28 Apr 2011

Beyond microfinance (3) : supporting the entrepreneurship


We opened the series “Beyond microfinance” on the 23th March 2010 with questioning whether granting a loan to a poor does really put him up to a better and safer living standard. In other words, does microfinance fit for sustaining economic growth ? This might come up to a disappointed hope among the public who has been learned that microfinance is the answer to poverty alleviation.
Don’t worry ! There are some solutions to this.

Microfinance, a perspective of limited growth for the Luxembourg place ?

The microfinance sector has experienced a tremendous growth over the last 10 years, consecutively to the set-up of the MIVs – Microfinance Investment Vehicules, i.e. funds specifically designed to drain the funding from foreign investors. Indeed the microfinance has emerged to be an alternative investment opportunity in the financial turmoil, as it is financing “bricks and mortar” activities which are relatively few at risk during economic downturns (breeding, agriculture, small businesses). Let aside the Indian crackdown in the Fall 2010 that can absolutely not be taken as a general trend in this market.

The growth over the last 2 years has slightly slowed down, which is a normal phenomenon in an industry which is becoming matured. While gaining in maturity, some turbulence may raise resulting from inevitable markets restructuration. Indeed, one of the greatest challenges microfinance will face in the near future – alongside the necessary reinforcement of its regulation – is the upgrade in quality. To be sustainable microfinance must evolve from its status of microcredit providers to those of global solutions provider, integrating a full set of services including technical assistance to the beneficiaries. It is surely an additional cost in the microfinance business case, which could result in a movement of concentration among the countless players in the world. This expected concentration should do the way easier for microfinance operators to access local capital markets for funding, reducing their dependency from foreign capital, and lowering the MIVs market share in this industry.

Conversely the need in consulting services will grow, as the concentration move will face strong demand for organizational reshaping, including specifically process streamlining for gaining in efficiency.
Passing this step will be vital for the new players to put their operational costs under control.

Alongside this, what gets more and more under scrutiny in the microfinance industry is its actual impact in the field. In many cases, we must dare to say that microfinance has missed its outreach. In reality it mostly targets the middle poor rather than the low poor as the assistance of this latter population would cost very much in term of day-to-day operations.

Filling the gap Microfinance can not cover, through the Impact Financing approach

Adding to it, a strong bias in this sector is to believe that microfinance is the key to economic growth and employment. The size of the loan a beneficiary may receive from a MFI (Microfinance Institution) will never give him the financial leverage to start a micro-enterprise from scratch. Microfinance has not been set out as being a start-ups incubator, because it does neither have the adequate volume of funding to do it, being not connected to the appropriate network of investors, nor the in-house skills to perform due diligences on business projects.

The mission of supporting micro-entrepreneurs in their business development is to another type of approach : Impact Financing. This activity seeks a financial return coupled with a social benefit (including environmental benefit also). Due to the social dimension marking this concept, it might be considered being positioned between philanthropy and traditional investment, even private equity.

But a possible bias in the looming Impact Financing industry could be to focus again on the financial return only, letting aside the social performance.

Never mind the investment objective

As part of a series of conferences held in Luxembourg in October 2010, under the name « new perspectives on doing good & doing it well », Uli Grabenwarter, lecturer and researcher in Impact Investing at IESE University, Barcelona (formerly Equity Fund Investments Head at the European Investment Fund) questioned the very reasons leading to the current financial crisis and how Impact Financing can help getting out of it. “We are in a value creation dilemma”, he said. What the financial markets create is a market value (i.e. an assumption of value of the venture, from a market’s point of view). The intrinsic value, being objectively based on the financial situation of the firm and its perspective of evolution is loosing field against the “borrowed” value created by the financial markets. In other words, the current crisis is not a financial one but “a value creation crisis”, he said.

Grabenwarter pointed that what should thrive the economic agents should not be creating further wealth, but distributing it more equally.
In this context, Impact Financing is a question of building up a sustainable economy. The “Impact” objective expresses the investor’s expectation on how and for what purpose the invested capital is to be used.
In a “sustainable” way of thinking, the investor should any longer think on investment costs but on investment objectives.

Grabenwarter delivers a possible message saying that “investors never invest with a financial objective only. There are other motivations, sometimes diffused”.
The challenge of the financial advisor (the private banker for instance) is to find them.

2 Responses to Beyond microfinance (3) : supporting the entrepreneurship
  1. I went looking for this in some of the other micro-finance based info on the site and blog, but didn’t find it – maybe you can help:One of my ccernons about MF is the interest rate charged to the borrowers. If this rate is very high (say, 15%+), then it seems likely that many borrowers would be unable to earn that from business investment. If, in fact, many/most borrowers are using the loans for more consumption-type purposes, then the issue is compounded – they are agreeing to pay, say, $230 next year for $200 today, but if their income doesn’t change, then all MF does is makes them $30 poorer over the course of a couple years. i.e. Could MF institutions be the third world equivalent (roughly) of payday loan places, pawn shops, and high interest credit cards in the first world? While I think these things have their place here, I think that many of those who use them end up worse off than if such options weren’t available, and certainly, the idea that I, as a donor, would want to make a charitable gift to enable Al’s Pawn Shope or Quick Cash Payday Loans to expand their reach is not very appealing. Yeah, these ccernons may be beyond the scope of what you’re trying to address in this blog post, but it’s just odd to me that we as a society generally condemn high interest loans to the poor in the U.S., but apparently seek to expand the practice in the third world (if indeed the typical loan is fairly high interest).

    • Right (and usual) question … that needs surely to be clarified. The 15%+ rate you mention, for instance, is absolutely not high, depending on the economic local situation. It is just the rate applying on the microfinance programme that I have assisted in Vietnam. This programme is run by the French NGO “Entrepreneurs du Monde”. A non-profit, the founder of which I know very well, who is definitely not business oriented ! Credit’s rates are to be compared and set up against the inflation rate. In the case of Vietnam, the inflation rate is roughly between 20 and 25 % a year. It means that you lose money (!) when lending at 15 % a year … Vietnamese State banks currently offer microcredit at 8 % (!) just because they are subsided by the governement. Borrowers from An-Chi-Em, the programme I assist, agree to pay 15 % because – against the State banks – they received technical assistance alongside the microcredit : free assistance of a veterinary for the care of their husbandry, or for an agronom for their cultures. Theses technicians are on the payroll of the programme. It has a cost, that needs to included in the interest rate.
      Unfortunately, a couple microfinance programmes still keep lending at unfair rates (40 %, 60 %, even more !), as it was widely reported (it was the case in India for instance). Nothing justified such levels of rate, unless taking advantage of the illeteracy and poor education of the borrowers. It’s a shame, because those programmes definitely do not provide any technical assistance … they are vulture practitionners. It reminds the subprime practices in the US housing market.
      Hope this elaboration helps.

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