During the 1990s, emphasis shifted to ‘microfinance’, seen as a range of financial services – deposits, transfers, remittances, even micro-insurance, as well as credit. Recently the idea of ‘financial inclusion’ – access to formal services for all – has taken hold. In the market-place, however, pure micro-lending operations have continued to grow. The arrival of a new class of for-profit investors is transforming the industry, previously the province of ‘non-profits’. Investors are attracted by the high interest rates and low NPLs of well-managed ‘MFIs’ (microfinance institutions).
Financialisation in micro-lending takes forms familiar from mainstream capital markets, including creation of specialised ‘microfinance investment vehicles’ (MIVs) and the use of securitisation, collateralised debt obligations and structured finance, among other risk-management tools. Examples abound of credit wraps or guarantees, loan syndications and hedging mechanisms. Ratings agencies support the industry and highly successful IPOs are occurring, increasing the allure of for-profit investment. Microcredit in developing countries has become a new asset class for metropolitan and domestic investors.
Data provided by CGAP, a World Bank affiliate, suggest that at end-2008 the return on assets for MFIs in many developing countries was higher than for commercial banks. Some 75 per cent of MIVs dealt entirely or mainly in fixed interest investments. Some were ‘socially focussed’ and accepted lower returns; others offered structured products with a range of risk/return options. Average gross yield on debt held by MIVs was a respectable 9.5 per cent. Other MIVs were private equity funds. This newest class had the highest rate of asset growth among MIVs. More than 100 MIVs held total funds under management of some $6.6 bn at end-2008. Asset growth was 72 per cent in 2007 and 31 per cent in 2008. Equity holdings of MIVs were growing even more rapidly, by 47 per cent in 2008. In aggregate, foreign capital commitments to MFIs from all sources totalled $14.8bn at end-08, divided almost equally between aid donors (48 per cent) and investors (52 per cent).
Negative impacts of this financialisation include looming credit and private equity bubbles in at least one of the most ‘advanced’ micro-lending markets, India. There, according to a CGAP/JP Morgan analysis, MFI equity deals are being done at up to six times historical book value. This will surely have negative consequences for excessively-leveraged institutions and over-indebted households. Even more damaging, long-term, is the neglect of domestic savings mobilisation that financialisation engenders. Access to investment funding disinclines MFIs from seeking deposit-taking status, or from exploiting that status fully. Many find it easier and cheaper to rely on external resources.
When financial institutions are ineffective in mobilising savings, financial intermediation is hobbled. Effective domestic intermediation contributes to financial deepening and supports financial development. Local deposit mobilisation is a platform for grassroots financial development, while greater reliance on deposits reduces MFIs’ vulnerability to external shocks. Growing reliance on external resources may void these benefits. Recent growth of micro-lending appears to have proceeded without corresponding growth in MFI deposit mobilisation and with growing leverage in balance sheets. For poor households, absence of deposit facilities denies important benefits to the self-employed, including vital learning and opportunity to acquire financial ‘identity’. Savings offer them a buffer against misfortune, permitting consumption smoothing and management of lumpy income flows. To the extent that it neglects or represses savings, investment in micro-lending does nothing to meet this complex bundle of needs.
Neither commercialisation nor for-profit foreign investment will necessarily repress financial development or distort MFI operations. Commercialisation is a necessary condition for building sustainable grassroots financial services and some level of foreign investment should be welcome. Foreign investors may bring technology spill-overs, benefitting domestic MFIs. Foreign investment might discourage domestic investment in MFIs, but might also prove complementary. But objections flow from repression of domestic savings and denial of deposit services. Worse, MFIs receiving foreign commercial funds may experience ‘mission drift’. Pressed to meet performance benchmarks, they may shift focus from poor to middle-income clients, and to consumer durable lending rather than livelihood financing.
Some level of funding from domestic investors should benefit MFIs, via technology spill-overs and mutually beneficial operating linkages. There are advantages in borrowing from local banks. Loans are generally in local currency and such banking relationships may grow deeper over time. Alliances with commercial banks may promise MFIs financial services they cannot themselves provide, including savings or ATMs. However, if domestic for-profit investment causes mission drift, or if it represses savings in particular sectors or social strata, there are compelling reasons to object.
Financially-inclusive policy frameworks may offer poor societies an escape from contradictions posed by foreign-funded micro-credit, as could ‘distributed’ financial institutions and systems. Distributed financial systems, comprising financial ‘microgrids’, with self-sufficient local power centres and drawing capital from local communities, offer prospects for greater financial inclusion. Distributed institutions, growing through savings accounts and local capital markets while offering responsible lending, could underpin a diversified and durable financial system. For MFIs in developing countries, this model poses a credible alternative to current pre-occupations with cross-border financing. The APEC Business Advisory Council should comprehend this alternative, among whatever others it considers, in its campaign for ‘financial inclusion’ in APEC economies.
John D Conroy is Special Consultant at the Foundation for Development Cooperation and a participant in the Advisory Group on APEC Financial Sector Capacity-Building.