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Microfinance is a success story: an innovative mechanism to supply credit to small businesses and the self-employed in the poorest parts of the world. Microfinance promotes entrepreneurship and financial responsibility and has helped people who suffer from financial exclusion, especially women, to improve their standard of living. What are the prospects for microfinance today, with the global financial system facing its most challenging year in living memory and with credit in short supply globally?
Heidemarie Wieczorek-Zeul, the German Minister for Development, said recently: "We have to ensure now that those that contributed least to the financial markets crisis do not suffer most from it". Her comments highlight an important distinction: microfinance institutions need capital to continue their successful expansion whereas many banks in the West need capital to recover from failure, due to substantial losses.
At the end of 2007 there were around 3,000 microfinance institutions (MFIs) worldwide, providing loans to 150 million people, with total loans outstanding of $30bn. Many of the more established MFIs are located in Asia and Latin America, but microfinance is growing quickly in Africa, Eastern Europe and in parts of the developed world. Some MFIs are banks, but some are not; some MFIs have millions of customers, but some have less than a hundred; some MFIs provide a range of services including employment and welfare services, but some simply offer low-cost loans; some MFIs are profitable but many are not.
There are five main source of capital for MFIs. First, and most important, are the local savings that MFIs have been able to mobilize by bringing large numbers of individuals into the financial system who previously were excluded. The level of these savings has been affected by rises in the cost of food and fuel. To the extent that food and energy price inflation falls from the highs of last year, local savings are likely to remain the principal source of capital for many MFIs.
By comparison, remittances from the developed world, the second source of funds, are expected to decline. Many of the individuals who left home to find more highly remunerated work, and who send cash back to their extended families, will be the first to lose jobs or to suffer lower wages, as unemployment rises. In some countries, the loss of remittance revenue will cause MFIs serious problems.
The third source of funding is the domestic capital markets of Asia, Africa and Latin America, markets that are populated by small and medium sized banks that play a central role in the creation and allocation of credit in their domestic markets. These banks are finding it much harder, and much more expensive, to access credit themselves, which limits their ability to raise funds for the MFI sector.
Fourth, in recent years there has been a big increase in the flows of private capital from the West to developing country MFIs. Many of these flows are "social investments" where the investor is looking to achieve social benefits and will accept a lower rate of return as a consequence. Some of these flows, however, are made as part of an asset allocation model, in which microfinance is treated as an investible asset class in its own right.
TIAA-CREF, the US pension fund manager for academic, medical and research staff, has recently made a $40mn investment into a microfinance equity fund as part of an allocation of $100mn to the sector that it announced in 2006. For the institutional investor, microfinance offers the likelihood of positive returns with low volatility and little or no correlation with the performance of other asset classes. In the present climate that makes microfinance very attractive.
Fifth and finally, there are a number of multi-national institutions that provide capital to the microfinance sector. If anything, these flows are now increasing. The Inter-American Development Bank has recently allocated $20mn to provide emergency bridge-loans for MFIs in Latin America and the Caribbean. And the International Finance Corporation (part of the World Bank group) and KfW (the German development bank) have announced the creation of a $500mn fund to support around 100 MFIs in 40 countries around the world.
Robert Annibale, head of microfinance at Citi, argues that the enormous variety among MFIs makes it difficult to generalise. Nevertheless the prospects for microfinance in the next two years do appear mixed. There is new capital available, but it is likely to go to the stronger, better-established MFIs. Smaller institutions will have to rely on their own ability to garner local savings. This may lead to slower but more sustainable rates of growth in the medium term.
The main determinant of success will continue to be the ability of microfinance institutions to achieve low default rates, so that existing capital can be repeatedly re-lent, thereby helping to stimulate economic activity in those parts of the world where it is most needed.