Building Financial Systems for the Poor

1. Building Financial Systems for the Poor

2. GLOBAL TRENDS IN MICROFINANCE: COMMERCIALIZATION AND FOREIGN INVESTMENT Baku, Azerbaijan May 27, 2006 Olga Tomilova, CGAP-MFC Central Asia Microfinance Center

3. CGAP – Consultative Group to Assist the Poor • Microfinance Consortium of 31 public and private development agencies working together to expand access to financial services for the poor in developing countries. • Resource center and standard setting body for the entire microfinance industry. • CGAP serves four groups of clients: • development agencies, • financial institutions including microfinance institutions (MFIs), • government policymakers and regulators, and • other service providers, such as auditors and rating agencies. • Specialized services: advisory services, training, research and development, consensus building on standards, and information dissemination.

4. MF and Access to Finance MF has made a relatively rapid impact, has achieved significant outreach, and can become sustainable within relatively short period of time Access to finance enhances growth and helps reduce poverty MF is now a real industry BUT: Big differences between regions (LAC, SA, ECA, MENA), and between countries 2 billion people still lack access to formal financial services

5. Global providers of microfinance services 750 million accounts in “social” financial institutions, many likely to be poor Source: CGAP, 2004

6. Microfinance is melting into financial sector Commercial banks move into MF MFIs are audited and comply with the IFRS 50 countries discuss and implement microfinance policies 12 rating agencies rate MFIs (Standard & Poor’s, Moody’s) Financial System Microfinance Financial Services for the Poor Financial Services for the Poor Unregulated MFIs report to national credit bureaus (Turkey, Peru) MFI clients access international ATM networks (Dominican Republic) MFI bank issues VISA credit cards (Paraguay)

7. Each country’s model is different Financial NGOs Credit Unions State Banks Commercial Banks Co-ops Postal Banks Rural Banks • Stage of financial sector development • Existence of infrastructure • Population density • Levels of poverty • Competition Self-Help Groups

8. Access points are multiplying Lottery Agent Traders and Processors Self-Help Groups Loan Service Agent Point-of-SaleNetworks PC Kiosk ATMs Leveraging existing + new infrastructure to offer multiple access points State Banks Commercial Banks MFIs CLIENTS

9. Using a range of risk in their engagements Higher level of engagement Sogebank, HaitiCreated loan service company Sogesol in 2000 Jammal Trust Bank and Credit Libanais, LebanonHave equity stake in Ameen, a CHF microfinance program ICICI Bank, IndiaContracts microfinance operations with self-help groups and MFIs Raffeissen Bank, BosniaLends to multiple MFIs in Bosnia Garanti Bankasi, TurkeyProvides front office functions through branchnetwork to Maya Enterprise for Microfinance Microfinance Bank, GeorgiaRents space in its offices to Constanta, a local NGO Bank creates loan service company Bank invests equity in MFI Bank buys MFI portfolioand / or contracts MFI operations Wholesale lending Sharing / Rentingfacilities Bank provides front or back office functions Lower level of engagement MFI- Bank partnerships taking off

10. Pioneer, breakout, consolidation and maturity? Most efficient, effective, client service oriented institutions will prevail and have access to funding sources M&AFailures ~10,000MFIs Formal FIs Top-tier NGO/MFIs GrameenProdem

11. Downscaling Downscaling: A bank or other formal financial institution expands its services to work with clients traditionally served, if at all, only by MFIs. Such an expansion can mean serving microfinance clients in one or many financial areas History: First “multi-global” operations financed by IDB in early 1990s. EBRD adapted and applied the concept in Russia and other NIS countries. Approach is again becoming popular (IFC/Accion, WWB) Significance LAC: 27 out of top 32 MFIs in LAC are commercial institutions, RoA for this group: 4.8%. Examples: Banco del Trabajo and Banco del Crédito (Peru), Banco Caja Social (Colombia), Financiera Vision (Paraguay) Significance ECA: Russia, Kazakhstan and Ukraine – 137,000 borrowers, $ 712 m LPF; commercial banks and greenfield banks have highest growth rates in the region

12. Downscaling in ECA – Portfolio $

13. High Relevance of Banks in ECA % Borrowers by Type of MFI 2002 Source: MIX Database

14. Downscaling – Summary • Downscaling model is one (but increasingly important) element in sensible approach to access to finance • Secured lending and credit bureaus will make positive impact • Commercial banks unlikely to reach the poorest segments of potential retail customers • Commercial banks unlikely to solve rural finance dilemma • Other (complementary) approaches: • Greenfield banks • CUs • Upgrading NGOs • Linking (cooperation between MFIs and Banks)

15. Downscaling – Summary • Access to Finance and especially downscaling can and should be integral part of successful regional development strategy • Government support is needed to ensure conducive environment for investment and growth of financial services industry • Don’t subsidize interest rates, don’t cap interest rates • Subsidize TA • Don’t build monopolies, enhance competition

16. Predictions Multiplying points of service allows exponential growth Technology and infrastructure are key drivers to scale Commercial and state banks will become core providers Major consolidation of MFIs will occur through buy outs by banks, mergers, partnerships, and wind-downs Domestic sources of funds will become even more important (savings, commercial debt) Donors will focus on frontier markets (very poor and rural)

17. FOREIGN INVESTMENT IN MICROFINANCE

18. CGAP Foreign Investors Survey • Survey of 54 foreign microfinance investors conducted by CGAP, MIX and ADA (June – September 2004) • Purpose – ascertain legal structures, investment focus and history, availability of uncommitted funds, and financial performance • Data on “direct” investments in 505 MFIs and “indirect” investments in 25 MF funds • Amount of foreign investments (disbursed and committed): • $1.2 billion – direct • $611 million - indirect

19. Where is the Foreign Investment Going? • Foreign investment in MFIs takes the form of: • Equity • Debt • Guarantees • Only regulated MFIs are legally structured to receive all three forms of investments – non-regulated cannot receive equity investments • Among 505 MFIs surveyed, 166, or 33% are regulated institutions • Heavy concentration of foreign investment in certain regions – 87% in Latin America and Eastern Europe/Central Asia

20. Where is the Foreign Investment Going? • By instrument: • Debt – 69% • Equity – 24% • Guarantees – 8% • By legal status – 82% to regulated MFIs • By size of investment – 89% over $1 million • By suppliers – nearly half of all investment is provided by four IFIs: IFC, EBRD, KfW and USAID’s Development Credit Authority • Two thirds of investment is provided by 6 of 54 funds

21. Are Foreign Investments Competing to Find MFIs to Invest in? • Numerous anecdotal suggestions that investors are not finding it easy to place funds in MFIs that meet their standards • Tendency for multiple investors to invest in a single MFI – for example, 20 out 54 funded Banco Solidario (Ecuador), 15 funded Confianza (Peru), and 11 funded Fundacion Nieberowski (Nicaragua) • The reason is not small investment amounts, but rather excess of supply over demand from suitable MFIs, i.e. those that meet the investors’ quality and risk profile • Instances of a single investor funding the same institution through several indirect channels

22. Why MFIs Seek Foreign Investment

23. Uncertain Demand for Equity – Regulated MFIs • Regulated MFIs will continue to seek more debt than equity from foreign sources: • High levels of equity capital  greater interest in increasing liabilities • Most MFIs have lower levels of legally allowed leverage • Council of MF Equity Funds revealed that only 115 out of several thousands of MFIs would be candidates for foreign equity investments, given their legal status, profitability and size • Regulated MFIs are increasingly seeking domestic deposits to fund their liabilities

24. Uncertain Demand for Equity – Unregulated MFIs • Unregulated MFIs – more numerous, but are not structured to take equity investments  more likely to seek foreign debt than regulated MFIs: • Less access to domestic banks • Generally prohibited from taking deposits • Foreign lenders will be attractive if they would lend beyond 1-to-1 debt-to-equity ratio and lower collateral requirements • Unregulated MFIs may have a relatively greater interest in foreign debt investment compared to regulated MFIs

25. Foreign Debt and Currency Risk • Most of MFI assets tend to be denominated in local currency  creates foreign exchange risk if they borrow foreign currency loans • Local currency in many developing countries is more likely to devalue than to appreciate • 92% of debt issued to MFIs is in hard currency • Many MFIs are not alert to this issue – out of 105 MFIs surveyed, only 25 fully hedged their currency risk • In most developing countries, adequate hedging mechanisms are not available or too expensive

26. Conclusions: Practical Lessons • Foreign investors would add more value to the market if they were able to tolerate more risk, and thus work with less-well-established MFIs • Regulated MFIs should be helped to access more local funding  use of guarantee mechanisms; improving credibility of MFIs with local funding sources • MFIs and investors need to be alert to the foreign exchange risk entailed by hard-currency loans

27. UNCDF Building Financial Systemsfor the Poor Thank you!