new horizons:creating value,enabling livelihoods

final report

opportunities in microfinance

for the UK financial services sector

11883 FFF microfinance report_v2 12/6/07 10:59 Page 1

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acknowledgements

Forum for the Future would like to thank all the individuals who contributed to this project through providinginterviews or participating in the workshop in October 2006.

This project has been supported by:

The Defra support came through funding from the Implementation Fund of the World Summit on Sustainable Development

forum project team

Alice Chapple a.chapple@forumforthefuture.org.uk

Vedant Walia v.walia@forumforthefuture.org.uk

Sven Remer Research intern

list of abbreviations

AECI-ICO – Spanish development finance

ATM – Automatic Teller Machine

BOMFS – Blue Orchard Microfinance Securities

BOLD – Blue Orchard Loans for Development

CGAP – Consultative Group to Assist the Poor (microfinance resource centre hosted at the World Bank)

CDO – Collateralised Debt Obligation

DFID – Department for International Development

EBRD – European Bank for Reconstruction and Development

FMO – Netherlands Development Finance Company

IFC – International Finance Corporation

KfW – German development finance (part of KfW Bankengruppe)

LIBOR – London Inter-bank Borrowing Rate

OPIC – Overseas Private Investment Corporation

MFI – Microfinance Institution

MIV – Microfinance Investment Vehicle

NGO – Non-Governmental Organisation

SRI – Socially Responsible Investment

June 2007

All dollar figures ($) used in this report refer to United States Dollars.

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executive summary

The majority of poor people across the world have no access to formal financial services such as credit, savings, insurance and payment products that help to grow incomes, accumulate wealth and manage risk. Microfinance has emerged as a successful bottom up intervention that has demonstrated that the poor can be served viably. Despite increasing global attention – including the 2006 Nobel peace prize to Mohamed Yunus and Grameen Bank of Bangladesh – the microfinance sector is highly fragmented and lacks the necessary capacity and capital to meet the massive latent demand for financial services. At best, the industry is currently only meeting about 10-20 percent of a total potential demand of US$ 300 billion. This is mainly demand for credit; provision of other products such as insurance and remittances is even lower.

Commercial involvement in microfinance is increasing. Financial institutions have tended to enter this space in the past because of a desire to engage the local community, to build their brand, to deflect criticism or simply as part of their charitable activities. In some cases, this has evolved into a recognition that microfinance can be profitable and can open up a massive new untapped market segment, and created fertile conditions for innovation and experimentation. From large international banking groups through to boutique microfinance investment management houses, commercial players are looking at ways to provide capital and deliver financial services through employing new techniques, technologies and business models.

This wave of innovation is emerging rapidly and starting to fundamentally alter microfinance by bringing it into contact with the financial, technical and managerial resources of the wider financial sector. However, this is still at an early stage and the opportunity – and necessity – for further innovation by mainstream financial institutions, including those based in the UK, is immense. For those examining microfinance through a commercial lens, this report sets out innovations that are transforming the industry landscape in three main areas.

In capital markets and investment, a number of new vehicles have emerged to channel private and public capital to microfinance institutions. They are growing fast, with about a US$ 2 billion portfolio in 2006, but have several challenges to overcome in order to become viable commercial investment propositions. Most tend to focus on short-term foreign currency debt to a narrow set of elite microfinance institutions. There are no standard performance metrics, transparency is poor and most do not offer market rate returns, forcing them to rely on donors and social investors. To expand the investor base and create new funding solutions, increasingly sophisticated mainstream financial techniques are being adopted in microfinance.

Groundbreaking transactions have introduced new capital structures that enable a wider range of international commercial investors to invest in senior layers of debt, while social investors and development agencies purchase the more risky junior layers. Over US$ 500 million of structured microfinance paper has been issued since 2004. Analysts expect a similar amount to be issued by the end of 2007, driven by larger deal sizes, the involvement of major institutions such as Morgan Stanley to structure and place the securities, helped by moves from rating agencies such as Standard and Poor’s to develop rating methodologies. Structured finance instruments such as collateralised debt obligations are a growing part of the capital mix but need to address concerns about liquidity, lack of a performance record, poor data availability and the need to offer local currency funding.

Equity investment in microfinance institutions only makes up about 17 percent of a total broadly defined US$ 30 billion microfinance portfolio (including state financed schemes through agricultural banks). High risk, a lack of exit opportunities and little publicly listed equity make investment difficult but the landscape is changing rapidly. In April 2007 alone, Compartamos floated a third of its equity in Mexico in a US$ 407 million issue, 85 per cent of which was successfully placed in the international equity market by Credit Suisse, and Sequoia Capital, a prominent American venture capital firm, invested US$ 6.5 million in a for-profit Indian microfinance start-up.

Institutions are also exploring new ways of developing and delivering financial services. Most commercial players cannot directly serve low-income clients due to inappropriate products and business models for low-margin, high volume microfinance markets.

Microfinance institutions tend to focus on credit – often using the Grameen model of group lending – and lack the capacity to offer an optimal suite of financial products designed for low-income

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clients. Commercial players, in collaboration with microfinance institutions, are exploring opportunities to develop a wider range – particularly critical products such as life and general insurance, remittances and dedicated agricultural finance and risk management.

Delivery channels that can bring appropriate products to target client groups cost-effectively are being developed to expand product range and availability. Banks and insurers are partnering with microfinance institutions to develop products which are then distributed through the institution’s field network or using the institution to originate and service loans or insurance policies. Innovative business models built on agent banking – through a network of community level microentrepreneurs – are being enabled through technologies such as smartcards and networked point-of-sale devices. New transformative technological innovations around technology enabled banking and payment services are pushing the boundaries and could radically lower transaction costs and increase efficiency. Low cost mobile banking is already being offered in many parts of Africa and pilot projects to revolutionise the remittances market through using a mobile-enabled platform could have significant pro-poor benefits.

Microfinance institutions are key intermediaries but require significant technical assistance to professionalise, scale operations and be able to absorb commercial debt and equity capital. This needs to happen both at an institutional level – transferring best practice in governance, operations, liquidity management and credit methodologies to name a few – as well as a systemic level, where rating methodologies, performance standards and supporting regulatory environments are critical.

Concerns about the commercialisation of the industry undermining its traditional focus on helping the poor should not be ignored. There is still a very important role for philanthropic funds to reach the poorest segments and provide added social services. The future could include a much more hybrid industry with a varied capital mix and the best use of resources – allocating commercial capital to the most profitable and robust areas and reserving donor funds for more difficult operating environments and for leveraging private funding.

The UK financial sector can play an important catalytic role in microfinance. Banking and insurance groups with a global footprint can be active through local subsidiaries – provide funding, product development and technical assistance – and leverage their global presence and expertise to transfer learning and successful models. Institutions with a global footprint such as HSBC, Standard Chartered and Barclays are increasingly offering wholesale services to microfinance institutions though local subsidiaries. London’s capital markets’ depth, expertise and access to investors can be harnessed to increase the flow of commercial capital to microfinance. Some capital market transactions have been arranged and placed in London with mainstream players such as Morley Fund Management and Standard Life investing. However, with industry-wide collaboration backed by public and non-profit agencies, there is a considerable amount more that can be done within a formalised and integrated strategy.

Some may be concerned about accusations of profiting from the poor. This is a misrepresentation provided that institutions take a long-term view and invest in developing the capacity to meet unmet needs for financial services in a way that adds value for both the client and the provider. On the basis of this analysis, it seems some commercial organisations are starting to do just that but it remains to be seen whether this can be transferred across the industry as a whole.

Microfinance and the mainstream finance sector have just started to engage. Systematic integration of microfinance as a mature financial sub-sector is just one of many future scenarios. The industry will need to work with both public and private stakeholders to build on its considerable success by creating strong foundations for future growth. At the same time, microfinance cannot deliver a magic solution. Efforts to improve socio-economic conditions for the world’s poor have to tackle a large and formidable range of issues. However, for the individual microentrepreneur or household, and within the growing agendas of base of the pyramid markets and enterprise solutions to poverty, microfinance plays a critical role. The UK financial sector can help propel the sector to maturity.

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introduction

Access to financial services is very difficult for low-income groups in the developing world. Microfinance has proven to be a successful model for viably providing credit and other financial services to the poor. This report presents the findings of a project to examine opportunities for the UK financial services sector to contribute to expanding access to finance. The project was undertaken by Forum for the Future with support from the City of London Corporation, Gresham College and Defra, as part of a follow on process to the London Principles project1.

Objectives

This report explores the potential and need for commercial involvement in microfinance and provides examples of commercially oriented innovations in products, processes or market mechanisms by which mainstream financial institutions have increased access to financial services to the poor. After assessing the case for commercial involvement, it examines three areas in more detail:

The current and potential role of commercial investment and capital markets

Initiatives to develop new products, technologies and business models

The need for technical assistance to develop and integrate the microfinance sector

This project focuses on access to finance for low-income groups that are not served by formal financial services – individuals, microentrepreneurs or group borrowers. It does not address wider questions regarding the macroeconomic barriers to investment in developing countries, or broader development finance issues.

1 The London Principles promote banking, insurance and investment for sustainable development and were launched at the Johannesburg Earth Summit in 2002. A progress review in 2005 identified progress on enabling access to finance and risk management products for the poor in developing countries as a key area of future action. Phase II of the London Principles has two workstreams on access to finance for developing countries (this project) and access to finance for environmental technologies. See www.forumforthefuture.org.uk for more information.

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1 global financial exclusion and microfinance

Globally, about 2.5 billion people do not have access to basic financial

services. As a broad generalisation, the percentage of the population with

access to financial services in poorer developing economies is about the

same as the percentage excluded from financial services in richer

industrialised countries. Financial exclusion is not just a simple measure of

access to bank accounts. The access frontier approach developed by

Finmark in South Africa uses a ladder of different levels of access – those

who have access to banking but do not use it, those who are users of other

formal non-bank services, those who use informal services only and those

who use no financial services at all1.

Figure 1. Global map of financial inclusion

High 7.5 - 10 Upper 5 -7.5 Medium 2.5 -5 Low 0 - 2.5 No data

Source: Maplecroft 2007

This map is based on World Bank data used to develop a Financial Inclusion Index with eight separate components. Countries are scored on an index of 1 to 10, with 10 being high access to financial services and 1 being little or no access. Data coverage is patchy and not all countries were analysed on the full set of metrics. See ‘Global Map of financial inclusion’ at http://maps.maplecroft.com/ for more information.

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‘Unbanked’ people are forced to rely on a narrow range of expensive and risky informal services. This constrains their ability to participate in economic exchanges, increase their incomes and contribute to economic growth. Improving access to financial services for underserved groups in the developing world can have strong development impacts, particularly at an individual or community level. It empowers the poor to establish livelihoods, improve (and smoothen) incomes, build assets and act as a buffer against high exposure to economic shocks. Informal activities to manage risk – selling assets, reducing consumption, and taking on expensive informal loans – are inefficient, not cost-effective and often have damaging effects on livelihoods and quality of life.

The formal financial sector was not interested in a low-income market perceived as miniscule, highly risky and with very poor returns. Around three decades ago, the ‘microfinance’ model emerged as a bottom up intervention to provide finance for the poor. Grameen Bank in Bangladesh pioneered the idea that the impoverished have skills that are underutilized, are surprisingly low credit risks, and can be served profitably.

1.1 the microfinance model

Microfinance broadly refers to the provision of credit and other financial services to low-income clients, usually in small increments with affordable service charges. Microcredit – the provision of small loans usually under $100-200 without formal collateral – is the most well known form of microfinance product but it also extends to savings, insurance, payment transfer and remittance services. Microfinance products are provided by a variety of financial intermediaries. Microfinance Institutions (MFIs) may vary in terms of size, legal structure and vision, and exist in many forms –such as credit unions, non-bank financial institutions, co-operative banks and, often, NGOs. Some other financial actors such as state-owned postal, development and agricultural banks are also active in microfinance. Some of the key differences between microfinance and mainstream finance models are outlined in the table below.

Table 1 Main differences between mainstream finance and microfinance

Product range Lending model Organisational status

Mainstream finance

Comprehensive product portfolio but based on higher value transactions.

Competitive transaction costs and interest rates.

Mostly built on collateral based lending. Use of sophisticated credit scoring systems.

Individual and enterprise lending.

Formal regulated institutions, with a wide variety of local, national and international entities.

Use strong management information, technology and risk management systems.

Microfinance

Limited products concentrated on credit but increasingly offering other services. Uses low value, high volume model.

Very high costs due to transaction-intensive business model.

No need for collateral. Group lending dominates, but increasingly lending to individual and enterprise clients.

MFIs use group lending to utilise social collateral. Short loan cycle (6-12 months) with weekly payments.

Diverse range from small NGOs restricted to lending services through to formal bank status.

Most use little or no technology, have rudimentary information systems and lack financial sophistication.

Many MFIs depend on leveraging social collateral, usually through lending to organised groups, mainly consisting of women who are seen as more productive users of the loans and better credit risks. MFIs charge interest rates that might sound high in a mainstream context— the average global rate is about 35-40 % annually — to cover the high administration costs incurred through originating and servicing small loans, often in rural areas with weekly payment collection. In this context though, it is important to note that although MFIs may charge rates of 30 to 70% to cover their costs, these interest rates are still significantly lower than the 300% to 3,000% annual rates that many borrowers were previously paying to informal money lenders.

Impact analysis studies are frustrated by the difficulty of identifying causality. Numerous studies have documented improvements at individual, household and enterprise levels as microloans have not only enabled productive entrepreneurial activity but also offered new ‘consumption’ opportunities for education, nutrition or healthcare. But an exhaustive survey of existing impact assessments found that positive impacts could only be attributed to specific contexts shaped by the

Improving access to finance can have powerful economic and social benefits.

Grameen Bank pioneered microloans in the 1970/80s.

Unsecured microcredit dominates but other financial products are emerging.

High costs due to transaction intensive model leads to high interest rates.

.

Proven impact at community level but difficult to extrapolate.

.

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type of services offered, client profiles and regional environment2. Microfinance works in specific cases but more research is underway to create a robust and credible evidence base that is valid on a broader scale.

Microfinance is not a magic solution to poverty, nor is it an automatic enabler of higher living standards. As a successful and scaleable bottom up solution it offers an alternative to the top down aid models of the past but does not tackle the important structural and macroeconomic drivers behind development such as infrastructure, legal systems, trade policy, governance and investment climate amongst others. Critics point to the simple fact that Bangladesh is the most successful microfinance country – both in symbolic terms as well as actual penetration with a US$ 995 million portfolio on loan to 9.2% of the total population – yet still ranks 137 out of 177 countries on human development indicators3. Other criticisms refer to microloans fuelling only immediate consumption but not improving productive economic activity and the risk of over-indebtedness exacerbated by high interest rates.

Ultimately, initiatives designed to develop and deepen financial sectors in developing countries will enhance the overall climate for delivering financial services to the poor. Successful microfinance depends on an enabling environment, some of which is industry-specific – such as interest rate caps, financial regulation or foreign investment rules – but also relies on general rule of law, functioning societies with microentrepreneurial opportunities and a range of other social and economic factors.

microfinance has been growing rapidly

Microfinance has been building momentum over the last 20 years that has accelerated in recent years – given a high profile boost by the 2005 UN Year of Microcredit and the Award of the 2006 Nobel Peace prize to Grameen founder Mohammed Yunus – and is now taking the first steps towards becoming a mature financial sub-sector. It is growing rapidly and now has thousands of MFIs, millions of borrowers, billions of dollars in loan portfolios, and numerous donors and investors. The exact scale of the industry is difficult to estimate reliably given conflicting data sources that use different methodologies and definitions and the disparity of the sector with weak information systems.

Figure 1 The microfinance industry is expanding rapidly

26.9

41.654.8

66.6

19.3

7.6 12.213.8

3164

1567

2186

2572

2931

1065925

618

0

10

20

30

40

50

60

70

80

90

100

1997 1998 1999 2000 2001 2002 2003 2004

Nu

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er o

f cl

ien

ts m

illio

n

0

500

1000

1500

2000

2500

3000

3500

Nu

mb

er o

f M

FIs

Poorest clients Total Number of MFIs

Despite increasing commercialisation and the successful use of commercial funds from banks and investors by some MFIs, the sector is still heavily reliant on public and private donors to provide grants and subsidised loans. CGAP has a broad estimate of the total global microloan portfolios

2 Nathaneal Goldberg “Measuring the Impact of Microfinance: Taking stock of what we know” Grameen Foundation USA 20053 UNDP Human Development Report 2006

Scaleable bottom up intervention but not a magic solution to poverty.

.

Grameen Nobel Prize raises profile.

. .

.

Substantial growth in scale but difficult to estimate size accurately.

.

Source: Microcredit Summit Campaign Report 2005. Note these figures are inflated by the addition of 2 very large Indian traditional women’s savings and credit groups that account for 31 million borrowers and also includes 16 million from government run programmes. Source: Accion 2006

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outstanding at about US$ 15 billion4. This is a very rough estimate that includes the loans made by state owned banks, agricultural and postal banks. Another estimate puts the amount of microfinance assets at about US$ 11 billion in 2005, forecast to grow to US$ 20 billion by 20085.

an elite band of MFIs dominate a fragmented sector

The size and reach of MFIs varies widely. On the one hand, there are the ‘top-tier’ or ‘tier-1’ MFIs, that have significant scale, established track records, highly professional operations, healthy finances and, often, many of the characteristics of commercial banks. Over the past 10 to 15 years, a number of leading MFIs have developed an excellent track-record as financial entities which compares favourably with mainstream financial institutions. This exclusive MFI club – which consists of around 75 to 100 organisations – contains the most commercial performers of the industry which share similar characteristics such as high growth rates, a solid product portfolio, strong profitability (return on equity in the 20s is common), low portfolio at risk (average default rates of 3%), strong Management Information Systems, excellent diversification and access to commercial funding sources. As some studies report, many top MFIs outperform local bank peers in terms of return on equity6. However, increasing professionalisation also introduces the potential for ‘mission drift’ as larger MFIs may be tempted to go upmarket and reduce their focus on poorer clients. Established networks of MFIs spread best practices and offer technical assistance, increased visibility, and public validation for established and emerging MFIs alike.7

A study found explosive organic growth in tier-1 commercial MFIs across all regions. Based on a sample of 71 MFIs between 2004 and 2006, total assets grew by 191% to US$ 6.7 billion, total equity by 122% to US$ 791 million, loan portfolios by 231% to US$ 4.8 billion and number of borrowers by 73% to 4 million8. Projecting the trends and organic growth rate forward results in strong asset and portfolio growth to about US$ 36 billion in loans to 23 million borrowers by 20119. However, this is a mechanistic projection that does not take account of several variables and assumes growth rates can continue at the same pace. The underlying assumptions of the scenarios include expansion of the number of elite MFIs, greater involvement of commercial capital, rapidly increased efficiency and much higher leverage. This also requires US$ 2.4 billion worth of external equity investment by 2011.

On the other hand, the remaining 98% of all MFIs below tier-1 vary dramatically from one another, in terms of business models, scale and financial health. Most MFIs face significant challenges, particularly 10:

o A lack of internal capacity: Most MFIs have rudimentary business processes, poor managerial capacity and a lack of technology systems. Their growth often stops once a programme reaches several thousand clients. Adequate internal operating capacity includes improvements in areas such as information technology infrastructure, internal controls, new product development, and human resources, all of which are costly to acquire.

o A capital gap: Many MFIs have limited options to mobilise capital. Most rely on a limited pool of donor and grant funds, and the majority are restricted from taking deposits and recycling them into loans as is common in the formal banking sector. They must either sell some of the debt on their balance sheets or otherwise secure substantial new funds in order to expand their lending activity. When MFIs only rely on philanthropic or subsidised funding, there is rarely enough money to make the necessary investments in key areas to create an operation that is well run and has the ability to grow on a sustainable basis.

4 “Foreign investment in microfinance: debt and equity from quasi-commercial investors” Consultative Group to Assist the Poor, Focus Note 25, January 20045 Source Celent 6 Jennifer Isern and David Porteous “Commercial banks and microfinance: evolving models of success” Consultative Group to Assist the Poor, Focus Note 28, June 20057 Examples of MF Networks are: Women’s World Banking, Opportunity International, Accion, FINCA, The Microfinance Network, Grameen8 Elisabeth Rhyne and Brian Busch “The Growth of Commercial Microfinance 2004-2006’ Council of Microfinance Equity Funds, September 2006 9 Ibid10 Source: Unitus

Tier1 MFIs are profitable but only represent 2% of the sector.

.

Spectacular growth in Tier-1 MFIs since 2004…

.

…if trends continue will grow 6x to meet 12% of demand by 2011

.

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Figure 2 Small scale MFIs dominate the industry

1.2 meeting demand for financial services

The main providers of funding have been local domestic sources – government grants, domestic investors and mobilised savings – and foreign donors. However, domestic funding from government sources can be very limited in low-income states and most MFIs are legally unable to mobilise savings. Donors have more flexibility in providing grants and subsidised loans, but have a limited amount of capital available and have many competing areas for development investment such as education or healthcare.

The industry is still unable to scale to meet the latent demand for financial services amongst the world’s poor. Estimates suggest that 80% of the working poor (more than 400 million families) are still without access to microfinance services. At current growth rates, the gap will not be closed for decades11. Only 55 million of the poorest families out of 250 million have access to microcredit. With an expansion of the definition of the poor, only 80 million out of about 600 million families have access to credit. This indicates, at best, about a 10-20 percent market penetration. When considering loans, the industry is doing an even worse job at meeting demand. Total demand for micro-loans is estimated at US$ 300-500 billion while supply is only US$ 15 to 30 billion12.

Microfinance is growing rapidly from a very small base but the potential demand is forecast to stay on a continued upward trend because predicted global population increases to around 9 billion by 2050 will mostly be in lower income (and microfinance target) segments in the developing world.

11 Source; Unitus 12 Source: McKinsey, CGAP estimates

Source: Grameen Foundation 2004, Unitus 2006

Domestic funding sources dominate…

.

… but industry only meeting a fraction of total demand.

.

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Figure 3 Microfinance is unable to meet potential demand

Expanding the tier-1 and 2 base by building institutional capacity and seeding many more new professionally driven commercial MFIs will be essential to enable the industry to scale and improve absorptive capacity for both debt and equity capital. Otherwise, the current trend of focusing on a handful of tier-1 institutions by both private and public investors could have dangerous consequences – and leave the large and unwieldy majority of small scale, inefficient and unprofitable MFIs to stagnate and decline. There is increasing evidence that the donor and philanthropic community is crowding out private sector investment by allocating soft funds to strong tier-1 MFIs that can access commercial sources of capital13. This soft funding should instead be directed to weaker and less commercially appealing organisations, be used to leverage private sector funding and be invested in public goods and an enabling infrastructure for the microfinance industry.

the solution? Moving from donor to market capital

Philanthropic sources, foundations and governmental organisations mainly provided the significant sums initially needed to launch and grow microfinance over the last three decades. They ‘pushed’ capital into the sector because of its ability to create sustainable microenterprises using a successful lending model, but with little regard for the risk as to whether the capital would be returned and often with limited understanding of whether it had been well deployed. These philanthropic investors played an important role as risk-tolerant angel investors who helped capitalize a new industry, and they need to continue to play a critical role in many circumstances, particularly for the vast majority of small-scale tier-2 and below MFIs.

The main public agencies active in international funding for microfinance are the development finance institutions – both multilaterals such as the International Finance Corporation (IFC) and those from individual countries such as Kfw (Germany) and OPIC (United States). These institutions held a combined microfinance portfolio of US$ 2.2 billion in 2006. Just five agencies accounted for 75% - KfW (Germany), AECI-ICO (Spain), IFC (multilateral), OPIC (United States) and EBRD (multilateral)14. DFID, the UK government agency, promotes microfinance within a broader inclusive financial sector strategy. It allocated approximately £86 million between 2003-06 on microfinance activities moving away from directly funding MFIs to providing support for financial

13 Julie Abrams and Damian Van Staffenberg “Role reversal: Are public development institutions crowding out private investment in microfinance?” Microrate MFI Insights, February 200714 Source: CGAP IFI survey 2006

Philanthropic and public funding nurtured microfinance.

.

$300 b

Foreign debt16%

Domestic debt19%

Domestic equity12%

Domestic guarantee

1%Deposits

45%

Foreign equity

5%

Foreign guarantee

2%

~$30 billion Current supply

Potential demand

Total investment – 100%= ~$30 billion

Domestic $26 b

Foreign $4 b

~$300 billion

Source: CGAP, McKinsey estimates. This refers to a very broad estimate of the total microloan portfolio including government run institutions.

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infrastructure, capacity building and its flagship Financial Deepening Challenge Fund – a £15 million pool managed by a private agency that is currently funding 28 projects in collaboration with private sector players15. DFID has also leveraged private money by providing a first loss position in a transaction arranged by Deutsche Bank.

An increasing number of industry experts argue, for microfinance to unleash its full potential, to operate at scale, and to create the economic virtuous cycle of development that builds the capital of the poorest communities, philanthropic and soft funding alone will not be sufficient. An estimated capital requirement of US$ 270 billion – 45 billion equity and 225 billion debt assuming a 5:1 leverage – will not come from donor funds or philanthropists. Total Official Development Assistance (ODA) – using the broadest measure including emergency assistance, debt relief, bilateral and multilateral funds – was about US$ 100 billion in 200516.

Commercial capital is needed at much greater scales in microfinance. The main potential providers are banks – either through provision of financial services to low-income clients directly or through dedicated subsidiaries and service companies or indirectly through wholesale services or outsourcing arrangements with MFIs17 – and domestic and international investors. The positive trends in the microfinance industry have not gone unnoticed in the mainstream financial community. An increasing number of domestic banks are ‘downscaling’ to seek new growth markets and large international banks are looking at strategic opportunities, initially driven by corporate social responsibility (CSR) concerns or regulatory requirements but increasingly moving to a commercial basis.

The other main group of potential commercial players is mainstream and socially responsible investors – and other actors in the investment value chain such as investment banks, raters and fund managers – who can allocate significant volumes if microfinance becomes a viable asset class.

In the medium term, the main portion of the capital requirement is likely to be provided by domestic sources – including mobilised savings, commercial bank loans, retained MFI earnings and domestic debt and equity investors – but this is only currently starting to happen in a few isolated cases with strong MFIs and active local capital markets. Domestic funding, particularly in low-income nations, is unlikely to be able to scale fast enough to meet demand without the injection of catalytic capital from international investors – particularly those who have a greater risk appetite than mainstream domestic investors. Ultimately, microfinance must become a segment of the formal financial sector, using as broad a mix of capital sources as mainstream banks, including a central role for mobilised savings.

Commercial involvement from international institutions can act as a catalyst to professionalise and scale the microfinance industry while providing value for mainstream participants. For MFIs, access to a much larger pool of more flexible risk capital – often at lower interest rates than commercial loans from domestic banks – options to leverage domestic funding, potential equity investment, market discipline, formalisation, an expanded product portfolio and technical assistance are all potential benefits.

Advantages for international commercial financial institutions will vary according to business objectives and strategic intent. For large global banking and insurance groups seeking mid to long term growth opportunities in emerging markets, early involvement in microfinance will provide market intelligence and access to a potentially massive future customer base. Some national commercial banks are downscaling while immediate opportunities for providing wholesale services to MFIs are being seized by both national and international players. The elite MFIs also offer valuable channels for developing and distributing new products such as insurance or remittance services.

The investment community can also benefit from examining the emerging opportunities in microfinance. Although microfinance investment is still embryonic and dominated by public and social agencies, it is possible to visualise some commercial opportunities that may be attractive for select institutions. Investment banking and asset management skills are increasingly being used to

15 Source: Hansard 27 January 2007: Column 2088W. Also see www.financialdeepening.org for more information. 16 Source OECD http://www.oecd.org/dataoecd/52/18/37790990.pdf17 Jennifer Isern and David Porteous “Commercial banks and microfinance: evolving models of success” Consultative Group to Assist the Poor, Focus Note 28, June 2005

But commercial capital is needed to scale.

.

Domestic sources unlikely to be sufficient in short term.

.

International investors can play a catalytic role.

.

Microfinance as a long-term strategy for international banks.

.

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create investment propositions to appeal to a broad range of investors – from foundations and high net worth individuals through to socially responsible and mainstream institutional investors. Benefits may lie in new product opportunities, options to respond to increasing client interest in investments that deliver both commercial and social returns and the possibility of establishing microfinance as an uncorrelated asset class to mainstream market trends.

Recent positive media and political support for microfinance is also driving many institutions to reap some reputation and brand advantage by publicly declaring an interest and involvement in providing financial services to the poor.

A range of commercial institutions around the world are taking the first steps in innovating to realise these potential advantages, often in partnership with other commercial stakeholders, development agencies and MFIs. This report showcases this innovation and explains the significant challenges that remain to be resolved before microfinance becomes a part of the formal financial system. Before proceeding to this, we highlight the added momentum that may be provided by the financial services sector in the UK.

1.3 the potential role of the UK financial services sectorThe UK financial services sector – in collaboration with a range of other public and private actors –can play an important role in propelling the microfinance sector to maturity, improve product coverage and establish microfinance as an asset class. This can create the foundations for truly inclusive international financial markets that provide both commercial and developmental returns.

The UK financial services sector is a global economic powerhouse accounting for about 5% ofGDP and providing £17 billion to the UK’s balance of payments18. This includes major UK based multinational financial institutions with a global footprint from the banking, insurance and investment management sectors such as Barclays, HSBC, RBS and Aviva. In addition, London is the world’s leading international financial centre with the presence of hundreds of financial institutions, deep capital markets and a range of ancillary service providers such as legal and accountancy firms. Although not all actors in the UK financial services sector can potentially have a role to play in extending access to financial services amongst the world’s poor – for instance purely domestic players or those without significant developing country exposure – there are significant opportunities for the UK to apply its expertise.

Several institutions are already involved in microfinance to some extent, starting from a reputation and CSR focus but increasingly underpinned by a longer-term commercial vision. Moving on from a philanthropic motivation that involved giving grants and providing some technical assistance to MFIs, some international banks are now starting to explore partnership options, provide wholesale services to MFIs (usually through local subsidiaries), develop pilot projects and create targeted financial products such as remittances and microinsurance.

Wholesale loans to MFIs are probably the most widespread form of commercial engagement in microfinance. Loans to MFIs by a set of international banks were estimated to amount to between US$ 450 to 550 million in 2006 – a US$ 100 million increase over 200519. Most of this is offered through local subsidiaries, particularly in India where regulatory stipulations mean that banks have to allocate some lending to microfinance and priority rural lending areas.

Institutions have taken different approaches in their microfinance strategy. Some are building on a CSR platform to develop a targeted commercial approach with several strands – such as developing customised funding options including local currency funding, guarantee schemes, raising dedicated funds and capital market transactions; exploring strategic MFI partnerships; taking equity stakes in MFIs and developing tailored products – while others remain driven by CSR commitments with some isolated commercial initiatives. Some regional and domestic banks are also emerging as strong contenders in microfinance, for instance Egypt’s Banc du Caire, as they have local market knowledge and presence. However, ICICI bank in India is remarkable for the sophistication and scale of its microfinance business. ICICI (profiled in a case study on page 40)

18 UKTI https://www.uktradeinvest.gov.uk/ukti/fileDownload/fin_services_invest_uk.pdf?cid=38874619 See ING ‘A Billion to Gain: update 2006’ – the sample set includes 11 banks: ABN Amro, Barclays, Citigroup, Commerzbank, Deutsche Bank, Grupo Santander, HSBC, ING Group, Rabobank, Societe Generale, Standard Chartered. Data is estimated and self reported by the banks.

Some potential advantages for asset managers and investors.

.

Innovation is accelerating.

.

Only some parts of the UK financial sector can potentially play a role.

.

Microfinance given initial traction by CSR, but business-led approaches emerging.

International bank microfinance strategies vary.

12

has innovated in several areas and is a valuable case study for international banks looking at integrated microfinance strategies.

Most banks provide some form of technical assistance to MFIs but this can vary from ad hoc volunteer programmes run by bank employees through to systemic support packages. Technical assistance is usually offered as a philanthropic activity with much more potential to expand –especially through partnerships with international financial institutions, trade associations, MFI networks and government agencies.

Figure 4 Mapping microfinance activity for some international banking groups

*Note refers to commercial business units, both Citigroup and Rabobank Foundations are also significant philanthropic actors in microfinance. Source: adapted from Figure 6 in ‘A billion to gain- update’, ING Microfinance Support 2006. HSBC, ICICI added separately.

Stated Commitment

Actual Involvement

CSR orientation

Commercial orientation

ABN Amro is building a strong microfinance business through its local subsidiaries in Brazil and India, focusing on wholesale loans and services to MFIs but also investing in microfinance venture funds and pursuing strategic partnerships.

Barclays has a small microbanking service in Ghana but a large retail presence in South Africa through its subsidiary ABSA, which has 4.3 million low-income clients.

Citigroup has a dedicated Microfinance Group which works across the global business to develop commercial relationships with MFIs, develop products, create financing facilities and facilitate capital market transactions, particularly in local markets. It is pursuing a partnership model with MFIs. (see extended case study)

Deutsche Bank manages a number of global microfinance funds that offer tailored funding options for MFIs including guarantees, long term local currency funding through co-lending, letters of credit and credit default swaps.

HSBC is piloting projects to provide wholesale services to MFIs, including loans, transaction and remittance services. It aims to embed microfinance within local subsidiaries.

ICICI Bank pioneered the partnership model in India and is aggressively pursuing a multi-pronged microfinance strategy that includes product development, use of new technologies and a comprehensive technical assessment and seed capital programme. ICICI has innovated in launching new products including life and crop insurance and is piloting a new internet enabled rural agent banking model. (see extended case study)

Standard Chartered offers wholesale loans to MFIs in Africa and Asia. The current portfolio is around US$ 50 million but it is establishing a US$ 500 million facility to disburse funds over five years in Africa and Asia. It also has equity stakes in a couple of Asian MFIs.

Source: ING ‘A billion to gain: Update’ 2006, ICICI, Citigroup

Citigroup*

ICICI Bank

Deutsche Bank

Rabobank*

ING ABN Amro Barclays

Standard Chartered

CommerzbankHSBC

Societe Generale

Citigroup Foundation

Rabobank Foundation

13

Institutions will develop a business case for engagement depending on their organisational characteristics, geographical spread and strategic objectives. For many, the microfinance market may be too immature or it may never align to business goals. However, for others who are actively seeking opportunities or for those who may not yet have analysed microfinance through a commercial lens, the rest of this report explores innovations that are transforming the microfinance landscape in three main areas:

Figure 5 Opportunities for the UK financial services sector to expand global access to finance

Market understanding will shape a business case for engagement.

Developing and delivering financial services

o Direct provision of retail financial services to low-income groups through local subsidiaries (accounts, loans, insurance, payment systems, remittances)

o Indirect services to MFIs including commercial loans, transaction services, value chain partnerships to originate and service loans and delivery of products.

Capital markets and investment

o Structuring and placing financial instruments including securitisation and collateralised debt obligations.

o Investment management including creating new equity and debt funds and distribution of existing products.

o Investor participation from mainstream institutional investors, social investors and high net worth individuals

Technical assistance and infrastructure

o Technical assistance on product development, governance, risk management processes, technology systems

o Supporting infrastructure for accessing local and international capital markets including ratings and performance standards

14

2 capital markets and investment

The demand for commercial capital in the microfinance industry is far greater

than current supply levels. As explained earlier, donor and philanthropic funds

are unable to meet the financing needs of MFIs. Mobilising savings is only an

option for a small portion of MFIs who are authorised to take deposits – and

particularly in many very low-income areas – this is not yet a viable and scaleable

source of capital. Only commercial funding – from international and domestic

sources – will be able to fill the gap. Nevertheless, donor funds will remain an

important component of the capital mix, especially for leveraging private

investment, seed capital for new MFIs, technical assistance and providing

finance for micro-loans for the extreme poor.

This section starts by examining emerging commercial investment opportunities

and exploring the growing force of microfinance investment vehicles before

focusing on debt and equity investment in more detail with some case studies.

A range of routes into commercial investment in microfinance have emerged in

recent years – for both mainstream commercial investors and social investors

looking for market returns. These include direct investments in MFIs or MFI

bonds or through microfinance investment vehicles such as dedicated debt and

equity funds, pooled guarantees and more esoteric structured instruments such

as collateralised debt obligations (CDOs). Venture capital style investing in start-

up MFIs is also gaining increased attention with a few small operators such as

Unitus and Aavishkar India. Accelerating growth and rapidly expanding the top

tier of MFIs will be essential to increase the sector’s capacity to absorb growing

amounts of capital.

15

Figure 6 Commercial investment in microfinance

Foreign investors include a broader mix of philanthropic and social investors, enabling a wider risk return profile and more flexibility in choosing investment options than purely commercial investors in most developing countries. Both international and domestic commercial investors have a much more conservative investment profile and will invest in a narrower range of low risk instruments –often through credit enhancement – or high quality MFIs. The large and growing multi-trillion dollar socially responsible investor segment in North America and Europe is potentially an attractive source of funds for the microfinance industry. However, the bulk of these funds are held in screened portfolios that exclude ‘sin stocks’ such as nuclear or tobacco but mainly invest in large corporate stocks. They may be more flexible than purely commercial investors but do not compromise on returns. Socially responsible funds run by institutions such as Morley in the UK and AXA in France have invested in microfinance securities, but only in relatively well structured and lower risk instruments.

Some of the larger institutional investors such as TIAA-CREF in the United States and ABP from the Netherlands have recently made significant allocations to microfinance but overall activity and interest in this space from pension funds is relatively low. Some mainstream financial institutions have also invested in the emerging structured instruments that can offer a range of risk-reward profiles to suit different investor types (discussed in more detail in the next section).

“Mainstream capital is not brave. It does not like going places where the rules are unclear or subject to multiple interpretations. It does not like to go where the expected returns are not calculated clearly and plausibly and where the risk is not fully detailed and explained”20.

Microfinance investment has only emerged in the last few years, and although it is growing rapidly, it is more of an umbrella term for a diverse range of investment approaches rather than a formalised investment thesis. It is a very young field with undefined metrics, poor performance measurement standards and insufficient disclosure. Liquidity is a concern as is the complete absence of any secondary markets for microfinance investments (apart from some ad hoc sales of microloan portfolios by ICICI to other banks in India, where demand is driven by priority sector

20 Jed Emerson and Josh Spitzer “Blended Value Investing: Capital Opportunities for Social and Environmental Impact” World Economic Forum March 2006

Microfinance institutions

Debt Funding

Commercial loans to MFIs made by international or domestic banks, MFI funds or international financial institutions.

Guarantees for MFI loans using approaches such as pooled guarantee funds.

Bonds for domestic capital markets.

Structured instruments including securitisation for both national and international debt offerings.

Microfinance investment funds and vehicles

Debt only / Debt & Equity / Equity only / Venture Capital

Equity Funding

Socially responsible equity directly or through microfinance funds

Commercial equity directly or through microfinance funds. Little MFI listed equity or mainstream funds yet.

Social venture capital using venture model for early stage investment in MFIs

Debt funding

Equity funding

Range of investor profiles from social to commercial.

Microfinance investment is a young and undeveloped field.

Local commercial investors

Local commercial bank loans

International donor

International philanthropic

International socially responsible

International commercial

16

lending regulations) making it very difficult for investors to freely trade microfinance assets and exit investments rapidly as is the case in most mainstream asset classes.

2.1 microfinance investment vehicles As private foreign funding to microfinance has grown, a series of investment vehicles have emerged to channel capital across a wide range of MFIs. These microfinance investment vehicles (MIVs21) vary widely in terms of capital structure, investment philosophy, size and targeted return rates. Many MIVs are more like development funds run by professional investment managers but offering sub commercial rates of return. The diversity of organisational structures –traditional funds, structured instruments such as CDOs, finance companies – reflects the early stages of commercial microfinance investing without an industry consensus on standards and structures22.

Recent surveys of the MIV universe have found rapidly growing funds with an increase in assets and microloan portfolios between 2004 and 2006. The analysis is undermined by very poor data quality across the sector with a lack of transparent performance standards and adherence to consistent reporting principles. Nevertheless, trends indicate that MIVs are a growing phenomenon in microfinance with significant portfolios approaching US$ 2 billion. MIVs tend to prefer investing in hard currency MFI debt with a regional bias towards Latin America (perhaps because of some dollarised economies reducing foreign exchange risk) with small allocations to Africa and Asia.

Figure 7 Growth in the microfinance investment vehicle universe

21 Following the lead of Microrate, we use the term Microfinance Investment Vehicles (MIVs) to reflect the diversity of the sector and the fact that many are not structured as funds in the conventional definition of the term. 22 Microrate “ Microfinance Investment Vehicles: An emerging asset class” Microrate MFI Insights November 2006

Very diverse range of investment vehicles. .

MIVs have a US$ 2 billion portfolio, focus on debt and Latin America.

Latin America & Caribbean

56%

Eastern Europe

17%

Africa8%

Asia12%

Other regions

7%

1700

175

250

350

0 500 1000 1500 2000

Preservation of capital

Quasi Commercial

Grants

Fully Commercial

US $ million

513

987

2000

54

74

43

0

500

1000

1500

2000

2500

2004 2005 2006

US

$ m

illio

n

01020

30405060

7080

Nu

mb

er o

f M

IVs

Microf inance portfolio Number of MIVs

C - Regional breakdown

B - Portfolio analysisA- Portfolio and MIV growth

D – Foreign funding type*

Guarantees1%

Debt74%

Equity25%

Local currency 30%

Hard currency 70%

Debt

*Note chart 8D refers to overall foreign funding including MIVs and direct donor and foundation investments. Source McKinsey 2006. Chart 8A, B from CGAP, 2007, chart 8C refers to 14 largest MIVs. Source Microrate 2006

17

Most MIVs are relatively small; 82% have less than US$ 20 million under management while only 8% have more than US$ 50 million. The top ten account for 65% of total investments23. The largest MIVs – ProCredit (a Germany based holding company for a group of 19 microfinance banks dominated by 10 banks in Eastern Europe with 5 in Africa and 4 in Latin America) and Oikocredit (a Dutch 30 year old privately owned cooperative society that offers investors a capped 2% dividend return) are mainly development MIVs but more commercially driven funds (Dexia or responsAbility) and CDOs are becoming increasingly important.

Figure 8 (a) Top ten microfinance investment vehicles (b) MIV investors by type

MIVs are still reliant on funding from social investors and international financial institutions. ‘Preservation of capital’ investment – where investors want to protect their principal but do not demand market returns – dominates overall foreign microfinance funding – directly or through MIVs. Socially Responsible Investors (SRI) are a growing force in private MIVs, accounting for about 47% of total investment – of which 70% comes from European investors – but this includes a wide variety of investment styles and return targets from near market rates through to minimal returns. Almost all MIVs (excluding the CDOs) offer subcommercial returns of around 1-3% rather than competitive market rate returns. The more mature MIVs that focus on debt offer returns of between 2.6% and 5.1% in US Dollars24.

Some MIVs are trying to expand their investor base by creating investment propositions that will attract a wider range of commercial investors. CDOs with credit-enhanced debt that can be purchased by conservative institutional investors are discussed in the next section. Another approach is to tap retail and high net worth investors, particularly those looking for social and commercial returns. Dexia Microcredit Fund is a Luxembourg registered SICAV (a type of open ended mutual fund) sponsored and distributed by Dexia, a large Belgian banking and investment group, and managed by BlueOrchard, a specialised Swiss microfinance investment firm. The fund offers investment in US Dollars, Swiss Francs and Euros. Since inception in 1998, the fund has grown to US$ 169 million in total assets with a top level 6.49% return in the last 12 months25. Credit Suisse, some other Swiss private banks and social venture capital firms sponsor the responsAbility global microfinance fund which invests directly in MFIs across the world as well as other MIVs with a focus on hard currency short to mid term MFI debt. The fund is Luxembourg registered and managed by Credit Suisse and has grown very rapidly. Since inception in 2003, it grew by 455% in 2005 and now has a total fund volume of US$ 96 million26. These registered funds can be

23 Xavier Reille and Ousa Saninkone “Microfinance Investment Vehicles” Consultative Group to Assist the Poor, Brief, April 2007. The data is based on two surveys in late 2006: a CGAP study on IFI microfinance portfolios and joint CGAP-MicroRate research on MIV trends24 Ibid. The data is based on the Symbiotic Microfinance Index available at www.symbiotics.ch 25 Dexia Microcredit Fund – February newsletter 26 Microrate “ Microfinance Investment Vehicles: An emerging asset class” Microrate MFI Insights November 2006, responsibility monthly report January 2007

Most MIVs do not offer market returns..

Rapid growth through tapping retail and high net worth investors.

3 90 .4

107

96

90 .7

8 1.2

6 0

5 2 .5

39 .8

19 9 .2

23 1.3

0 100 200 300 400 500

P ro Credit Ho lding A G

Oikocredit

Euro pean Fund fo r So utheast Euro pe

Dexia M icrocredit Fund

B lueOrchard Loans fo r Develo pment*

respo nsA bility glo bal micro finance fund

B lueOrchard M F Securit ies*

Develo ping World M arkets XXEB *

Glo bal Commerc ial M F Conso rtium

Grey Ghost Fund

US $ million

M ainstream Investo rs

17%

Develo pment Finance

Instituio ns 36%

So cially Responsible

Investo rs 47%

* Refers to collateralised debt obligations (CDOs). Source CGAP Microrate Survey 2005

18

distributed using traditional channels and follow mainstream fund management processes including daily or monthly pricing, have International Security Identification Numbers (ISIN) - a uniform identification system – and are usually sponsored by well established mainstream commercial institutions which provides credibility.

Industry-wide efforts to improve transparency and develop a standard set of disclosure guidelines, led by CGAP, are underway. Although still at a draft stage, the proposed guidelines include a set of robust performance metrics, valuation procedures, cost structures and a classification scheme.

2.2 debt funding for MFIsDebt is clearly the preferred method of foreign funding for MFIs. After donated funds, debt makes up the bulk of capital that has flowed to MFIs and is considered less risky for the investor. With many investors still unsure of the potential of equity investment at this early stage of the industry, debt instruments are the best way to become familiar with an MFI’s operations and management. Furthermore, debt ensures a regular flow of interest income. Most MFIs are not structured as joint stock companies, preventing them from issuing equity. However, debt funding has also seen the most innovation in products and processes. Moving beyond commercial loans or lines of credit to a select handful of MFIs, a number of recent innovations have pushed the envelope in debt funding for MFIs by adapting structuring techniques from mainstream capital markets such as securitization or creating innovative loan guarantee structures. However, the emerging asset class of MFI debt faces significant challenges in expanding outreach, creating appropriate products, and managing risk.

Most of the foreign debt investment is going to a small number of Tier 1 MFIs with funds increasingly competing to lend to elite institutions who might be able to attract domestic investors or mobilise savings27. Increasing competition and declining yields encourages these regulated MFIs to increase domestic financing of their liabilities, as this is seen as less expensive than debt. This does not necessarily mean that these MFIs want the absolute amount of their foreign borrowings to decline. But it does suggest that, in the future, the regulated MFIs that have absorbed most of the foreign debt may need less of it as a proportion of total liabilities28. In contrast, the vast majority of unregulated Tier 2 and below MFIs are not structured to take equity investment, and they are generally prohibited from taking public savings. Few domestic banks lend to those Tier 2 MFIs – and if so, often only for a mortgage on the MFIs’ property and only at very expensive rates.

Smaller MFIs offer a huge opportunity for foreign debt – and in some cases equity – investment. At the same time, Tier 2 and below MFIs also present a risky proposition for debt investors. Their legal structure does not include owners that banks can hold accountable in case of default. Arguably most critical however is the lack of collateral. Tier 2 MFIs don’t have an asset base apart from an unsecured microloan portfolio, which is hard to evaluate given poor information quality. Credit enhancement and pooling for risk diversification may help overcome some of these barriers.

Another frequently raised concern about efficient debt funding for MFIs relates to foreign exchange risk. Around 70% of foreign investment in MFIs is in hard currency - whilst most of an MFI’s loans and other assets tend to be denominated in local currency. Since MFIs operate in developing countries where the risk of currency depreciation is highest, they are vulnerable to risk that has at least three components: 1) devaluation or depreciation risk, 2) convertibility risk, and 3) transfer risk. While some instruments do exist for some MFIs to hedge against foreign exchange risk29, evidence indicates that most MFIs that take on foreign debt are heavily focused on the apparent interest rate advantage. But they are not alert to the fact that a foreign loan with a lower nominal interest rate may be more costly in real terms. Some risk management and hedging instruments are available but are often too expensive meaning that FX risks are currently not managed well. Sophisticated initiatives that can offer local currency funding are slowly emerging but have yet to scale effectively and be used by the majority of MFIs. The TCX facility being developed by IFC,

27 “Foreign investment in microfinance: debt and equity from quasi-commercial investors” Consultative Group to Assist the Poor, Focus Note 25, January 200428 Ibid29 Possible methods to ‘hedge’ against exchange risk could involve, for instance, e.g. 1) Conventional instruments (Forward contracts and futures, Swaps, Options; 2) Back-to-Back Lending, 3) Letters of Credit, 4) Local Currency Loans Payable in Hard Currency with a Currency Devaluation Account, 5) Self-imposed Prudential Limits, 6) Indexation of Loans to Hard Currency.

Debt dominates foreign investment , but innovation is increasing.

Investment concentrated in elite MFIs, who need it least.

Tier-2 MFIs are higher risk but offer massive opportunities.

Foreign exchange risk is not managed.

19

Kfw and FMO is an example of efforts in this space as are currency swaps used by Morgan Stanley and the emergence of local currency microfinance funds such as Minlam Asset Management and LOCFUND.

Innovations are emerging in both onshore funding (where the transaction is based solely in domestic jurisdictions) and offshore funding (where the transaction is across national borders and is often based in an attractive tax domicile such as Luxembourg). Bonds, guarantees and syndicated loan facilities are some of the main onshore innovations.

local currency bonds

Some MFIs have issued successfully issued bonds in their local capital markets. However, this is only appropriate where the MFI is suitably large and mature enough to tap local commercial investors and where local bond markets are developed enough to facilitate transactions. Latin America has emerged as the favourite region for local currency bonds as the table below highlights although Faulu in Kenya issued the first African microfinance bond in 2005. The bonds were a first in their respective local capital markets and used credit enhancement, ratings and attractive returns to attract investors in a series of roadshows. Investors became more comfortable with microfinance bonds and subsequent issues were more keenly priced but were still often oversubscribed.

Table 2 Local currency bond issues

Compartamos (Mexico)

Mibanco (Peru) WWB Cali (Colombia)

Faulu (Kenya)

Type of institution Consumer finance company (SOFOL)

Commercial bank NGONon bank financial institution

Year of first issue 2002 2002 2005 2005

Number of issues 5 3 1 1

Total public debt placed US$ 68 million US$ 14.5 million US$ 52 million US$ 7 million

Rating agent Standard & Poor’s Mexico

Class & Associates and Equilibrium

Duff & Phelps (Fitch) Colombia

Not known

Credit enhancement International Finance Corporation

USAID -Agence Française de developpement

Source: Accion 2006, Faulu

International banks are involved in arranging local currency bonds through local subsidiaries. Citigroup was involved in arranging and placing the Compartamos bond issues through Banamex, its local subsidiary. The transaction received international recognition and was awarded Latin Finance’s magazine ‘Best Structured Deal of the Year’, and won the first Financial Times ‘Sustainable Deal of the Year’ award.

Local currency bonds are an attractive option for a few MFIs but are unlikely to be appropriate for the majority of smaller MFIs, especially in countries with weak capital markets. Moreover, they do not offer opportunities to leverage the risk appetite of social investors to create products that can bring in a much wider range of commercial investors while offering funding to smaller MFIs that cannot directly tap local markets alone. Nevertheless, local currency bonds will be an important source of longer-term capital for many MFIs, while also contributing to deepening relationships with local capital markets.

loan guarantees

Loan guarantees and similar approaches offer opportunities to leverage funding for MFIs, particularly from local sources such as commercial banks. The guarantee encourages MFIs to build stronger relationships with local banks and demonstrates to the banks that the MFIs are viable business partners30. Guarantees function as a form of insurance, mitigating credit risk to the lender by the guarantor undertaking to pay an agreed portion of any defaults.

30A loan guarantee is a form of credit guarantee that focuses on a loan from a bank or lender to a single institution. Broader credit guarantees – for instance covering an entire lending portfolio are also used. CGAP Focus Note 40

Guarantees can unlock local currency funding and build MFI-bank relationships.

Local currency bonds issued mainly in Latin America.

Only suitable for large MFIs with appropriate local capital markets.

Innovation in onshore and offshore funding.

20

Although guarantees are not always appropriate for all MFIs or countries and can sometimes be more expensive and less catalytic than intended, they can be powerful tools for leveraging guarantor capital, enabling local currency funding with low FX risk and overcoming regulatory hurdles to foreign investment31. Guarantees are a small but growing part of the microfinance capital mix – accounting for 2% of the estimated US$ 4 billion foreign investment. Although development finance agencies are the main guarantors, some private initiatives have emerged in recent years.

local lending facilities

Some international banks, with Citigroup probably doing most to innovate in this area, are also pursuing an alternative funding strategy by developing syndicated loan and local currency funding facilities. A US$ 100 million term facility supported by a US$70 million guarantee by OPIC (a US government agency that provides guarantee services) will enable funding to a broader set of tier 1 and 2 MFIs through Citigroup’s global branch network.

Other banks such as HSBC, ABN Amro and Standard Chartered also intend to mainly channel funding through local subsidiaries.

structured products

A recent development in microfinance debt funding is using mainstream financial structuring techniques to create products that enable MFIs to tap domestic or international debt markets. Structured finance techniques such as securitisation – which pools assets together and transfers them to a special purpose vehicle, which then issues securities backed by these assets to

31 CGAP focus note 40

Case – International guarantee schemes

Pooled guarantee schemes that use international investors to back local currency loans to MFIs by domestic commercial banks are increasingly being used as an effective way to enable MFIs to raise capital without having to make direct investments.

Some early initiatives used philanthropic investors to pledge assets in a special account that were in turn used to offer standby letters of credit (SBLOC) and other guarantee mechanisms to MFIs. Deutsche Bank’s Microcredit Development Fund used donated capital from private bank clients to set up a revolvinf fund that offered subsidised loans to MFIs to improve their balance sheet position (not for on-lending to MFI clients) and thus attract local capital.

Grameen Foundation USA’s Growth Guarantee programme uses donor-guarantors who pledge a minimum of US$ 1 million for 5 years to Citibank in the USA. The money is held in an agreed portfolio, the donors still earn returns and the pledges are pooled by Citibank to issue SBLOCs to domestic banks in the MFI’s country. This SBLOC can be used to guarantee a commercial loan, provide a first loss cushion or other forms of support.

Deutsche Bank’s Global Commercial Microfinance Consortium (GCMC) – which closed in November 2005 with US$ 75 million in committed capital – is an innovative transaction that uses structuring techniques to create different tranches with different risk-reward characteristics suitable for a range of investors and offers very flexible funding options for MFIs across the world. It is essentially a structured product (covered in the next section) but is discussed here due to its use of guarantee mechanisms.

The consortium’s sophisticated capital structure leverages credit enhancement by public agencies and social investors to create a debt tranche of US$ 60 million senior five-year notes (offering a return of LIBOR +1.25%) cushioned by three equity tranches totalling US$ 15 million (US$ 5.5 million class B equity offering 12% return, US$ 8 million class A equity offering 8%). A US$ 1.5 million first loss position was taken by the UK Department for International Development and USAID guarantees 25% (US$ 15 million) of the senior notes. Foundations and social investors bought the equity tranches while commercial investors like AXA, Merrill Lynch, State Street and Standard Life purchased the notes.

GCMC offers MFI flexible funding options including co-lending with domestic banks, use of deposits, SBLOCs and credit default swaps. This enables MFIs to build relationships with banks, leverage GCMC funding to attract local capital and reduces conventional hard currency debt loans with the associated foreign exchange risk.

These forms of innovative funding solutions for MFIs have a lot of potential for replication and scalability. By focusing on both investor needs (risk-return, credit enhancement) and MFI needs (flexible funding, improve commercial links, local currency) these structures can add significant value.

Source: Case study information adapted from WEF Blended Value Investing 2006

Microfinance securitisation uses a collateralised debt obligation (CDO) structure.

21

investors – and the associated collateralised debt obligations (CDOs)32 have increasingly been used to raise capital for MFIs. The figure below outlines a generic microfinance securitisation structure. Most microfinance securitisations are not ‘true’ securitisations in that they do not actually aggregate and securitise specific microloan portfolios33 (see point 1 in the figure below). Instead, the majority of instruments so far have used a CDO structure to pool together loans to a set of MFIs( see point 2). ‘True’ securitisation of microloan portfolios is rare, but cross-border CDOs that pool loans made to multiple MFIs in different countries are growing – both in size and sophistication.

Structuring techniques that divide debt into different risk-reward layers (or tranches) are of particular interest because they can bring in a synergistic mix of investors – with more socially minded or risk tolerant investors taking on the junior tranches and more conservative investors choosing senior, highly secured tranches that can fit within their investment parameters. Tranching enables risk-averse institutional investors to place funds in microfinance assets because senior tranches can be rated and protected by a loss cushion. Depending on the structure chosen, the risk level of the senior tranche can be significantly reduced by having fatter equity and subordinated layers. The cash ‘waterfall’ means that senior note holders are paid first and then in descending order with equity holders only receiving residual cash left after all the other investors have been paid.

Figure 9 Generic securitisation structures in microfinance

As a first step in linking microfinance to the international capital markets, the groundbreaking structured finance transactions since 2004 have engaged a broad range of investors, demonstrated the applicability of sophisticated mainstream techniques and introduced a new, allegedly uncorrelated, but still miniscule asset class for investors. These transactions could herald a new future for commercial investment in microfinance but still have considerable challenges to overcome. Most rely on credit enhancement and participation of public agencies to create a investable product, require private placement to overcome a lack of mainstream credit ratings,

32

Securitization is a process through which homogenous illiquid financial assets are pooled and repackaged into marketable securities. Generally, the assets are held in a bankruptcy remote entity termed as a Special Purpose Vehicle (SPV) or are otherwise secured in a manner that gives the investors a first ranking right to those assets. We use the term CDO to refer to pooled loans, including collateralized loan obligations as a subset of CDOs.

33See for example: Jed Emerson and Josh Spitzer “Blended Value Investing: Capital Opportunities for Social and Environmental

Impact” World Economic Forum March 2006, Claudia Schneider and Harald Huttenrach “Securitisation: A funding alternative for microfinance institutions” KfW Bankengruppe 2005, Brad Swanson “The role of international capital markets in microfinance” Developing World Markets, 2007

Tranching enables more commercial investors to get involved.

Strong potential but considerable challenges.

MFI

MFI

$Microloan

Originator

Special Purpose Vehicle

Senior Tranche (70%)

Mezzanine Tranche (20%)

Equity Tranche (10%)

Loan

Interest & principal

Loan portfolio

$

Investors

Credit enhancement

MFI

Microborrowers

Interest & principal

Rating agency

Law firmStructurer

True microloan portfolio securitisation

Typical CDO structure pools multiple loans to MFIs2

1

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need to address documentation issues, small transaction size and a lack of industry data. At the moment most of the mainstream involvement in these deals – whether as a structurer or investor –is primarily driven by reputation and brand concerns (in other words most of this is ‘story paper’).

Crucially, secondary markets do not yet exist for microfinance debt securities. Cross border CDOs also need to address the challenges of operating with Tier 2 MFIs and providing appropriate local currency funding34. The recent BOLD transaction used a currency swap provided by Morgan Stanley – 20% of the funding is in local currencies, including Mexican Pesos, Colombian Pesos and Russian Roubles – and reports of other local currency facilities in the pipeline are an encouraging sign of progress.

The recent securitisation of the microloan receivables of BRAC’s (a large MFI in Bangladesh) is the first groundbreaking ‘true’ microfinance securitisation35. FMO (Netherlands) and KfW (Germany) are the public agencies involved in the transaction, with FMO providing a guarantee and investing in a third of the securities, and with Citigroup acting as both co-arranger and investor. This is a landmark onshore transaction and the first securitisation in Bangladesh’s capital markets. This deal may enable other large MFIs to securitise their microloan portfolios in the future and may also open up opportunities for domestic banks to securitize their loan portfolios to MFIs.

Table 3 Major structured microfinance products

NameKey Players – obligors, sponsors and investors)

Amount and year

Capital structure

SHARE MICROFIN

ICICI bank – Sponsor & investor

ICICI later sold portfolio to another Indian bank.

US$ 4.3 million

2004

Securitisation of 25% of loan portfolio. 8% first loss guarantee provided by GF USA

Blue Orchard Microfinance Securities

BOMFS 1 & 2

Blue Orchard – Originator

Developing World Markets – Arranger

JP Morgan – Trustee and placement agent

OPIC – credit enhancement

66 investors including foundations, SRI funds. microfinance funds, institutional investors.

1st closing US$ 40 million (2004)

2nd closing US$ 47 million (2005)

Cross border collateralised debt obligation (CDO) provides hard currency loans to 9 MFIs.

5 tranches – US$ 48 million in senior notes with OPIC guarantee (+55 basis points over reference rate), US$ 35 million in class A (5% return ), B (6% return), C (8% return) subordinated notes, US$ 3 million in equity (12% return)

OPIC Guarantee for 25% of senior notes

Blue Orchard Loans for Development

BOLD 2006-1

BOLD 2007-1

BOLD – 1

Blue Orchard – Originator

Morgan Stanley – Structurer

FMO – credit enhancement

11 investors – 17% mutual funds, 66% banks, 9% insurance companies, 8% advisory accounts

(Details not yet available for BOLD –2)

US$ 99.1 million

2006

US$ 108 Million

2007

BOLD 1 - Cross border CDO provides 20% soft currency (through Morgan Stanley as swap provider) and 80% US$ and EURO loans to 21 MFIs in 13 countries.

3 sets of Class A notes in US$, GBP and EURO and US$ 28 million Class B notes totally underwritten by FMO.

BOLD - 2 – First mainstream rated CDO. US$ 42 million tranche rated AA/ US$ 16 million rated BB by Standard & Poors. BOLD 2 will offer loans to 21 MFIs in 13 countries in local currencies.

Microfinance Securities

XXEB

Developing World Markets – Sponsor

Global Partnerships and Symbiotics – servicers

HSBC – Trustee

Microrate – Rating agent

Morley Fund Management, Civic Capital (equity investors) Senior note investors include several pension funds, SRI houses and a hedge fund

US$ 60 million

20063 tranches of debt

BRAC/

Citigroup

BRAC – Originator

RSA Capital – Arranger

US$ 180 million over 6 years

Securitisation of microloan receivables, expected dynamic pool of 3.3 million loans over 6 years. Approximately US$ 15 million will be disbursed every 6

34 Claudia Schneider and Harald Huttenrach “Securitisation: A funding alternative for microfinance institutions” KfW Bankengruppe 200535 Deutsche Bank securitized a 47.8 million euro portion of Procredit Bulgaria’s Euro denominated loan portfolio in May 2006. As this was a hard currency deal in a near term EU accession country, it is not highlighted here as a landmark transaction.

Landmark local market microloan portfolio securitisation.

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Citigroup – Co-arranger and investor (1/3)

FMO - Co-arranger, credit enhancement and investor (1/3 )/ KfW - Co-arranger, credit enhancement

Citigroup Bangladesh and two domestic banks –investors (1/3)

2006 months to BRAC.

No tranching, FMO purchased 1/3 of securities, Citigroup purchased 1/3 backed by guarantees from Kfw and FMO, and Citibank Bangladesh and 2 other domestic banks purchased remaining 1/3.

The industry is tackling challenges in order to unleash the potential of structured products to funnel more capital to microfinance. The BOLD 2 transaction in May 2007, again with the involvement of Morgan Stanley, marked a step change in microfinance CDOs as it was the first to be rated by a mainstream agency. Standard & Poor’s – which has been working to develop a specific microfinance rating methodology – has assigned a preliminary AA (third highest) rating to the top US$42 million tranche. This means that mainstream investors can now buy this paper as it is now risk weighted for Basel II capital adequacy rules. Standard & Poor’s expects to rate another 2-3 further CDOs in 2007 (bringing up a total of around US$ 500 million – almost doubling the total amount raised in one year) and Morgan Stanley believes that annual microfinance CDO issuance could reach US$ 3 - 4 billion in the next five to ten years36. Deutsche Bank has announced plans for a second US$ 200 million CDO on a similar model to the Global Commercial Microfinance Consortium in summer 2007.

Despite advances in microfinance CDOs outlined above, microfinance securitisation is still in its infancy, and a number of obstacles currently make it difficult for MFIs to offer true securitization transactions:

- These deals require considerable financial engineering and must be of a sufficiently large scale to warrant mainstream bank and legal firm attention

- Microloans require relatively expensive and active administration, and the MFIs themselves in most cases can perform that maintenance at the lowest cost

- It would be difficult for an MFI to sell its loans without third parties to continue administering those loans

- The maturity of the microloans (often less then one year) can limit the maturity of any securitized notes

- Portfolio risk analysis is difficult without a track record and is complicated by low country ratings for many MFI operating regions37

None of these obstacles should prevent the ultimate securitization of microloans, and those challenges can be – and are increasingly being - met with the sort of financial engineering that investment banks are experts at. As mainstream investors become more comfortable with the investment prospects of microentrepreneurs and as the cost of administering microloans continues to fall (through adoption of technology and sharing of best practices), full microfinance securitization deals will become reality.

At present though, these innovations do not yet seem to have entered the mainstream markets. The products and structures are not yet standardised, there remain too few of these securities, and they have existed for too little time for financial analysts to understand their aggregate behaviour. Most institutional investors require a defined asset class (where products have similar structures enabling quantitative analysis and modelling)38. Institutional investors with fiduciary responsibilities will not be able to invest in unrated products – most mainstream rating agencies do not yet rate microfinance debt – from an asset class that has not built a historical track record of documented performance. Fund managers running complex portfolios require this information to be able to make quantitatively-driven asset allocation decisions. Even if presented as an ‘emerging market financial services high-yield debt’ investment opportunity, microfinance securities will not be able to fit into standard low risk fixed income portfolios but will have to compete with hedge funds, private

36 International Herald Tribune – Morgan Stanley selling loans to support microfinance May 7, 2007 37 Ian Callaghan et al “Microfinance: On the road to capital markets’ Journal of Applied Corporate Finance Vol 19 Number 1 Winter 2007; Brad Swanson “The role of international capital markets in microfinance” Developing World Markets, 2007 38 WEF Jed Emerson and Josh Spitzer “Blended Value Investing: Capital Opportunities for Social and Environmental Impact” World Economic Forum March 2006

Obstacles to further securitization.

A long way from becoming a formal asset class.

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equity and other opportunities for the small ‘alternative assets’ segment of mainstream institutional investor portfolios. Most current microfinance investments are also too small to merit analysis by large investors who often only invest in large chunks of several million dollars. The lack of liquidity and absence of secondary markets makes it even more difficult to attract mainstream commercial investors at meaningful scales.

For securitization to become more wide-spread, a number of factors are important: Investor demand; depth and diversification of local capital markets; appropriate legal and regulatory framework; servicer rating or (rated) back-up servicer; MFI portfolio of standardised loan receivables; portfolio data and historical loss information39. Before commercial capital may fund the microfinance industry on a large scale, capital markets will require investment products capable of meeting investor needs. To have greater market appeal, liquidity and fairly easy to trade, microfinance debt products need to have investment terms that are understood by the average investor, allow leveraging due diligence and similar costs across multiple investors, and provide a measure of broader portfolio diversification.

2.3 what about equity investment? Equity investment can be the preferable financing method for MFIs, particularly for the vast majority of less established and unregulated Tier-2 and below MFIs. These institutions need to build capacity and improve their ability to attract commercial capital. They can only borrow up to a certain multiple of their total equity (a requirement that varies by regulatory regime), so additional equity investment can unlock follow on debt -funding. Furthermore, equity investment encourages engagement and influence that can be exercised through membership on the board of directors. Such investor engagement often encourages transfers of best practice and organizational capacity building. Equity funding also means that there are less regular cash outflows for interest payments.

Potential MFI investors, however, often perceive equity investments as very risky. Equity investors, literally, buy into the operations of the MFIs they support. But with equity even further behind debt in its claim on an MFI’s free cash flows, an equity investor must be much more certain that sufficient cash flows accumulate. Consequently, equity investors (such as venture capitalists) put particular emphasis on the managerial and financial expertise and experience of the management teams leading the organization they consider for investments.

MFIs have not yet reached the public markets as listed companies, although recent landmark initial pubic offerings of Compartamos in Mexico, Equity Bank in Kenya and BRI in Indonesia could herald the start of an emerging trend. Investors seem to be interested; the Compartamos US$ 407 million issue in April 2007 was oversubscribed and shares jumped 30% on the first day of trading.

Large mainstream banks are also starting to purchase equity in successful MFIs. Standard Chartered recently took on equity stakes in MFIs in Nepal and Pakistan. ABN AMRO invested in ShoreCap International, a microfinance equity fund that invests between US$ 500,000 to 2 million in equity in local currency in MFIs in Africa, Asia and Eastern Europe. TIAA-CREF, a large US institutional investor, has recently set-up a US$ 100 million Global Microfinance Investment Program and has taken a US$ 43 million private equity stake in ProCredit Holding AG – a group of 19 large commercially driven MFIs in Eastern Europe, Latin America and Africa – one of the first cases of direct equity involvement by an international institutional investor.

There are several barriers to equity investment, particularly in the smaller MFIs that arguably need it most. As NGOs, many MFIs are legally unable to accept equity funding and need to transform into a formal commercial organisation before being eligible. Management quality, corporate governance processes, organizational capacity and scale are unlikely to satisfy investor demands. Out of thousands of active MFIs, only about 220 have the regulatory permission and are structured to issue share capital and attract equity investors40. Currently, exit opportunities for equity investment are also very limited as most MFIs will not be listed on public markets or sold to other investors easily. There is little liquidity and a lack of secondary MFI equity markets.

Equity flows into microfinance are concentrated in rapidly growing top-tier MFIs. About 17% of the total very broadly defined US$ 30 billion microfinance investment is in the form of equity– 5%

39 WEF Blended value 2006 40 CMEF equity funds

Liquidity, rating and portfolio performance data are crucial.

Equity is important for smaller MFIs…

… but is rarely available.

Mainstream investors are getting involved.

Several obstacles to equity investment.

Tier-1 MFIs dominate equity portfolios …

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foreign equity (~US$ 1.5 billion) and 12% domestic equity (~ US$ 3.6 billion) – while around 23% of MIV portfolios are held in MFI equity41. MFIs are getting larger with the elite MFIs in the top-tier hitting the milestones of 100,000 borrowers or loan portfolios of US$ 100 million. In 2004, only 5 MFIs had more than 100,000 borrowers and only 4 had 100 million dollar loan portfolios – in 2006 this had jumped to 20 for both metrics.

To manage risk and reduce the burdens of due diligence, many foreign and domestic investors are more prone to purchase equity in a few tier-1 MFIs. But many of these institutions are likely to have limited demand for such investment. According to the CMEF, many leading regulated MFIs reported having no need for additional equity capital over a three-to-five-year period and indicate a preference for using deposits or profits to finance growth. Many tier-1 institutions are relatively underleveraged, although for the top 70 institutions, leverage had increased from an asset/equity ratio of 6.6 in 2004 to 8.6 in 200642. There is a concern about quality with many investment funds competing to fund the same institutions, who are also courted by donor and foundation investors. As these stellar MFIs mature, their need for foreign equity declines as they mobilise savings or tap local commercial capital.

Figure 10 (a) Total MFI equity by region (b) Number of MFIs by total equity

As the figure above shows, most eligible MFIs (apart from the Procredit group of institutions in Eastern Europe) have relatively small amounts of total equity– typically in the US$ 500,000 to 2 million range – with implications for due diligence, relatively fixed high transaction costs and investment decision-making processes. Providing equity investment to small scale MFIs and developing an institutional acceleration model is being attempted by a handful of new funds that seek to apply venture capital techniques by investing in early stage companies with good growth prospects. Although still very young, funds like Aavishkar India, Lok Capital, Unitus LP, ShoreCap, Andromeda and Microvest are starting to build a microfinance venture investment model.

These funds are looking to seed a new generation of professional MFIs that can attain rapid growth rates and significantly expand the Tier-1 category of MFIs that are able to access a wide range of capital sources and provide a suite of financial services. With a much higher risk appetite needed for this type of early stage equity investment, these funds have a mix of social, high net worth and donor investors but also some strategic investment from banks such as ICICI and ABN Amro in India, where many of these funds are focused, piggybacking off the country’s rapid economic growth, maturing financial sector and attractive microfinance market.

In a groundbreaking transaction, Sequoia Capital, one of the most prominent US venture capital firms behind companies such as Yahoo and Google, invested US$ 6.5 million as part of a US$ 11.5 million round in SKS Microfinance, a for profit Indian MFI. The deal has an exit clause stipulating that SKS will either be floated on the stock market or acquired within the next three to five years43. Developing creative exit strategies will be essential in bringing in more venture capital investment in microfinance and creating a new breed of rapidly growing professional MFIs. It is too

41 Source McKinsey, CGAP, Microrate 42 CMEF equity funds43 Sequoia invests $11.5 million in microfinance fund. CNBC March 29, 2007 http://www.cnbc.com/id/17844093

New venture capital style approaches emerging.

…but arguably need it least .

Mainstream US fund makes first microfinance venture investment.

Source: CMEF 2006

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soon to say whether microfinance venture capital will be a successful approach as most funds have only made a few investments and not exited any yet. However, growing interest in acquiring MFIs by some banks, initiatives that provide options to finance management buy-outs, such as those offered by ICICI Bank in India, and a slim opportunity for select MFIs to float on local stock markets offer some hope for a effective exit environment for microfinance venture capital in a few years.

Case: Successful equity investment requires creative exit strategies

In 1995, for-profit investment fund, ProFund Internacional S.A. (ProFund), was incorporated in the city of Panama. Sponsored by a handful of social investors, headed by ACCION International, Calmeadow-Canada, Triodos – The Netherlands and Fundes - Switzerland - the first commercial microfinance equity fund ProFund Equity Fund with an equity base of $23m was created. Managed by Costa Rican fund manager and consulting firm Omtrix, SA and to provide equity and quasi-equity resources to eligible regulated and efficient financial intermediaries. The main target market was the small and micro enterprises of Latin America and the Caribbean. To protect against undue investment concentration, ProFund set a $4 million cap on any single investment and opted not to take controlling positions; 20-30% target became the norm.

Expecting to invest passively, initially, Profund bought stakes with a view to hold. ProFund was liquidated after ten years according to the terms of its charter. Getting out of investments proved complex since, unlike in developed countries, there were no local stock markets eager for new listings, nor hungry local investors. Profund had to work hard and under duress on each exit deal.

The fund relied on several exit strategies, many of which are suitable for liquidating minority positions, which can be especially difficult to sell when most buyers are seeking controlling interest:

Put Options: These gave ProFund the right to sell shares in the investment to a particular buyer, usually a larger co-investor, on a particular date at a price determined by the investment’s performance

Controlling Block Shareholders’ Agreements: Here, a number of minority investors agree to coordinate in selling their shares in unison so that a buyer can buy a controlling stake by aggregating several smaller shareholders’ stakes.

Management buy-outs: ProFund negotiated provisions by which an MFI’s management could purchase ProFund’s shares.

Redemption: When ProFund relied on quasi-equity structures, it typically included a redemption feature that would coincide with its closure and liquidation date.

ProFund realized a net IRR of 6.65%. This was a remarkable performance given that all of Profund’s capital was contributed in dollars and invested in local currency. Its dollar returns were reduced by local currency depreciations, reflecting the economic chaos in much of Latin America.

Case: Adapting a venture capital style model for microfinance

Established in 2000, with headquarters in the US, the nonprofit organization Unitus aims to accelerate the growth of carefully selected, high-potential small and mid-sized MFIs through significant investments in capital and active involvement in capacity building.

The Unitus ‘Acceleration Model’ combines best practices from strategy consulting, venture capital, and investment banking industries with the aim of dramatically accelerating the number of microcredit loans that can be made to the poor

Unitus helps its MFI Partners prepare thorough business plans, determine equity and cash flow needs and strengthen their balance sheets. It also works with each MFI partner to customize packages that combines some or all of the following depending on individual needs: linkages to local and international banks, grants, debt, and equity. Each unique financing package helps the MFIs accelerate their growth while building sustainable capital structures.

One of the main goals of the Unitus Acceleration Model is to help MFI partners transform into for-profit regulated financial institutions that are mission-driven to serve the poor. Transformation is important to the Unitus Acceleration Model because commercial MFIs demonstrate a more sustainable and scalable model for microfinance than their nonprofit counterparts.

Transformed MFIs are more sustainable for three primary reasons:

Quality control regarding minimum capital adequacy, financial performance, reporting accuracy, and operational rules to obtain a license.

Enhanced service quality and product offering such as clients’ saving/deposit offers to provide a cheaper source of funds for funding loan portfolio growth

Clear ownership and board structure to provide better access to significant funding from the capital markets, including access to stable, long-term sources of financing that have the capacity to meet the needs of the institution as it grows. Once this transformation occurs, Unitus helps its partners access equity investments from third parties.

The fund initially targeted at $20 Million to be invested in 12-15 MFI equity positions, predominantly in India, with a 7-10 year exit goal, and aiming for: Financial: Target IRR 8-11%Social: Forecast 5 million additional borrowers with improved income, housing and education It closed a first-round investment of $8.5 million, and made its initial investment in March 2006- a $470,000 investment in SKS Microfinance, India. Unitus recently upped the fund size to $35 million to launch a fund focused on microfinance startups. It claims of getting positive feedback from about 70% of the approached institutional investors.

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2.4 towards a best practice approach for international investors

International investment in microfinance is growing rapidly, bringing in a broader set of commercial investors using innovative techniques, creating more investment vehicles with the increased involvement of international banks and investment managers. However, this is still very limited in scale compared to the estimated capital needs if the industry is to meet demand. Donors and social investors currently dominate international investment in microfinance, with very few truly commercial investment opportunities available. Most of the funding is in hard currency debt with no risk mitigation and is channelled to a handful of tier-1 MFIs in certain regions, without addressing the vast majority of unregulated small scale institutions that urgently need assistance to graduate to a more robust commercial footing.

Investors in microfinance are faced with a fledgling industry that does not conform to the standards common in mainstream investment. There is a lack of common performance disclosure, investment vehicles are structured in a bewildering variety of ways and most investments are not rated, making risk assessment very difficult.

Industry specialists believe that microfinance investment vehicles such as securities will eventually be able to stand on their own, appealing to investors without needing a ‘socially responsible crutch’, and without any concession to the risk-adjusted market rate of return. Many feel that these products will be very desirable because they are both safe and relatively uncorrelated to other asset classes. Indeed, for large investors, microloans could be an appealing asset class with an unique combination of social and financial returns within the same product and with an appealing financial risk-return profile for a number of reasons, for example: high diversification; high insulation of the microfinance sector from macroeconomic shocks; low correlation with other asset classes in portfolio; low default rates; low prepayment risk; low volatility of financial returns. A recent academic study found low correlation between microfinance and wider economic and fiscal shocks44.

Microfinance investment is evolving rapidly but faces a number of challenges with regard to both meeting the needs of investors, particularly commercial, and meeting the needs of MFIs, particularly those which are not among the handful of elite institutions.

Meeting investor needs

Investors require clearly defined investment opportunities that adhere to standard principles and can be analysed using standard analytical techniques. Using techniques such as securitisation has attracted more risk-averse commercial investors but these transactions are dependant on credit enhancement and participation of social investors in the junior tranches to work.

Microfinance investment vehicles will need to work much harder to attract more commercial capital. MIVs need to offer market returns, improve disclosure to align with standard fund performance reporting to enable investors to compare different MIVs. In order to reach retail investors, funds also need to be registered and have strong distribution partnerships.

Meeting MFI needs

Microfinance investment needs to be able to offer local currency funding, use more guarantees and offer more equity investment to a much broader range of MFIs then is reached at present. Providing hard currency loans to a select band of large MFIs is relatively easy with relatively low risk (at least for the investor but not usually for the MFI). But in order to have an effective catalytic impact, international investment must move beyond its comfort zone to develop further innovations that allow the vast majority of MFIs to get funding options that are most appropriate. Most investment is concentrated in a few top-tier institutions

The current mix of investors in microfinance – from international donors and development banks, foundations and social investors to the more recent (and limited) entry of high-net worth and institutional investors – need to work together to maximise impact. There is some concern that

44 Ingo Walter Can microfinance reduce portfolio volatility

Microfinance investment needs to become more commercial.

Potential to eventually become a viable asset class.

Investors need more credible products.

Local currency debt and equity needs to be offered to a much broader range of MFIs.

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donors are crowding out private capital by providing subsidised loans to large MFIs who are able to attract commercial capital. In the future, the strongest commercial opportunities should be left to commercial investors, while social investors and donors should leverage their ability take higher risk to provide capital in less commercially compelling opportunities.

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3 developing and delivering financial services

Direct provision of retail financial services to low-income clients is not currently

viable for most mainstream international players, even those with local

subsidiaries. A lack of relevant physical infrastructure (e.g. branch network) in

the target customer areas, a business model with high overheads that cannot

absorb microfinance’s high transaction costs and slim margins and a lack of

customer and market knowledge have combined to keep international and

domestic mainstream institutions away from microfinance.

This is now starting to change as opportunities are being explored through

creating dedicated products, developing new technology enabled delivery

channels and using innovative business models and value chain partnerships.

While these innovations are not without risk, they demonstrate that it is indeed

possible, with adequate strategies, to profitably exploit the opportunities offered

at the vast bottom of the pyramid market, even if the profit margins for individual

clients are small. Most of this activity is very recent and many projects are

experimental pilots but momentum is building that could eventually revolutionise

the microfinance sector.

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3.1 microfinance product innovation

Microfinance is moving beyond the delivery of only microcredit products towards a full suite of financial services designed to meet low-income client needs. Some of the best tier-1 MFIs already offer a broad product range that includes targeted credit for housing, savings accounts, insurance and payment and remittance services.

Figure 11 BancoSol (Bolivia): from mono to multi-product offer

The ability to offer more products depends on organisational capacity and very few MFIs are currently offering anything close to BancoSol’s wide range. A basic set of products designed for the financial needs of low-income households includes savings, credit, insurance and payment services. There is a quality gap in product provision. Reported numbers of microfinance clients and loan portfolios do not reveal the differences in quality and client experience45. After the basic range, targeted products that focus on specific client needs or life-cycle products such as education loans or pensions are even more rare. Financial services designed for micro-entrepreneurs, particularly around specialised agricultural finance such as crop insurance, leasing and weather derivatives are still in the experimental pilot stage.

Even less attention has been paid to leveraging the microfinance model and distribution network to design a range of themed financial services that offer specific services for specific objectives. For instance, offering climate related insurance for farmers, health insurance or clean energy financing packages that enable access to low cost solar or other renewable energy sources for the vast number of people without access to grid electricity and forced to rely on scavenged firewood or other unsustainable sources of energy.

Combining microfinance with entrepreneurial income-generation initiatives designed for the base of the economic pyramid (BOP) can also have profound impacts. Grameen Phone built up a network of rural telecoms micro-entrepreneurs who were not only offered a viable income generating opportunity but also access to a tailored financing package to purchase a handset and airtime. As more and more companies become alert to the opportunities in BOP markets – and social enterprises demonstrate the success of unconventional approaches – the potential for value-added microfinance should grow exponentially. Donors and social investors need to trail blaze and experiment in this space, but need to engage with corporate, NGO and governmental actors to maximise impact.

45 Elisabeth Rhyne and Maria Otero “Microfinance through the next decade: Visioning the Who, what, when, where and how” Accion International, November 2006

Only very few MFIs offer a broad range of products.

Opportunity in specialised products – energy, healthcare, water.

Source: Accion 2006

Value-added microfinance.

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Figure 12 Microfinance product range and availability

Mainstream institutions are starting to see valuable product distribution opportunities in partnership with MFIs. Most MFIs lack the ability to develop and deliver products in-house but have the customer relationships and distribution ability to enable adapted or specially designed mainstream products to reach the customer.

For mainstream institutions, domestic or local subsidiaries of international groups, microfinance product development and distribution through MFI channels, offers attractive opportunities. Potentially, almost every type of retail financial product could be redesigned for low-income customers including life and general insurance, savings, (micro) investment and remittances. However at present most activity has taken place in two specific priority areas:

Remittance related services – the volume of global remittances from migrant workers to their home regions in developing countries has rocketed as the globalisation of labour becomes more widespread. It is now the second most important capital flow after foreign direct investment and arguably has a more immediate development impact as the money flows straight to migrant worker families.

Insurance and risk management products – the poor are more exposed to both systemic (natural disasters, drought, crop prices) and idiosyncratic risk (illness, theft, fire) than more affluent groups but rely on inefficient informal insurance mechanisms – such as savings, distress sales of assets, borrowing – which often only offer limited cover. Microinsurance is a growing area as many providers are experimenting with ways to provide a host of insurance products from simple bundled loan insurance, to more complex crop and weather products. .

As a completely underserved market – and now with the potential offered by leveraging new business models and technologies to create a viable and cost-effective delivery infrastructure –many players, including new entrants from the telecommunications and retail sectors, are actively looking at opportunities. However, to be marketable, and profitable, these products require adaptation to local conditions and customer needs. Pricing structures and business models need to

Housing loans

Remittances

*Note this includes smallscale farmers – as the dominant employment activity in most developing countries but also includes micro-entrepreneurs from shop keepers to market traders. Agricultural finance refers to dedicated products such as tractor loans, input and fertiliser loans, commodity derivatives etc although microloans are used by farmers as working capital.

Small business*

Household

Widely offered

Experimental pilots

Product availability

Target clients

Pensions

Life insurance

Health insurance

Crop insurance

Weather insurance

Group Microloans

Leasing

Micro-investment funds

Bundled Loan insurance

Bundled Loan insurance

Individual Microloans

Group Microloans

Individual Microloans

Consumer finance

Education loans

Agricultural finance*

Savings

Use MFIs as partners to co-develop products.

Remittances and insurance offer immediate potential.

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be carefully designed to deliver profitability in a low margin, high volume market and products need to address customer requirements.

insurance and risk management products

Microinsurance is defined as ‘the protection of low income people against specific perils in exchange for premium payments proportionate to the likelihood and cost of the risk involved’46. Insurance extends the coping capacity to a next level of leverage as it increases the scope of risk coverage; and insurance products are rapidly gaining popularity as an additional financial tool to help people living with poverty to cope with the risks and vulnerabilities .In developed countries, a vast variety of insurance products exist to manage and mitigate risk for individuals as well as businesses. In developing countries, by contrast, insurance products are hardly available, and particularly not for the poor. They often don’t even know about the actual value of those products, and/or premiums may be prohibitive, income may be too low or insecure, and distance may be a problem. Only 1% and 3% of households and businesses in low- and middle-income countries, respectively, have catastrophe insurance coverage, compared with 30% in high-income countries47. Instead of insurance, they rely on family and public support, which is not always forthcoming for catastrophes that affect people throughout a region or country at the same time (referred to as dependent or covariant risks). Without support, disasters worsen poverty as victims take out high-interest loans (or default on existing loans), sell assets and livestock, or engage in low-risk, low-yield farming to lessen exposure to extreme events.

The insurance market in developing countries is forecast to grow rapidly from a very low base. Non-life premiums collected are expected to double from US$ 123 Billion by 2003, to around US$ 250 Billion by 2014, and life premiums will increase even faster. Only 6% of the 670 million people in rural India have insurance, while studies indicate that 300 million can afford life, health and pension products48.

The formal sector has traditionally shown little interest in servicing poor clients: they were considered ‘uninsurable’. As microfinance has shown that the poor are bankable, microinsurance is starting to show that they are insurable as well. Insurance not only improves the poor’s coping capacities but also helps to manage risk for organisations serving them, such as loan insurance for MFIs.

Consequently, many MFIs have become involved in various forms of insurance. When managed properly, these programs allow MFIs to protect their loan portfolio (both by developing an adequate insurance cover for their clients and by educating them how to manage risk and plan for the future) whilst simultaneously generating income (by selling insurance). To be serviced efficiently and effectively, insurance provision must be affordable, simple, timely and relevant to their specific risks. The most widespread product in this context is loan insurance. If the borrower dies, her family does not have to repay the outstanding loan. The cost of this insurance is paid for by a relatively small fee at the time of taking the loan. The other major product is life insurance. When a client dies, her family gets a certain amount, the benefit, from the microfinance institution. Premium is paid for by, again, a special service charge, or, even less demanding from an administrative point of view, by paying the claims out of the gross profit of the microfinance operations. Both products can be fairly easily integrated with the loan administration and many institutions offer these products on a mandatory basis: the insurance is directly linked with loan provision. As these products do not represent great risks to the institution, a number of more established MFIs have begun to offer these products.

Life and loan insurance is comparatively simple as it focuses on assessing individual risk (at least when ignoring the increasing risk of epidemics such as AIDS/HIV). However, if it comes to crop or livestock insurance, however, the risks are more volatile. Crop is sensitive to weather conditions and livestock to diseases, including endemics, and there is a chance that all clients of a crop insurance scheme may face damage at the same time.

In this context, new technological developments might help to some degree. In recent years, state-of-the-art methods to forecast food shortages created by bad weather have significantly improved.

46 Toon Bullens and Herman Abels ‘Microinsurance: An Overview of Client, Provider and Support Perspectives’ (, MIAN, NOVIB Working Paper Nr. 1, 200547 Provention consortium (2005)48 Mc Cord 2004, DFID

Formal insurance is desperately needed but unavailable for the poor.

Attractive market opportunity.

Microinsurance is growing…

… but focuses mainly on loan insurance.

Crop and livestock insurance is complex.

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For example, the East African Livestock Early Warning System is now able to provide reliable estimates of the deviation below normal up to 90 days prior to serious problems. These systems use a variety of information: 1) satellite images; 2) weather data from traditional ground instruments; 3) weather data from new systems, and 4) sampling from grasslands to determine nutrient content. More importantly, these systems allow problems to be forecast at a local level using geographic information systems. Since many of the early warning systems have now been in place for as long as twenty years, it is now possible to model the risk and begin pricing insurance contracts that match the risk profile.

Index based insurance models – which differ from traditional ‘indemnity’ insurance in that it does not require evidence of loss to pay out a claim, instead relying on a pre-defined trigger payment if a certain index point is reached – has considerable potential to offer agricultural and weather insurance cost-effectively. However, these mechanisms require credible and sophisticated data systems – to establish the index and assess if trigger thresholds have been reached – an area where the private sector can play a role.

This notwithstanding, in most developing countries, because of patchy and missing historical data and lack of experience, the actual level of risk is difficult to assess (although it is expected to be high). There are other considerations to take into account when developing microinsurance products – particularly when addressing the needs of the poorest – past experiences, accessibility, simplicity and timeliness of procedures, financial literacy and awareness raising are all essential. Together with the fact that most microinsurance clients are, by definition, poor, this makes it challenging, to say the least, to develop viable products and to calculate the appropriate premiums.

The operating context is very different from traditional mainstream insurance markets even if the technical factors are not necessarily very different. Customers are much more exposed to risk, have fewer options for risk mitigation and rely on assets (such as cattle) that are hard to value accurately. Providers of microinsurance face three sets of specific challenges, relative to the insurance industry at large49’:

- Firstly, it requires specialised actuarial capacity in the light of lack of reliable statistical data.

- Secondly, for poor clients the concept of insurance may be quite new or negatively loaded because of past experiences. It often takes time and effort for them to see the potential benefits of insurance.

- Third, microinsurance is quite demanding in terms of distribution: large numbers of clients paying small premiums for limited coverage is a different ball game than handling few clients paying high premiums for top-end products’.

Furthermore, in some countries, such as India, liberalisation of the insurance sector has brought about new regulatory framework that seek to stimulate the provision of insurance services into rural areas and among customers that would not otherwise be targeted. India’s Insurance Regulatory Body, for instance, has made it mandatory for all the insurance providers to reach out to the rural population, and a certain portion of total insurance business written must be from the rural and social sectors - and adherence is monitored on a regular basis. Service provision in rural areas is expensive. Individual premiums amounts are low and business volume is of paramount importance. Several Indian Insurance groups – both domestic and international joint ventures – are looking at ways to cost effectively serve this market and meet compliance requirements.

However, by its nature, the insurance business is extremely risk-averse - and to a large extent has to be, to stay alive. Despite their general interest, international insurers have largely stayed away from this sector, rendering the potential market for microinsurance products largely underserved. A number of organisations are beginning to take advantage of the newly created opportunities in this market, for instance, in partnership with (agent-) organisations, such as MFIs, that have the relevant infrastructure in and knowledge of the local markets to provide them with access to sufficient clients.

49 Toon Bullens and Herman Abels ‘Microinsurance: An Overview of Client, Provider and Support Perspectives’ (, MIAN, NOVIB Working Paper Nr. 1, 2005

Regulatory drivers in India are pushing activity.

Technology may help provide data to assess risk.

Products need to designed carefully to reflect customer needs.

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Table 4 Potential advantages of the partner-agent model50

MFI benefits Insurance partner benefits

- Limited initial capital investment and low variable costs

- Rapid product launch and scale-up

- Compliance with legal and regulatory requirements

- Potential for stable revenue stream from commissions

- Opportunity to learn the business without taking on the risk

- Access to new markets

- Access to clientele with verifiable financial records

- Reduced transaction costs in serving a new market

- Improved political or public image

- Compliance with license requirements stipulating that an insurer maintain a certain portion of its portfolio in low-income areas (applicable only in countries, such as India, where such regulations exist)

remittance services

The term ‘remittances services’ refers to money transfers on behalf of consumers (often migrant workers) wishing to send money (remittances) back to friends and family in their country of origin. Most of these transactions are for small sums of a few hundred dollars. The number of people living outside their home country globally is 175 million, and are the core sender group for remittances to their country of origin. While some of these people will be from the OECD, based on World Bank figures, global remittance flows to developing markets were estimated at $125.8 billion in 2004, having grown by at 13% p.a. since 2000. Furthermore, experts argue that the unofficial transfers could be as large as formal flows. This would represent to a total flow to developing countries of $251.8 billion.51 Remittances constitute the second largest flow of resources to developing countries, after foreign direct investment (FDI). They are significantly in excess of capital market and official (i.e. governmental aid) flows, and are projected to grow at a faster rate than other flows. Relative to foreign direct investment (FDI), remittances have grown consistently over the past 15 years whereas FDI has reduced since 200152.

50 Brown ‘Insurance Provision in Low Income Communities Part II: Initial Lessons from Micro-Insurance Experiments for the Poor’, MBP/DAI 2000 51 As regards the UK as a ‘sending nation’, according to the UKRWG (2005), the overall volume of remittances sent from the UK totals £2.3 billion. The UKMTA (2006) further believes that this figure can reasonably be increased by at least 100% to take account of remittances sent through unofficial mechanisms - this gives a total annual volume for remittances sent from the UK of £4.6 billion.52 Due to the lack of specific reporting of worker remittances, there is substantial uncertainty in the figures presented. Part of the growth in remittances has been attributed to better reporting of remittance flows and movement of remittances into registeredchannels. Illegal and unregistered channels form a significant part of remittance flows, but as yet cannot be quantified to any degree of certainty.

Remittances are second largest flow of capital to developing countries.

Case: AIG Uganda & Finca Uganda – Co-develop insurance product for microfinance clients

In 1996, AIG-Uganda (AIG-U) - the local subsidiary of the giant American Insurance Group was approached by the MFI FINCA Uganda (FU) to develop an insurance product for the MFI’s clients. Having seen the difficulties of bereaved families, FU decided to work with an insurer to help clients cope with this risk. At first, AIG-U and other insurers rejected the idea. But when a new expatriate managing director arrived at AIG-U, he agreed to collaborate with FU.The basic product launched in 1997, was complimented in 1999, with an expanded version including coverage for the spouse and four children. AIG-U’s foray into microinsurance, 8 years since inception, has been highly successful for all the involved parties. For the microfinance clients, AIG’s group personal accident (GPA) product has been useful and affordable in managing traumatic lifecycle events. Ugandan MFIs that participate in the scheme have generated revenues and helped improve loan portfolio quality. AIG-U benefited from its microinsurance activities in three ways: Growth – The GPA product covers 1.6 million lives through 26 MFIs, totally covering 12% of the population, and generating about $750,000 in premiums in 2003 with conservatively projected premiums of $800,000 for 2004. Almost all of the major MFIs in Uganda offer the AIG product. Profitability –With profits of around 20% on the premiums, this product provided nearly 17% of all of AIG-U’s profits for 2003. Innovation (at least initially) – taking a chance on this market when no other insurer would has been a leading example to others internationally.

As such, a microinsurance product can be developed and implemented reasonably well without external funding as can been seen with AIG-U, which has its innovative product become its number one generator of revenue and profits, gaining it international attention. The case also provides other valuable lessons, like, more importantly it relates a story of a product that has not seen a reasonable amount of evolution. This is partly due to a lack of pressure from the MFIs, and partly because AIG-U did not recognise the importance of microinsurance within its product mix. Client needs are not constant and therefore products, services, and processes must continually evolve to meet these dynamic demands. Some improvements have been witnessed by AIG-U’s microfinance product since inception, like added coverage and dedicated resources. Some broad areas, however, still call for significant upgrading, including customer education and service, the claims procedures, and the transaction processes between AIG-U and the MFIs.

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Examining the impact of remittances separately from other effects of migration is difficult. However, existing research shows that remittances reduce the level of poverty in developing countries; and the greater the volume of remittances sent, the greater the impact in reducing the levels of poverty. The research also demonstrated that a 10% increase in remittances from each migrant would lead to a 3.5% decline in the share of people living in poverty; and the vital importance of ‘diaspora investments’ based on remittances is now widely acknowledged53. Remittances are qualitatively different from other sources of development finance in that they are both relatively stable and counter-cyclical in nature, since migrants tend to remit more during periods of economic downturn in their home countries. Because remittances represent private money sent person-to-person, they benefit the poor directly and as poor people determine they need it on demand. They are used for all sorts of development purposes, including payments for education and health services.

However, whilst the remittances market overall offers substantial developmental opportunities, so far, it is not fully competitive, but dominated by specialized operators (e.g. Western Union and MoneyGram). This, in effect, creates an oligopoly, where the key players can charge high fees. For instance, for sums up to £100, a charge of 14% is not uncommon. By contrast, smaller independent operators, charge 5%.

New players in remittance services are emerging attracted by the compelling business opportunities. This will increase competition with the established companies and bring consumer prices down. International banks in particular are likely to have some important advantages by leveraging their cross-border payments system as there are virtually zero marginal costs of sending additional payments – whilst a smaller operator needs to access a bank and an international payments engine where commercially priced fees apply. Furthermore, international banks often will have the relevant infrastructure, at least in the sending countries. The remittance market is complex and comprises large registered money transfer operators, commercial banks, post offices, foreign exchange bureaus, credit unions, and niche money-transfer companies, with different players dominating specific markets – which are linked in a complex value chain. Realizing this potential, some local banks in developing countries are already beginning to tap this market. For instance, ICICI Bank’s remittance service, Money2India, has a 22% market share in the Indian business, and it is expecting the business to grow 15-20% annually in the next 4-5 years.

There is a need to address the problems with ‘last mile’ delivery of remittance services. Many recipients are in rural areas without formal access to financial services. They might have to travel long distances to access payments or pay very high transaction costs by using informal channels. There is a lack of cash access mechanisms and complicated markets with poor infrastructure. Most of the innovations in this area have involved collaboration between local and international players. The large agent network in recipient countries is a strategic advantage that large operators have over other payment providers. Using technology to create alternative networks can reduce the advantage of the agent network. Linking existing parts of the value chain – leveraging the fixed infrastructure already in place - requires little incremental investment. If a company can create partnerships which link up existing infrastructure systems, it will have lower average costs relative to competitors.

Companies are pushing traditional industry boundaries to experiment with new solutions. A consortium of 19 mobile operators announced a pilot project to create a global money transfer platform for the US$230 billion migrant worker remittance market54. Mastercard will provide the transaction and payments infrastructure while the operators will create partnerships with domestic banks in the target markets. Vodafone’s M-Pesa service was launched in association with a Kenyan MFI, enabling subscribers to transfer payments and make deposits/withdrawals from a network of agents. M-Pesa was supported by DFID’s Financial Deepening Challenge Fund. Vodafone has recently announced a global partnership with Citigroup to launch mobile-based remittance services, with the first trail planned for remittances from the UK to Kenya.

53 Published by the World Bank's International Migration and Development Research Programme in 200554 See GSMA February 2007 Press release ‘Global Money Transfer Pilot Uses Mobile To Benefit Migrant Workers And The Unbanked’ Available at http://www.gsmworld.com/news/press_2007/press07_14.shtml

With strong direct development benefits.

Remittances market is uncompetitive and overpriced.

New market entrants include banks.

‘Last mile’ delivery to unbanked recipients is difficult.

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3.2 transformation through technology

The rural poor are - often literally - not able to access the formal financial sector; and many hoard their savings at home. Those saving methods prevent savings from being productive. Furthermore carrying cash can entail security risks, and sometimes can literally be a life threatening experience. Processing and monitoring loans is a manpower-intensive effort made even more difficult by a lack of rural infrastructure. The small loan sizes and margins make it hard to recoup operating costs. With the rapid spread of information technology throughout the world, the cost of completing an electronic transaction has continued to fall over the past few years. Innovative platforms that rely on cell phones, handhelds, and smart cards drive down transaction costs dramatically while improving security, speed and enabling real-time processing. New software is also making tracking loans and saving easier and cheaper. Technology provides an alternative to the traditional (and expensive) bricks and mortar bank branch model. In Brazil for example, using point of sale (POS) terminals that can read cards to offer credit, savings, insurance and money transfer services costs approximately 0.5 % of the cost of establishing a typical bank branch55.

Figure 13 Transaction costs for US Banks

Technological advances are beginning to reduce the expense of servicing microloans, which in turn has the potential to make new lending models available. Beyond financial management information systems (MIS), an increasing number of MFIs are now using technology developed for established, mainstream financial service firms such as (Mini-) ATMs, smart cards and innovating with handheld

55 Gautam Ivatury “ Using Technology to Build Inclusive Financial Systems” Consultative Group to Assist the Poor Focus Note 32, January 2006

Technology can bring down transaction costs.

Case: Opportunity International UK and HSBC’s Opportunity Card

Since May 2003, Opportunity International, a global nonprofit microfinance organization, has been working with MasterCard to develop a co-branded card called the ‘Opportunity Card’. HSBC has joined as the sender bank that will issue the card and provide for the recipient a remittance account from which funds can be withdrawn.

Based on a pilot project with three Philippine MFIs, which was started in November 2005 and funded by a €530.000 grant from the European Commission, the intention is to reduce fees for the sender by providing cheaper card-based products and services to an unbanked sector.

At present it is expensive to remit money through other secure channels, with fees averaging between 13-20%. The “Opportunity Card”, the first of its kind, will provide Philippine migrant workers with a low cost means of sending money earned abroad back home to their families via designated HSBC website. The money can be accessed in the Philippines using local ATM machines (via Mastercard and Cirrus) at an affordable rate ($6.95 for the sender in the US through a bank account or $7.95 if funded through a cedit card, with a $1.50 ATM withdrawal fee for the recipient). This means that families and dependants will receive a much greater proportion of the money. Senders also have the option to add a small contribution to benefit the recipient’s local community in the developing world by assisting education, healthcare, and other social projects.

If this pilot is successful, the project will be rolled out in other remittance channels. Again, also this approach might provide a valuable examples for other players looking to enter remittances: Linking existing parts of the value chain – leveraging the fixed infrastructure already in place requires little incremental investment. If companies can create partnerships which link up existing infrastructure systems, the firm faces lower average costs relative to competitors.

Source CGAP 2004

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computing and mobile banking and transaction services. Technology impacts microfinance in three main areas56.

Credit methodologies: As credit scoring becomes more advanced in developing countries, there may be potential to move to automated credit processing, which reduces transaction costs and the burden on loan officers. Some MFIs are using handheld computers for their field personnel.

Backend processing: Technology has revolutionised banking operations and, as costs continue to fall, could have the same impact on MFIs by offering secure, cheap processing and robust management information systems.

Automated payment systems: A host of devices are being used to develop electronic payment systems including POS terminals, low cost ATMs, biometric smartcards and mobile phones.

The potentially revolutionary impact of technology has not yet been harnessed yet in microfinance. Numerous pilot projects are starting to build an evidence base but it is still to early to know what works best and how technology will enable successful business models. There are significant technical, economic and regulatory hurdles to overcome but the promise of technology – combined with fresh approaches by mainstream institutions and new business models – could overcome many of the barriers to profitably offering financial services to the poor at significant scales.

the new world of mobile (micro) banking

In many developing countries the cellular infrastructure now is in place and mobile penetration continues to grow in these markets, exceeding the expectations of private sector companies and telecom regulators alike.57 The mobile phone provides an access point to financial service delivery that is unrivalled, relative to bank branches, ATMs, and landline connected service locations. A mobile network is peculiarly suited to roll out in a developing market. It is more flexible than a fixed line system as it can be easier to deploy and can therefore adapt to the challenges of an inadequate infrastructure. Other benefits for operators include early pay-back on investment when compared to fixed line. For customers, on the other hand, the flexibility offered by sharing handsets and the pre-pay business model helps to overcome credit barriers.

Given that there are now large numbers of prepaid users in developing markets who are very familiar with using their phones for text and voice messaging as well as refilling their credit balance on the prepaid system, this same group is an ideal segment to target with a micro-payment feature. In many cases they have no relationship with any bank, do not use credit cards and yet they have the ability to perform financial transactions as evidenced by their ability to purchase and activate prepaid cards for additional credit.

A number of mobile-based services are being used to offer financial transactions and mobile banking services across the developing world58. While many of these are still small scale or at pilot stages, lessons are being learnt about how mobile banking can work to expand access to finance. Mpesa, WIZZIT and CelPay are African initiatives that bring mobile operators, banks and MFIs into partnership to offer competitively priced services such as money transfers, bill payments and access to credit and deposit services. However, the Philippines leads the world in providing mobile based financial transactions, particularly in payments and money transfers.

56 Elisabeth Rhyne and Maria Otero “Microfinance through the next decade: Visioning the Who, what, when, where and how” Accion International, November 200657 According to Vodafone (2006), the first cellular call in Africa was made in Zaire in 1987. But now there are more than 52 million mobile users in the continent (compared with 25 million fixed lines) and mobiles account for at least three quarters of all telephones. This extraordinary jump, 5000% between 1998 and 2003, is due mainly to the relatively low cost of rolling out a mobile network in comparison to that of a fixed line network. This means that Africa has seen faster growth in mobile telephone subscriptions than any other region in the world over the last 5 years; mobile phone usage in Nigeria for example grew 143% between June 2003 and June 2004. India is not far behind; its sheer size means it is the largest mobile market in Asia with 65.1 million customers despite low penetration levels.58 See “Economic Empowerment through Mobile” Vodafone CR Dialogue No 3 for an overview of initiatives at the end of 2006

Mobiles are widespread – and can be used to deliver financial services.

New information systems and real time transaction processing.

Wide range of initiatives underway.

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3.3 new business models for delivering financial services

Setting up an extensive rural base of branches is expensive and makes offering microfinance services economically unviable. Some mainstream commercial players are now looking for opportunities to leverage existing infrastructure or identify alternative service delivery channels through using agents or partnering with MFIs and NGOs already active in low income markets.

Using models created through base of the pyramid market access strategies, the concept of value chain collaboration is becoming more prevalent in the microfinance field. Banks or other mainstream institutions partner with MFIs – including tier 2 and below – or other actors serving low-income markets to create a viable business model. These approaches are enabled by using technology to reduce transaction costs and provide cheap, fast and reliable documentation of transactions such as using point of sale terminals, mini ATMs and mobile phones.

Value chain collaboration with MFIs.

Case: SMART Telecom ‘s mobile banking and transaction services

SMART Telecom, a Philippines based mobile operator, has developed a business model that has a ‘base of the economic pyramid’ (BOP) market orientation; and the company has continuously modified its products and services to sell further downstream in this market. Particularly noteworthy in this context is the subsequent development of ‘Smart Buddy’, ‘Smart Money’, and ‘Smart Load’.

Smart Buddy is the pre-paid cellular phone subscriber service upon which their BOP focus rests. Smart Buddy subscribers used pre-paid, text-only phone cards initially in units of P100 ($1.80) to re-load airtime onto their cellular phones. In December 2000, Smart introduced, in partnership with MasterCard, ‘Smart Money’ – ‘the world’s first electronic cash card linked to a mobile phone’ to both post- and pre-paid subscribers. Smart Money enables users to transfer money from a bank account to a Smart Money account. Subscribers can then use a Smart Money card like a debit card to pay for a variety of goods and services at a network of retail stores and restaurants. Another element of the service allows users to transfer cash from one Smart Money card to another via short message system (SMS).

An extension of this service is marketed by SMART under the banner of SMART Padala and is aimed at the significant number of Overseas Filipino Workers (OFWs) who regularly transfer funds to family back in the Philippines. This will be described in some more detail in a subsequent section (see chapter on remittances).

In May 2003, Smart introduced yet a new service based on the Smart Buddy mobile commerce technology platform. Called Smart Load, the service enables the electronic transfer of airtime via SMS. Whereas Smart Money transferred cash and required a bank account, Smart Load transfers pre-paid airtime from a retail merchant or other reseller to a pre-paid phone customer, allowing for cash payments to the reseller. This capacity provides merchants with incentives to sell airtime, effectively expanding Smart’s distribution network and market.

In searching for a way to increase their revenue on pre-paid sales, Smart’s answer was to eliminate the need for a physical card as the mechanism to purchase or re-load cellular phone minutes. As a result, by the end of the second quarter of 2003, Smart eliminated production and distribution of their P100 re-load card. Also at that time, Smart Load prices were broken down into smaller denominations: P30 ($0.54), P60 ($1.07), P115 ($2.06), and P200 ($3.58). Advertised by Smart as ‘telecoms in sachets’, the smaller denominations were designed for the low-income Filipino market that already purchases consumer goods in small quantities.

Additionally, the Smart Load payment model paid attention to low-income market practices. Despite the technology of the product, as noted by the company, ‘relationship selling’ is what ultimately makes Smart Load possible. Smart retailers are predominantly ‘sari-sari’ (‘varied’) storeowners – small merchants with close connections to their patrons. Furthermore, sari-sari merchants often provide credit when their patrons are unable to afford cash purchases. Smart has created a network of retailers including sari-sari stores, housewives, students, and other ‘roving agents.’ Retailers complete transactions using SMS as well, but Smart catered a special system to their needs, including a unique menu and a specially-designed subscriber identity module (SIM). According to the company, some retailers earn up to P1000 ($18.00) per day in re-load sales.

Smart had 50,000 outlets when Smart Load was launched in May 2003, but that number jumped to over 700,000 retail agents due to the success of its current distribution network. In December 2003, Smart introduced the Pasa Load initiative, which further lowered the denominations of pre-paid cellular services into P2 ($0.03), P5 ($0.08), P10 ($0.18), and P15 ($0.27) increments. With minor exceptions, SMART receives its income entirely from the SMS charge that is levied for the transaction.

SMART report that as at November 2005 their customer base was approximately 20 million of whom 2.5 million had subscribed to SMART Money. Information made available indicated that the service was continuing to grow at a steady rate. A major driver was the ability to recharge prepaid services by quite small amounts. Almost all the company’s prepaid users (98% of total customer base) utilize the OTA (over the air) recharge feature either directly by transferring credit from SMART Money or by purchasing airtime in ‘sachets’ from around 700,000 co-operating dealers.

Users transferring airtime contribute a load of around one transaction per customer every four days. SMART Money transactions are approaching $100 million per month, all of which pass through the BDO network, and the banking partner, BDO, reports an added cash

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Figure 14 Value chain collaboration to create new distribution channels

Using agents in a branchless banking model has been very successful in Brazil where approximately 58,000 agents such as small neighbourhood shops offer a range of financial services59. In India, TATA-AIG is developing a micro-agent model that partners with NGOs to identify direct marketing community based agents that sell and service microinsurance policies in their neighbourhoods60. Micro-agents form a group of peers, referred to as a CRIG (Community Rural Insurance Group), which operates in a similar fashion to an insurance agent’s firm. The agents are trained by TATA-AIG, which help for the CRIG leader to obtain an agent’s license. Partner NGOs may play additional roles such as aggregating the premiums, allowing the agents to use their offices to conduct business, paying the benefits in public ceremonies and training the micro-agents.

Mainstream financial services providers such as banks and insurers are increasingly facing competition from new entrants such as mobile phone operators, either working alone (SMART and Globe Telecom in the Philippines) or in collaboration with banks (WIZZIT in South Africa) to offer financial transactions and mobile banking services.

59 Timothy R Lyman et al “Use of agents in branchless banking for the poor: rewards, risks and regulation” Consultative Group to Assist the Poor Focus Note 38, October 200660 See www.TATA-aig-life.com/MicroInsurance/solutionMicroInsurance.htm

Mainstream institution (Bank/Non-Bank)

MFI partnerships: Use MFIs to distribute financial products or act as loan originators/servicers. Formal partnership or joint venture.

Agent banking: Branchless banking using network of small shops as retail agents that offer financial transactions and a customer interface.

NGO collaboration: Partner with local NGOs to develop and distribute financial products.

Micro-agent model in India and Brazil.

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Case: The joint venture - ABN Amro Banco Real & Accion create Real Microcrédito

In 2001, Banco ABN AMRO Real, a major Brazilian bank owned by ABN AMRO, recognising the untapped loans market (ca. $3.7 billion/p.a.) of the over 10 million Brazilian informal micro-entrepreneurs with profitable businesses but without access to credit, entered into an 80-20 joint venture with ACCION (a microfinance network) a for-profit microlending subsidiary - Real Microcrédito. The loans made by Real Microcredito can be used to expand existing businesses, buy equipment or as working capital. The monthly interest rate on its micro-credit loans is consistent with industry standards for retail (non-subsidized) micro-finance institutions and is much lower than the rate charged by predatory lenders who have been known to charge interest as high as 300% and use forceful methods to collect.

Real Microcredito is competing in an increasingly crowded urban market, and tries to mitigate overindebtedness risk by working with the Brazil bank regulatory institutions to ensure regulations are in place to mitigate the ubiquitous risk of borrowers’ default. Moreover, it also has a number of in-house procedures in place, including performing extensive credit checks on its potential clients and requiring guarantors. In this context, it also helps that Brazil has an infrastructure in place that keeps track of individuals that have defaulted on loans.

While the social impact of Real Microcredito program is too early to be determined, evidence of improved living conditions, especially home improvements can be seen among its clients. Since beginning operations in August 2002 until March 2006, Real Microcrédito has made 18,400 loans (40% of which are below $500) totalling more than $13.5 million and generated a portfolio of 8,000 clients (48% of which are women) totaling $5.3 million

Case: Barclays Bank Ghana - Pilot Project with ‘Susu Collectors’

Barclays Bank Ghana, a wholly owned subsidiary of Barclays Bank Plc, has developed an unconventional solution that meets both its social and commercial objectives in Ghana, where around 90% of the population are unbanked, and 80% of the cash in the economy is outside the mainstream financial services sector.

The philosophy behind Barclays Microbanking is that a truly financially inclusive society can only be achieved by supporting existing, indigenous financial institutions that already provide financial services – either loans or savings facilities to the unbanked.

In a pilot project, started in December 2005, Barclays is connecting modern finance with Susu collection, an indigenous and well-respected system that has been in place for 300 years. Ghana’s 4,000-strong Susu Collectors offer basic banking to the needy. For a small fee, they personally gather the income of their clients and return it at the end of each month, providing greater security for their client’s money. Though each individual client’s income is too small for ‘high street’ banking, collectively it amounts to a $137 million economy.

One drawback to this system is that the collectors themselves are often holding larges sums of cash. They also are unable to help their customers with loans, since their unconventional system does not provide them with large amounts of capital.

Under the pilot program Barclays provides bank accounts to 100 Susu collectors to deposit their funds and will also provide the collectors with loans of their own, which they can ‘lend on’ to their customers, helping them build their capital. By giving the Susu collectors bank accounts, Barclays Bank supports their deposit taking service, and transfers money from the informal to the formal economy. In addition, with finance from Barclays, the Susu Collectors can provide their clients with loans, helping them to establish or develop their business. In addition, the bank is also providing capacity building training to the Susu Collectors to make sure that they do their credit risk correctly and any training needs they may need Finally, Barclays will use its expertise to educate the clients of the Susu Collectors on basic financial issues and is committing an amount of $273,000 to fund the project.

If successful, it will look to roll the model out to other African countries where Barclays has a retail presence. However, as Dr. William Derban, Barclays' manager of financial inclusion, who is from Ghana himself, points out, ‘the goal of the program is not necessarily to replicate the new system elsewhere, but to develop a structure that will work with any indigenous system….We don’t have to bring products in from Europe and America. We can look at the market and design products that work here. And to me that’s the only way finance can play its rightful role in the development process.’

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4 technical assistance

Technical assistance is not only needed for individual microfinance providers,

but on a broader level, across the financial system in most developing countries.

A range of efforts to develop and deepen financial sectors – with the associated

capacity building amongst private institutions, governments and regulatory

agencies – are underway, lead by multilateral agencies such as the World Bank

and amidst a host of other actors. Standardised rules based approaches such as

the Basel Accords on capital adequacy requirements are designed to be

applicable globally and set an international standardised baseline using the same

language and principles.

The UK financial services sector operates globally and already provides a lot of

technical assistance in developing country markets. This can be relatively

straightforward but limited – for instance transferring best practice operating

procedures and technologies to local subsidiaries – or can be implemented as

part of a philanthropic strategy to provide assistance to MFIs or roll out financial

literacy programmes.

Financial systems are part of the overall economic infrastructure in developing

countries and depend on functioning economies with rule of law, established

property rights and a wide range of other critical factors. Initiatives that aim to

improve the overall economic climate, especially for international investment,

also have a role to play in improving financial systems in developing countries.

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Although an enhanced financial architecture with greater organisational capacity does not automatically translate into improved access to financial services for low-income groups, it is an important part of creating an overall enabling environment to integrate microfinance as a sub-sector of the mainstream formal financial system with the subsequent benefits in scale, outreach and overall development benefits.

Access to finance operates across a spectrum from the micro-entrepreneur at one end through to large business and infrastructure finance at the other. In development terms, improvement across the spectrum is of critical importance, linking up the different segments and eliminating finance gaps. For instance, there is growing recognition that a gap exists between very small scale microenterprise finance and large business or project finance. This ‘mesofinance’ area should focus on providing financial services to SMEs and growth businesses, including venture capital and bank loans.

Figure 15 Microfinance as part of a continuum of financial services

4.1 technical assistance for the microfinance industryThe need for technical assistance varies according to the MFI’s status and operating context. Large tier-1 MFIs may require very specialised assistance in specific products or treasury management, and can often pay for consultancy assignments. Small scale and start-up MFIs require a much broader range of technical assistance and are not in a position to pay for services. The microfinance industry has a wide range of providers of technical assistance services – from the development finance agencies, microfinance networks such as Accion and WWB, NGOs, foundations, private players and some microfinance funds – but both the quality and quantity of assistance will need a step change if a broad set of MFIs are to become credible members of the wider financial sector. IFIs alone are said to have allocated around US$ 750 million to microfincane technical assistance activities in 200661. There is an emerging trend towards offering commercially priced technical assistance and many IFIs are starting to untie their technical assistance from their investment activities. This creates an enabling environment for commercial banks to offer technical assistance to MFIs.

The transition to more commercial microfinance will put additional burdens on institutions, particularly those used to lending on grant funds. MFIs will need to professionalise to attract private capital and demonstrate robust institutional capacity to manage risk and grow the business successfully. Mainstream financial institutions have a lot to share with MFIs but the practicalities of technical assistance need to be addressed. Is it a philanthropic gesture – using grants and in-kind support from employees – or should MFI technical assistance be pursued commercially? The answer will depend on the institution, but for many international and large domestic players, it is

61 CGAP IFI survey 2006

Addressing finance gaps.

More assistance needed as MFIs commercialise.

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likely to be a mix of both philanthropy and commercially driven assistance, particularly for those pursuing strategic relationships with MFIs.

Table 5 MFI needs for technical assistance

Governance and leadership

Many MFIs do not follow good practice standards for corporate governance such as an independent Board with non-executive directors. Technical assistance to improve management capacity is also necessary, particularly in strategic leadership, financial understanding and functional areas.

Information systems

Management Information Systems (MIS) are often rudimentary, paper-based and inefficient, particularly amongst smaller MFIs. Automating systems improves data capture and reporting, provides management with accurate information and can reduce costs significantly.

Operations This runs the whole range from back office processing systems, compliance with legal requirements, accounting and finance.

Treasury management

MFIs often lack balance sheet management skills to optimise capital flows, lower cost of capital and manage interest rate and foreign exchange risks. This includes asset-liability monitoring and liquidity management with tracking of key ratios and use of stress tests to manage potential volatility.

Product design and marketing

Product design assistance can vary from advice on general advice (understand market, develop and price product, market) through to more specific involvement in developing a specific product. This includes credit and loans, savings, current accounts, insurance, remittances and payment transfer.

Risk management and internal controls

MFIs need to improve financial and other risk management systems. Banks have developed very sophisticated systems and can share knowledge and provide assistance. Key areas include: risk management policies and compliance systems; measure and control credit risks for individual clients; and internal operational risks. Credit methodology is another area where MFIs can incorporate scoring and other sophisticated techniques.

TechnologyThis includes technology for internal purposes (IT systems, automated back office processing, handheld computing for loan officers) and for customer facing areas such as developing new mobile banking channels, Point of sale systems, smartcards and ATMs.

Sustainability

Microfinance may be used for activities which are not sustainable: for example, these activities may damage the environment and/or may not be in the interest of the wider community. MFIs need support to identify the sustainability of the activities they are financing, and to develop policies in this area.

Some international banks offer technical assistance to MFIs using a range of approaches. Employee volunteering and some philanthropic support to MFIs and MFI networks are most common. ING sends employees to offer specific skills in areas such as product development, risk management or technology systems, but has also set up a dedicated ING microfinance centre in the Netherlands that has partnerships with major MFI networks62. Rabobank pursues a dual strategy of philanthropic services through its Foundation and commercial assistance through RIAS (Rabobank International Advisory Services) to help improve the expertise and management quality of MFIs. UK banks such as HSBC and Barclays also provide technical assistance, primarily through local subsidiaries.

There is an opportunity to significantly boost the technical assistance offered to MFIs either by individual banks but also through collaborative projects. UK banks – with the involvement of others with a presence in the City of London or even with the larger domestic banks in developing countries – could create a comprehensive technical assistance programme in consultation with microfinance industry experts.

London has a natural role to play in promoting global access to financial services. It is arguably the most international financial centre with an incredibly diverse community of institutions. At the moment, Switzerland, Luxembourg and Wall Street are more actively involved financial centres in microfinance. As an immature sector, microfinance requires a lot of assistance and expertise if it is to evolve into a mainstream asset class. In the short term, some of this will need to be on a non-commercial footing as microfinance may not be an immediately compelling business or investment opportunity. This is where trade associations, donors, governments and other actors can play a role to promote pilot projects, fund supporting infrastructure and raise awareness.

62 See www.ingmicrofinance.org

MFIs need to build capacity in many areas.

International banks offer some support already.

UK financial sector could play a leadership role.

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case 1 – Citigroup: the global giant looks downwards

Citigroup, the world’s largest financial services firm, set up a dedicated Citi Microfinance Group in London in 2004. This group works directly with Citigroup’s business units to develop commercial relationships with microfinance institutions, investors and networks63.

Capital markets and investment

Citigroup is developing several initiatives to offer onshore and offshore funding to MFIs. The main focus is on providing funding through local subsidiaries and building partnerships. It was involved in the Compartamos bond issue in Mexico, arranged and invested in the groundbreaking securitisation of BRAC in Bangladesh and arranged the first local currency loan syndication in Romania for a subsidiary of ProCredit Holding.

A range of Citigroup’s business units are also getting involved. The Export Agency Finance group (EAF) is working with development agencies and local subsidiaries to create financing facilities for MFIs, including those smaller institutions that have difficulties accessing commercial capital. The US$ 100 million medium term facility is supported by a guarantee from OPIC, the US government agency. The Private Wealth Management group is also examining opportunities to create vehicles for clients to co-invest in the microfinance sector. It has recently announced the launch of a charitable fund for high-net-worth clients to

make minimum donations of US$50,000 to be granted to MFIs.

Citigroup is also looking at building up an MFI partnership model. In May 2007, it recently entered into a partner-agent agreement with SKS Microfinance, an Indian MFI. Under the terms of this deal, Citi will purchase loans originated by SKS and share the credit risk. Grameen Foundation is providing a guarantee. This partnership is expected to enable SKS to scale rapidly by freeing up its balance sheet and should reach about 250,000 new borrowers.

Developing and delivering financial services

Citigroup is involved in developing savings, insurance and remittance products for low-income groups. In 2005, its Mexican subsidiary Seguros Banamex, partnered with Compartamos to design and launch a life insurance product specifically for micro entrepreneurs. Unlike many other micro-insurance products, this does not function as loan insurance but pays out the entire benefit amount directly to the beneficiary.

It has also entered into agreements with MFIs to provide remittances such as the link between Citibank (US) and

63 Source: Citigroup Citizenship Report 2006

Comprehensive commercial microfinance strategies This section presents two extended case studies of large mainstream banks that are developing a broad

based commercially-driven approach to microfinance which is being embedded through different business

units and operating regions.

The first case explores Citigroup’s increasing commercial involvement in microfinance through its massive

global footprint. The second study focuses on a regional approach by examining ICICI bank’s innovative

and rapidly growing microfinance business in India.

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BancoSol, a Bolivian MFI.

Citi’s Global Consumer Bank business is looking at new ways to viably provide savings products. The Indian subsidiary launched ‘Pragati’ an innovative new product using new technologies and a partnership business model. Using specially developed biometric ATM technology that does not rely on literacy and can use fingerprint identification and can speak in six local languages, Citi has partnered with two Indian MFIs to roll out the product. Under the partnership, the ATM’s are located in MFI offices and clients can bank their microcredit loans.

Technical assistance

Citigroup has offered philanthropic grants and technical assistance through its foundation for over 30 years. It is still a significant provider of assistance, and has developed partnerships with MFI networks such as WWB, Accion and FINCA to design and deliver training programmes. It has committed almost US$40 million to MFIs and MFI networks over the last seven years64.

The foundation also supports technical training institutes for the microfinance industry including the Indian School of Microfinance for Women and funded a US$500,000 agreement with the ASPEN Institute in 2006. ASPEN will provide graduate interns to work for MFIs and also set up a ‘Scale Academy’ to identify and analyse successful MFI business models and share leaning.

case 2 – ICICI Bank: betting on banking India’s billion

ICICI Bank (India's second-largest bank - total assets US$ 56.3 billion) has developed a comprehensive business strategy to offer financial services to low-income groups. ICICI’s core strategy focuses on developing a comprehensive product suite including remittances, savings, insurance, investment and derivatives products (such as rainfall insurance and commodities). The bank is creating new channels to deliver products by building strategic partnerships with microfinance institutions (MFIs) – from providing commercial credit lines to developing an outsourcing model which uses MFIs to originate and service loans that are held by ICICI or securitised and sold on to other investors – and creating a village level technology-enabled delivery infrastructure based on kiosks run by local entrepreneurs.

Capital markets and investment

ICICI Bank has begun to design some innovative structures, which draw upon the comparative advantages of the Bank (financial strength) and MFIs (social intermediation). The structures diversify risk for the bank and reduce capital constraints for MFIs. The primary structures include:

Portfolio buyout: assignment of existing assets of well-performing MFIs in favour of ICICI Bank in return for a purchase consideration;

On-tap securitization: arrangements for future buyouts, in the form that the MFIs would continually sources loans and assign the receivables under such loans to ICICI Bank under a mutually agreed arrangement determining sourcing criteria and operational guidelines65;

Partnerships: entering into partnerships arrangements wherein assets are originated directly in the books of ICICI Bank, and the MFI originates and services loans.

Equity through venture capital funds: ICICI has invested in three venture capital funds in India that target microfinance start-ups. Not only is it investing in Lok Capital, Aavishkar and Bellweather, but ICICI is also facilitating an exit route for investors by offering capital for management buyouts in 3-5 years. MFI ventures will also be able to access mezzanine financing from ICICI66.

ICICI’s MFI partnership model is an innovative solution that, a) uses capital parsimoniously, b) permits all the costs of the operation to be recovered in a commercially viable manner and incentivises growth, and c)

64 Source: Citigroup Foundation 65 65 In 2004, the largest ever securitisation deal in microfinance was signed between ICICI Bank and SHARE Microfin Ltd, a large MFI operating in rural areas of the state of Andra Pradesh. Technical assistance and the collateral deposit of $325,000 (93% of the guarantee required by ICICI) were supplied by Grameen Foundation USA. Under this agreement, ICICI purchased a part of SHARE's microfinance portfolio against a consideration calculated by computing the NPV of receivables amounting to Rs. 215 million ($4.9 million) at an agreed discount rate. The interest paid by SHARE is almost 4% less than the rate paid in commercial loans. Partial credit provision was provided by SHARE in the form of a guarantee amounting to 8% of the receivables under the portfolio, by way of a lien on fixed deposit. This deal frees up equity capital, allowing SHARE to scale up its lending. On the other hand, it allows ICICI Bank to reach new markets. And by trading this high quality asset in capital markets, the bank can hedge its own risks.66 Economic Times ‘ICICI joins hands with 3 VCs to fund microfinance institutions’ June 5, 2006

46

preserves the incentives of the originator (of the portfolio) to maintain portfolio performance (including careful selection of borrowers and ongoing supervision and information management). This expands the retail operations of the bank by leveraging comparative advantages of MFIs, while avoiding costs associated with entering the market directly.

Under the partnership model, the bank forges an alliance with an MFI, in which the MFI acts as a collection agent instead of a financial intermediary. The loans are contracted directly between the bank and the borrower, so that the risk for the MFI is separated from the risk inherent in the portfolio. This enables more favourable loan pricing than that available through wholesale commercial loans and frees up the MFI’s balance sheet and increases its return on equity. ICICI’s rural lending portfolio doubled to US$ 3.2 billion and clients tripled from 1 to 3.2 million in 2006. By 2006, its partner strength of MFIs rose to 102, from 49 in 2005; and it plans to partner with 200-250 MFIs, The bank’s profit rose by more than 30% and share price by 21% in the same period67.

Developing and delivering financial services

ICICI is developing a comprehensive suite of financial products designed for low-income clients and building a new distribution infrastructure. Particularly innovative solutions include remittances and insurance products and ICICI’s village level e-kiosk model.

In order to tap the rapidly growing international remittances market in India, ICICI launched its Money2India remittance service targeted at migrant workers in the Gulf, Europe and America. Realising that last mile delivery to rural remittance recipients is difficult, ICICI developed a new distribution channel through using innovative micro-entrepreneur led business model and custom designed technologies. The vehicle for achieving the goal of simplifying access to remittances funds was introducing low-cost technologies and rural kiosks.

Source: ICICI

The kiosks offer a combination of telephone, financial, educational, and other services. Kiosk operators are independent entrepreneurs, remunerated through commissions paid by service providers and user fees paid by customers. They pay for set-up costs themselves, for which they typically obtain a partial loan from ICICI Bank. Since ICICI does not incur any fixed costs, the system is a cost-effective way for the bank to extend its outreach to rural areas. ICICI estimates that kiosks can be profitably placed in villages as small as 2,000 residents. This option is very attractive for rural recipients because it eliminates transaction costs involved in traveling to a larger town to visit a bank branch. From an operator’s perspective, the business model is only viable if multiple services are routed through a single kiosk. However, other non-financial service providers, such as companies that offer educational and health information/diagnostic services, also opt to use the kiosks, creating multi-service businesses that ensured operator profits, even without the money transfer service, which can be added later.

ICICI is also developing insurance products through its joint ventures ICICI Prudential Life Insurance and ICICI Lombard General Insurance. ICICI Prudential is collaborating with Megatop Insurance in India to develop endowment, term and pension policies to provide protection and savings vehicles to marginal farmers in 9,000 Indian villages. Currently, the target customers have little or no awareness of/access to financial products such as loans and life insurance. The products will be distributed through an internet linked kiosk network – the e-choupal model – maintained by ITC. Satisfactory penetration has been

67 Bloomberg ‘ICICI seeks 25 million rural clients to lift growth’ November 8, 2006

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reached with operations in 41 hubs covering 1,400 kiosks with a coverage of 70,000 people. During the first three months of sales, a total of 2000 proposals have been converted into policies.

ICICI Lombard and BASIX– supported by the World Bank - have pioneered weather-linked insurance products for rural farmers in India. The rainfall insurance product is linked to a weighted and capped rainfall index – based on transparent and independent data provided by Indian Meteorological Department – which means that more critical periods for plant growth are weighted more heavily than others. Farmers do not have to file claims. Instead ICICI Lombard will compensate them at the end of the crop season for any deviations from the normal conditions index on the basis of a pre-agreed formula.

Within a span of three years, the 2003 pilot program has become a full-scale weather insurance programme. In 2005, the product has been rolled out in all six states where BASIX has an operational presence. In the monsoon of 2005, BASIX sold 7685 policies to 6.703 customers in 36 locations. ICICI Lombard also sought out reinsurance, and one of the top five global re-insurers has agreed to reinsure this rainfall insurance portfolio. In the three product cycles that have been completed so far, significant progress has been achieved in terms of the product design and delivery mechanism.

Technical assistance and support

ICICI offers a wide range of support services to MFIs. Apart from the direct assistance offered to its group of partner MFIs such as training, management information systems and information technology services. But ICICI has created a much more comprehensive infrastructure for technical assistance. It has set up a Centre for Microfinance Research to provide analysis and generate industry knowledge. ICICI is also a major equity investor in FINO (Financial Network Information and Operations) an independent company dedicated to providing technological solutions and services to MFIs. This includes tie-ups with IBM and I-flex to offer software, biometric card systems, insurance data services, credit rating and transaction analysis systems

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5 promise or pitfall? The future of microfinance

Now that international and domestic players are starting to look at

microfinance business opportunities, will this initial engagement turn into a

viable business approach that provides value for low income clients, MFIs

and the mainstream firms? Or will so much initial promise dissipate after

facing some stark realities.

These approaches push mainstream actors outside their comfort zones into

completely different customers and markets, which require new products and

unconventional business models. The microfinance industry also needs to

adjust to the rigours of the commercial world and the demands of

mainstream investors. Lessons are being learnt but the hurdles are

considerable. Profitability is difficult in a very low-cost environment with a

high volume of low value products, most of the industry lacks capacity and

competitive investment opportunities are very rare.

The UK financial sector can play a stronger role in the future of microfinance.

Banking and insurance groups with a global footprint can be active through

local subsidiaries and leverage their global presence and expertise to

transfer learning and successful models. Many of them are already starting to

do so but can be encouraged to go much further. London’s capital markets

depth and access to investors can be harnessed to increase the flow of

commercial capital to microfinance. But before this can happen, the

microfinance industry, regulators, donors and mainstream financial players

need to work together to create an enabling environment. We offer some

broad areas for action aimed at improving microfinance investment

prospects, increasing the range of products, creating new delivery channels

and providing technical assistance.

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5.1 Scenarios for microfinance in 2015The Consultative Group to Assist the Poor (CGAP) – a donor funded resource centre for microfinance housed at the World Bank – recently conducted a scenario building exercise to develop microfinance scenarios for 2015. We build on this work and other analysis68 to develop a set of three scenarios with particular reference to involvement of the UK financial services sector. These are not meant to be reliable predictions about the future but instead offer internally consistent stories of alternative paths for the industry over the next eight years.

Elements from all three scenarios may come true in the future. The focus is ensuring the microfinance industry – and its stakeholders – takes action to resolve underlying weaknesses and set itself on a long-term sustainable growth trajectory that aims towards eventual integration with the wider financial system, but retains its focus on serving low-income clients. The UK financial services sector can be a key player in this effort.

68 CMEF projections, ACCION next 10 years and Microrate MIV analysis

Scenario 1 – Commercial pullbackThe high hopes for scaling microfinance through involving commercial players have evaporated, leaving microfinance as a stagnating donor supported industry with a very few elite MFIs that have proven to be commercially sustainable but with the vast majority continuing to rely on shrinking grant support. Industry growth has receded dramatically since the boom between 2000-2007. The promise of commercial involvement never became reality because of donors crowding out commercial players at the top of the industry, an oversupply of hard currency funds to a few institutions – some of which suffered high profile collapses in the volatile economic downturn that hit many parts of the developing world in 2008 – and a restrictive, heavy handed and politically charged regulatory framework. Commercial players rapidly retreated as opportunities dried up, particularly in international investment, although some local banks have built up microfinance operations.

Scale and outreach: After a growth spurt until 2008, the industry has stagnated with the withdrawal of commercial funding, social investors looking for other opportunities and gradually declining donor support. The industry now has about US$ 15 billion in outstanding loans to 30 million borrowers (excluding large self help groups and government sponsored programmes), the majority of which is domestic savings with some donor funding and very few remaining MIVs at the top of the market.

Capital mix: For the few MFIs that have been able to build deposit taking facilities and recycle savings, access to a sustainable source of funds is not a problem. However, this is around 2% of the entire sector, and the rest of the industry is declining amidst furious competition for a dwindling pool of donor and philanthropic funds. Donors are shifting out of microfinance and the social investment community has become disillusioned amidst a growing backlash that accuses microfinance of being about predatory lending and over-indebtedness rather than helping the poor. Mainstream investment and access to capital markets disappeared almost overnight after the MFI, and subsequently MIV, collapses triggered by unsustainable exposure to hard currency funding in 2008.

Product coverage: The industry focuses on the easiest products that require the least investment and institutional capacity i.e. the group lending model. Larger MFIs offer a broader range of products, particularly savings and access to remittances, but there is a massive quality gap across the industry. The promising innovations in insurance and other areas have not been translated into reality.

Enabling environment: Microfinance is undermined by a very suspicious and restrictive regulatory regime that stifles innovation and makes it very difficult to serve low-income markets profitably. Rising over-indebtedness –with distressing high profile suicides and a growing social problem – caused by an oversupply of soft funds and hard currency loans to a narrow set of MFIs - have pushed regulators to crack down even harder. In 2012, the Chinese and Indian regulators both pushed through stringent restrictions in areas such as interest rate caps, partner-agent models and mobile banking models.

Role of UK financial services: UK players have joined in the mass commercial withdrawal from microfinance. Although most UK investors were not exposed to MFI collapses, some banks lost marginal sums through defaults on wholesale loans. Capital market activity has disappeared and microfinance is not even on CSR and reputation agendas of international banks and insurers any longer.

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Scenario 2 – Unequal growthMicrofinance remains a donor-dominated industry but with ongoing participation from commercial players, mainly downscaling local banks in Latin America, India and China. International banks continue to pursue some strategic opportunities, but this is still mainly focused on limited CSR led commitments rather than significant commercial involvement. MFIs have become even more fragmented with some of the larger players now functioning as banks but with the vast majority of the industry still small scale and inefficient.

Scale and outreach: The industry has continued to grow at a fairly strong rate (although rates have tapered off since 2010), particularly in urban regions in Latin America and Asia, but is less successful at reaching rural areas and making significant inroads in Africa. There is about US$ 60 billion in loans to 35 million borrowers outstanding (excluding large self help groups and government sponsored programmes).

Capital mix: Donor funds remain very important in driving the industry forward but commercial capital –primarily from domestic investors and mobilised savings – has become much more prominent. Foreign investment through MIVs has grown with a portfolio of about US$ 8 billion but MIVs have been unable to attract mainstream investors in sufficient scales due to delays in developing a common industry standard and plugging into formal investment markets. Microfinance debt products continue to appear on domestic and international capital markets but still mainly rely on donor and social investors, microfinance is not yet a formal asset class.

Product coverage: Microloans still dominate and there are real concerns about the quality and availability of microfinance products. Some leading MFIs have partnered with international and domestic players to co-develop dedicated products, especially insurance, but a full suite of services is still missing. There has been hardly any progress in developing pensions, specialised micro-enterprise, agricultural finance and risk management products. The remittances market however has been transformed by the entry of new firms and very low cost systems that use mobile phone technology to transfer money internationally, enabled by a supporting international regulatory regime that relaxes the application of anti-money laundering and financing of terrorism rules to low value transactions.

Enabling environment: Microfinance regulation is a mixed bag globally. Some regions have pursued smart policies that enable microfinance providers to flourish through a supportive regulatory framework. Progress in other areas has been hampered by strict regulation that keeps microfinance outside the formal financial system and rules on interest rate caps that keep commercial players out of the industry. Microfinance has become a political issue in some regions struggling with stark inequality, particularly Latin America.

Role of UK financial services: The UK financial sector has continued to play a part in expanding access to finance for the poor. Some of the main players with a large presence in emerging markets – such as HSBC, Standard Chartered and Barclays – have expanded their microfinance operations through local subsidiaries and acquisitions of domestic banks, but are still waiting for significant business opportunities to materialise. Most activity is focused on wholesale services to MFIs, with no large-scale product or strategic partnerships.

London’s capital markets have also played a role albeit limited. The centre of activity in international microfinance investment is Luxembourg and Switzerland for Europe and New York for North America. However, the limited innovation since 2010 has mainly been found in Shanghai and Mumbai as increasingly important regional centres for investing in Indian and Chinese microfinance.

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Scenario 3 – Systematic integrationMicrofinance has become a part of the formal financial sector in many countries. There is a very vibrant and diverse industry built up on providing financial services to low-income clients. The commercial MFI model has been proven with several stellar institutions and a massive increase in the number of tier-1 MFIs – including some large specialised regional players that offer services across countries – nurtured by dedicated efforts to provide equity funding and assistance to smaller MFIs since 2005. The microfinance venture capital industry – both dedicated and mainstream venture funds – added real momentum by funding some of the best performers in the industry today. Some of these MFIs are now listed on domestic stock markets while others have been acquired by mainstream banks, who, along with consumer finance companies, retailers and mobile operators, have become very active in microfinance. Small scale and NGO MFIs are still an important part of the sector, particularly in very difficult operating environments or to provide services to the extreme poor.

Scale and outreach: The industry has grown at a stellar pace to meet the underlying demand for financial services. The sustained involvement of commercial actors, combined with clever intervention by donor and social investors, has pushed the sector to maturity. The industry now has about US$ 130 billion in outstanding loans to 120 million borrowers (excluding large self help groups and government sponsored programmes).

Capital mix: Commercial capital is the most important component – mainly domestic savings and investors – but with a much more sophisticated and effective collaboration between international mainstream, social and donor investors to offer a broad range of financing solutions. This includes catalytic funding to mobilise and develop domestic capital funding, more local currency debt and equity for smaller MFIs and a range of other innovations.

Microfinance now offers opportunities for a range of investor profiles – from conservative institutional investors seeking attractive but safe bond-type returns that are uncorrelated to the rest of their portfolio, funds looking to invest in growth opportunities in listed microfinance equity, through to high risk/ high return venture capital plays. Through sustained collaboration between industry stakeholders and mainstream financiers, microfinance has gradually evolved into a formal asset class with mainstream ratings, liquidity and secondary markets. The track record built up through the first groundbreaking capital market transactions between 2004-06 have proven the risk-return characteristics of these investments.

Product coverage: Although microfinance still does not match the product range offered to more affluent clients, the industry has worked hard to develop a basic range of credit, savings, insurance and payment products. The early pilots with mainstream players led to further product and business model refinement. Technology advances have revolutionised service delivery, radically lowering costs and enabling agent and mobile banking models to scale. Donors have carefully funded product development in priority areas, including the growing need for climate related insurance, especially for small-scale agriculture. Derivatives, capital markets transfer and other innovative insurance solutions are now being trialled.

Enabling environment: Regulators have collaborated to learn lessons about the most effective way to regulate microfinance activities. Political drivers have receded as governments realise the real development benefits of a large-scale access to financial services and recognise the crucial role of the commercial sector in delivering them. Smart regulatory solutions have been implemented at both international – adapting Basel guidelines to enable more microfinance investment and amending money laundering and terrorism financing safeguards – and domestic levels, particularly around electronic money, use of technology, non-bank financial regulation and other areas.

Role of UK financial services: The UK financial sector announced a major 5 year industry initiative to increase access to finance for the world’s poor in late 2007. This initiative has played an important role in accelerating the development of the sector through offering technical assistance, providing research and raising awareness. The initial motivations were reputational and commercial but microfinance has now become a viable business line for some institutions. Through collaborations with donors and others, the UK has become an incubator for global microfinance innovation in the areas of products and access to capital markets.

UK based institutions are collaborating to co-develop microfinance products and share learning. Innovative insurance schemes, including the major global climate and health insurance initiatives since 2012, have been led by UK players. Most major UK groups are active in microfinance through local subsidiaries.

London has emerged as a major centre for international investment in microfinance with a strong skill set in arranging, structuring and placing microfinance debt instruments. The cross border CDO model has become standardised with a documented understanding of performance characteristics and growing volume (around US$ 25 billion by the end of 2014) leading to increased liquidity and functioning secondary markets.

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Figure 16 Projected microfinance loan portfolio growth in the three scenarios69

5.2 a role for the UKThe UK financial sector can play an important catalytic role in microfinance. Banking and insurance groups with a global footprint can share their expertise and provide funding, product development, services and technical assistance through local subsidiaries. HSBC, Standard Chartered and Barclays are among the companies already involved in the microfinance sector. London’s capital markets can also offer expertise and help facilitate access to commercial investors.Some capital market transactions have been arranged and placed in London, with investment from mainstream firms such as Morley Fund Management and Standard Life. Industry-wide collaboration, backed by public and non-profit agencies, would make it possible to develop a formalised, integrated strategy that ensures much more is done.

London has a natural role to play in promoting global access to financial services. It is arguably the most international financial centre, with a huge diversity of institutions. Yet at the moment Switzerland, Luxembourg and Wall Street are all more actively involved in microfinance. Microfinance will require a lot of assistance if it is to evolve into a part of the mainstream financial sector. In the short term some of this will need to be on a non-commercial footing, as microfinance may not be regarded as a compelling investment opportunity. This is where trade associations, aid donors, government and other actors in the UK can play their part – by promoting pilot projects, funding infrastructure and raising awareness.

The UK Government may have a role to play in supporting initiatives in partnership with the City and the broader UK financial sector. For example, DFID is an important public funder of microfinance and financial sector programmes through its work on the financial deepening challenge fund, by taking first loss positions in instruments such as the Commercial Microfinance Consortium, in supporting several multi-stakeholder initiatives such as the Consultative Group to Assist the Poor, and via funding to the Finscope studies which provide market intelligence about low income clients in several African countries.

A collaborative initiative will need high profile support from the public, private and NGOs in order to realise scale initiative that draws in wider financial sector stakeholders from the City and elsewhere. Some of the key areas for further investigation include:

A UK based microfinance product development centre could be set up in partnership between industry, government, donors and academia. The expertise and resources within UK institutions can be brought to bear in the search for solutions in some particularly important product areas such as crop insurance, agricultural finance, climate related insurance, health insurance and micro-investment products.

69 These forecasts are not quantitatively derived but are based in part on projections developed in CMEF 2006 and Microrate 2006

0

20

40

60

80

100

120

140

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

US

D b

illio

nSystematic integration ~US$130B

Unequal growth ~US$60 B

Commercial pullback ~US$15 B

53

Examine opportunities to blend sustainable livelihoods approaches with microfinance and environmental objectives. This could include new methods to finance clean energy, water and sanitation at a domestic or community level. Corporations with extensive global supply chains – primarily those that involve low-income producers of agricultural commodities –could be brought in to examine innovative supply chain financing, access to markets and risk management.

Innovative deal structuring techniques, new partnerships, and new ways of deploying technologies are changing the landscape for investment in microfinance quite rapidly. A learning network for UK-based financial institutions – possibly with a web presence, an annual meeting and an occasional written update – would enable interested parties to share information on key developments.

Technical assistance can be pursued by individual institutions but also developed through collaborative industry-wide and broader projects that can pool resources and exploit synergies. Microfinance requires technical assistance on a variety of issues. These include regulation – both at a domestic level as well as international rules for risk weighting, consumer protection, new technologies and anti-money laundering/terrorism financing regimes – but also needs to cover a host of ancillary issues to improve the architecture of the microfinance sector such as legal protocols and documentation, accountancy standards, risk management, governance amongst others. London has a cluster of advisory expertise in these areas.

For some, the business case for action may not yet stand up on solely commercial criteria, as the potential for steady future revenues is still some years away. However, evidence that new investment structures and business models can be profitable is beginning to change the microfinance landscape. Combined with an immediate reputation, corporate responsibility and ‘moral’ case for action, the UK financial sector can follow a dual strategy of philanthropic and commercial involvement and help propel the microfinance sector to maturity.

Forum for the Future, the sustainable

development charity, works in partnership

with leading organisations in business

and the public sector.

Our vision is of business and communities

thriving in a future that is environmentally

sustainable and socially just.

We believe that a sustainable future can

be achieved, that it is the only way

business and communities will prosper,

but that we need bold action now to make

it happen.

We play our part by inspiring and

challenging organisations with positive

visions of a sustainable future; finding

innovative, practical ways to help realise

those visions; training leaders to bring

about change; and sharing success

through our communications.

For more information visit

www.forumforthefuture.org.uk

ISO 14001 EMS 59526

Registered charity number: 1040519

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