%

Ability to attract other lenders and investors

56% 60%

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Uncertain Demand for Equity – Regulated MFIs

Regulated MFIs will continue to seek more debt than equity from foreign sources:

High levels of equity capital greater interest in increasing liabilities

Most MFIs have lower levels of legally allowed leverage

Council of MF Equity Funds revealed that only 115 out of several thousands of MFIs would be candidates for foreign equity investments, given their legal status, profitability and sizeRegulated MFIs are increasingly seeking domestic deposits to fund their liabilities

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Uncertain Demand for Equity – Unregulated MFIs

Unregulated MFIs – more numerous, but are not structured to take equity investments more likely to seek foreign debt than regulated MFIs:

Less access to domestic banks Generally prohibited from taking deposits

Foreign lenders will be attractive if they would lend beyond 1-to-1 debt-to-equity ratio and lower collateral requirements Unregulated MFIs may have a relatively greater interest in foreign debt investment compared to regulated MFIs

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Foreign Debt and Currency Risk

Most of MFI assets tend to be denominated in local currency creates foreign exchange risk if they borrow foreign currency loans Local currency in many developing countries is more likely to devalue than to appreciate 92% of debt issued to MFIs is in hard currency Many MFIs are not alert to this issue – out of 105 MFIs surveyed, only 25 fully hedged their currency risk In most developing countries, adequate hedging mechanisms are not available or too expensive

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Conclusions: Practical Lessons

Foreign investors would add more value to the market if they were able to tolerate more risk, and thus work with less-well-established MFIs Regulated MFIs should be helped to access more local funding use of guarantee mechanisms; improving credibility of MFIs with local funding sources MFIs and investors need to be alert to the foreign exchange risk entailed by hard-currency loans

UNCDF

Building Financial Systemsfor the Poor

Thank you!