#1

When the “Microfinance Banana Skins 2008” report was published based on a survey conducted in November 2007, liquidity did not even appear as a top “biggest risks,” other than “too much funding,” which was identified as a rising risk.

However, the assumption that the microfinance sector is not correlated with the formal economy is being increasingly challenged. The flurry of new microfinance collateralized debt structures has all but disappeared. Foreign exchange risks associated with unhedged borrowings are now significant as many local currencies have depreciated dramatically. Country risk premiums and local credit spreads, including MFIs, have increased as investors have become more risk adverse. A number of countries have seen domestic bank liquidity tighten and the credit performance of consumer’s served by banks deteriorate, presenting new challenges for those MFIs working in urban and peri-urban areas. MFI’s portfolios are increasingly showing early signs of credit deterioration in some markets. MFIs that are not well capitalized nor have diversified funding sources will be challenged by increased liquidity risk. Some of the fastest growing institutions have slowed their growth, perhaps prudently, as funding becomes more restricted and expensive. Some regulators are tightening prudential requirements for MFIs, such as capital adequacy. The earlier debate whether official and donor funding is ‘crowding out’ commercial investors is no longer topical.

Citi Microfinance’s global commitment to expand access to financial services through building relationships with MFIs, as partners and clients, leverages Citi’s global franchise and its local presence—we share the same local currency, legal and regulatory context, political and economic realities. We focus on accessing local funding for MFIs, whether through direct lending, partnering with international agencies and pioneering with MFIs in their domestic capital markets, which is likely to be more challenging for many MFIs in the year ahead. We are working creatively in over 30 countries with microfinance networks, investors and MFIs to support their growth and objectives. We jointly develop savings, insurance and remittance products. As market conditions become more challenging, we will continue to serve our clients and partners in the sector. In parallel, the Citi Foundation continues it’s over 30 year commitment to supporting microfinance, including programs to strengthen national and regional networks, expand financial education and to develop micro entrepreneurship.

#1

Above all, the financial crisis will affect liquidity going to the MFI's—a phenomenon we are already beginning to see. This will be amplified and will slow MFI growth. What liquidity remains will cost more to borrow.

#2

To address these challenges, we are redoubling our efforts to raise money in these difficult markets with new and innovative products targeting microfinance. We are also expanding our outreach beyond the already existing network of microfinance investors.

#1

In the coming year, the microfinance industry will face a liquidity crisis as most MFIs receive the majority of their financing from international investors. Major Funds that were to come to market have been delayed as the pricing has reached levels that cannot be supported by MFIs. Before the credit crisis, triple A tranches were trading at 150 basis points above the London Interbank Offered Rate (LIBOR) and now they are in the range of 500 basis points above LIBOR.

Certainly, the growth of MFIs would be affected and they would have to re-trench. The majority of MFIs use step lending in which clients who perform well are incentivized by larger loans. Given that this model would have to be changed, it would impact the credit quality of MFIs. In this market condition, MFIs will not be able to rely on socially motivated investors either (excluding grantmakers) because these investors do not live in a vacuum and are making their investments in the current context.

The liquidity crisis will certainly weed out some of the weaker MFIs as money gets tighter and investors raise their crediting standards to avoid risk. The positive aspect of the liquidity crisis is that it may force MFIs to improve their efficiency. Development agencies have a role to play at this time of crisis and the Inter-American Development Bank (IADB), for example, has announced a liquidity finance for development purposes that provides some relief.

#2

Inflationary pressures will have a direct impact on the credit quality of MFIs as poor people are stretched to meet their basic needs of food and shelter. Repayment of microfinance loans may take a secondary position. There has been some rise in delinquencies at some of the leading MFIs which are directly related to food price increases. For example in Pakistan, there has been a 40% inflation rate in the last six months. The only ways for MFIs to deal with the inflationary pressures are to work to become more efficient and reduce the rate or extend the maturity of the loans to make them more affordable.

Microfinance institutions can also reduce their growth expectations. But once growth is not there, what will happen to traditional MFI lending models?

One of the most central elements on the regulatory front is allowing MFIs to gather savings. These savings would provide low cost funding sources that could serve to create greater efficiency and ultimately lower cost to the borrower.