Innovations In Microfinance Funding-PDF Free Download

Innovations in Microfinance Funding

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Innovations in Microfinance Funding . Lillian Kamal . University of Hartford . Microfinance institutions (MFIs) have been making microfinance loans for several decades now, and their impact on poverty alleviation and living standards for women has been well documented. A challenge for MFIs lies in securing adequate and sustainable funding. A ...

The role of microfinance in economic development has been documented from a macroeconomic
perspective Imai et al 2010 used cross country and panel data and found that when countries have
more microfinance loans they also tend to have lower poverty measures From the economic standpoint
and from the investor standpoint it is vital to understand the channels through which microfinance
institutions henceforth referred to as MFIs are able to influence economic activity Maksudova 2010
has discussed several channels through which microfinance organizations can impact economic growth
Underlying these channels is the relationship between financial sector development and economic growth
which is a well known body of literature One of the channels is the impact of microfinance on production
and entrepreneurship and the reduction of poverty and income inequality A second channel is through
the formalization of shadow financial markets or the implementation of missing financial markets A third
channel of impact lies in the interaction between MFIs and commercial banks Findings show that there is
bicausality in these channels Ahlin 2011 carried out a study of MFIs and included country specific
economic and institutional data the results showed that MFIs can meet their costs better when there is
strong economic growth and when the country s financial system is better developed
MFIs have proven themselves as viable institutions with low default rates From an investor
standpoint an important question that arises with any new financial instrument is the risk involved in that
instrument One way to assess the risk of an instrument is to assess its role in a portfolio of assets A well
balanced portfolio has assets that have a spread of risk such that not all asset values are moving in the
same direction Using data from 1998 to 2006 Krauss and Walter 2009 have shown that MFI asset
values generally do not have high correlations with the asset values of domestic and international assets
typically available to commercial investors Gonzalez 2007 found that there was no significant
relationship between MFI returns and economic growth This indicates that MFI returns can move
independently of macroeconomic changes and can thus be a useful portfolio asset during economic
downturns Oehri and Fausch 2008 carried out a study on the impact of microfinance investment funds
on standard portfolios consisting of four assets stocks bonds hedge and money market funds They
found that the microfinance investment funds showed stability in terms of volatility and did now show a
strong correlation with the other assets This indicates that microfinance funds are a very good way to
diversify typical portfolios In addition investors also benefit from gaining additional social returns
Dorfleitner et al 2010 Overall it has been shown that well leveraged MFIs tend to improve their
performance by enjoying economies of scale and widening their target markets and therefore enjoying
greater efficiency Kyereboah Coleman 2007
In terms of the progression of microfinance organizations moving to external funding there is a
normal progression from donations and grants to loans from commercial banks Thereafter if the
financial system is well developed the MFIs can seek funding from the capital markets For example
MFIs can opt for microfinance funds which offer investors a variety of instruments including debt
instruments The use of debt instruments can range from local small bonds to international bonds Reddy
and Rhyne 2006 Local bonds can be issued in domestic currency and these kinds of local bonds can be
seen as attractive to investors who are seeking to diversify their portfolios domestically As the
microfinance organizations become larger and increase their scale they can issue international
microfinance bonds This stage involves exposure to exchange rate risk as the bonds are priced in one of
the international trade currencies MFIs that seek international funding find themselves exposed to one or
more risks these risks include interest rate risks country risks and exchange rate risks Holden and
Holden 2004 Exchange rate risk is particularly acute when exchange rates are volatile between the two
countries These MFIs must then consider appropriate hedging instruments
Recent examples include the Dignity Fund from California and Global Partnerships Microfinance
Funds from Seattle There are also a few equity funds and some mixed funds such as MicroVest I Wall
Street Journal 2006 Annual returns for investors may range anywhere from 1 to 5 for microfinance
bond funds and may range anywhere from 5 to 10 for microfinance equity funds Wall Street
Journal 2006 These kinds of advanced capital market instruments are not the norm in the developing
Journal of Applied Business and Economics Vol 18 5 2016 107
countries and so beyond commercial banks there is a need to develop adequate microfinance bond
markets In all area of the world in order for microfinance bonds to succeed domestically and
internationally these organizations must be able to offer competitive terms and there must be investors
who are interested in the central mission behind these organizations
In what ways is microfinance linked with capital markets in the world today Reddy and Rhyne
2006 have identified three main ways through the use of local microfinance bonds the use of
international microfinance bonds and through the use of equity funds ACCION Investments is an
example of the use of equity funds in microfinance
BlueOrchard issued a collateralized debt obligation CDO in the amount of 108 million in 2007
Reuters 2007 This CDO combined the loans made to more than twenty MFIs who had in turn issued
loans to more than 70 000 people All the MFIs were in thirteen different emerging markets and the result
was excess demand by investors for the CDO This result indicated that investors are ready and willing to
subscribe to microfinance backed bonds as they consider the returns and investment grades of these
bonds to be above those of other instruments based on emerging market assets
Mexico s Banco Compartamos the largest MFI in Mexico had a very large IPO organized by Credit
Suisse Davis and Dubitsky 2008 Earlier in 2002 the same MFI had issued 68 million microfinance
bond Krauss and Walter 2009 Richard Rosenberg of CGAP 2007 discusses how the Banco
Compartamos 2007 IPO was hugely oversubscribed and in fact excess demand caused the share price to
rise more than 20 on the initial trading day
In 2006 RSA Capital and CitiGroup among others securitized Bangladesh s BRAC Bank s
microcredit loans with an AAA rating Citigroup 2006 This allowed BRAC to expand its loan offerings
There are several key advantages to holding microfinance bonds The investor who is interested in
social impact social investors find these instruments attractive Credit Suisse undertook a study of the
effects of the 2007 2009 financial crisis on the microfinance sector and found that microfinance bonds
could be a good method of portfolio diversification because of the low or negative correlation with other
types of assets Struber 2011 The study did find however that the SMX microfinance index was
correlated with short term interest rates the explanation lies in the short term nature of microfinance
instruments During recessionary periods MFIs may find that their key sponsors or donors are not as
able to fund their operations The slowdown in incoming funds would affect the number of loans issued
by MFIs Microfinance backed bonds not only allow for investors to find a way to diversify their
portfolios but can also widen the flow of funds to MFIs during economic downturns Overall the 2007
2009 financial crisis had the effect of causing microfinance institutions to focus on moving away from
donation based funding and local banking sector funding to more market based sources of funding
In May of 2016 the European Investment fund under the umbrella of the European Union Program
for Employment and Social Innovation reached a landmark agreement with a Greek bank Karditsa
Bank to support Greek micro borrowers who are mostly involved in farming or green micro enterprises
or are unemployed borrowers who want to start businesses Given Greece s continued government budget
problems economic woes and even discussions on a possible exit from the European Union a large
missing market may be satisfied by the existence of more MFIs in Greece Based on findings in the
literature regarding the low correlation between MFI returns and income per capita data MFI backed
bonds would seem to be a good way to spread risk during economic downturns such as the one in Greece
The question then arises as to how microfinance bonds should develop to attract a greater number of
investors There are innovative bonds such as inflation indexed bonds and GDP indexed bonds and social
impact bonds SIBs Typical social impact bonds work in the following way A contract is written
108 Journal of Applied Business and Economics Vol 18 5 2016
between the lender organization and the borrower organization The contract stipulates that repayment
occurs only when certain development targets or social targets are reached Development impact bonds
are a more recent innovation whereby financial organizations that are involved in development initiatives
are able to use a version of the social impact bond Rockefeller Foundation 2014
Thus these kinds of development impact bonds can be used to create impact in the areas of poverty
reduction disease prevention and control educational projects etc A lucrative area of innovation in
microfinance bonds may lie in the adaptation of some characteristics of social impact bonds In other
words a new type of microfinance bond called a microfinance impact bond MIB could develop
whereby a pay for impact model is introduced The idea is that the microfinance institution can link its
objectives and projected goals with the bond instrument being issued For example if a microfinance
institution has a goal to reduce poverty by half in a particular area through the use of microfinance loans
which the target market could use to start up small businesses these loans could be funded through an
innovative use of MIBs If microfinance institutions are able to engineer the use of the impact bond
methodology this would be a very useful and timely innovation for the microfinance industry
The way forward for microfinance is to increase the potential for sustainability Therefore MFIs
should extend the degree to which they tap the financial markets In order to achieve economies of scale
efficiency and greater impact on a larger target market MFIs need to issue more financial instruments
Furthermore the increased use of MFIs will allow for poverty reduction and economic development even
when monetary and fiscal authorities are not able to engage in active macroeconomic policies in
recessionary economies Garnering investor interest will happen through innovation in the debt
instruments offered by MFIs
The future of microfinance lies in sustainability Since microfinance organizations do not typically
issue large loan amounts and since interest payments are used to fund administrative expenses and new
loans it is imperative that these organizations engage in wide scale use of funding sources that tap into
the market Moreover for microfinance to have a large spread of impact and become widely used as a
development tool and a poverty alleviation option it is imperative that these organizations have a
continuous flow of funds Microfinance institutions have proven their success in different aspects of
welfare improvement and economic development and so there is no doubt that these organizations play a
role in improving the economic status of loan recipients and by extension their families especially their
children Microfinance backed bonds have proven their feasibility in the market
It is now time to weld these two concepts together in a large scale way to increase the presence of
microfinance institutions in the financial markets around the world The key lies in the innovation of
microfinance backed instruments through the use of new microfinance impact bonds Policymakers
should focus on making the transition to the markets easier for microfinance institutions and financial
organizations such as large multinational banks and investment banks should expand their portfolios to
include assets based on microfinance loans In this way the impact that these institutions have on poverty
alleviation and economic welfare can be amplified
A New Way to Do Well By Doing Good The Wall Street Journal January 5 2006
Ahlin C et al 2011 Where Does Microfinance Flourish Microfinance Institution Performance in
Macroeconomic Context Journal of Development Economics Vol 95 No 2 pp 105 120
Bangladesh Citigroup Supports World s First AAA Rated Microcredit Securitization Citigroup July
2006 http www citigroup com citi news 2006 060706b htm
Davis S R Dubitsky 2008 Microfinance Meets Wall Street Forbes Magazine March 26
Dorfleitner G Leidl M J Reeder 2010 Theory of Social Returns in Portfolio Choice with
Application to Microfinance Working Paper
Journal of Applied Business and Economics Vol 18 5 2016 109
First Rated Microfinance Bond Sells to Strong Demand Reuters June 1 2007
Gonzalez A 2007 Resilience of Microfinance Institutions to National Macroeconomic Events An
Econometric Analysis of MFI Asset Quality MIX Discussion Papers
Imai K S et al 2012 Microfinance and Poverty A Macro Perspective World Development Vol 40
No 8 pp 1675 1689
Innovations in Finance for Social Impact September 5 2014 Rockefeller Foundation
https www rockefellerfoundation org blog innovations in finance for social impact
Krauss N I Walter 2009 Can Microfinance Reduce Portfolio Volatility Economic Development
and Cultural Change The University of Chicago Press Vol 58 No 1 pp 85 110
Kyereboah Coleman A 2007 The Impact of Capital Structure on The Performance of Microfinance
Institutions The Journal of Risk Finance Vol 8 No 1 pp 56 71
Maksudova N 2010 Macroeconomics of Microfinance How Do the Channels Work Working Paper
No 423 The Center for Economic Research and Graduate Education Economic Institute
Oehri O J Fausch 2008 Microfinance Investment Funds Analysis of Portfolio Impact Geneva
Papers on Inclusiveness No 6 October World Microfinance Forum Geneva
Rhyne E R M Reddy 2006 Who Will Buy Our Paper Microfinance Cracking the Capital Markets
ACCION International s InSight Series April 2006
Schwarcz S L 2011 Helping Microfinance Become Commercially Sustainable Gonzaga Law Review
Vol 46 pp 495 502
Struber M 2011 Microfinance An Attractive Portfolio Diversifier Credit Suisse Research Monthly
Zurich 15 September 2011
110 Journal of Applied Business and Economics Vol 18 5 2016

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