An empirical review of the actual impact of financial crisis and recessions on MFIs, and other factors explaining recent microfinance crisis

Many, although not all, of the problems observed in microfinance sectors recently were triggered by the latest financial crisis and fluctuations in both food and fuel prices. At the same time, many problems began before the most recent financial crisis, or were intensified by other elements, including saturated microfinance markets, deficient credit policies and governance structures, and negative policy interventions. The goal of this paper is to identify and share lessons for strengthening microfinance institutions (MFIs) to weather the challenges of future financial crises, fluctuations in food and fuel prices, and other major risks. The impact of financial crises on both MFIs and their clients depends on several characteristics including: the macroeconomic environment, the level of integration of the country to the global economy, cost and funding structures for the MFI, and the ability of management to deal with crises. The aim of this paper is not to make specific recommendations for individual MFIs, but to identify general lessons for all MFIs. For these lessons to be useful, MFI boards and management have to identify the most important risks for their institutions in order to act on the most relevant lessons for them. For practical implementation, lessons are divided in two categories: before the next crisis and during the crisis. The paper is divided in five sections. In the first section the components of financial crises that are most relevant for MFIs are identified, and contrasted with exposure. The second section summarizes the most 1 I would like to thank Scott Gaul, Jesse Marsden and Sam-Daley Harris for useful comments and suggestions. All errors and omissions are mine. important consequences of financial crisis for MFIs, empirical evidence (when data is available), with particular focus on claims about liquidity crunches, increases in cost of funds and foreign exchange relating them to the components and sub-components of financial crises discussed in the first section. Section three reviews the performance of MFIs during the 2009 financial crisis and explores some of the reasons why the sector as a whole demonstrated less resilience than before. Section four discusses whether a focus solely on financial crises, may lead to underestimating other major risks of serious consequences for MFIs, particularly for portfolio quality. One of the most important new risks discussed in this section is market saturation. Finally, section five summarizes the main lessons for MFIs, donors and governments.

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