6th Azerbaijan Microfinance Conference

1. Microfinance – A Risky Business? The perspective of a development finance institution Baku, 5 October 2012 Sandra Lutz 6th Azerbaijan Microfinance Conference

2. Tendencies of recovery, but effects of financial and reputational crises far from being overcome Leading professional MFIs continue to show a robust performance Improved (and mostly acceptable) levels of portfolio quality Stable earnings situation with „decent“ RoEs (10-20 %) Strong inrease of the volume of deposit collection (now on av. more savers than borrowers) Fund portfolios: good portfolio quality, more private funding. Continued criticism over industry practices Indications of unhealthy competition and tendencies of saturation in some markets Growing evidence on institutional deficits in MFIs (Management, Corporate Governance) Improvements on the regulatory front but remaining risk of undue political interference Global Developments Some good news… …but also some challenges Microfinance - a risky business? / Baku / 5 October 2012

3. What went/can go wrong Lack of information Poor market infra- structure Low credit Approval standards High growth/ Return expec- tations Regulators Funding distortions Investor/Financiers Fund managers financial institutions clients Low client aware- Ness/irresponsible borrowing Unhealthy competition Client over- indebtedness Microfinance - a risky business? / Baku / 5 October 2012

4. Perceived microfinance risks:Results of the „Banana Skins Report“ Report „Microfinance Banana Skins 2012“ • Over-indebtedness (- -) • Corporate Governance (4) • Management Quality (7) • Credit Risk (1) • Political Interference (5) • Quality of Risk Management (- -) • Client Management (- -) • Competition (3) • Regulation (6) • Liquidity (16) What does this story tell us? • 7 out of 10 TOP risks refer to MFI capacities, the rest to op. environment • most TOP10 risks relate, in some way or other, to responsible finance issues • Risk perception reflects negative press on microfinance What does this mean for us: • Many of our partners perform better than this perception • Professionalization is a prerequisite for sustainability • Corporate governance and responsible finance key elements of professional MFIs Microfinance - a risky business? / Baku / 5 October 2012

5. Responsible Finance as a holistic response What does Responsible Finance mean to KfW‘s role?  No Responsible Finance without responsible inestors, i.e. DFIs are part of the story Strengthening responsible finance practices is part of KfW‘s additionality as microfinance funder Promote responsible practices at institutional, policy and sector level  Setting up credit bureaus, study works on overindebtedness, contract clauses… Be a patient investor – „buy and hold“ Strengthen MFIs‘ governance through board seats  Putting RF on the agenda „Crowd in“ the private sector, through Public Private Partnerships Microfinance - a risky business? / Baku / 5 October 2012

6. Addressing the risks, possible early warning indicators;for MFI management, DD and dialogue among stakeholders • Strengthen stakeholders at macro level, particularly improve the effectiveness of credit bureaus • Number of financial institutions with delays in data transmission • Number of client data records • Number of reported multiple loans • Time lag of data collection and reporting of credit bureaus • Regulatory Framework addressing over-indebtedness issues • Be more cautious with estimating the relevant demand in the financial sector • Number of bankable clients • Regional distribution of bankable clients • Analyse carefully the competitive situation and the behaviour of competitors • Number of relevant (M)Fis and number of different branch offices at „strategic locations“ • Market shares of five biggest relevant (M)Fis • Homogeneity of credit products among competitors • Major differences in competitors‘ lending conditions (e.g. „race to the bottom“? • Number of multiple-loans-clients Microfinance - a risky business? / Baku / 5 October 2012

7. Addressing the risks, possible early warning indicators;for MFI management, DD and dialogue among stakeholders • Take a critical look at the loan selection and approval process • Existence of a reasonably detailed credit approval manual • Share of visits to client locations as part of loan analysis • Duration of loan analysis • Existence of incomplete borrower files • Detailed analysis of the loan portfolio with regard to over-indebtedness factors • Share of „pure“ consumer loans in the portfolio • Shrae of open foreign currency loans in the portfolio • Evolution of the PAR > 1 day in the last three months • Percentage of restructured loans and/or write-offs • Clients with one, two or more loans with other MFIs according their repayment status • Discuss the institutions‘ response strategy to (perceived) over-indebtedness Microfinance - a risky business? / Baku / 5 October 2012

8. Conclusions • DFIs‘ role far beyond mere financing • Key challenges: preparing the ground for future responsible investors and for conducive MFI governance Microfinance - a risky business? / Baku / 5 October 2012

9. Contact Financial System Development Eastern Europe, Caucasus, Central AsiaSandra LutzProject Manager KfW BankengruppePalmengartenstrasse 5–960325 Frankfurt am Main Phone +49 69 7431 - 9681Sandra.lutz@kfw.de Microfinance - a risky business? / Baku / 5 October 2012

10. Thank you for your attention!