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| Volume 1, Issue 3: July 2003 | ||||
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In This Issue Plenary Session: Financing Microfinance for Poverty Reduction Microcredit Summit Director Honored Asia/Pacific Regional Microcredit Summit Meeting of Councils Archived Issues
Vol 1 Iss 4 Sept. '03 E-News Information |
Plenary Session: Financing Microfinance for Poverty ReductionRemarks by Jennifer Meehan
It is going to be difficult to get to 100 million in the next four years if we do not overcome the largest hurdle to rapid growth and outreach today. That is: the lack of capital. Capital is financing that can cover losses prior to break-even, or before an MFI becomes sustainable, and can be used to leverage financing from lenders such as banks. This paper offers a solution for overcoming the hurdle, which was pioneered by CASHPOR Financial and Technical Services in India. Based on experience in Bangladesh, we know massive growth and outreach to the poor is operationally possible. We also know that banks, apex institutions, social investors and others are increasingly interested in wholesaling funds to microfinance institutions for on-lending to their poor clients. Capacity-building services are also widely available. But there is a critical missing piece to the puzzle: capital.
Twenty-nine MFIs alone are responsible for more than half of our outreach to the poorest today. Around the globe the reality is that most microfinance institutions are small. Seven of ten are reaching less than 2,500 poorest clients. Nine of ten are reaching less than 10,000 poorest clients. As Elizabeth Littlefield of CGAP said this morning, MFIs aren't growing very fast. We need to change this. Small and medium-sized MFIs who are serious must gain access to capital in order to grow, and to grow fast. There have been three traditional sources of capital for microfinance institutions: equity investments, grants, and internally generated profit. However, these are not available in sufficient amounts today to grow small, promising MFIs. Most for-profit investors do not see microfinance for the poor as profitable, and as a result, seem intent on nudging MFIs towards being more profitable, and by which I mean [toward] less poor clientele. Elizabeth Littlefield made an interesting comment today about donors, saying that there is a sudden and serious waning of interest by donors of microfinance. Grants are not likely to be sufficient either. And finally, there are significant trade-offs between profits and impact, as well as rapid expansion and profitability. And for both reasons, profits will also be insufficient. We have developed a new financial paradigm, and this is based on out-of-the-box thinking. It's a solution that can be developed immediately, without changes in rules, regulations, or laws, and it doesn't necessarily require the raising of huge new pools of money. It is applicable to all MFIs, both for-profit and not-for-profit. And it tailors recognized financial market instruments and approaches to meeting the needs of microfinance for the poor. The paradigm comes in two parts: the first is to identify two alternative sources of capital for microfinance institutions. The second seeks to maximize the impact of each dollar of capital raised by challenging industry practice standards on capital adequacy. The first new source we've identified is quasi-equity, a type of financing that has some features of debt, but two very important and distinct advantages. First, it's not restricted in how funds are used… second, it can be included in total capital for purposes of leveraging funds from banks. If structured properly, (and by this we mean long-term with repayments coming out of profits after break-even), it can meet the needs of MFIs. The second new source of capital relates to below-market rate or soft loans, which must be reclassified on the balance sheet to show their true nature… There is an intended subsidy element in soft loans. Because of this subsidy, an MFI with soft loans will have more profit in the future than an MFI borrowing at market rates, and this is directly because of the lower interest payments they're making. We need to calculate today's value of this future, new, or incremental profit, and show it on the balance sheet as equity. The market value of the soft loan must then be booked as a liability. By reclassifying soft loans into these two component parts, a truer and fairer picture of an MFI's financial position will be presented. The second part of the new financial paradigm is to ensure that MFIs maximize the impact of each dollar of capital raised. To do this we need to challenge our industry's conservative view of capital adequacy, which basically compares an MFI's total capital to its assets. Commercial banks examine this ratio very carefully when determining how much to lend to an MFI. According to current Microfinance industry guidelines, the minimum capital adequacy target is 20 percent. That means for every dollar of capital you have, you can borrow up to five dollars. However, international banks are allowed to leverage up to ten dollars, not just five, for every dollar of their capital. Given that MFIs have extremely high portfolio quality, the Microfinance industry needs to adopt an international standard allowing MFIs to more than double the impact of each dollar of capital raised.
How do we know the new financial paradigm can work? It was put into practice by CASHPOR Financial and Technical Services in India. Following the new financing paradigm, CFTS has reached almost 20,000 poor women in five years, using a fast-track approach to scaling up. It is on-track to break-even within five years, and it has achieved best practice levels of efficiency. Some people have discounted that capital is really the biggest hurdle to scaling up, but I think we all need to listen to the voices of people like David Gibbons, like Udaia Kumar, like the CASHPOR network and all of the practitioners in this room. If our target of 100 million is to be reached, then the capital hurdle must be overcome. .... On the technical side, we're not advocating any changes to audited financial statements. When we talk about quasi-equity, this is a source of financing that is used by international banks, by companies, to leverage financing from banks. When we talk about challenging the industry standard for capital adequacy, we're not creating our own standards; we're asking people to accept guidelines for international banks. And finally, for marking soft loans to market, we're talking about taking audited statements and adjusting them for analytical purposes. |