Investing in Microfinance: in whose interest

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Investing in Microfinancein whose interest?
Presentation for the AHRC Microfinance Research
Network, Birmingham By Robert Lensink (RUG/WUR)
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Commercialization of MF

• Commercial banks more involved in microfinance
• Traditional services MFIs expanded
• From microcredit to microfinance
• A rapidly changing funding situation
• Traditionally MFIs funded by public donors and
  aid organisations
• capital market funding is becoming important
• institutional investors are also interested in
  microfinance

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Why is MF Interesting for international investors?

• 1) increased attention for socially responsible
  entrepreneurship
• 2) The potential size of the microfinance market
  is huge
• 3) high returns on microfinance lending
• 4) low default rates on microfinance lending
• 5) microfinance provides attractive opportunities
  for portfolio diversification

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1) increased attention for socially responsible
entrepreneurship

• MF could be an interesting alternative for
  private investors who, for altruistic motives,
  want to contribute to the fight against poverty
• By directly targeting the poor, and therefore
  circumventing inefficient/corrupt government
  structures, micro lending could be an efficient
  means of doing well.
• There is considerable evidence that MF helps to
  reduce poverty. However, many uncertainties
  remain.

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2) potential size of the microfinance market

• There are currently up to 3 billion people
  without access to proper financial services!
• There are also an estimated 500 million
  micro-entrepreneurs worldwide
• Thus, there is a huge untapped source of micro
  credits for international investment banks that
  can be pooled together and sold to investors all
  around the world

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3) high returns on microfinance lending

• Micro lending probably gives higher returns than
  traditional lending
• Typically, a poor farmer or entrepreneur in a
  developing country generates much higher returns
  on his assets than a corresponding business in
  the developed world
• MFI Clients have a higher investment ratio and
  higher marginal returns on investments
• Thus, as is argued by some, many poor can afford
  to pay much higher lending rates

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3) high returns on microfinance lending

• Some empirical evidence indeed suggests that
  interest rates can be much higher for lending to
  the poor
• There is evidence that moneylenders in developing
  countries ask daily interest rates of 20 (which
  is more than 5000 a year!!!)
• Access to finance is more important than its
  price!

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4) Low default rates on microfinance lending

• Many authors show that default rates are below 5
• Why low default rates?
• 1) Loans have a shorter average maturity
• 2) Mainly women tend to have a better repayment
  discipline
• 3) Close ties to and knowledge of borrowers and
  local markets and innovative MFI lending
  techniques (group lending etc)
• 4) Lower operational and financial leverage
• However there is some evidence that default
  figures are deflated
• In addition, credit quality of average borrowers
  could fall if the client base is widened.

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5) MF attractive in terms of portfolio
diversification?

• Some argue that risk adjusted returns of MFI
  exhibit low correlations with other assets/market
  risks. Why?
• 1) Mostly non-public ownership structure reduces
  sensitivity to market signals and dependency on
  capital markets
• 2) Lower international exposure of MFIs and their
  clients
• 3) Borrowers from the informal sector are less
  sensitive to market movements

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5) MF attractive in terms of portfolio
diversification?

• Study by Krauss and Walter
• MFIs may have useful diversification value for
  international portfolio investors away from
  country risk exposures.
• However, for emerging market domestic investors,
  domestic microfinance investments do not seem to
  provide significant portfolio diversification
  advantages.

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5) MF attractive in terms of portfolio
diversification?

• Study by Galema, Lensink and Spierdijk
  International diversification and microfinance
• We investigate whether adding microfinance funds
  to a benchmark portfolio is beneficial to
  investors
• Methodology mean-variance spanning tests
• This methodology assumes that investors only care
  about risks and returns of assets
• The mean-variance method examines whether adding
  microfinance to a benchmark portfolio allows
  investors to reach a mean-variance efficient
  portfolio with a higher mean and a lower variance.

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International diversification and microfinance

• MFIs covering the period 1997-2007 (MixMarket
  database) in 1997, 25 MFIs in 2006, 800 MFIs
• Return measures MFIs ROE and ROA
• Benchmark portfolios (to mimic an investors
  broad investment portfolio) several global
  equity and bond indices (Morgan Stanley Capital
  International world and emerging market total
  return indices and the JP Morgan Global Broad and
  JP Morgan Emerging Markets Global Composite bond
  indices)

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Conclusions study Galema, Lensink and Spierdijk

• Spanning more often rejected for bond benchmarks
  than for stock benchmarks MF is particularly
  valuable as addition to the bond share of a
  globally diversified portfolio
• Spanning never rejected for Africa
• Spanning mostly rejected for MFIs in Latin
  America.
• Mixed results for other regions
• Spanning always rejected for microfinance banks.
  This is much less the case for Cooperatives and
  NGOs
• Africa special case Africa worst performer in
  terms of ROE/ROA higher operating costs due to
  weak infrastructure interest rate ceilings.

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MF and International Investors Hurdles

• 1) mainstream investors deal with regulated
  entities that work in a clearly defined legal
  environment
• 2) Macro policy and government regulations have
  to be adapted to accommodate commercial micro
  lending
• 3) If international capital markets are to be
  tapped on a larger scale, the MFI investors have
  to be able to hedge the foreign exchange risk
  that appear when they borrow/ lend in a foreign
  currency
• 4) lending on subsidized terms may lead to
  crowding out of commercial lending

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Why is investing in microfinance attractive to
the poor?

• more funds available, hence a better outreach
  studies show that roughly 40-80 percent of
  populations in most LDCs lack access to formal
  banking services!
• more loans with longer maturities
• more diversified funding sources

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Is there a tradeoff between outreach and
commercialization?

• Some possible conflicts
• 1) since lending to the poor may be very costly,
  outreach and sustainability may be conflicting
• 2) Unit transaction costs are higher for smaller
  loans. For this reason, achieving financial
  sustainability reduces outreach
• 3) Mission drift focusing on wealthier clients
• Study by Hermes, Lensink and Meesters Outreach
  and efficiency of MFIs, World Development,
  forthcoming using a SFA analysis they show that,
  on average, tehir is a tradeoff bewteen outreach
  and efficiency of MFIs.

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Outreach and financial indicators for individual
versus group lenders

• Table 1

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Conclusions table

• 1) MFIs with individual loans yield better
  results in terms of profitability
• 2) When it comes to outreach, MFIs with group
  loans yield better results (average loan balance/
  loans to females)
• Hence tradeoff between outreach and profitability

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Microfinance commercialization Financially and
socially optimal investments

• Study by Galema and Lensink
• Main question study deals with
• Is is possible to select a subset of microfinance
  institutions that offer portfolio diversification
  opportunities for international investors and at
  the same time score high on the outreach goal?
• We select different groups of MFIs that score
  high on outreach, and apply spanning tests to see
  whether they are financially attractive for
  international investors

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Galema, and Lensink main conclusions

• 1) Investing in MFIs that provide individual
  loans attractive from a diversification point of
  view. However, this group performs relatively bad
  in terms of outreach.
• 2) Investing in MFIs that provide group loans is
  less attractive from a diversification point of
  view. However, this group scores high in terms
  of outreach.
• However further disaggregation suggests
• 1) MFIs that offer group loans can be interesting
  in terms of diversification if they are not from
  Africa or South Asia!
• 2) Within Africa, is is also possible to select a
  group of MFIs that does offer diversification
  benefits these are MFIs that offer individual
  loans.

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MFI of interest for the poor and investors?

• 1) Subsets of MFIs are attractive in terms of
  financial returns as well as in terms of outreach
• 2) However, in general tradeoff if MFIs focus
  more on the poor, this reduces its
  attractiveness for investors
• and, given the average outreach of (portfolio of)
  MFIs, is the MFI efficient in terms of
  risk-return?

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Trade-off between outreach and efficiency

• What is the price in terms of risk-return if we
  want to achieve higher outreach?
• Paper by Galema and Lensink Social investment in
  Microfiannce the trade-off between risk, return
  and outreach to the poor

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Galema, Lensink

• How can we evaluate MFI fund performance when
  investors also care about outreach?
• We examine the mean-variance frontier for
  different degrees of outreach. This yields a
  mean-variance-outreach surface
• Each level of outreach corresponds to a
  particular mean-variance frontier
• More outreach downward shift of mean-variance
• We can calculate the price of higher outreach

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Changes Average Loans Size and Return
Standard Deviation 6.5
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Further research

• More data on MFIs monthly
• Other indicators for outreach
• Other indicators for financial performance
• Role of subsidies