2009 Publications

BANKING ON THE FUTURE: EXPLORING MICROFINANCE AS SERVICE September 29, 2009 PROCEEDINGS Sponsored By:

Francis Center for Servant Leadership Pfeiffer University

BANKING ON THE FUTURE: EXPLORING MICROFINANCE AS SERVICE September 29, 2009 PROCEEDINGS

Published by Pfeiffer University Dr. Rosemary E Minyard, editor Copyright owned by Pfeiffer University

ISBN – 13: 978-0-615-35916-8

ALL RIGHTS RESERVED No part of this work covered by the copyright hereon may be reproduced or used in any form or by any means – graphic, electronic, or mechanical, including photocopying, recording, taping Web distribution or information storage and retrieval systems, or any other manner – without the written permission of the publisher.

For permission to use this material submit a request to microfinance@fsmail.pfeiffer.edu

Table of Contents Preface

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Introduction: Microfinance as Service

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Bios

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THE PAPERS CHAPTER I……………………………………………………………….........MICROFINANCE AND FAITH “The Spiritual Mission of Microfinance” Mark Russell, Ph.D. “Financing Small Enterprises Through Mudharabah” Yahsoub Al-Eryani, Ph.D., Kais Aliriani, Manal Al-Asbahi CHAPTER II…………………………………………………………..CONFLICTS WITHIN MICROFINANCE “Conflicts in Microcredit: The Battle over Mission and Sustainability” Warner Woodworth, Ph.D. CHAPTER III……………………………………………MICROFINANCE AND THE CAPITAL MARKETS “Capital Markets Style Risk Assessment: Testing Static Pool Analysis on Microfinance” Rupert Ayton, Stephanie L. Sarner, Ph.D. CHAPTER IV………………………………….THE EVOLUTION OF THOUGHT ON MICROFINANCE “Critical Theory and Microfinance” Dwight Haase, Ph.D. CHAPTER V…………………………………………………..MORE ON FUNDING FOR MICROFINANCE “The Challenges of Public Equity Capitalization for Microfinance Institutions” Deena Burris, Ph.D.

Table of Contents |

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CHAPTER VI…………………………………………………………………………………….BONUS MATERIAL “Leveraging Microfinance as Improvised Tool for Up-Scaling Accessibility to Financial Products & Services in the Hinterland of India” Prasun Kumar Das, Ph.D. “Are Customer Relationships the Key to Productivity in Microfinance Institutions?”

Karl Dayson, Ph.D., Pal Vik

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PREFACE

The reason we are publishing these proceedings is so our readers will be able to appreciate the complexities of microfinance as an example of servant leadership. When the Francis Center first learned about microfinance we were as excited as everyone else who had learned about microfinance over the last decade. But we were also puzzled about how we could participate not only in practicing microfinance but also in the debates that were surfacing on microfinance in several disciplines. We began by reaching out to those on campus who already had some experience and exposure to microfinance and realized that microfinance can be approached from many perspectives, ranging from the religious to the business. From this we saw the benefit of emphasizing the links and made a concerted effort to bring together those in the colloquium with experience in microfinance through faith based, servant leadership, academic and practicing institutions.

This publication matters because we are bringing together these different perspectives in one document. We explore microfinance and faith, we explore microfinance and the capital markets, we explore critical theory and microfinance and we explore the conflicts within microfinance and this is our first attempt to participate in the dialogue on microfinance which is already broad and growing.

To be able to know and understand these perspectives is a way of making us more effective as servant leaders.

This publication goes hand and hand with the web site which you can access by copying and pasting the link below in your browser. You can listen to the video presentations on the web site and then read the papers or you can read the papers and then watch and listen to the videos. Together they will deepen your understanding. http://www.pfeiffer.edu/academics/undergraduate/2009-microfinance-colloquium Since we are beginning to develop our own voice in the debate on microfinance, if you have an opinion about what you think that should be, let us hear from you. Please email us with your comments or suggestions at microfinance@fsmail.pfeiffer.edu.

I would also like to thank all who helped in putting this colloquium together, including but not limited to Dr. Rosemary Minyard, Dr. Phil Wingeier-Rao, Ms. Sudie Nallo, Ms Susannah Bales, Ms. Marissa Wheeling and Mr. Scott Eisnaugle. In addition, many thanks to those not mentioned, or those who wanted to support us and could not. This event was an unqualified success in presenting Pfeiffer University’s concept of microfinance as service. We hope you’ll be inspired by this publication to explore your interest in microfinance further.

Dr. Tracy Espy Provost and Vice President for Academic Affairs

Preface |

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Introduction Dr. Ruth Anderson of The Servant Leadership School of Greensboro has said that "micro financing is a part of the servant leadership movement as it envisions a world in which as many poor and verging- on- poor households as possible have access to an appropriate range of high quality financial services. Servant leaders see how microfinance can help poor people deal with the complex and baffling issues of poverty." Our colloquium features a variety of voices in the microfinance field, including those who see microfinance as an effective tool of faith, those who believe that microfinance is losing its original focus on the poor by pushing hard for sustainability, those who understand the dichotomy between being efficient and being effective in delivering microfinance, to those who are evaluating what the next steps are in expanding microfinance through both commercial lenders and the capital markets.

What you will learn from this colloquium is how service can be informed and enhanced by fruitful dialogue.

Dr. Christopher Hughes writes in his booklet on the “University as Church: On Becoming the Model Church Related University”, that at Pfeiffer “We do not promote a particular denominational polity. We promote a faithful response to the gift of life.” So it is only natural in the context of what Pfeiffer is about for the colloquium to include the voices of faith. Since faith based institutions have been and will continue to be involved in microfinance, the question is not whether they should be, but rather when they are, how and under what conditions they can make a difference. To answer this question is not to make a statement about the strength of a faith’s principles or precepts, but to help determine what could be an effective way to serve. While we certainly didn’t attempt to present definitive answers with our selections on faith we do explore the views of those who, when they do believe that faith based institutions should be involved, believe that they can make a difference.

Dr. Mark Russell from HOPE International argues that microfinance lending with Christian values is important to spreading the benefits of microfinance evenly within a community in order to reduce tensions. Dr. Yahsoub Al-Eryani, Kais Aliriani and Manal Al-Asbahi, all of the Arab Academy for Banking and Financial Sciences, try to identify the extent to which the faith based precepts within the Muslim faith, as practiced by microfinance institutions in Yemen that lend using the Islamic financing tool known as Mudhabarah, do make a difference. They compare the effectiveness of Mudhabarah with conventional lending and Murabaha, another Islamic financing tool.

No field of inquiry is without controversy and microfinance is no different. If everyone could agree on the way forward to make microfinance as effective as it could be microfinance institutions (MFIs) could achieve their goals and make a significant dent in eradicating poverty in their communities.

In his presentation on the conflicts within microcredit Dr. Warner Woodworth from Brigham Young University explores some of the reasons why not. We include those views here because of the push to expand microfinance’s path to growth and sustainability through the capital markets. Even though there may be a downside and some unintended consequences from expanding through the capital markets, there are also many benefits. The challenge is understand what you might be giving up to get there and to determine the appropriate balance.

Introduction |

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Then there are the views on the side of the capital markets from Rupert Ayton and Dr. Stephanie Sarver at the Center for Development of Social Finance (CDSF). They demonstrate that MFIs who are better positioned to attract capital markets investors will be those that can report on their performance using standard methods already in use. With information provided by two (2) MFIs, one in India the other in Tajikistan, they demonstrate that standardized analysis is feasible if MFIs collect sufficient historical data in a consistent format. This is certainly no small task for any institution but one that can reap great benefits even in the face of all the uncertainties in the capital markets that will result from this most recent credit market induced recession. Uniformity and transparency will be essential going forward for MFIs to access the capital markets on anything other than a small scale.

Dr. Deena Burris of Guilford College also inspired us with her study of the capital markets from another angle, the challenge of public equity capitalization. All institutions will be able to grow much easier if they can continuously access the cash to grow either through the asset securitization side of the balance sheet or the equity side. In exploring how to make that possible she examines the barriers that MFIs face in accessing the public equity capital markets. We learn not only that large scale change is needed in the way MFIs operate, but also that change is needed in the structure and regulation of the industry.

Noteworthy in our collection of articles is another voice which is asking whether microfinance is really a strategy for empowerment. In his paper on critical theory Dr. Dwight Haase from the University of Toledo addresses this by reviewing the assumptions and values embedded in the theoretical perspectives which have guided both academics and practitioners in microfinance. He applies the insights of Marxist and feminist theories to raise awareness of the limitations. He argues that microfinance may not be empowering when it leads to more streamlined services rather than more holistic involvement which can result in more fundamental social, economic and political change.

We have included two (2) more voices in this publication which were not part of the colloquium but which we think will add important perspectives in the dialogue on microfinance.

The first bonus paper by Dr. Prasun Kumar Das of KIIT University focuses on how to leverage the success that has already been demonstrated by Self Help Groups (SHG) based lending in India when delivery channels for financial services were expanded to rural populations in India. The Indian model for microfinance focuses on building social capital by linking access to financial products and services for the poor with mainstream lending. He reviews the available channels for the delivery of microfinance through the formal financial system and identifies the potential for micro banking within rural markets by different players in the formal system. This results in the identification of various factors that can contribute to continued expansion of lending in this sector. This is the kind of issue that is continuously being explored by many in the microfinance industry around the globe.

The second bonus paper by Dr. Karl Dayson and P책l Vik at the University of Salford evaluates the most effective way to increase the productivity of loan officers in the UK microfinance sector. Since productivity is a key driver of overall sustainability, increasing it can lead to reduced costs and greater incomes. They conclude that the pathway to increased productivity may differ depending on the topology of the organization. Lending in Western Europe and South America is mostly individual and in

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Asia traditional microfinance group lending is still dominant. Their findings may have important implications for sustainability around the globe.

We encourage readers to explore all of these papers and have divided them into six (6) separate chapters to make it easier to find what you’re interested in. Our view is that these various views and implementations of microfinance are all related. The more you explore them as an integrated whole the more you’ll be able to see and understand how microfinance can be an effective tool of service.

Dr. Rosemary E. Minyard

Introduction |

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BIOS Banking on the Future: Exploring Microfinance as Service explored different implementations of Microfinance and included experts on Microfinance from academia, faith based and practicing organizations and focused on the links between the Microfinance and the philosophy of Servant Leadership.

The Spiritual Mission of Microfinance Mark Russell, Ph.D. Dr. Mark L. Russell is the author of The Missional Entrepreneur: Principles and Practices for Business as Mission and the editor of Our Souls at Work: How Great Leaders Live Their Faith in the Global Marketplace. He currently works for HOPE International, a Christian faith-based, non-profit organization focused on alleviating physical and spiritual poverty through microenterprise development. In 10 years of operation, HOPE has never returned profits from any of its microfinance programs to the United States.

When a program becomes profitable, HOPE invests the money in further program growth and in community initiatives such as Christ-centered children’s ministries or complimentary healthcare.

HOPE’s programs are highly successful, boasting a repayment rate of 99%, and highly leveraged. He received a Ph.D. from Asbury Seminary *

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Financing Small Enterprises Through Mudharabah Yahsob Al-Eryani, Ph.D., Kais Aliriani, MBA, and Manal Al-Asbahi Yahsob Al-Eryani, Ph.D.: Vice Dean, and professor of finance at the Arab Academy for Banking and Financial Sciences-Yemen. His PhD research was on Yemen’s banking system. He is one of few experts on Yemen’s financial system. He is also an expert on financial markets, and has done research on financial markets in the region.

Kais Aliriani, MBA: Director of Investpro, a Yemeni firm that provides business services. Kais is an expert in SME development and microfinance with over 14 years of experience. He is a trainer and a researcher in the area of management and finance. Kais is a pioneer in supporting the foundation of the microfinance services in Yemen. As a member of the founding team of the Social Fund for Development in Yemen, he played an important role in introducing best practice microfinance services to Yemen.

Bios | ix

Conflicts in Microcredit: The Battle over Mission and Sustainability Warner Woodworth, Ph.D. Dr. Warner Woodworth received a Ph.D. from the University of Michigan and works around the globe to combat poverty. Author of 10 books and over 200 articles and conference papers, he has been a visiting scholar in Hawaii, Lithuania, Brazil, Switzerland. Over the years he has been based at the Marriott School of Brigham Young University where he teaches MBAs courses such as Organizational Consulting, and Change Management, Leadership, Third World Development, and Social Entrepreneurship. Using the university as an NGO incubator, he and his students, alumni, and business associates have designed and launched some 20 NGOs which last year collectively raised more than $40 million, trained 310,000 microentrepreneurs, and grew their client base worldwide to 6.1 million individuals--in 2008 alone. *

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Capital Markets Style Risk Assessment: Testing Static Pool Analysis on Microfinance Rupert Ayton, Stephanie L. Sarver, Ph.D.

Mr. Ayton is the founder of the Center for the Development of Social Finance. CDSF is a non-profit organization that provides education and conducts research that creates a wide understanding of money and finance and how it shapes our communities. Mr. Ayton has more than twenty-five years experience working in corporate finance, the capital markets, and philanthropy. He has also taught finance at the University of Portland. Mr. Ayton is recognized as an expert in applying capital markets practices to microfinance, and has spoken publicly as well as published a number of articles and reports on the subject. Mr. Ayton holds a B.S. degree from California State University, Northridge, and a M.B.A. from Golden Gate University.

Theory and Microcredit Dwight Haase, Ph.D. Dr. Dwight Haase is an Assistant Professor in the Department of Sociology and Anthropology at the University of Toledo. Before receiving his PhD in Sociology at the University of Wisconsin-Madison in 2006, he worked and conducted research with numerous microfinance institutions in South Asia and the U.S. His research interests also include globalization and social movements. Dwight is a native of Toledo, but in recent years most of his time has been spent working and studying in other parts of the world. After completing his BSW at Purdue University, Dwight lobbied for anti-poverty legislation in Washington, DC. His work in DC inspired Dwight to move to El Salvador for one year to help assess the impact of a law he helped passed, which provided microcredit loans to disadvantaged entrepreneurs.

Being impressed with the empowering potential of microcredit – especially for women – Dwight next worked with the Grameen Bank in Bangladesh, which is considered the leading microfinance institution worldwide. Dwight then resumed his academic career at Clark University, pursuing a MA in International Development and Social Change. He also returned to Bangladesh as a Fulbright scholar to study decision-making processes within various nongovernmental organizations. Dwight went on for his PhD in Sociology at the University of Wisconsin-Madison. While studying there he also took time off to serve as a consultant to the Grameen Bank’s expansion into Mexico, and served as loan fund manager for nonprofit agency promoting socially responsible investing in Nicaragua. Dwight also traveled to Albania to assist with U.S.AID-led cadastral reform. And as a Tinker Nave scholar Dwight conducted his dissertation research on Nicaragua’s informal sector.

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The Challenges of Public Equity Capitalization Deena Burris, Ph.D. Dr. Deena Burris is currently Assistant Professor of Business Management and Department Chair at Guilford College in Greensboro, NC where she teaches in both the Business Department and International Studies Department. Dr. Burris graduated with a Ph.D. in International Development from the University of Southern Mississippi, and her research focus is in field of microfinance, particularly on connecting capital markets and microfinance institutions. She has an M.A. from the University of Denver School of International Studies in International Economics and Business and a B.A. in Business and English from the University of North Carolina at Charlotte. Prior to academia, Dr. Burris worked in international banking and trade. *

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Leveraging Microfinance as an Improvised Tool for Up-Scaling Accessibility to Financial Products & Services in the Hinterland of India

Prasun Kumar Das, Ph.D. Dr. Das is an Associate Professor in Rural Finance, School of Rural Management, KIIT University, Bhubaneswar-751024, India and presently working as consultant with Food & Agriculture Organization of United Nations (FAO) at Rome, Italy. He received the C. H. Bhaba Research Scholarship & award of Indian Banks’ Association, Mumbai, India in 2005 for research work on “Increasing the Credit Flow to Agriculture by the Commercial Banks in India- the Task ahead” and has conducted micro level research on risk management practices in micro finance and received an award from The Indian Institute of Banking & Finance, Mumbai, India. He has a Ph.D. in Agronomy from Bidhan Chandra Krishi Viswavidyalaya (The State Agriculture University of West Bengal, India).

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Are Customer Relationships the Key to Productivity

Karl Dayson, Ph.D. and Pål Vik, Dr. Karl Dayson is the Director of Sociology and the Executive Director of the research and development unit Community Finance Solutions at The University of Salford, United Kingdom. Karl’s research is in the fields of community finance, financial exclusion and institutional forms of collective and communal ownership. Karl’s current work includes research on credit cards and assessing the social impact of microfinance initiatives.

Pål Vik is a research assistant at Community Finance Solutions and a PhD candidate at the Department of Sociology at The University of Salford, United Kingdom. Pål specializes in the sustainability and social impact of microfinance and his current research focuses on the effectiveness of microinsurance schemes and the social impact of microfinance initiatives in Developed countries.

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THE PAPERS

The Papers |

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The Papers |

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THE SPIRITUAL MISSION OF MICROFINANCE Mark Russell, Ph.D., Director of Spiritual Integration, HOPE International

ABSTRACT The paper explores the model of microfinance and how it can create community and be a servant to those in need. It argues that it needs to be intentionally integrated with the values of servant leadership so that microfinance clients become servants to their communities rather than simply wealthier people.

Jesus is undoubtedly one of the most well known leaders in human history. At the same time, he was a person who clearly served others and taught his followers to be servants of all. One of the most famous stories that Jesus taught has become known as the parable of the Good Samaritan. Jesus taught this story in reference to a question about what was the most important commandment. Jesus said two commandments, to love God and to love one’s neighbor, fulfilled the law and the prophets.

Microfinance should be seen as a tool to help people in need, not simply as a means to inject capital. Many underdeveloped countries are also countries with ethnic rivalries and social unrest and microfinance can be a space for the reconciliation of these groups.

One of the key factors in the success of microfinance is the utilization of solidarity groups. While integrating intentional reconciliation work these groups can become catalysts for reconciliation throughout the broader community and society.

Without bringing in the values of servant leadership, increased capital can spread the benefits of microfinance unevenly in a community and lead to increase tension. The uniqueness of Jesus was not that he served people, but that he led the same people to serve others.

KEYWORDS: microfinance, Christians INTRODUCTION Poverty is a daily reality for billions of people on the planet. The numbers are so staggering that we can simply become numb. Approximately 3 billion people live on less than $2 a day. The World Bank estimates that 1.4 billion people are living in extreme poverty.1 The result of this is real.

Consider the following facts:

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Over 140 million children in developing countries are underweight and over 2 billion are undernourished.

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Every year more than 10 million children die of hunger and preventable diseases that's over 30,000 per day and one every 3 seconds.

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Extreme or absolute poverty is typically defined as living on less than $1 per day.

Microfinance and Faith | 3

• • • • •

800 million people go to bed hungry every day.

Every year nearly 11 million children die before their fifth birthday.

600 million children live in extreme poverty.

The three richest people in the world control more wealth than all 600 million people living in the world's poorest countries.

Income per person in the poorest countries in Africa has fallen by a quarter in the last 20 years.2

And the situation is only going to get worse. Recent increases in the price of food have had a direct and adverse effect on the poor and are expected to push many more people, millions of people, into absolute poverty. What are we, as the people of God, supposed to do about this?

One unfortunate response that many people have could be defined as fatalistic. The problem is so immense and overwhelming that some Christians simply throw up their hands and say it’s up to God. They believe that not much can be done and they refrain from trying to make a difference. Another subpar response is despair and depression.

Some Christians are so focused on the horrors of poverty and the immense suffering it produces in the lives of others that they become increasingly negative, hostile and judgmental. They are depressed and think it is wrong to be otherwise. Often they cast spiritual stones at others who are not so engaged in eliminating poverty.

However, there is a third way and, I believe it is God’s way, when it comes to responding to global poverty. This third way has two major components: 1) We recognize how we treat the poor is a reflection of how we treat Jesus.

2) We focus on approaches that work.

SOME NEW PERSPECTIVES Many people become confused when they read these words of Jesus, “The poor you will always have with you, and you can help them any time you want. But you will not always have me” (Mark 14:7). On the surface this statement appears to absolve us of responsibility of caring for the poor. However, two things must be pointed out. First, Jesus said this after Mary had poured valuable perfume on Him. Within this context, Jesus’ statement is not absolving anyone of any responsibility, but showing that the orientation of a heart toward Him is what is most important.

Second, what is little known today to most readers of the Scriptures, is that many statements in the New Testament had the purpose of directing people toward Old Testament (OT) Scriptures. This comment from Jesus starts off with a near quote of the following OT verse, “There will always be poor people in the land. Therefore I command 2

United Nations Millennium Development Goals & Oxfam International

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you to be openhanded toward your brothers and toward the poor and needy in your land” (Deuteronomy 15:11). So, Jesus is not saying that we should not care for the poor, but rather that we should first have a heart committed to Him. Then we should be “openhanded” toward “the poor and needy” in our world.

This truth is brought home when Jesus said quite clearly, “I tell you the truth, whatever you did for one of the least of these brothers of mine, you did for me” (Matthew 25:40).

Perhaps sensing that many people might just choose to opt out of doing something good, Jesus made clear that not doing good is the equivalent of doing bad when he flipped the phrase saying, “I tell you the truth, whatever you did not do for one of the least of these, you did not do for me” (Matthew 25:45). So, how we treat the poor is a reflection of how we treat Jesus.

God created a beautiful world, prepared for those created in His image to be enjoyed with abundance and blessing (Genesis 1:28). But this world has been corrupted and broken and we are in a world of scarcity and cursing. The ones who suffer the most are the poor.

God created us to build community together and to work his creation (Genesis 1:28).

Poverty tends to disrupt genuine community and prevents people from engaging in the dignified work that God intended. Even in prosperous, developed countries, finances are a primary cause of stress and problem within marriages. The same is true the world over.

Where there are financial pressures, relationships tend to dissolve. Where that pressure is immense, rioting and war can even result.

Part of the mission of the church is not only to treat “the least of these” with respect and dignity, but also to find real and practical ways we can restore them to the life that God intends for them. We need to focus on interventions that work.

THE LINK TO MICROFINANCE A recent United Nations Millennium Development goal report said that the number one intervention that has worked to eradicate poverty in the last eight years is microfinance.

Microfinance is an umbrella term that refers to the provision of small loans and other financial services such as savings and micro-insurance to people who are cut out of traditional banking structures. Microfinance has helped many of the world’s poor to increase their incomes. In 2006, microfinance institutions provided loans to approximately 113 million clients worldwide.

Although there are 113 million microfinance clients in the world, there are approximately another 550 million people who would benefit from microfinance but do not have access to it. We are reaching less than 20% of the people who most desperately need it. Of the people who are being reached only about 1% are being served through Christian microfinance institutions (CMFI). That means that CMFI’s are serving less than one fifth of one percent of the need.

At church and academic conferences I frequently give this information about the lack of access to basic microfinance and ask if it’s a problem that CMFI’s and the Church as a whole are not making a bigger impact. Quite often the general response is that the biggest problem is that people do not have access to these basic financial services and it does not really matter who the provider is. These responses demonstrate to me that many people of Microfinance and Faith | 5

faith still do not understand poverty and the spiritual mission of microfinance.

As a citizen and resident of the wealthiest nation in the history of the world, I have observed that access to financial capital is not the solution to the world’s problems.

Increased wealth can lead to a decreased spirituality. Greed can flourish where the economy prospers. However, in saying that, the extremity and scale of poverty in the world today needs a financial response. These people do need financial capital. But that is not all that they need.

THE INTEGRATION Recently, I visited with a microfinance client in the Democratic Republic of Congo who is a microfinance success story. He had built his salon business up and was generating significant profits. He had been able to construct a new building for his business.

However, he was a functional alcoholic. 3 The vast majority of his profits had been consumed with his business and his alcohol. When his loan officer at a CMFI confronted him on his alcoholism and offered him new life in Christ, the man was changed. He became a follower of Christ and gave us his expensive alcohol habit. When I asked him what tangible result this had on the lives of others around him, he confessed that he was now able to buy milk for his six children. Though this man was a microfinance success story, the benefits of that improved lifestyle did not even trickle down to his own children until God changed his heart.

The spiritual mission of microfinance is not to simply help the poor be less poor, but it is to radically transform their lives and give them the practical and spiritual tools to live life as God intends. We want to help the poor, but it is not like solving a math problem.

Microfinance is a solution that works, but it only helps in so far as we understand what the real problem is. We are working to change the world in which we live, not just make people wealthier. We need to eradicate spiritual and physical poverty. That is the spiritual mission of microfinance.

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A functional alcoholic is someone who consumes alcohol as an addiction and extensively but is still able to function as a well performing person.

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FINANCING SMALL ENTERPRISES THROUGH MUDHARABAH Yahsoub Al-Eryani, Ph.D., Vice Dean, Arab Academy for Banking and Financial Sciences Kais Aliriani, MBA, Director, Investpro Inc. and Manal Al-Asbahi, MBA Candidate, AABFS

ABSTRACT Small enterprises in Yemen, like many other countries, lack the financial means to develop. They have limited access to the traditional lending market. In Yemen, small entrepreneurs need more innovative approaches to finance, and Islamic financing tools are gaining popularity as an alternative to traditional loans. This research investigates the characteristics of mudharabah (an Islamic financing tool) and how it could be used to finance small enterprises, comparing it to other financing tools. It also surveys the use of mudharabah among financiers and clients.

Financial ratios were used to compare conventional lending, Murabaha (another Islamic financing tool), and mudharabah. The conclusion is that there are differences between the three financing tools with regard to liquidity of small enterprises, with mudharabah being the best for small enterprises. On the other hand, there are no significant differences between the three financing tools with regard to profitability and solvency of small enterprises.

Mudharabah, as a new financing tool, could be a good tool for financing small enterprises. It could contribute with other Islamic financing tools in filling the gap in lending to small enterprises. There is, however, a lack of knowledge about mudharabah among financiers, and clients. Mudharabah, and other Islamic financing tools, need be further developed, and experimented in financing small enterprises, so further empirical research could take place.

KEYWORDS: finance, murabahah,Yemen, lending

small

enterprises,

Islamic

finance,

mudharabah,

INTRODUCTION Small enterprises play an important role in the economies of countries regardless of their development stage. They contribute to economic development by creating jobs and incomes to large numbers of people. The contribution of SMEs has been demonstrated in both developing and developed countries. Mahatma Ghandi in one of his famous quotes defined development as “putting in the front those that society usually puts in the back�.

A small enterprise is an enterprise that uses a limited number of employees. It is managed by owners and it usually serves the local market. It is a form of self employment. SMEs, like other projects, need financing. Finance is the foundation of any small project. Decision makers need to make essential decisions related to the finances Microfinance and Faith | 7

of the enterprise, including the source of funds, and their use, to achieve the highest return with the lowest risk.

The number of organizations that provide finance to SMEs in Yemen is still limited.

Banks are reluctant to finance SMEs due to the lack of traditional collaterals. In addition, SMEs have limited capacity in planning and proposal writing, which further limits their access to finance. In many cases SMEs depend on their own savings to run business.

This limits their ability to grow. With better financing facilities SMEs could significantly increase their contribution to the economy. This is especially true in a country like Yemen that suffers from high unemployment.

In this study the researchers introduce traditional lending, murabahah, and mudharabah as three methods to finance SMEs. A comparison between the three lending methodologies is presented. Liquidity, profitability, and other financial ratios are used in the comparison. The efficiency of each methodology in financing SMEs is discussed.

For the purpose of this research the following definition are used: -

Lending: or “traditional lending� is a contract between a borrower and a lender.

The borrower receives a cash advance (a loan) from the lender. The loan plus a premium (interest) is paid back by the borrower on specified time schedule.

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Murabahah: an Islamic financing tool. It involved the buying and selling contract between two parties. The financier (bank) buys the goods required by the client and resells them to the client at a mark up. The client is then required to pay the price at a later time. (Gait,2007). Murabahah is widely used by Islamic banks.

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Mudharabah: an Islamic financing tool. It is a contract between two parties: an investor (individual or institution) who provides the entrepreneur with financial resources to finance a particular project (Gait, 2007). The risks of the project are shared between the two parties and profits as well as losses are shared at the end of the agreed period.

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Entrepreneur/ client: owner of small business.

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Financier: the entity that provides finance to SMEs.

IMPORTANCE OF THE RESEARCH SMEs in Yemen have limited access to financing sources (Elk, 2000). In addition to the fact that they are not able to access funds from banks due to the high requirements of guarantees, many SMEs owners prefer Islamic banking products, which are not readily available. The importance of this research is to learn about the different financing methods in the search for suitable methods to finance SMEs. 8 | Microfinance and Faith

Financial analysis and financial ratios are used to compare the different financing methods, both traditional and Islamic. This comparison is used to find if there is any preferred way that best suits the needs of SMEs. The research also looks in more details into mudharabah financing. A mechanism for mudharabah financing is proposed, in addition to several guidelines and recommendations that could help organization that are interested in using mudharabah as a mean to finance SMEs. The research could help increase the use of mudharabah in financing SMEs, and hence increase the financing available to SMEs.

RESEARCH PROBLEM The problem the research is trying to solve is to answer the following questions: 1. What are the differences between the methods of financing SMEs, and how could these differences be identified and measured?

2. What is the possibility of using mudharabah as a financing tool for SMEs, and how is it compared to traditional lending and murabahah?

RESEARCH OBJECTIVES The objective of this research is to investigate the use of mudharabah as a financing method for small enterprises, and compare its use to other financing methods. To achieve this objective the research will include: 1. Using mudharabah as a financing methodology.

2. Proposing a mechanism to use mudharabah in institutions that finance SMEs. 3. Comparing the effect of the different lending methodologies on SMEs. 4. Drawing some suggestions and recommendations that help SMEs in choosing the appropriate financing method.

RESEARCH QUESTIONS 1. Are there any differences between the various financing methods with regard to the liquidity ratios of SMEs? - To answer this question the following questions need to be answered: a. Are there any differences between lending and mudharabah with regard to liquidity ratio (L3)? b. Are there any differences between murabahah and mudharabah with regard to liquidity ratio (L3)?

2. Are there any differences between the different financing methods with regard to profitability ratios of SMEs? To answer this question the following questions need to be answered: a. Are there any differences between lending and mudharabah with regard to profitability ratios (P1, P2, P4, P5, P6)?

Microfinance and Faith | 9

b. Are there any differences between murabahah and mudharabah with regard to profitability ratios (P1, P2, P4, P5, P6)?

3. Are there differences between the various financing methods with regard to solvency ratios of SMEs? To answer this question the following questions need to be answered: a. Are there any differences between lending and mudharabah with regard to solvency ratios (S1, S2, S3, S4, S5, S6)? b. Are there any differences between murabahah and mudharabah with regard to profitability ratios (S1, S2, S3, S4, S5, S6)?

PREVIOUS RESEARCH (1)

Application of Islamic Banking on Microfinance (Dhumale, 1998).

One of the main principals of Islamic Banking is risk sharing, which reduces the need for hard collaterals for some types of loans. This is very suitable for some SMEs, and it encourages the establishment of new SMEs. The spread of these types of financing could help reach the poor, and encourage development. Islamic law allows for innovation in financial dealings. Several Islamic contractual arrangements could be used to come up with a new arrangement. Observing practices of successful microfinance institutions with some modifications to Islamic financial dealings, Islamic banking could provide alternatives in microfinance. Those enterprises that are rejected by traditional lending institutions because of the lack of hard collaterals could be acceptable by Islamic banks, based on profit sharing principals.

In some circumstances, the mudharabah (profit sharing) model, and the murabahah (buyresell) model, could be suitable for microfinance. Although murabahah results in higher initial administration costs, these costs could be offset by reducing the costs of administration and follow up of loans, due to the simplicity of the model.

Although the mudharabah model requires continuous assessment of project profits, it could still be used practically to achieve the objective of financing SMEs. The study discusses two financing methods using a simple hypothetical example for lending. Our research, however, is carried on real projects financed by murabahah and traditional loans. Mudharabah is applied to see the differences in financing methods and their effects on SMEs. (2)

Small business finance in Italy (www.eib.org, 2009):

This paper talks about financing SMEs in Italy through bank loans. 25% of industrial companies have no bank loans, and this percentage is higher among small companies.

Companies with loans have capital structure similar to larger companies.

10 | Microfinance and Faith

The paper demonstrates that the lack of bank loans in the balance sheets of many companies is either due to the voluntary choice of companies not to borrow, or due to the rejection of banks. The percentage of companies without a loan is higher than those with a loan. Companies that already have loans are not usually rejected from having another.

Ownership is also an important factor in the access to the credit market. In the study, one model of financing is used, not other options are studied.

(3) Small and Medium Industries in the Republic of Yemen- Obstacles to growth, and Methods for Development (Qaid, 2007) This study is an attempt to unleash the obstacles that small and medium enterprises in Yemen are facing, and to provide some suggestions to help develop them.

The study covered three areas: • A General overview of small and medium enterprises, definition, characteristics, relation to Yemeni economy, and indicators of their contribution to the economy.

• Obstacles of growth the development of small and medium enterprises and analysis of the most important obstacles.

• Suggested strategies to develop small and medium enterprises The study was concluded that there is a lack of a universal definition of SMEs in Yemen.

It also confirms the importance of SMEs in the Yemeni economy, and highlights the most important obstacles to growth, one of which is the lack of financing opportunities.

(4) The Role of Islamic Banks in Financing SMES, an applied research in Jeddah City (Nasseef, 2006) SMEs find difficulties in securing finance for their activities. Islamic banks have opportunity in tapping this market, especially that many small entrepreneurs prefer Islamic financing. The objective of the research is to learn about the obstacles that SMEs face when they deal with Islamic banks (in Jeddah City, Saudi Arabia). In addition, the research investigates the Islamic financing methods that suit SMEs. A field study was done on SMEs and a few results were reached.

• The quality of banking services and the marketing activities of the bank are very important in the client’s decision to select an Islamic bank.

• Small entrepreneurs need to pay more attention to training, and improve their investment awareness.

• Islamic banks need to invest more in marketing as well as in the development of new financing methods.

POPULATION AND SAMPLE OF THE STUDY The population of the study is two institutions specialized in financing SMEs in Sana’a City (Yemen); namely the Small Enterprise Development Fund, which uses traditional lending, and Azal Lending Program, which uses murabahah. The sample for the study was chosen randomly from each institution. 20 projects were chosen, with the condition Microfinance and Faith | 11

that they were financed for working capital during the period 2004-2007, and have fully repaid their loans. Loan size ranges from YR 20,000 to YR 600,0000.

Two research methods were used in this study. Descriptive analysis method was used in data collection related to murabahah and Traditional Lending and the analysis of the data.

Experimental research method was used in applying mudharabah on the data from the institution that uses murabahah, and the data from the institution that uses traditional lending. The objective is to learn about the advantages and disadvantages of the different financing methodologies, and the applicability of mudharabah as a tool used to finance SMEs, and its potential benefits to SMEs.

DATA COLLECTION TOOLS 1. Interviews: interviews were used to get the feedback of individuals on the different financing methods of SMEs and learn about the procedures used to finance SMEs. They were also used to collect documents and data related to the research sample.

2. Office Resources: To enrich the research, a literature study about the subject was done.

FINANCIAL ANALYSIS In this research financial ratios are used in analyzing the feasibility of SMEs, and how profitable they are. The ratios used in this research are: Liquidity Ratios: liquidity ratios are used as a tool to evaluate the credit worthiness of an enterprise. It measures the ability of the enterprise to fulfill its short term obligations (Matar, 2006).

L3: Current Ratio = current assets/ current liabilities: shows how assets are covering current liabilities, so it measures the financial balance. It measures the project ability to fulfill short term liabilities (Shabib, 2007).

Profitability Ratios: shows how profitable the project is (Al-Najjar, 1999).

P1: Net Profit to Total Assets = net after tax profits/ total assets : this ratio measures the effectiveness of the enterprise in managing available funds (whether they are assets or borrowed) to generate income (Shaker, 2005).

P2: Return On Equity (ROE) = net profit after tax and before interest/ Equity: this ratio shows the profitability of equity, the higher the ratio the better it is for owners, since net profits will be distributed among them (Al-Maidani, 2004).

12 | Microfinance and Faith

P3: Gross Profit Margin= ((sales-cost of sales)/sales)= (Gross profit/sales): this ratio measures the ability of each Riyal (unit of currency) of sales to generate gross profits (AlRawi, 2000).

P4: Profit Margin Ratio= net after tax profit/sales: this ratio measures the ability of one Riyal (unit of currency) of sales to generate profits. The higher the ratio, the better (Shaker, 2005).

P5: Return on Assets= net before tax profits/ total assets: this ratio shows how effective the enterprise has been in using its available financial resources, regardless of their sources (Al-Khalailah, 2004) P6: Return on Investment= net before interest and after tax profits / Invested capital: this ratio measures the profitability of invested funds, the higher is the ratio the better (Shaker, 2005).

Solvency Ratios: measures the contribution of owners and creditors in funding the project (Al-Zoghbi, 2000) S1: Equity to Total Assets = Equity/Total Assets: the portion of assets that is financed by equity, this ratio measures the project’s ability to finance its assets (Matar, 2006).

S2: Total Assets to Total Liabilities = Total Assets/Total Liabilities: this ratio measures how the total assets cover the total liabilities, and the ability of the project to fulfill its obligations.

S3: Equity to total liabilities= Equity/Total liabilities: measures the project’s ability to finance its liabilities by its own funds, the higher the ratio the more independent the project is (Shaker, 2005).

S4: Debt-Asset Ratio= Debts/ Total Assets : the ratio measures the contribution of lenders in financing the project, the higher the ratio the higher is the credit risk, and the higher is the cost of financing (Al-Rawi, 2000) S5: Current Liabilities to Equity= Current Liabilities/ Equity: this ratio measures the short term liabilities to equity. The lower the ratio the more confident creditors will be (Al-Zoghbi, 2000).

S6: Debts to Capital= Debts/ Capital: this ratio shows the percentage of debts in comparison to the capital.

In the experiment mudharabah was applied on the SMEs that were actually financed by murabahah. The murabahah rate was ignored, and the actual cost of finance was used.

The contribution of the financier in the project was proposed to be 35%, and the entrepreneur was 65%. The profits at the end of the financial year were calculated at 21 % for the financier and 79% for the entrepreneur.

Microfinance and Faith | 13

ANSWERS TO RESEARCH QUESTIONS

1. Answer to Question 1: Are there any differences between the various financing methods with regard to the liquidity ratios of SMEs? To answer this question the following questions are answered: a. Are there any differences between lending and mudharabah with regard to liquidity ratio (L3)?

TABLE (1): DIFFERENCES BETWEEN LENDING AND MUDHARABAH IN TERMS OF LIQUIDITY RATIOS Liquidity Ratio Lending Mudharabah Details 1.957 2.174 Mudharabah financing is better than lending L3

Table (1) shows that there is a difference between Lending and mudharabah in terms of liquidity ratio (L3) in favor of mudharabah.

b. Are there any differences between murabahah and mudharabah with regard to liquidity ratio (L3)?

TABLE (2) DIFFERENCES BETWEEN MURABAHAH AND MUDHARABAH IN TERMS OF LIQUIDITY RATIOS Liquidity Ratio Murabahah Mudharabah Details L3

5.936

6.907

Mudharabah Financing murabahah financing.

is

better

than

Table (2) shows that there are differences between murabahah and mudharabah in terms of liquidity ratios in favor of mudharabah.

2. Answer to Question 2: Are there differences between the various financing methods with regard to profitability ratios of SMEs? To answer this question the following questions are answered: a. Are there any differences between lending and mudharabah with regard to profitability ratios (P1, P2, P4, P5, P6)?

TABLE (3): DIFFERENCES IN PROFITABILITY RATIOS BETWEEN LENDING AND MUDHARABAH Profitability Lending Mudharabah Details Ratio Lending finance is better than P1 2.529 2.312 mudharabah Lending finance is better than P2 0.709 0.626 mudharabah Lending finance is better than P4 0.189 0.173 mudharabah

14 | Microfinance and Faith

P5

2.572

2.314

P6

3.415

3.056

Lending finance is better than mudharabah Lending finance is better than mudharabah

Table (3) shows that differences in profitability ratios between Lending and mudharabah are negligible. Profitability of SMEs financed by lending is slightly higher.

Using profitability ratios and liquidity ratios to analyze the differences between Lending and mudharabah, it was demonstrated that there is a reciprocal relation between the profitability of SMEs and their ability to fulfill obligations using the available liquidity. b. Are there any differences between murabahah and mudharabah with regard to profitability ratios (P1, P2, P4, P5, P6)?

TABLE (4) DIFFERENCE IN PROFITABILITY RATIOS BETWEEN MURABAHAH AND MUDHARABAH Profitability Ratio Murabahah Mudharabah Details There is slight difference in favor P1 0.332 0.326 of murabahah There is slight difference in favor P2 0.254 0.228 of murabahah There is slight difference in favor P4 0.086 0.085 of murabahah There is slight difference in favor P5 0.353 0.326 of murabahah Murabahah Financing is better P6 0.563 0.516 than mudharabah

Table (4) shows that there are no significant differences in terms of profitability between murabahah and mudharabah. Projects financed by murabahah were slightly more profitable than those financed by mudharabah. This does not mean that murabahah is better than mudharabah.

The analysis of the profitability ratios and liquidity ratios (L3) for murabahah and mudharabah reveals a reciprocal relation between the profitability of SMEs and their ability to fulfill their obligations using the available liquidity.

Although the analysis shows that Lending and murabahah are better than mudharabah, the differences are very small, and there were some examples of SMEs that actually had higher profits with mudharabah financing. The analysis shows that mudharabah is better for the financier than murabahah and Lending.

The comparison between murabahah and mudharabah shows that the ratios are comparable. Since both are Islamic financing methods, mudharabah could be used to finance working capital, while murabahah could be used to finance assets (machines), Microfinance and Faith | 15

that is because it is usually difficult to find the real income from “one machine� in a whole project, so it is difficult to use mudharabah. On the other hand, murabahah does not require assessment of profits from the project, so it is easier.

The financier could ask for bigger share when financing with mudharabah since it has many advantages for the entrepreneur. First the financier shares the financial risk in case of losses, in such case the entrepreneur is not obliged to repay the whole financing amount back (as in Lending and murabahah) . In addition, and since profits are shared at the end of the financial year, the entrepreneur is not under pressure to pay installments.

3. Answer to Question 3: Are there any differences between the various financing methods with regard to solvency and profitability ratios of SMEs? To answer this question the following questions are answered: a. Are there any differences between Lending and mudharabah with regard to solvency ratios (S1, S2, S3, S4, S5, S6)?

TABLE (5): COMPARISON OF SOLVENCY RATIOS BETWEEN LENDING AND MUDHARABAH Solvency Ratios Lending Mudharabh Details Mudharabah Financing is better than S1 3.179 3.221 Lending Mudharabah Financing is better than S2 2.663 2.954 Lending Mudharabah Financing is better than S3 8.253 9.329 Lending Mudharabah Financing is better than S4 0.387 0.346 Lending Mudharabah Financing is better than S5 17.038 14.970 Lending Mudharabah Financing is better than S6 0.616 0.549 Lending

Table (5) shows small differences in ratios between the two methods, with some preference for mudharabah. b. Are there any differences between murabahah and mudharabah with regard to solvency ratios (S1, S2, S3, S4, S5, S6)?

TABLE (6): COMPARISON OF SOLVANCY RATIOS OF MURABAHAH AND MUDHARABH Solvency Murabahah Mudharabah Details Ratios Mudharabah Financing is better than S1 1.199 1.220 murabahah Mudharabah Financing is better than S2 11.482 13.411 murabahah S3 13.136 5.244 Murabahah is better than mudharabah S4 0.132 0.112 Murabahah is better than mudharabah

16 | Microfinance and Faith

S5

11.344

15.536

S6

0.153

0.139

Mudharabah Financing is better than murabahah Murabahah is better than mudharabah

Table (6) shows little differences between the two methods, with some preference for mudharabah.

The results of the analysis show that there are some differences between the financing methods under consideration, sometimes in favor of mudharabah, others in favor of Lending or murabahah. Taking a closer look at the methods we could see the advantages of each.

Mudharabah is a profit and risk sharing arrangement. It is sometimes preferred by entrepreneurs because it gives them some psychological support. Unlike other methods, mudharabah could allow entrepreneur to adjust his/her plans to changes in the environment, and make better profits. Entrepreneur does not have to worry about the fixed schedule of repayments. In addition mudharabah is recognized as a lawful method of financing in the Islamic Sharia (Islamic law). It could be a good alternative for entrepreneurs who are reluctant to get financing either because they think it is Riba (or Usury that is prohibited by Islamic Law), or they fear making commitment to a fixed repayment schedule. In a way mudharabah seems to be fair, since benefits as well as risks are shared between financier and client.

On the other hand, mudharabah requires special strategy by financier. Unlike other methods, the financier must understand the business and be convinced that it could generate the profits required. Financier must also follow up to ensure that the project is performing according to plans. The entrepreneur needs also to understand that partnership requirement. S/he needs to be transparent and ready to share the information with the financier. S/he needs to put every effort to increase the income and reduce the costs.

Traditional lending is a common financing method. It requires little effort from the borrower and the lender to organize. The gains of the lender (interest) are fixed up front, and the cost to the borrower is also fixed. The lender assumes no risk, so the borrower has a disadvantage. Regardless of the outcome of the business, the borrower must repay the loan. The borrower is usually required to present hard collateral to secure repayment in case of default, so the borrower is putting at risk some of his/her assets in order to get the facility. In many cases borrowers find difficulties in securing the collaterals, so they lose the ability to get finance. murabahah in many ways is similar to traditional lending. The difference is the requirement from lender to actually take acquisition of the asset (subject of the financing) and resell it to the borrower. It requires additional management effort from the lender. It could also complicate the acquisition of the asset by the

Microfinance and Faith | 17

borrower. What has been mentioned about the advantages and disadvantages of traditional lending holds true for murabahah.

PROPOSED MECHANISM FOR THE USE OF MUDHARABAH IN SMEs FINANCING Mudharabah is a tool that could be used to facilitate the provision of finance to SMEs. As a risk-sharing mechanism it will encourage entrepreneurs to get finance. With the deeper involvement of the financier in the business, the SME owner could benefit from the experience of the financier. The need for collaterals from the part of the financier is reduced because the financier will have better understanding of the business, as a partner.

The financier shares the risk, but also the benefits, which could be much higher and improve the return. Inflation risk is reduced with sharing. The entrepreneur has more confidence, but also holds more responsibility. S/he is held responsible in case of mismanagement or ignorance.

In the following the researchers present some of the aspects that need to be observed, and the tools that could be used to improve the use of mudharabah in SMEs financing.

Suggested conditions related to mudharabah: To encourage the use of mudharabah in SME financing, the following should be considered by financiers and entrepreneurs, and organizations that want to make more mudharabah financing available to SMEs: • • • •

• • •

Financiers need to establish separate units, or departments specialized in mudharabah.

Financiers should have a clear definition of SMEs. There should be a mechanism to exchange experience related to the finance of SMEs by mudharabah. Studies could be done to learn from those experiences.

There should be a mechanism to help SMEs improve their competitiveness by providing training the coaching. Mudharabah and its advantages could be introduced to entrepreneurs.

Financiers need to build their knowledge about SMEs and their experience in dealing with this sector.

To encourage mudharabah financing, a credit guarantee mechanism need to be introduced to help financiers reduce the risk of financing.

The use of controlled-mudharabah is appropriate, especially at the initial stage.

Controlled mudharabah is limited by time, whereas un-controlled mudharabah is not limited by time, nor space, or type of business. Due to the difficulty in measuring the profits that come from machines and equipment, traditional lending and murabahah could be used to finance them.

18 | Microfinance and Faith

THE ACCOUNTING CYCLE OF MUDHARABAH FINANCING FIGURE 1: THE ACCOUNTING CYCLE OF MUDHARABAH FINANCING Investment Department

Entrepreneur

Entrepreneur

Head of Investment Department ( responsible of SMEs financing)

Investment Department

Archive

Entrepreneur

Entrepreneur

Feasibility Study form

Feasibility Study form

Feasibility Study form

Entrepreneur

Entrepreneur

save save

Audit Audit

Execution order

Microfinance and Faith | 19

FIGURE (2): ACCOUNTING CYCLE FOR THE PAYMENT OF MUDHARABAH FUNDS Investment Department

Cashier

Investment Department

Achieve

Entrepreneur Payment Receipt Payment order Feasibility Study form

Payment Receipt Entrepreneur Issue of payment receipt

Cash Receipt

Mudharabah Execution Order Mudharabah Contract Fund payment order

Mudharabah Contract Payment Receipt Save Entrepreneur

Auditing

PROCEDURES FOR THE USE OF MUDHARABAH IN SME FINANCE: 1. Entrepreneur fills an application using a form that specifies the amount required, the purpose, and the time in addition to any details that clarifies the application.

2. Application is carefully reviewed and compared to the policy of the financier. A full study of the application is done by a specialist who gives special attention to: o the character of the entrepreneur. o the experience of the entrepreneur.

3. A feasibility study is preformed for the project, including market study, income, and risks.

4. A report about the results of the appraisal of the application is forwarded to a committee that makes the decision about the application.

5. In case of acceptance of the application the entrepreneur is informed about the acceptance and the conditions of the financing.

6. The entrepreneur presents the required documents, and signs the contract.

7. The financier opens an account under the name of the entrepreneur.

8. The entrepreneur manages the process of buying and selling using his/her best judgment and observing the contract with the financier.

9. Financier follows up the entrepreneur regularly.

20 | Microfinance and Faith

10. At the end of the contract, the profits are calculated and distributed between the financier and entrepreneur.

In addition, the following could be considered: - The entrepreneur could be required to provide a guarantee against the risk of ignorance or mismanagement.

- The entrepreneurs could be asked to provide periodic reports to the financier.

- In case of loss, the financier losses the funds, or part of them, as long as there is no mismanagement by the entrepreneur.

FIGURE 3: MUDHARABAH FINANCING PROCEDURES Entrepreneur

Application

Review of Application

Feasibility Study of Project

Rejected

Review of report by committee

Informing Entrepreneur

Accepted Informing Entrepreneur about financing terms

Presenting Required Documents and Signing of Contract

Follow up

Source: Researchers

Microfinance and Faith | 21

RESULTS OF THE RESEARCH First: Results of Financial Analysis 1. Answer to question 1: Are there any differences between the various financing methods with regard to liquidity of SMEs? a. There are differences between lding and mudharabah with regard to liquidity raios L3, mudharabah results in higher liquidity ratios. b. There are differences between murabahah and mudharabah with regard to liquidity ratios L3, mudharabah result in higher liquidity ratios.

2. Answer to question 2: Are there any differences between the various financing methods with regard to profitability of SMEs? a. There are slight differences between lending and mudharabah with regard to profitability ratios (p1, p2, p4, p5, p6). Lending results in higher profitability. b. There are slight differences between murabahah and mudharabah with regard to profitability ratios (p1, p2, p4, p5, p6). Murabahah results in higher profitability.

3. Answer to question 3: Are there any significant differences between the various financing mehthods with regard to the solvency of SMEs? a. There are slight differences between lending and mudharabah with regard to solvency ratios (s1, s2, s3, s4, s5, s6). Mudharabah results in higher solvency ratios. b. There are slight differences between murabahah and mudharabah with regard to profitability ratios (s1, s2, s3, s4, s5, s6). Mudharabah results in higher profitability.

Second: Other Results: The following could be concluded from the research.

1. Mudharabah could be used as a financing tool for SMEs, and is sometimes preferred by entrepreneurs (Dhumale, 1998).

2. Mudharabah is particularly suitable for enterprises that need working capital financing.

3. Mudharabah financing could provide reasonable profits for the enterprise and the financiers.

4. Mudharabah financing enables entrepreneur to adjust to the changes in work procedures.

5. Mudharabah financing gives SMEs more chances to sustain and grow.

6. Mudharabah helps in reducing the inflation risk to the financier.

7. Mudharabah can help achieve fair distribution of benefits between financier and entrepreneur.

8. Using mudharabah can help reduce the need for collaterals, which will result in increasing financing to SMEs. 9- There is no common definition of SMEs in Yemen.

10- Lending and murabahah financing are less flexible than mudharabah since they are governed by a fixed repayment schedules and collaterals.

11- There is a lack of knowledge about mudharabah among entrepreneurs and financiers.

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RECOMMENDATIONS: Based on the results of the research, the following recommendations are proposed: 1. Introducing mudharabah as a tool to finance SMEs. 2. Performing a real study on mudharabah using the ratios presented in this research on projects that are financed by mudharabah to compare the results to those presented in this research.

3. Establishing an organization, or a window, that is specialized in mudharabah financing.

4. Establishing a common definition of SMEs in Yemen.

5. Raising the awareness of entrepreneurs about mudharabah and how it could be used to finance SMEs. 6. Encouraging more research on the alternative Islamic financial tools like ejarah, musharakah, and istesna.

REFERENCES Al-Khalailah, Mahmoud A. (2004) “The use of Accounting Data in Financial Analysis”, Amman, Jordan, 3rd Edition, p. 115 Al-Maidani, Mohammed (2004) “Financial Management in Companies”, Obaikan House, Ed. 4, p. 145.

Al-Najjar, Farid (1999) “Management of Small Enterprises”, Alexanderia, p. 97 Al-Rawi, Kahled (2000) “Analysis of Financial Statements, and Disclosure”, Al-Maserah House, Amman, Jordan, p. 64, 75 Al-Zoghbi, Haitahm (2000) “ Management and Financial Analysis”, Al-Fikr House, Amman, Jordan, p. 242 Dhumale, Rahul and Amela Sapcanin (1998). “An Application of Islamic Banking Principles to Microfinance- A technical note” Retrieved July 13, 2009 from http://www.mafhoum.com/press/54E19.pdf, p. 11 Elk, Van Koos and Paul Winminian (2000), The Baseline Survey of Small and Micro Enterprises in Yemen, Netherland Economic Institute, Sana’a p. 7.

Gait, A. and Worthington (2007). “A primer on Islamic Finance: Definitions, Sources, Principles and Methods”, University of Wollongong, Retrieved on July 5, 2009 from http://ro.uow.edu.au/cgi/viewcontent.cgi?article=1359&context=commpapers, p. 15,17 Lyman Timothy R., Mahieux, Thierry, Reille, Xavier" Microfinance in Yemen" Report of CGAP Multi-Donor Mission, June 2005. P.7

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Matar, Mohammed (2006) “Modern Trends in Financial Analysis and Credit” Al-Awael Publishing, Second Edition, Amman, Jordan, p. 34, 61 Naseef, Ghadah (2006) “Role of Islamic Banks in Financing Small Enterprises, applied research” Jeddah City, Master’s research.

Qaid, Ali (2007). “Small Enterprises in the Republic of Yemen: Obstacles to growth and Methods to Development”, Arab Forum for SMEs, Sana’a 25-26/11/2007.

Shabib (2007) “Introduction to Modern Financial Management” Al-Maserah Publishing, Amman, Jordan, p.85 Shaker and others (2005) “Financial Analysis- an Introduction to Decision Making”, Wael Publishing, Amman, p. 62, 66, 182,185

24 | Microfinance and Faith

Conflicts in Microcredit: The Battle over Mission and Sustainability Warner Woodworth, Ph.D., Brigham Young University

ABSTRACT Within the field of microcredit, a growing divide is occurring as proponents argue for or against its purposes, its sources of capital, and its methods. On the one hand are the early founders of the movement, many of whom feel that its thrust ought to focus on the “poorest of the poor,” and that their mission should always be humanitarian in nature. On the other hand, many becoming involved in the recent past criticize the slowdown of its growth, and claim that it is due to the lack of a profit motive and participation of the capital markets. In this paper I seek to explain these two paradigms, and argue for a resolution.

KEYWORDS: microfinance, humanitarian, capital markets

INTRODUCTION Increasingly there is a brewing struggle between groups within the microcredit movement about ends versus means. What began as an intellectual conversation a decade or so ago now is becoming an ideological battle. On the one side are those seeking to channel the movement into capital markets which will fund the work much like any other investment which turns a profit.

Their argument is that we should use traditional instruments of the banking industry to access greater sums of capital in behalf of the poor.

At the other extreme are the humanitarians who want to retain the spirit of NGOs doing good, institutions that rely on donors who feel the best way to change the world is to mobilize the giving nature of individuals who act from a charity mindset.

This paper attempts to highlight this growing schism, and articulate my criticisms of the capital market crowd while defending the humanitarian view. It raises critical issues on both sides of the debate, and explores if a resolution may be possible. My assumption is that we probably will not come to an agreement at this conference, but at least the two sides will be identified, and perhaps these controversial issues will be threaded throughout the conference discussions.

The research dozens of my students and I have done over the years since I first began teaching a microcredit course back in 1989 has quite consistently led to concerns about microlending mission drift. Who should be the recipients? Those who are less of a risk? Clients who have decent credit ratings? The less poor who are literate and perhaps have greater potential to lift themselves? How is “success” calculated? By numbers of borrowers? Economic well-being?

Social impacts? ROI? Conflicts in Microcredit | 25

The debate over MFI mission drift, for-profit strategies, and the gouging of the poor by unscrupulous lenders goes back quite a while. A decade ago two colleagues and I published a paper articulating the different perspectives of this emerging schism (Woller, Dunford, Woodworth, 1999). We tried to analyze practices of lending to the poor and what we perceived to be the growing conflict between non-profit humanitarian organizations vs. the “institutionists” in microfinance. Back when the movement began, it was a humanitarian strategy to provide tiny loans to the "poorest of the poor." With $30 to $80 loans, disenfranchised families at the bottom of the social pyramid could obtain credit without collateral, without a financial history, and do so at viable interest rates.

With such practices, they would thus be able to feed their children two meals a day and perhaps eventually be able to send them to school. It was never intended to give the lower classes thousand-dollar loans so they could buy TVs, CD players, and furniture. Nor was it perceived as a tool for the wealthy to increase their capital holdings as an investment in poverty. Early sources by officials at Grameen Bank of Bangladesh, ACCION and its spread of microcredit services in Latin America, and the work of John Hatch, founder of FINCA International, all seemed to coalesce around central themes of tiny loans going to the poorest in a given village. For example, Muhammad Yunus, founder of the Grameen Bank in Bangladesh in the early 1980s, cites in his book that he always advocated giving loans to the very poorest (Yunus, 2003).

The method for accelerating an NGO’s impact was to grow the nonprofit until it had enough clients to make it sustainable. By this, I mean reaching sufficient borrowers so that the organization could not only cover its overhead costs, but generate a surplus of new capital so as to distribute more loans. Questions about using investment tools, getting a financial return, moving up the ladder from the most impoverished to aid those who may be less risky were not part of the dialogue during those early years.

As the Microcredit Summit Campaign (2009) was established in 1997 to mobilize more NGOs, governments and even corporations to join the cause, the explicit targets were focused on the very poorest, and a core value centered on women borrowers because credit for them was much harder than attempts by men to obtain loans. Indeed, to ensure microcredit was reaching the poorest, the Summit stressed the need to target 100 million adults worldwide who were trying to eke out an existence on less than $1 per day. This threshold was eventually picked up by the World Bank as an appropriate target.

Yet as microcredit has gained traction and grown from a few million borrowers and a few hundred Microfinance Institutions (MFIs), the original emphasis on the poorest has morphed into a strategy for scaling up by entering the capital markets. The logic here is that if wealthy individuals, banks and other large investors were to embrace microcredit, MFIs could grow much faster, spread across the globe more widely, and instead of reaching a few million poor families, perhaps a billion could be reached. Such a business model would not only expand microcredit services, but create whole new markets who could benefit by additional financial services such as microinsurance, education loans for poor children, cheap healthcare, and such.

26 | Conflicts in Microcredit

At one level, such ideas made a lot of sense. After all, as a founder and the first board chair of Unitus a decade ago, we started our new NGO precisely because our analysis of the MFI market indicated that the approximately 70 percent of such organizations had an average of only 2,500 clients (Unitus, 2001). They grew in their earlier years, but then leveled off because they lacked funding to reach a larger amount in which they might begin to obtain surpluses for giving more loans and truly scaling up. These social enterprises may have skilled managers, dedicated staffers, top notch technology, strong boards and so on, but they can’t grow very large or fast.

Unitus’ research confirmed this problem and captured the problems of the old system (2009): “Without sufficient internal operating capacity, growth stops once a program reaches several thousand clients. Adequate internal operating capacity includes improvements in areas such as information technology infrastructure, internal controls, new product development, and human resources.

“When MFIs rely on donor dollars, there is rarely enough money to make the necessary investments in these key areas to create an efficient operation that can grow on a sustainable basis. That's why most MFIs are built small and stay small.

In other words, the bulk of such MFIs do not possess large-scale operating capacity, and thus remain on a borrower plateau of between 2,000-3,000 clients which they generally cannot grow beyond.”

Having clearly identified barriers to the rapid growth and success of the MFI movement, the call went out to change the paradigm. Starting with a few microcredit advocates within the movement and soon joined by bankers, venture capitalists, and nonprofit experts with MBA degrees, the idea began to be propounded that microcredit ought to abandon its earlier mission and reframe itself (Rhyne and Busch 2006).

Instead of being a humanitarian enterprise, microfinance, as it began to be called, ought to become a for-profit corporation. Instead of focusing on impoverished female clients who tend to have difficulty in obtaining financing from traditional banks, loans ought to focus on men or women who are most likely to pay back their borrowed capital with interest and on time. Rather than go to the worst urban slums to find potential customers, or travel out to the farthest villages where there is no banking system at all, MFIs should stay where there are more accessible and bankable clients, where giving loans will be quick and cost little to manage such portfolios.

BANCO COMPARTAMOS Perhaps the most egregious case of the shift away from the earlier humanitarian model is that of Compartamos in Mexico. It originated in the early 1980s as a nonprofit MFI using grants from foundations and individuals. It was founded in a country with over a hundred million people, about half were classified and referred to as “asset poor.” The nation had gone through several economic crises in recent years, hoping to benefit from much-promised economic benefits of NAFTA, but the actual results were not so beneficial. Millions of the poor try to survive through underemployment in the so-called “black market” or “informal economy.”

Conflicts in Microcredit | 27

At its inception the NGO was called Gente Nueva (“New People”), having broad objectives of providing a range of development services to poor families which would improve the quality of life in marginalized communities. It offered food programs and health services to those having almost nothing. Foundations provided the bulk of its funding for a considerable time.

In the early years of Gente Nueva, multiple tiny microenterprises were financed by equally tiny microloans of a few hundred dollars. Clients used the monies for new start-ups, or, in some cases, to expand already existing income-generation projects.

Then in 1990, the NGO was redesigned to primarily seek and channel capital to the poor, utilizing the increasingly popular notion of microcredit. The following year, it became affiliated with ACCION, a significant U.S.-based MFI with programs throughout Central and South America. A decade later the name was changed to SOFOL (in 2001), and several years after that it had grown to become the largest MFI of the many which by then were flourishing throughout the nation. Finally in 2006 it was restructured and became a regular Mexican bank, Banco Compartamos, subject to the traditional regulations the government enforced over all formal financial institutions, and it now had license to collect and manage customer savings as well.

Shares were issued to the initial investors, including ACCION, the World Bank’s IFC, and some wealthy investors in Mexico.

As its strategy shifted, earlier programs serving health and nutrition needs diminished, and lending became the primary thrust. Not only were new financial products generated, but the organization saw huge potential growth by spreading geographically south into new regions.

Eventually it was operating in nearly 30 of Mexico’s states, managed by a staff of over 3,000 employees. Large institutional funding from CGAP of the World Bank, along with USAID and major U.S. foundations accelerated the MFI’s expansion.

Over time, as its client base exploded, it began to generate surpluses and no longer needed to seek donations as its lifeblood. Through the decade of 1996-2006 it had impressive annual growth rates of above 30 percent. As the new firm, now called Compartamos, grew to over 600,000 borrowers, it became fully sustainable and had a promising future addressing the impoverished regions in which it operated. Gradually its reputation grew and it became known as one of the largest and most successful MFIs in all of Latin America (Compartamos 2006).

The primary customer sought by Compartamos was female, and she received an average loan size of $446. A mix of services were offered including the use of Solidarity Group loans, individual loans, and loans to men or women. By the end of 2006 its total loan portfolio had grown to some $271 million, and the firm enjoyed a healthy Return on Equity (ROE) of 56 percent and an ROA of 23 percent ACCION 2007). These impressive results made the MFI appear more successful than most traditional Mexican banks at the time.

Yet further changes were to come with this so-called bank for the poor. In April 2007 Banco Compartamos launched an initial public offering (IPO) of its stock. Some 80 percent of the shares were offered in New York, while 20 percent went public in Mexico City. During the single day of April 20, over 111 million shares were sold, starting at $3.65 a share and rising to $4.84 before dropping off a bit at the day’s end. The IPO was nearly 13 times oversubscribed 28 | Conflicts in Microcredit

and considered a huge success by most financial market standards. Pent-up demand caused the share price to mushroom 22 percent during its first day of trading. The original investors, ACCION, IFC, and the Mexican investors, saw a huge return in a single day. They received an average of some $450 per share, and the future of their investments looked even brighter (ACCION 2007). It was projected that the internal rate of return of selling shareholders would enjoy approximately 100 percent a year compounded over the next 8 years!

CRITICISMS AND DEBATES For its advocates, demand for Compartamos stock was seen as driven by its exceptional growth and profitability, as well as other factors--dearth of Mexican investments for emerging market portfolios, strong management, and the appeal of microfinance in general.

Some praised the spectacular success of the IPO, regarding it as a milestone not only for Compartamos, but for the microfinance movement as a whole. Mainstream international fund managers and other truly commercial investors, not primarily socially responsible investors, bought most of the shares. The transaction was hoped to boost the credibility of microfinance in commercial capital markets and accelerate the mobilization of private capital for the business of providing financial services to poor and low-income people.

But for others of us in the microcredit field, it was a troubling development. While praised by the “Big Boys” of the formal capital markets, some were not so sure. Muhammad Yunus, the founder and managing director of Bangladesh’s Grameen Bank told Business Week (2007): "They're absolutely on the wrong track….Their priorities are screwed up.” This author and many others posted comments on the home pages of the Microcredit Summit Campaign and other sources, voicing our concerns (Lewis 2007). A few employed such words as “reprehensible,” a “flagrant violation” of ethics, and “outrageous.”

Of course, other voices defended the IPO (Chu 2007), and many huge banks are entering the field such as Citigroup, Morgan Stanley, Deutsche Bank, ABN AMRO, the European Investment Bank, Societé Generale, and even the large investor TIAA-CREF. In observing all this, the flavor of many complaints seems to suggest that this shift toward forprofit microfinance is akin to allowing loan sharks back into the communities of the poor, only this time they wear the suits of Wall Street.

The claim of certain parties that Compartamos is the ideal example of success calls to my mind how far the once-heralded idols of AIG, Enron, General Motors, Citigroup, Adelphia, Lehman Brothers, and Goldman Sachs, pushed a similar ideology. While some of these instances may not have engaged in illegal practices, their huge bureaucratic systems made them quite ineffective and they lost sight of their basic values of serving customers. Making as much money as possible came to override everything else. They were each lauded as huge successes before they collapsed.

Their decline was not simply due to fraud or other illegal activity. Rather, in some cases they became too greedy, too focused on profit maximization, too full of pride.

Conflicts in Microcredit | 29

To me genuine microfinance must maintain its true mission of microenterprise job-creation, such that the poor can move toward economic self-reliance. In its purest form, financing the poorest is about grassroots self-sufficiency, not banking for commercialization.

With Muhammad Yunus and a few other pioneers of the movement, I oppose the growing drive for huge profits. Apologists claim such strategies are needed to channel the large sums of capital required to meet the demands of hundreds of millions of the global poor who are either ignored or underserved by the financial markets.

A number of the defenders of today’s pro-capitalist paradigm attempt to justify their plunder by claiming all they seek is sufficient capital to channel funds from the Big Boys in order to get microloans to the millions who still can’t access needed capital through donations from those who care. But to remake microcredit into a for-profit strategy that primarily seeks bottom line results may not be any better than Freedman’s famous dictum that the sole purpose of the firm is to make a profit. This view has robbed recent free market practices from their spiritual underpinnings.

Referring again to Compartamos, its initial public offering raised $467 million. One of its founders and early investors in 1990, José Ignacio Avalos, enjoyed an extraordinary return. His $250,000 borrowed to invest in back in 2000 grew to over $100 million, a quarter of which he sold in the IPO. Avalo still sits on the bank's board (Epstein and Smith 2007).

Reaping such gigantic gains from working with the poor seems unconscionable to me. Such values are more akin to Herbert Spencer’s, he who complained about the poor and argued that they should suffer the natural consequences of their poverty, that they experience “survival of the fittest,” (his term, not Darwin’s). In fact, Spencer would be the forerunner of Darwin’s later explanation that evolution requires a “Law of the Jungle” system in which the strong live off the weak (Spencer 1866). We have seen much of this mindset in the actions and policies of traditional American financial institutions, both back in the day of the Robber Barons, and again in recent years with the emphasis on managerial greed and corporate power.

In contrast, Adam Smith’s values in the late 1700s centered did not advocate a heartless society, but one of justice, sympathy, and generosity (Smith 1976). He sought a world based on altruism, not selfishness. He worried about the “love of domination and authority over others.” Rather than emphasizing a cold efficiency, Smith called for brotherly love.

Whose microcredit values do we seek: Spencer’s advocacy of a mercenary-based system of exploitation, or Smith’s economic vision of altruism and love?

I also wonder what the hurry is to reach hundreds of millions with loans, no matter what the human costs. The poor have survived over centuries in squalid conditions. They are tough, and have the capacity to overcome all odds. I don’t believe they want us to empower them at the expense of our own humanity and ethical values.

Clearly, they would welcome a better quality of life, but at what price? That they cannot obtain capital from traditional banks is true, and it is wrong. Likewise, that they are exploited by 30 | Conflicts in Microcredit

unscrupulous loan sharks is also wrong. But it is equally immoral to claim one is concerned for the poor by offering high cost, exploitative loans by MFIs. This is especially egregious when we do this in the sacred name of “sustainability.” My decades of studying microcredit suggest that with humanitarian donations alone, it is possible for an NGO to become financially viable over the long haul after reaching a threshold of numbers of borrowers. After reaching that point, sufficient capital generated from even low interest rates will be significant enough to accelerate its growth without further outside donations. Witness the cases of Grameen Bank and BRAC which are both free from donors and the capital markets (Yunus 2003). The challenge is to get one’s NGO to scale up for this to kick in.

I think it’s more appropriate to administer microcredit in ethical and socially responsible ways than to bury the poor in graves of onerous debt from which they will never be able to extricate themselves. We can see all around us the devastation which the U.S. capital markets created as they gained quick profits through irresponsible lending practices. This was all done in the name of serving the poor of so they could “own” hugely expensive homes which they could never afford. Such policies were driven by high-sounding phrases like becoming able “to own the American dream.” But these practices led to an ethical overhang that has pushed many families into home foreclosures. If you like Freddie Mac and Fannie Mae, you’re going to love these profit-driven MFIs. To a degree, MFIs appear to be trying to emulate Wall Street by eventually becoming giant financial institutions akin to Bank of America, Bear Sterns, and Merrill Lynch. They operate from an ethos that moves away from “Small is Beautiful,” to “Gargantuan is Great.” For various reasons, they seem to be imitating the giants that are now going down in flames before our very eyes. Freud might refer to such behavior as “identification with the aggressor.” That is, in the past we practiced microcredit as an alternative to oppressive exploitation by traditional banks, but now we have begun to try and be just like them. What’s worse, many MFIs that are engaged in such coping mechanisms appear to deny the objective reality which is quite apparent to the outsider.

Why some in the movement feel that scaling up microfinance is the ultimate objective is really beyond me. We are witnessing the creation of huge, complex MFIs that are perhaps going to become impossible to manage. They are fast becoming bureaucratic, inefficient, and may eventually become corrupt. Perhaps they hope to grow “too big to fail,” as the swan song of contemporary loan institutions sings loudly each day. But I feel we need to go back to our roots by emphasizing human scale institution that focus on the poorest families, and provide personal, caring customer service.

CONCLUDING ISSUES Where interest rates like those of Compartamos exceed 100 percent a year, the legitimacy of microfinance comes into question. Government officials in various countries are increasingly critical. For instance, the Prime Minister of Cambodia has called for lower interest charges in the microfinance sector, while the Bangladeshi Minister of Finance has criticized such practices as “extortionate,” and dozens of other national leaders are demanding cuts to the costs of capital for the poor.

Conflicts in Microcredit | 31

Lately in conferences at a number of universities and business events, I have observed a hue and cry which grows ever stronger and more insistent that the microfinance movement depends on scalability, on “reasonable” returns for investors, etc. One seldom hears the story of a single mother’s life that is transformed by a microloan through a face-to-face relationship of trust and caring between her and an NGO staffer. Instead, the speeches are full of power point presentations consisting of business models, numbers, efficiencies, and statistics. I argue we need to re-focus on the individual, the precious human being who struggles to survive another day.

One other idea may be worth mentioning. Early in my career, I focused a great deal of my time and energy on establishing such mechanisms as Employee Stock Ownership Plans (ESOPs). To build this movement in the U.S., we lobbied Congress and secured considerable legislation that gave incentives to banks and ESOP firms. We got funding to create the National Cooperative Bank, and, in general, developed a long-term strategy to empower blue-collar workers and rustbelt communities that faced factory shutdowns and de-industrialization. The result is that today there are thousands of ESOP firms employing millions of worker-owners, many of which now have seats on company boards of directors and considerable workplace democracy.

Reflecting on those impacts, perhaps the MFI movement, which claims to be serving the poor, ought to put a few of their own clients on their boards, not to raise more funds as is typically the practice for board selection today. Instead, they would be the voices of the poor who would articulate their concerns, argue for their needs, criticize bad policies, and act as a buffer to prevent the organization from becoming too profit-driven.

I call for countering the mission drift which had driven our movement off course in recent years.

We need to reclaim the restoration of our original vision as tiny loans were first being given to suffering mothers and their children. My sense is that if we build more transparency into our MFIs, the light of the sun will foster better policies. But it needs to be real, not rhetorical. I don’t even prefer to use the term “microfinance” anymore because it sounds increasingly like just another tool of capitalism. MFIs ought to become pro-poor advocates for the world’s have-nots, not financial instruments which yield profits to their large, outside investors.

Let me conclude with a few questions relative to Compartamos, but which raise issues about the broader shift toward MFI profit-taking: 1) Was the aid money granted to Compartamos in its early years used inappropriately to enrich private investors through the IPO? 2) Can these actions be justifiably challenged as unethical even though they are obviously legal? 3) Did the IPO alter Compartamos so that it will be harder for the company to balance stated social and commercial objectives? 4) How do such terms as “usury” and/or “extortion” apply in such cases, if at all? 5) Are exceptional profits such as these, and the high interest rates they are built on, defensible for pro-poor organizations and their mission?

My personal belief is that what the microcredit movement needs today is less of profit-focused strategies, systems and structures. We don’t so much require greater efficiencies and the crazed growth of dehumanizing institutions like the World Bank and the IMF. What we really need is more heart and spirit in our practice.

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REFERENCES ACCION (2007) “The Banco Compartamos Initial Public Offering” InSight, vol. 23, p. 1-23.

Business Week (2007) “Online Extra: Yunus Blasts Compartamos” December 13, Retrieved September 2, 2009, from the web site: http://www.businessweek.com/magazine/content/07_52/b4064045920958.htm.

Chu, Michael (2007) “Profit And Poverty: Why It Matters,” Forbes, December 20.

Compartamos (2006) Annual Report. Mexico City, Mexico: Compartamos.

Danel, Carlos & Labarthe, Carlos. (2008) “Letter to our Peers.” Mexico City: Compartamos Banco.

Epstein, Keith & Smith, Geri (2007) “Compartamos: From Nonprofit to Profit, “ Business Week, December 13, Retrieved September 4, 2009 from the web site: http://www.businessweek.com/magazine/content/07_52/b4064045919628.htm.

Lewis, Jonathan C. (2007) “What Would Leland Stanford Do?” Speech at Department of Political Science, Palo Alto, CA: Stanford University, May 30.

Malkin, Elizabeth (2008) “Microfinance’s Success Sets Off a Debate in Mexico” The New York Times, April 5.

Microcredit Summit Campaign (2009) Retrieved July 8, 2009, from the web site: http://www.microcreditsummit.org/about/about_the_microcredit_summit_campaign.

Rhyne, Elisabeth & Busch, Brian (2006) “The Growth of Commercial Microfinance: 2004-2006,” Washington, DC: Council of Microfinance Equity Funds, September.

Smith, Adam (1759) The Theory of Moral Sentiments. Edited by D, D. Raphael and A. L. MacPhie. Reprint Oxford, UK: Clarendon Press, 1976.

Spencer, Herbert (1866) Social Statics. New York, NY: D. Appleton.

Unitus (2001) Retrieved April 17, 2002, from the web site: http://www.unitus.com/unitus-inaction/background-poverty-and-microfinance/why-the-poor-still-lack-access/why-cant-mfisgrow-faster.

Unitus (2009) Retrieved August 13, 2009, from the web site: http://www.unitus.com.

Woller, Gary, Dunford, Christopher & Woodworth, Warner (1999) “Where to Microfinance?”

International Journal of Economic Development, vol. 1(1), p. 29-64.

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Yunus, Muhammad (2003) Banker to the Poor: Micro-lending and the Battle Against World Poverty. New York, NY: Public Affairs.

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CAPITAL MARKETS-STYLE RISK ASSESSMENT: TESTING STATIC POOL ANALYSIS ON MICROFINANCE Rupert Ayton, Center for the Development of Social Finance Stephanie L. Sarver, Ph.D, Center for the Development of Social Finance

ABSTRACT This study was conceived in response to microfinance sector calls for capital market access as a path for greater microlending success. The Center for the Development of Social Finance asserts that microfinance institutions (MFIs) will be better positioned to attract capital market investors when MFIs report on their performance using standard methods already used within the capital markets. One such method is static pool analysis.

This study sought to determine whether static pool analysis could be applied to microfinance, and whether the results met a standard consistent with that of capital markets-funded lending institutions. Two MFIs participated in the study, one operating in India and one in Tajikistan.

CDSF determined that static pool analysis could be applied to their lending portfolios, and that the result, in both cases, was consistent with capital markets standards.

This study affirms the importance of bringing capital markets tools to MFIs as a means of accessing capital. It also demonstrates that standardized analysis is feasible and requires only that an MFI has collected sufficient historical data in a consistent format. CDSF recommends that MFIs begin the practice of applying static pool analysis to their loans as a first step toward gaining access to the capital markets. MFIs lacking sufficient historical data should begin to collect loan performance data in a consistent format that would lend itself to static pool analysis at a later date.

KEYWORDS Microfinance, microlending, capital markets, static pool analysis, cumulative default analysis, stratifications.

INTRODUCTION Microlending gained world-wide attention when lending pioneer Muhammad Yunus of the Grameen Bank of Bangladesh was awarded the 2006 Nobel Peace Prize. Yunus founded Grameen in 1983. Since then it has earned a reputation for its successful lending practice to the very poor, and often to women typically denied access to loans. Yunus is currently the bestknown practitioner of a global tradition of “self-help� lending and can be included among a wide array of community loan programs that have emerged over the past several decades.

The Microcredit Summit reported that as of December 31, 2005, 3,133 microlenders worldwide were serving more than 113 million clients, of whom more than 70% were first-time very poor

Microfinance and the Capital Markets | 35

borrowers (Harris-Daley 2006). Of these poorest clients, 84.2 percent were women. Lending to these poorest clients affected over 410 million family members.

According to Accion, microlenders are deploying $9 billion worldwide (Rhyne 2006). The money they lend comes from a variety of sources including deposits, bank loans, debt securities issued, equity shares sold, donations, and government aid programs. MicroCapital reports that 79 microfinance investment vehicles (funds) currently are supplying capital to MFIs as either investments or donations. Of the 79, only 13 are structured to receive external investments and offer investment returns. Those 13 funds are open to retail or private investors, and have total assets of $900 million (MicroCapital). The proportion of these assets invested in microfinance, however, is far smaller.

Advocates of developing markets view microlending as a vital tool in catalyzing economic development, asserting that such development will mitigate poverty and associated health and environmental issues as it has in the United States and other developed countries (Reddy 2006).

They point to two decades of microlending success in serving small populations in developing regions, but recognize an inherent challenge to its wider benefit: Can it be scaled to deliver more widely on its economic development promise? The answer centers on a key issue: access to capital (Ehrbeck 2006).

Before microlending institutions can expand to serve wider constituencies, microlenders must be able to consistently borrow the money they need at a cost that enables them to operate selfsufficiently. To accomplish this, microlenders require access to a large population of unbiased investors, i.e., investors who select investments, whether in microlending or other sectors, based solely on their objective investment potential (Brugger 2004).

Rationale for This Study This study was conceived with a key question: Do MFIs undertake their lending activities according to standards that would enable them to draw on the large pools of capital circulating in the mainstream capital markets?

CDSF sought to determine whether selected microfinance institutions (MFIs) structured their loans and collected loan data in a format consistent with lenders operating in the global capital markets, and if this data could be analyzed by a method known as static pool analysis, a riskassessment tool used widely in the global capital markets.

Static pool analysis is critical to a meaningful study of MFIs because it provides a measure of the frequency and severity of defaults among a historical sample of loans. Such assessment provides a basis for evaluating the investment potential of a MFI or a portfolio of loans. To-date, default data typically provided by MFIs to investors has been insufficient to attract unbiased investors and their substantial investment dollars, which has limited the ability of MFIs to expand their lending activity.

MFIs in emerging regions have adopted a reporting process consistent with generic reporting requirements of regulating bodies around the world. They typically report point-in-time portfolio 36 | Microfinance and the Capital Markets

data using a historical accounting format. This data may include new loans, paid-off loans, delinquencies, and defaults. This data is of limited value in explaining the financial dynamics of a lending entity. In 2006, Fitch Ratings noted that static pool analysis, necessary for securitization, is typically not included in emerging market reporting (Fitch Ratings 2006).

Detecting loan portfolio trends is crucial for capital market access (OCC 1999). Capital markets are efficient when investor confidence is high. Confidence in loan portfolios as investments is measured by the extent to which the performance (or loan repayment) adheres to expectations.

The U.S. Securities and Exchange Commission (SEC) has affirmed the value of static pool analysis in calculating risk, and in 2004, ruled that static pool data be disclosed for investments in asset-backed securities when material to the securitization (Code 2004).

The trend suggested by Fitch’s observation and the SEC was affirmed in the initial exploration of this study. In preparation for this study, CDSF contacted 49 individuals representing 12 sectors affiliated with investment, finance, and MFI development. These included governmentsponsored development organizations, microfinance and mutual fund investors, bankers, microfinance investment vehicles, microfinance networks, rating agencies, MFI transaction attorneys, foundations, microfinance trade groups, microfinance managers, and scholars. CDSF found that individuals most familiar with the workings of the capital markets affirmed the value of static pool analysis and of bringing such analytical techniques to the microfinance sector.

CDSF also undertook a literature survey to determine whether similar studies of MFIs had been completed. We surveyed web-published research, academic journals, capital markets journals and research reports, MFI industry research and news articles, and financial news articles.

CDSF did not identify substantial research or commentary generated by the global capital markets that specifically addressed static pool analysis in the context of microlending. The literature addressing microfinance focused on the need to access capital (without identifying viable, widely applicable solutions). Many discussions centered on defining microlending as either a charitable or business activity.

Where discussion argued for microlending as a business activity, authors considered the creation of bonds or securities as a means of accessing capital. One article was identified that specifically called for the adoption of analytical tools to facilitate such financing vehicles (Meehan 2004).

Based on the scarcity of publications on this topic, CDSF concluded that opportunities exist to advance microlending and MFI access to capital by introducing a capital market tool, static pool analysis.

This CDSF pilot study is a first effort to apply static pool analysis to the microlending sector, a necessary step to advance microlending into the global capital markets. This method is new to the microfinance sector for several reasons. The static pool analysis, while widely used by large finance institutions to calculate default risk, is not well-understood among the advocates and supporters of microlending, who have emerged from entrepreneurial business, investment, and philanthropic sectors, rather than global finance. In addition, the cost of undertaking static pool analyses is great for small MFIs: static pool analysis requires logistical support in the form of quantitative technology, data mining abilities, and expertise in their use and application.

Microfinance and the Capital Markets | 37

CDSF has undertaken this study as a test case to determine the feasibility of applying this standard risk-assessment tool to microlending activities. It is our hope that the information gained here can contribute to the advancement and maturation of microlending.

Study Goals The goals of the study were to answer the following questions:

•

Is the microfinance community interested in the value of static pool analysis as a tool to help management manage and to help rationalize capital markets access for commercially viable MFIs? Does an interested MFI have the historical data necessary to undertake static pool analysis?

•

Is the data available in an efficiently extractable format?

• •

Is the available data sufficient for statistical analysis in terms of data points and critical fields?

Does the data have sufficient integrity to be of value?

•

Does data reveal homogeneity of trends?

•

Could data be applied to capital markets perspective?

•

Are MFIs concealing defaults by restructuring loans?

•

Are micro borrowers prone or encouraged to continue borrowing beyond their capacity to repay?

•

BACKGROUND ON STATIC POOL ANALYSIS Static pool analysis is a method for evaluating the repayment rates and defaults, and detecting the emanation of positive and negative trends embedded within a portfolio of loans. Its value extends into broader management activities of a lending institution such as a MFI. Static pool analysis can be used in assessing cash flows (asset and liability management) and losses resulting from loan activity (credit management), and it can provide the information necessary to define and monitor loan production goals. It is especially valuable during periods of rapid growth when the addition of new loan balances to portfolios dilutes standard accounting performance ratios (NCUA 2006).

Static pools are aggregated by the dates of loan origin, or “vintage,” rather than by the total loan portfolio as in historical accounting. A vintage may be a year, a quarter, or a month. The designated pools are tracked over the total life of the pool, i.e., from the origination of the first loan to the pay-off of the last loan.

38 | Microfinance and the Capital Markets

A static pool analysis examines the frequency at which various loan characteristics occur within a pool. Static pool analysis provides a foundation for modeling loss patterns based on historical trends using probability theory and actuarial methodologies. When a lending operation such as a MFI has collected a large pool of well-diversified, homogenous data sets, it becomes possible to generate reliable information about the performance of its loans (Raynes 2003). This information can be used to generate models for predicting future performance of a pool of loans.

Static pool analysis consists of stratifying pool characteristics into homogeneous groups. The most important characteristic of a loan pool is its propensity for defaults. Information gleaned from a static pool analysis is typically depicted as a graphed curve of cumulative defaulted loans, with each curve representing a vintage, or pool of loans. The more curves generated, the more accurate the statistically-derived model curve used for predicting future losses. When the curves of multiple vintages follow similar patterns, a trend emerges that points to consistent performance.

Loan characteristics such as location, purpose, amount, term, repayment frequency, and interest rate are also included in a static pool analysis. These characteristics reflect portfolio diversity (the extent to which a portfolio has many characteristics) and homogeneity (the consistent frequency of the characteristics). Establishing a homogeneous distribution for each of these characteristics is important to the integrity of an expected default curve and the integrity of loan pricing and valuation. For example, a highly concentrated geographic distribution may place a pool at risk for a localized economic event.

STUDY PARTNER RECRUITMENT AND SELECTION

Recruitment Criteria MFI study partners were recruited through MFI and social finance trade organizations, microfinance funds, postings on internet bulletin sites, and a press release.

To be considered as a study partner, candidate MFI portfolios could include no fewer than 2,000 loans originated over a minimum 5 year period, with data deliverable in an electronic format within the CDSF study window of September to November 2006. Study partners were required to deliver data that included the following:

Microfinance and the Capital Markets | 39

Loan number

Interest rate

Original loan amount

Loan product identifier

Current loan amount

Origination office

Origination date

Loan officer

Last payment made date

Geographic identifier (town, state, region, country)

Maturity date

Loan purpose identifier (purchase, working capital)

Defaulted loan identifier

Loan type identifier (agriculture, commercial, consumer)

Delinquent loan identifier

Borrower type identifier (individual, business, group)

Restructured loan identifier

Partner Selection CDSF planned to recruit one MFI study partner. The recruitment process yielded a higher-thanexpected interest among MFIs; therefore, it was decided to include two MFIs in the study. The inclusion of two MFIs provided an opportunity to compare and contrast study results, which may provide insights into MFI lending activities and standards.

During the recruitment process, CDSF evaluated eight MFI candidates. Analysis on the first MFI portfolio commenced before the second partner was selected.

Eight candidate MFIs were evaluated for inclusion on the basis of their responses to CDSF queries and sample data delivered. Six candidate MFIs were not selected for one or more of the following reasons: •

Response was not appropriate to the request.

•

MFI was unresponsive after initial contact.

•

MFI could not access the data in usable format.

•

Loan portfolio was below the 2,000-loan threshold needed for inclusion.

•

Qualifying MFI declined to participate, possibly due to unrelated operational issues.

40 | Microfinance and the Capital Markets

•

The data sample delivered by the MFI suggested a fraud trend that was not immediately disclosed (but which was later validated).

•

MFI met CDSF candidate criteria but could not deliver data within the study window.

MFI Study Partners Two MFIs were selected as study partners, SKS Microfinance Pvt. Ltd. (SKS) and International Micro Loan Fund (IMON). Their institutional traits are summarized below.

SKS Country National structure Legal System Languages

Corporate form Finance businesses History

Lending Currency Branches or regions Last reported month’s volume in data file Date data first delivered Data file size Data time frame Unique traits

IMON

India Constitutional Federal Republic English Common Law Hindi plus 14 regional tongues; fluent in English

Tajikistan Constitutional Republic

603,338 loan records July 1998 to Oct 2006 Payment calculation and rounding

22,796 loan records May 2000 to August 2006 Currency conversion and variable loan terms

Civil Law Tajik, fluent in Russian, can communicate in English For-profit Non-profit Lending only Lending only Founded in 1998 as Swayam Founded in 1995 as Krishi Sangam and NABWT, partnered with subsidiary SKS Microfinance Mercy Corp to establish Fund, reorganized as SKS microlending in 1999, Microfinance Pvt Ltd in reorganized as IMON in 2005 partnership with MEDA in 2004 Indian Rupees (INR) Somonis (TJS) and U.S. Dollars 134 26 45,432 loans for INR305.8 645 loans for TJS3.8 million ($6.6 million) million ($1.2 million) November 2006 September 2006

Microfinance and the Capital Markets | 41

STATIC POOL METHODS Data delivered by the study partners was prepared for analysis. All data was migrated into a uniform electronic format, a process which involved concatenating data files and merging data from multiple sources. Data not relevant to this study, such as confidential borrower information, was removed from data files. Where necessary, data was translated to English and standard financial format.

Data Stratification Data was stratified by the following variables: loan amount; interest rate; term (or tenor); product type; loan purpose; geographic location; and loan borrower cycle. Within each stratification, interest rate and tenor were calculated using weighted averages.

Diversity was assessed by evaluating the number of characteristics and identifying critical concentrations by loan amounts and locations. Homogeneity was assessed by evaluating the consistent pattern of characteristics.

Cumulative Default Analysis A default is defined as a loan that does not pay according to the MFI payment policy or convention. For SKS, payments were weekly and any non-payment was deemed by SKS to be a default. No full or partial default recoveries were assumed for the analysis, so all cumulative curves were gross. For IMON, any loan computed to be delinquent by 90 days or more was deemed a default. Ninety days is a capital market convention for declaring default, and captures all restructured loans.

To determine the first date and amount of default, one of two algorithms was used. For SKS, an algorithm was devised that calculated the age of the loan and the hypothetical unpaid principle balance on the date of first default. This algorithm used the level yield method (see also SKS Summary of Results). For IMON, an algorithm was devised that calculated the date and age of the loan on the first default. Where the default amount was not provided, it was assumed to be 50% of the original loan amount.

Cumulative default curves were computed for each loan vintage analyzed. Default amounts were accumulated by loan by payment period. The accumulated amounts were divided by the total original loan amount of all loans originated in the vintage. The calculation was displayed as a percent of total.

In addition to a cumulative default curve, a synthetic cumulative default curve also was computed. This curve 1) provided an alternative to simple cumulative defaults when the number of observed statistical defaults was insignificant per vintage; 2) allowed for calculating defaults when the typical loan term was less than a year, but borrowers continued to revolve their credit; 3) helped to determine whether repeat borrowers eventually over-extend their credit and default; 4) enabled comparison to curves observed in the mainstream finance markets; and 5) could be replicated for comparative purposes across MFIs with significantly different loan terms.

42 | Microfinance and the Capital Markets

A synthetic portfolio consists of term loans synthesized by borrower ID. Each borrower is assumed to borrow the entire amount of their cumulative historical borrowings as reflected in the data base. This amount is amortized on a level yield over 5 years.

The synthesis procedure is not perfect but is a valid method in an environment of very short-term repeat lending. For example, some borrowers included in the static pool curve started their borrowing relationship only recently; therefore, anticipating their repayment rate over an extended borrowing horizon is imprecise. However, if borrowing standards have improved over the past few years, this technique is a more accurate representation of the current situation than one derived exclusively from borrowers with five years of data, the population of which is statistically insignificant.

In addition to calculating historical cumulative defaults, the empirical cumulative gross default curve was interpolated. This was tested for IMON, and it was determined that a piece-wise linear fit was the optimal method.

For SKS, a test was created to determine whether new loan branches experienced more defaults sooner in their lives than established branches. A default rate per day was established for branches with more than 20 historical defaults.

RESULTS This study was framed within the context of several questions for which CDSF sought answers.

The first question centered on the level of MFI interest in static pool analysis as management tool. Based on the response of MFIs to limited queries in the MFI community, we believe that there is an interest among MFIs to adopt such tools, and that similar efforts will find willing candidates.

SKS IMON Was historical data Yes. Loan system is a Yes. Loan system is a sufficient? custom Access data base. Kredits off–the-shelf product. Data was migrated from old systems.

Was data collected in an Yes. Access data queries Yes. Kredits reports exported extractable format? exported to Excel to Excel or printed in word spreadsheets. and parsed in Excel.

Was data sufficient for Yes. Necessary data Yes. Necessary data fields analysis? fields exist or can be exist or can be calculated. calculated.

Was data integrity Yes. Reasonableness test Yes. Reasonableness test was sufficient for analysis? was completed on data completed on data samples. samples.

Were loans diverse and Yes. Lending had diverse Yes. Lending had diverse homogenous? characteristics; diversity characteristics; diversity was was homogeneous and homogeneous and consistent consistent with type of with type of lending lending operation. operation.

Microfinance and the Capital Markets | 43

Could data be applied to capital markets transactions?

Are defaults concealed by restructuring loans?

Was evidence of borrower over-extension identified?

Yes. Lending operation has the traits of a mass production lender.

No evidence identified.

Yes. Lending operation has the traits of a boutique lender.

No evidence identified.

No

No

This study also sought to characterize the participating MFIs by lending organization categories generally accepted within the global capital markets. The traits of the participating MFIs, by which lending institutions are categorized, are summarized below:

Loan business type Loan product offering Loan size Loan origination volume Loan gross margin Loan risk Loan handling Operating capital requirement Capital markets access

SKS Mass production lender Limited terms High concentration in low balances High Low Low Low Low Simple to execute

IMON Boutique lender Variable terms Varied concentration with higher balances Low High High High High Complex to execute

The experience of working with the two subject MFIs was not unlike that of working with a United States lender preparing for its first static pool analysis. The data necessary for this project differed from that currently collected for operational and regulatory accounting purposes and sometimes lacked key fields necessary for static pool analysis. To generate the full range of data necessary, files were reconstructed from a variety of sources in a painstaking process.

The initial data-gathering process required more time and effort than would be characteristic of a lender experienced with static pool analysis; nonetheless, once the data was assembled and analyzed, a picture of the study partner MFIs emerged. Data indicated that both MFIs operated in a manner that is scalable and replicable.

SKS possessed the attributes of a high-volume, low-yield mass-production lender, while IMON possessed the attributes of a low-volume, high-yield boutique lender. These models are common in the U. S. capital markets and are financed differently. Both MFIs studied here reported increased loan volume and geographical extension while maintaining the degree of consistency expected for each type of lending business.

44 | Microfinance and the Capital Markets

Study findings are summarized by MFI. Figures and tables summarizing study results begin on page 24. The large volume of data prohibits publication of all stratifications for each vintage in this brief report.

For each vintage selected, CDSF analyzed diversification and homogeneity by loan amount, rate, tenor, purpose, product, cycle, and geography. Each of these characteristics was stratified into tables containing logical increments of the analyzed characteristic followed by computed loan counts; loan amount totals; mean loan amounts; tenor and rate weighted averages; and where meaningful, minimums and maximums by characteristic and stratification.

SKS monthly loan origination was sufficiently large to necessitate stratifying the data by month of vintage; therefore, stratifications were compiled for the most recent 6-month (May 2006 to Oct 2006) vintages and compared to a 48-month cumulative vintage. For IMON, loan origination volume necessitated stratifying the data by year of vintage; therefore, stratifications were completed for the most recent 6 years (2001 through the first 8 months of 2006).

SKS Summary of Results

Growth rate Figure 1

Synthetic cumulative default Figure 2

Cumulative default Figure 3

SKS monthly loan origination increased dramatically in November 2004 and continued through the subsequent 24 months. October 2006 originations of 45,432 loans were 7.85 times the 5,790 loans originated in November 2004.

A synthetic pool was developed from data derived from five branches: the three oldest branches and two randomly selected branches. (The quantity and age of data from all 134 SKS branches was too great to synthesize all data within the scope of this study.)

Data covered the period July 1998 to October 2006. The five synthetic default curves demonstrate similar 3-phase slope characteristics of rapid early defaults, followed by gradual midterm defaults, and minimal end-of-term defaults.

Loans were categorized by individual month of origination, and 24 static pool loss curves were generated for the period November 2004 to October 2006. An all-time static pool loss curve also was completed on data from July 1998 to October 2006. The SKS results are consistent with that expected for homogenous lending.

Historical defaults have been low, relative to unsecured lending in the United States at a range of 0.012% to 1.5% for the range of static pools. This finding is consistent with the synthetic default analysis, which indicates a high of 1.22%.

An exogenous event at one branch caused significantly higher defaults during the months December 2004, January 2005, and February 2005, with a consistent shape to those defaults.

The speed of defaults (the rate of accumulation) is higher for static pools March 2005 and later versus November 2005 and earlier, Microfinance and the Capital Markets | 45

Mean loan and weighted average rate Figure 4

Loan amounts Table 1/Figure 5

Loan rates

Loan tenors Loan products Loan purpose Figure 6

Loan geographic location Table 2 Borrower cycles Figure 7

Default rate by loan characteristic

which corresponds to the rapid growth of SKS during the latter period. Under such conditions, a sacrifice in quality would be expected. The shape of the static pool default curves for the current production is consistent and would predict cumulative defaults in the 1% range.

An exogenous event at a branch during the May/June/July/August/ September 2004 periods caused static pool defaults of 1.9% to 8.8%, but the number of new loans originated during that period was 10% to 20% of current levels. (Not summarized in Figure 3).

During the elapsed 48 months, SKS mean loan amounts have ranged from 6,000 INR to 8,200 INR, with greatest consistency in the 12 months ending October 2006. Loans originated during the period April to October 2006 followed a similarly consistent pattern. The loan rate history shows two distinct patterns split around November 2004 when SKS reduced interest rates in Andhra Pradesh territory from 15% to 12.5%. Since then, the increased loan origination volume in the 15% product in other territories has slowly recouped the effective rate on loan origination.

The distribution of loan origination by loan amount has remained consistent over the period analyzed. In the stratification (Table 1), a minor aberration is noted in three loans with rates of 174%, a likely data error.

Interest rates were limited to 15%, 12.5%, or 0% for special accommodations. Sample stratifications did not reveal any meaningful trends; therefore the rate was not specifically analyzed in any stratification.

SKS issues all loans at a tenor of 50 weeks; therefore, tenor was not specifically analyzed in any stratification.

SKS offers three loan products whose differences are not material to the purposes of this analysis.

The purpose of loans was stratified by the top 15 purposes, which comprised 66% of all loans issued. The loan purpose was consistent from month-to-month. The results for May through October 2006 and for the 40-month history were similarly consistent.

The geographic location of loans was stratified by the top 20 concentrations. The results for May through October 2006 demonstrated concentrations of less than 2% per region.

The borrower cycle identifies repeat borrowers by product. As expected the trend illustrates the effect of significant lending expansion via the weighting toward first time borrowers. However the pattern is consistent from month-to-month and over the 48-month history.

The original loan size, default week, default amount, and effective interest rate characteristics of the defaulted loans were stratified.

The analysis revealed a distribution pattern similar to the patterns

46 | Microfinance and the Capital Markets

Branch default rates Table 3

of characteristics found for each vintage.

SKS has experienced rapid growth and expansion during the period studied. It is therefore prudent to consider whether newer branches exhibited higher defaults in their early life versus more established branches. Beyond the two branches affected by exogenous sociopolitical events (Nizamabad-B and Madhira), we believe the Sambalapur and Bhubaneswar branches deserve more detailed analysis based on their relatively higher rates of default.

Discussion of SKS SKS is a for-profit organization founded in 1998 as the Swayam Krishi Sangam and its subsidiary, SKS Microfinance Fund. The microlending operations were restructured in 2005 as SKS Microfinance Pvt. Ltd, a private company. SKS began operations in southeast India and from there expanded geographically.

India has a national government and 35 provincial governments. The national currency is the rupee with an exchange rate of 46 INR to $1 U.S. India is a diverse country marked by significant political, economic, cultural, climatic, and geographic differences.

For this study, SKS provided individual data files on 134 loan branches covering loan histories from July 1998 to October 2006. The data files were concatenated into a single data base of 603,338 loans.

SKS provided a marker in the data files that designated 4,981 defaulted loans during the period July 1998 to October 2006. This represented 1 in 121 loans made. Using an algorithm, it was determined that SKS experienced 39,649,000 INR of gross defaults during the reported period.

Gross is defined as not accounting for partial or complete recoveries.

Analysis of the defaults revealed useful consistency. The rate at which loans defaulted (slope of the default curve) was similar for each vintage. The stratification of characteristics of the defaulted loans was consistent with the pattern of stratifications for all loan vintages.

SKS loan origination volume increased significantly during the period studied. The steep production increase can be attributed to the start-up of 96 new branches during the final 12 months studied, which accounted for 42.8% of loan volume for that period.

SKS demonstrated remarkable loan origination consistency over its lifetime including the explosive growth period ending October 2006. This consistency likely results from a very limited loan product menu. All loan terms were 50 weeks with all loan payments due weekly. Interest rates were limited to 15%, 12.5%, or 0% for special accommodations.

This study identified two SKS practices that may work effectively within the institution, but which are inconsistent with the practices of the wider capital markets. These relate to the calculation of loan payment principle, and interest and loan payment rounding.

Microfinance and the Capital Markets | 47

SKS interest rates are not immediately comparable to developed market rates. The calculation of interest rates derived from traditional lending activities in developed capital markets is based on a level-payment, level-yield method. SKS uses a method common to other MFIs, whereby the borrower repays a loan in fixed weekly payments comprised of 1/50th of the original loan amount of the loan plus 1/50th of the interest rate times the original loan amount according to the formula: Payment = [Original Principle ÷ 50 weeks] + [Original Principle × Rate ÷ 50 weeks] The level-yield method, which is the common method employed within the capital markets, shifts the composition of the weekly payment between interest and principle as the loan balance pays down: Payment = Current Loan Balance × [Rate (1+Rate)Periods] ÷ [{(1+Rate)Periods} – 1] Under the two methods, the decline in outstanding loan balances over time differs, which is critical for calculating defaults. When considering the interest collected during the same period, the results derived from the two methods may differ significantly depending on the point in time at which the default occurs.

The importance of this difference in methods for SKS is that the 15% loan has an internal rate of return (IRR) or effective rate of 28.13%, while the 12.5% loan has an effective rate of 23.6%.

For the purposes of this study, all data points were converted to the level-yield method of computing outstanding principle and effective rates to provide a meaningful basis for comparison with capital markets data for similar loan activities. This approach is crucial to understanding the context of defaults and cash flows in this analysis.

SKS allows borrowers to prepay loans, but charges a fixed 2% fee on the original loan balance.

This fee effectively acts as a “make-whole” premium. (Within the capital markets, a make-whole premium is one that compensates investors for lost future income.) A test of the 2% fee revealed that investors were generally fairly compensated regardless of when the loan repays.

A second area where SKS differs from capital markets lenders is in a subtle accounting method for rounding non-whole numbers. SKS lends in rupees (INR), the lowest currency denomination.

Uneven loan amounts such as 5,000 INR with a 12.5% interest rate result in a weekly loan payment of 112.5 INR. SKS rounds this payment down to 112 INR. Rounding down reduces the yield by 1-2% depending on the loan amount.

Rounding is a problem for all lenders. Traditionally the developed markets have rounded payments up to the next whole currency denomination for all payments except the last payment, which is adjusted to compensate. Using the hypothetical loan amount of 5,000 INR, the loan would be repaid with 49 payments of 113 INR plus a 50th payment of 88 INR. While half a rupee may seem insignificant, on a volume of 50,000 loans per month it amounts to 15 million INR per year, or 38% of the principle of SKS cumulative defaults.

These inconsistencies notwithstanding, the SKS data could be analyzed in static pool format.

48 | Microfinance and the Capital Markets

This study found that the data possessed the homogeneity and consistency that would give confidence to a capital market investor with regard to the certainty of repayment cash flows from the portfolio. No pattern was identified that suggested restructured loans concealing technical defaults, nor was a pattern of evidence found suggesting that borrowers repeatedly borrowed until they could not repay their loans.

IMON Summary of Results Growth rate Figure 8 Synthetic cumulative default Figure 9 Cumulative default Mean loan amount and weighted average rate Figure 10 Loan amounts Table 4/Figure 11 Loan rates Figure 12 Loan tenors Figure 13 Loan products Figure 14 Loan purpose Loan geographic location Table 5 Borrower cycles Figure 15 Default characteristics Branch default rates

IMON monthly loan origination volume increased during the final 24 months of data analyzed. August 2006 originations of 645 loans were 1.94 times the 313 loans originated in September 2004.

Cumulative gross defaults were 6.4%

Not calculated. The ratio of defaults to the total loan data provided was insufficient to derive statistically meaningful conclusions.

The mean loan amount and weighted average rate shows a steady shift from a mean loan amount of 3,425 TJS in 2001 to a mean loan amount of 6,438 TJS in 2006, with a commensurate drop in interest rates from 40.6% to 38.2% over the same time frame. Interest rates peak in 2004 before declining.

Distribution by loan amount shows a shift away from loans of 3,000 TJS or less to loans between 3,000 and 6,000 TJS, with business also shifting into the 6,000 to 9,000 TJS range.

Distribution by loan rate shows a major shift into the 30% to 39% range, with IMON charging 33.6% to 39.2% on loans, with a weighted average of 38.8% IMON consistently originates a predominant number of 12- to 24week loans. Short term loans increased slightly in 2004 and then declined. 24- to 36-week loans increased in 2006.

Distribution by loan product reflects a re-categorization of group lending into the Purfaiz product. Group lending remains the core product, while lending to individuals has remained relatively flat.

The data provided by IMON lacked sufficient consistency to enable evaluation by loan purpose.

IMON has diversified its geographic distribution. No area accounts for greater than 15% of lending, two areas account for 25%, and 12 areas account for 80% Despite the geographic expansion, distribution by previous loans show a trend to higher repeat lending, which can be interpreted as a function of short loan tenor and limited alternatives.

Not calculated. The data provided was insufficient to derive statistically meaningful conclusions.

Not calculated. The data provided was insufficient to derive statistically meaningful conclusions.

Microfinance and the Capital Markets | 49

Discussion of IMON International Micro Loan Fund (IMON) is a non-profit organization founded in 1995 by the National Association of Business Women in Tajikistan (NABWT). In 1999 NABWT formed a partnership with Mercy Corps to establish a microlending fund. In 2004 it restructured itself as IMON in a partnership with the Mennonite Economic Development Association of Canada (MEDA).

Tajikistan is a former Soviet Bloc country located in Central Asia. Its predominant language is Russian although the official language is Tajik. Tajikistan is a constitutional republic. The national currency is the Somoni with an exchange rate of approximately 3 TJS to $1 U.S. IMON borrowers are typically traders and livestock raisers for whom cross-border travel and foreign currency access are necessary to their livelihoods.

As the basis for this static pool analysis, IMON provided 3 database export files from their Kredits loan system. Kredits is an off-the-shelf system to which IMON converted all branches commencing in 2000. The data included information on closed loans, active loans, and loans disbursed during the report period. All files were concatenated. IMON also provided periodic reports on defaults and delinquencies. The data from these reports was parsed and merged with the loan data.

Much of the descriptive data in the file required translation to English or recoding to terms understandable by U.S. analysts. Financial amounts and rates were converted into standard western formats. Information on 3,046 loans was delivered in U.S. dollar amounts; these were converted to TJS amounts ($1 = 3 TJS).

Data review revealed 432 loans (1.9%) with one or more data errors that would distort the analysis and were therefore eliminated. Their errors were as follows: 4 loans recorded no scheduled payment amount; 42 loans recorded a term of zero; 185 loans recorded no interest rate; 203 loans recorded a balance greater than 30,000 TJS, which suggested file conversion or transcription problems. (Two loans reflected two fatal errors.)

The initial analysis of IMON data suggested a flexible loan operation. The Kredits system collected data on a variety of loan structures and the data pointed to a changing slate of products over the analyzed period. Loan payment terms were structured on a 2 week, 4 week, or monthly basis. IMON operated in a boutique fashion, tailoring loans to meet client needs. This flexible strategy would seem suitable to the population and economy of Tajikistan.

The flexibility of IMON loan activities was further confirmed through validation of payment amount, loan rate, default date, and default amount. The variability in loan data indicates that IMON made small accommodations to borrowers. In addition, several inconsistencies in data were identified that pointed to special accommodations to borrowers: 6 loans with an illogical combination of terms; 128 loans where the payment amount would not amortize the loan for the periods given; and 270 loans where a calculation of the payment periods did not match the given field. A slight degree of imprecision also was identified in a few paid-off loans which carried very small negative balances, indicating overpayment.

50 | Microfinance and the Capital Markets

After initial data review, IMON data was segmented into vintages by calendar year of loan origination. The stratification of those vintages revealed positive general trends of geographic expansion, increased loan size, stable loan tenor, and a narrowing of interest rate dispersion.

IMON was rigorous in its classification of restructured loans as well as its pursuit of collections.

Although some borrowers had borrowed more than 30 times in the period examined, we found clear evidence that loans were repaid according to schedule before new loans were funded.

IMON removed defaults from its Kredits system after 360 days, but continued to collect past due balances for years after that.

IMON historical defaults were 55, or 1 in 415 loans made. 664 loans showed a late repayment but not a default. When those loans were included as defaults, the count increased to 729, or 1 in 31 loans.

Cumulative synthetic gross defaults were 6.4%. This default rate is consistent with the typical non-prime borrower rate in the U.S. capital markets. The shape of the curve indicates that defaults occur more randomly than in the United States. A U.S. curve typically shows much curvature in the middle of the range (18-24 months post-closing). The shape of the IMON synthetic curve also lends further credence to the hypothesis that their defaults are largely random and most likely occur early in the borrower relationship as the borrower either succeeds or fails in launching his or her enterprise.

CONCLUSIONS AND RECOMMENDATIONS This study sought to determine whether selected microfinance institutions operating within developing regions collect operations data in a format that could be adapted easily to global financial markets practices. In particular, the study considered whether subject MFI data could be analyzed by static pool analysis.

CDSF relied on two MFIs operating in very different markets to serve as test cases to gain insights to the workings of the microlending sector. The two participating MFIs were motivated participants that recognized the value of bringing capital markets tools to their operations, and both understood that their operations could benefit from an infusion of capital market investor dollars in their operations. They were self-selected participants.

Based on the data collected here, CDSF affirms that the MFIs studied here do operate according to the standards of global lending entities and that their activities could be integrated into the global markets. The threshold for entry into the capital markets is high; static pool analysis is only one tool that could be applied to advancing this entry. This study affirms, however, that the study participants have within their existing systems data that can be analyzed to provide useful default predictions.

This study provides valuable information to investors, philanthropic organizations, and the microfinance sector. Investors and philanthropic organizations should now understand that they can add a useful quantitative tool, static pool analysis, to their MFI evaluation criteria. The

Microfinance and the Capital Markets | 51

microlending sector itself can call for the introduction of this analytical tool to their practices as a means of attracting a more vigorous pool of capital market investors.

CDSF recommends that MFIs worldwide begin to embed static pool analysis in their public reporting, and that they bring static pool analytical training to microfinance training programs.

We also recommend that investors and philanthropic organizations who support microlending consider that static pool analysis can enhance their efforts. Among the more than 3,000 microlenders worldwide, many are appropriately funded by charity; however, many may be poised to expand their operations through funding from investors who demand the information provided by static pool analysis.

CDSF is continuing in this work and welcomes comments from the philanthropic, investor, and microlending communities.

52 | Microfinance and the Capital Markets

APPENDIX Figures and Tables Figure 1. SKS Growth Rate: November 2002-October 2006

50,000 45,000 Loans Originated

40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000

N

ov -0 2 Fe b03 M ay -0 3 Au g03 N ov -0 3 Fe b0 M 4 ay -0 4 Au g04 No v04 Fe b0 M 5 ay -0 5 Au g05 N ov -0 5 Fe b06 M ay -0 6 Au g06

0

Origination Date

Figure 2. SKS Synthetic Cumulative Defaults by Branch

Defaults as % of Total Loans

1.4% 1.2% 1.0% 0.8% 0.6% 0.4% 0.2% 0.0% 1

53

105

157

209

261

313

365

Loan Tenor in Weeks Naryankhed

Jogipet

Medak

Sadhashivpet

Sanga Reddy

Microfinance and the Capital Markets | 53

Figure 3. SKS Cumulative Defaults: Monthly Vintage versus Historical Total The dotted line represents the default rate for the entire history of the portfolio.

1.2%

Defaults % of Total Loans

1.0%

0.8%

0.6%

0.4%

0.2%

0.0% 1

3

5

7

9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 Week of Default

Figure 4. SKS Mean Loan Amount versus Weighted Average Yields 8,500

29%

8,000

28%

7,500

27%

7,000

26%

6,500

25%

6,000

24%

5,500

23%

5,000 Nov-02

22% Nov-03

Mean Loan Amount

Nov-04

Nov-05

Weighted Average Interest

54 | Microfinance and the Capital Markets

Table 1. SKS Example Loan Amount Stratification: October 2006 and 4-Year History Mean Loan

Minimum Effective

9,984,000

500

3,000

2,133

0.00

28.13

25.86

Amount

Oct-06

0

4,680

Oct-06

3,001

16,900

37%

83,720,000

4,000

6,000

4,954

23.60

28.13

26.02

Oct-06

6,001

15,914

35%

125,634,000

7,000

9,000

7,895

23.60

174.13

26.95

Oct-06

9,001

7,145

16%

74,786,000

10,000

12,000

10,467

23.60

28.13

25.00

Oct-06

12,001

579

1%

8,113,000

13,000

15,000

14,012

23.60

28.13

23.87

Oct-06

15,001

193

0%

3,152,000

16,000

18,000

16,332

23.60

28.13

23.63

Oct-06

18,001

21

0%

420,000

20,000

20,000

20,000

23.60

23.60

23.60

Oct-06

21,001

0

0%

0

0

0

0

0.00

0.00

0.00

Oct-06

24,001

0

0%

0

0

0

0

0.00

0.00

0.00

Historical

0

72,118

12%

156,539,500

250

3,000

2,171

0.00

28.13

24.83

Historical

3,001

193,143

33%

973,647,000

4,000

6,000

5,041

22.69

28.13

25.28

Historical

6,001

188,714

32%

1,492,906,200

7,000

9,000

7,911

22.95

174.13

25.99

Historical

9,001

115,340

20%

1,183,914,000

10,000

12,000

10,265

23.19

28.13

25.36

Historical

12,001

15,027

3%

201,515,000

13,000

15,000

13,410

23.25

28.13

24.83

Historical

15,001

4,191

1%

68,266,000

16,000

18,000

16,289

23.33

28.13

24.15

Historical

18,001

481

0%

9,473,000

19,000

20,000

19,694

23.36

28.13

24.11

Historical

21,001

29

0%

644,000

22,000

24,000

22,207

23.60

28.13

23.76

Historical

24,001

5

0%

129,000

25,000

26,000

25,800

23.42

23.60

23.57

10%

Max Loan

Weighted Average Effective

Period

%

Min Loan

Maximum Effective

Number of Loans

Total Amount in INR

% Rate

Figure 5. SKS Loan Amount: Historical 4-Year versus 6 Months Ending October 2005 (in INR)

Microfinance and the Capital Markets | 55

Figure 6. SKS Distribution of Loan Purpose May-October 2006

Table 2. SKS Top 20 Geographic Regions for Loans as % of Portfolio May-October 2006 May

June

July

Aug

Sep

Oct

Bellary

1.8

1.1

1.1

1.4

1.4

1.9

Bhadrachalam

2.3

2.0

2.3

1.0

1.0

1.8

Bodhan

1.6

1.4

0.9

1.2

2.0

1.7

Khammam-B

1.2

1.3

1.2

0.3

1.3

1.6

Kodada

1.8

1.4

1.1

0.6

1.0

1.6

Hospet

2.0

1.2

1.1

0.7

1.2

1.6

Armoor

1.2

1.5

1.0

0.2

1.2

1.5

Nizamabad

0.9

0.9

0.9

0.1

1.5

1.5

Jammikunta

0.7

0.8

0.7

0.9

1.2

1.5

Berhampur

1.2

1.0

1.1

1.1

1.1

1.5

Gagawathi

0.0

0.0

2.7

1.8

3.3

1.5

Karimnagar

1.3

1.2

1.0

1.4

1.6

1.4

Sadashivpet

2.1

1.7

1.5

0.2

1.4

1.4

Narayankhed

1.5

1.4

1.1

0.7

1.3

1.4

Chityal

1.2

0.8

1.4

0.1

2.1

1.4

Thallada

1.7

1.4

1.6

0.8

1.1

1.4

Korutla

1.2

1.2

0.8

1.5

1.3

1.4

Pedapally

0.7

0.8

0.7

0.7

1.8

1.4

Sathupally

1.1

1.5

2.0

0.2

1.8

1.3

Sanga Reddy

2.1

1.7

1.1

2.3

1.5

1.3

56 | Microfinance and the Capital Markets

Figure 7. SKS Borrower Loan Cycles May-October 2006

Table 3. SKS Default Rate by Branch

Branch Name

Number of Defaults

Disbursed Amount of Loans (INR)

Default %

First Date of Loan Origination

% Default Per Day

Nizamabad-B

2,210

20,460,000

87.8728

5/24/04

0.0987

Sambalpur

26

183,000

4.3624

8/10/06

0.0532

Madhira

699

4,707,000

12.3804

7/26/05

0.0268

Bhubaneswar

37

270,000

2.2169

7/6/06

0.0189

Nanded

226

1,650,000

3.1371

11/16/05

0.0090

Berhampur-B

76

552,000

2.3990

1/2/06

0.0079

Bhokar

30

204,000

1.0225

3/14/06

0.0044

Kurdhar

25

156,000

0.7379

3/6/06

0.0031

Bidar-A

89

566,000

0.9025

7/27/05

0.0020

Sathupally

56

425,000

0.5580

5/9/05

0.0010

Huzur Nagar

92

689,000

0.7935

6/8/04

0.0009

Miryalguda

116

775,000

0.7095

5/24/04

0.0008

Microfinance and the Capital Markets | 57

Figure 8. IMON Monthly Growth Rate: 2001-2006 700 650 600

Loans Originated

550 500 450 400 350 300 250 200 Sep-02

Sep-03

Sep-04

Sep-05

Origination Date

Figure 9. IMON Synthetic Cumulative Defaults 7%

Defaults % of Total Loans

6%

5%

4%

3%

2%

1%

0% Elapsed Time 0-5 Years Actual

58 | Microfinance and the Capital Markets

Linear

Figure 10. IMON Mean Loan Amount (in TJS) versus Weighted Average Rates 7,000

44%

6,000

42%

5,000

40%

4,000

38%

3,000

36%

2,000

34%

1,000

32%

0

30% 2001

2002

2003

2004

Mean Loan Amount

2005

2006

Weighted Average Interest

Table 4. IMON Example Loan Amount Stratification 2005 Vintage Range

Number of Loans

Total

Mean Loan Min. Loan Amount in TJS

Max. Loan

Wt Avg

Min Max Days

Wt Ave

Min Max % Rate

0-3000

1,725

3,976,125

2,305

380

3,000

162

56

730

42.3

22.0

3001-6000

2,249

10,016,219

4,454

3,020

6,000

148

56

730

41.7

22.0

50.4 50.4

6001-9000

1,005

7,411,420

7,375

6,050

9,000

145

56

730

41.1

22.0

50.4

9001-12000

399

4,147,920

10,396

9,090

12,000

193

56

730

39.9

22.0

50.4

12001-15000

218

3,100,800

14,224

12,100

15,000

307

84

504

39.0

22.0

50.4

15001-18000

32

528,600

16,519

15,200

18,000

244

56

504

39.4

39.2

44.8

18001-21000

22

437,800

19,900

18,500

21,000

333

56

504

39.7

39.2

50.4

21001-24000

42

956,857

22,782

21,150

24,000

449

140

672

38.6

34.0

39.2

24001-27000

6

152,200

25,367

24,600

27,000

364

168

504

39.2

39.2

39.2

27001-30000

32

958,125

29,941

28,125

30,000

493

168

1,008

38.8

34.0

39.2

Total

5,730

31,686,067

5,530

380

30,000

195

56

1,008

40.9

22.0

50.4

Microfinance and the Capital Markets | 59

Figure 11. IMON Loan Amount by Year: 2001-2006 (in TJS)

Figure 12. IMON Loan Interest Rate by Year: 2001 to 2006

60 | Microfinance and the Capital Markets

Figure 13. IMON Loan Tenor in Weeks: 2001 to 2006

Figure 14. IMON Loan Products

Microfinance and the Capital Markets | 61

Table 5. IMON Top 20 Geographic Regions for Loans as % of Portfolio Region

2001

2002

2003

2004

2005

2006 15.3

Истаравшан

19.3

15.4

18.4

19.1

16.1

Исфара

2.4

9.6

10.1

11.6

13.1

10.2

Худжанд

38.2

22.3

17.5

14.1

12.5

9.6

Канибадам

13.6

10.2

7.8

7.9

8.6

8.0

Турсунзаде

0.1

4.3

6.0

7.0

6.2

6.2

Пенджекент

0.0

0.0

0.0

0.2

3.8

6.2

Шаартуз

0.3

5.3

7.4

8.5

5.7

5.1

Душанбе

8.8

12.2

7.2

6.1

4.2

5.0

Гиссар

3.8

5.2

4.6

4.5

4.4

4.4

Спитамен

0.0

0.0

0.0

0.3

3.6

3.8

Дж.Расулов

0.0

0.0

0.0

0.0

1.6

3.6

Кабодиён

0.4

4.6

5.7

5.8

3.9

3.1

Колхозобад

1.4

1.7

3.1

3.7

2.9

2.4

Курган-Тюбе

0.0

0.0

0.0

0.0

1.4

2.3

Гафуров

8.8

3.8

2.6

2.5

2.1

2.3

Носир Хусрав

0.0

0.8

2.1

3.1

2.0

2.0

Джиликуль

0.0

2.2

5.6

3.1

2.5

1.9

Кумсангир

0.0

0.0

0.0

0.0

0.5

1.9

Рудаки

1.1

1.4

1.1

1.3

1.1

1.8

Вахдат

0.0

0.0

0.0

0.5

1.0

1.4

Figure 15. IMON Borrower Loan Cycles 100%

Portfolio Concentration

80% 31-35 26-30 60%

21-25 16-20 11-15

40%

6-10 0-5

20%

0% 2001

2002

2003

2004

62 | Microfinance and the Capital Markets

2005

2006

Glossary Asset-backed securities Capital Capital markets Characteristic Cumulative default Cycle Default Diversification Effective yield Geographic location Gross default Homogeneity Interest rate Level yield Loan origination MFI Microloan Product Purpose Securitization Static pool Stratification Tenor Vintage Volume Weighted average

An investment security whose return to investors is based on the payments of, and is collateralized by, a pool of loans The money used to fund loans, i.e., debt, equity, or donations The system and organization by which money moves from investor to investor or borrower and vice versa Amount, tenor, rate, product, cycle, purpose, geographic location or other quantifiable or identifiable outcome of a loan The sum of current defaults plus all prior defaults The number of times a borrower has borrowed Failure to make a loan payment as agreed, resulting in acceleration or restructuring of the loan and possible loss to the lender The range of possible outcomes for each loan characteristic The imputed rate of interested earned on the repayment of a loan The general vicinity of the borrower or the branch where the loan was originated The unpaid loan principle on the of default regardless of future loan payments Similarity of diversification of characteristics from one vintage to another The interest payment divided by the outstanding loan principle The fixed rate of interest earned on an amortizing loan where each payment is a fixed amount The underwriting and disbursement, or funding, of a loan Microfinance intermediary or institution A loan smaller than the status quo for a lending business A lender’s standard offering of loan amount, rate, tenor and other characteristics The use of the loan proceeds cited by the borrower The act of pooling loans and issuing asset-backed securities The data from a discrete pool of loans typically originated within a given time period The tabular representation of pool characteristics stratified by logical increments of all possible outcomes The elapsed time between loan funding and loan maturity The time period during which loans in a pool were originated The number of loans, or total amount of loans, originated in a period Each observation is weighted by the loan amount, summed, and divided by the total of the loan amounts

Microfinance and the Capital Markets | 63

REFERENCES Harris-Daley, Sam. State of the Microcredit Summit Campaign Report 2006. Microcredit Summit.

Rhyne, Elisabeth and María Otero. “Microfinance through the Next Decade: Visioning the Who, What, Where, and How.” Nov 2006. Accion.

MicroCapital.

“MicroCapital: On Microfinance http://www.microcapital.org/FundsBlog2.htm.

and

Microcredit

Investment.”

Reddy, Rekha and Elisabeth Rhyne. “Who Will Buy Our Paper: Microfinance Cracking the Capital Markets?” April 2006. InSight. Number 18. Accion.

Ehrbeck, Tilman. “Optimizing Capital Supply in Support of Microfinance Industry Growth.” AED Conference Center, Washington D.C. 24 Oct 2006. Omidyar Network. SEEP Network.

Brugger, Ernst A. “Micro-Finance Investment Funds: Looking Ahead.” Zurich. Nov 2004. KFW Financial Sector Development Symposium.

FitchRatings. “Securitisation in Emerging Markets: Preparing for the Rating Process.” 17 Feb 2006.

Structured Finance.

“Interagency Guidance on Asset Securitization Activities.” 13 Dec 1999. Office of the Comptroller of the Currency. Federal Deposit Insurance Corporation. Board of Governors of the Federal Reserve System.

Office of Thrift Supervision.

Code of Federal Regulations. 17 CFR Parts 210, 228, 229, 230, 232, 239, 240, 242, 245 and 249.

Securities and Exchange Commission. 22 Dec 2004.

Meehan, Jennifer. “Tapping the Financial Markets for Microfinance: Grameen Foundation USA’s Promotion of this Emerging Trend.” Oct 2004. Grameen Foundation USA. National Credit Union Administration. “Static Pool Analysis: Evaluation of Loan Data and Projections of Performance.” Mar 2006. NCUA. Raynes, Sylvain and Ann Rutledge. The Analysis of Structured Securities. Oxford. Oxford University Press, Inc. 2003. p. 32.

64 | Microfinance and the Capital Markets

ACKNOWLEDGEMENTS This project was undertaken by the Center for the Development of Social Finance (CDSF) with support from the Taylor Jordan Donor Advised Fund of RSF Global Community Fund and Omidyar Network.

Taylor Jordan, Director Investments, RSF, and Jim Bunch, Director, Investment, Omidyar were especially helpful in launching this study.

Kylie Charlton of Unitus and Kyle Salyer of MicroCredit Enterprises assisted on this project by providing introductions to potential study partners.

We thank SKS management and staff: Jennifer Leonard, Chief Financial Officer; M. R. Rao, COO; Kanchan Pandhre, VP Finance and Accounting; Ashish Damani; AVP Finance and Accounting; and MIS staff Shashi Kumar, Prasad, and Shridhar Kannuri.

Thanks also to IMON management, Sanavbar M. Sharipova, General Director, and Umed Usupov, Deputy Manager of Operations for their assistance.

R&R Consulting assisted on this project. In particular, Sylvain Raynes and David Arbitol brought their expertise and interpretation to the analysis of MFI data. Evgeny Panov, Anna Filippova, Gary Schurman, and Wendy Suzuki provided volunteer assistance on various aspects of the project.

DISCLAIMER The data and analysis presented herein was collected and compiled for the sole purpose of this study. We offer no opinion on the accuracy of the data we received from study participants, nor do we offer an opinion on the financial health of the individual study partners or the microfinance industry in general.

The contents of this report are provided for informational purposes only; they are not intended for trading purposes or investment advice.

Microfinance and the Capital Markets | 65

66 | Microfinance and the Capital Markets

CRITICAL THEORY AND MICROFINANCE Dwight Haase, PhD, University of Toledo

ABSTRACT A more fruitful dialogue about the social and economic impact of microfinance requires a full vetting of the assumptions and values built into the theoretical perspectives guiding both academics and practitioners. This paper intends to facilitate that process by relating critical theoretical perspectives – especially from Marxist and feminist schools of thought – to the existing literature on microfinance – both academic and nonacademic. The literature shows that microfinance has some potential to address Marxist concerns of alienation, exploitation and domination in society, but recent trends focusing on financial sustainability have distracted the microfinance community from these goals.

Meanwhile, a rather narrow conceptualization of empowerment has inhibited the full potential of microfinance for transforming gender relations.

KEY WORDS: Microcredit, microfranchise, Marxism, feminism.

INTRODUCTION My first hands-on experience with microfinance was a USAID-funded project in postwar El Salvador. As an intern helping to assess the impact of the project, I accompanied field workers as they hiked over hillsides to reach borrowers. I found it amazing to be walking alongside former FMLN fighters and supporters who now worked for an organization funded by the US Government. At that time it seemed to me Muhammad Yunus had managed to do something countless politicians before him had largely failed to do: find some common ground between Marxism and Liberalism.

Since that time I have noticed increasing antagonism between leftists and the microfinance sector. Feminists also have been vocal in their disgruntlement with microfinance. Meanwhile, advocates of microfinance seem more dismissive of critical thought, as if it is too theoretical to be relevant to their work on the ground. Indeed, a common danger of theoretical dialogue is that it can become to abstract, losing touch with reality. However, microfinance should not lose appreciation for the utility of critical theory in helping us ascertain the causal factors of what they might see occurring in the field, as well as interpreting the data.

In this paper I will consider two facets of critical theory – Marxism and feminism – and how they can help make sense of microcredit’s benefits – and its shortcoming. By no means is this an exhaustive survey of critical theory, but rather a first step in bringing theory back into the discussion of microfinance.

The Evolution of Thought on Microfinance | 67

MARXISM Marxism at first seems irrelevant to microcredit. After all, Karl Marx developed his theories based upon observations of workers in industrial capitalism, and microcredit typically targets self-employed persons, mostly in the informal sector and rural areas.

But Marx’s three central concerns are quite pertinent to the goals of microcredit and its impact. Those central concerns are: (1) alienation, (2) exploitation, and (3) domination. I will address each of these in turn. In so doing I will compare the insights of Karl Marx to the ideas of one of microcredit’s founding fathers, Muhammad Yunus. Yunus himself was inspired by Marxist thought in college, although he says he found it too impractical (2003: 203-4). While such pragmatism has its merits, I will argue that recent developments in microfinance also suggest that practitioners and planners should revisit Marxist theory to better assess their accomplishments, their shortcomings, and where they are headed.

Alienation Alienation is a topic that receives little attention anywhere in the microfinance community. Even Marxist scholars sometimes forget about this more psychological dimension of Marx’s writings. To best understand Marx’s concept of alienation, it is useful to begin with someone who is a primary target of Marx’s critiques: Adam Smith.

According to Smith, the essence of being human is to communicate, which allows us to negotiate, and thus to reach compromises that are mutually beneficial.

Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog.

Nobody ever saw one animal by its gestures and natural cries signify to another, this is mine, that yours; I am willing to give this for that….

In almost every other race of animals each individual, when it is grown up to maturity, is entirely independent, and in its natural state has occasion for the assistance of no other living creature. But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of… The greater part of his occasional wants are supplied in the same manner as

68 | The Evolution of Thought on Microfinance

those of other people, by treaty, by barter, and by purchase (Smith: 168-169).

Marx dismisses Smith’s view as another case of liberals indiscriminately imposing their own believes and preferences – very much a product of their time - on all of history. For Marx, the essence of being human, that which sets us apart from animals, is our ability and propensity to work with both our hands and our minds. Marx accuses Smith and his protégés of simply projecting their bourgeois ideals on other cultures when they advocate for free markets. In fact, there are many examples of societies throughout history that did not trade, so how could this be the essence of humanity? (1858: 345-347) So while Smith sees trade as innate to human nature, Marx sees production as innate to human nature. And for Marx that act of production, work, is a “positive” activity (370); it includes relationships with other workers, ourselves, and the product itself. From this perspective, sitting on an assembly line – or even taking orders from a boss for eight or more hours a day – is not only unfulfilling, it is inimical to what it means to be human (367). Workers eventually come to feel their lives are controlled by the commodities they produce. These products no longer make their lives more convenient or enjoyable, as they are advertised to do, but instead make their lives seem meaningless and empty (1867: 508-510, 515-516). The zombie-like lifelong “shoprat” at the start of Ben Hamper’s (1991) factory memoir, obliviously chain smoking while he stares blankly at the wall muttering expletives (9-10), is a classic example of what Marx feared would become of workers in a capitalist world.

Like Marx, Yunus is has doubts about wage labor - but not because it is alienating.

Instead, Yunus argues that it is an impractical development strategy in many countries, and it may be very difficult for workers to be productive and to accumulate capital through wage labor (2007: 52-54). Yunus presents his stance as a direct contradiction to mainstream economic theory, but at the same time he implicitly affirms the liberal tradition by making productivity and capital accumulation the end game for development.

But even if there is no explicit intention to address problems of alienation, microfinance could do so indirectly. After all, microcredit is not industrial production; and at least in that sense it is not an affront to humanity, in Marx’s eyes. In fact, this might be the most appealing aspect of microcredit: it conforms both to both Marx and Smith’s concept of what it means to be human. But the conformity with Marxist theory is more a coincidence than a commitment, and so the danger is that this aspect of microcredit might be forgotten in the pursuit of liberal objectives. Indeed, we now see new projects in the microfinance sector that are designed to increase the productivity of the beneficiaries, but at the same time decrease their autonomy and creativity as workers. A prime example of this is microfranchising, “a development tool that seeks to apply the proven marketing and operational concepts of traditional franchising to small businesses in the developing world.” According to the Economic Self-Reliance Center’s microfranchising blog site, “The primary feature of a microfranchise is its ability to be streamlined and replicated.

The businesses are designed for microentreprenuers and usually target development issues such as health, sanitation, and energy” (http://microfranchise.blog.org).

The Evolution of Thought on Microfinance | 69

The site goes on to say, As an illustration consider a microcredit borrower who is not particularly gifted as an entrepreneur. With the option of a microfranchise they could get a loan from a microfinance institution along with a 'business in a backpack' and therefore gain access to an entire system of training, support, branding, and marketing as a franchisee.

The franchisor would operate with the efficiency of a McDonalds or Subway and subsequently drive prices down and increase distribution of essential products and services.

Most microfranchises have the ability to provide additional employment to a handful of people beyond the franchisee which could potentially be the poorest of the poor.

These microfranchises include selling reading glasses, solar panels, portable movie screens, and vitamin-fortified yogurt (Fairbourne et al. 2007; microfranchising.blog.org).

It is exciting to see economic activities like these that generate employment while at the same time providing products and services that many communities otherwise would not have access to. But microfranchising also represents a discouraging shift toward a kind of development strategy that treats people as just labor. In fact, perhaps the most important difference between the microfranchisees and the employees of McDonald’s or Subway is that the latter don’t assume the risk of failure of the business; microfranchisees do.

Exploitation Exploitation is the economic dimension of Marx’s concerns with capitalism, and perhaps the most commonly recognized topic of his writings. Again, Marx differs sharply from Adam Smith, who basically regards trading as a win-win situation. Smith’s mentality has endured to this day, and remains a driving force in the mainstream business world, as well as the socially responsible business sector. As Kelley et al. (2008) argue, the business world “can successfully address poverty without converting to philanthropy” (19).

For Marx, while the act of trading – buying and selling – at first glance may appear to be a win-win situation, in fact it obscures the exploitation of workers and appropriation (and often also degradation) of the environment that occurred while producing the items being traded. In his earlier writings, Yunus espouses Marx’s perspective: Poor people have not only survived due to their skills and hard labour, but others have acquired wealth and reaped bounteous harvests because of them. A big part of the national income is created this way by the poor. But it is not admitted in economics textbooks. The poor people, 70 | The Evolution of Thought on Microfinance

however, cannot keep for themselves their due share of what they produce. The bigger share is credited to the accounts of others. To ensure a bare living, they feel so desperate that they are hardly in a position to claim from more powerful people what is their due share. They try to manage with whatever little they get. Moreover, the powerful people have created such social and economic institutions that there is no scope for the poor people to raise any objections. Whatever the poor see around them, they have learn to accept as the inevitable dictum of fate.

Consider their powerless situation, they find it prudent not to raise any loud protests (1992: 26-27).

Yunus is not so sanguine as Smith about the prospects of a free market. He acknowledges that people are poor not for lack of human capital or financial capital, as liberal economic theory might suggest, but because the economic and social system in which they live is has been designed to oppress them. Marx would have agreed; he asserts that labor power creates more value than the laborer consumes, but that extra value he/she created never comes back to him/her in the paycheck. Marx’s solution is class conscientization, which he envisioned would lead to collective action among the oppressed. More precisely, Marx foresaw the workers taking over and ultimately abolishing the exploitative institution Yunus mentions.

But while Yunus and Marx seem to share the same diagnosis of the situation, their prognoses are not at all similar. Instead of collective action, Yunus’ solution is classically liberal: inject capital. This is ironic since Yunus has described a system that is inherently inimical to the interests of the poor, yet he is offering a solution that would encourage the poor to participate more actively in that system. Furthermore, credit ultimately is an individualistic approach to empowerment. Although Grameen borrowers form groups to receive loans and those groups are mandated to “engage in collective enterprises whenever possible,” (Yunus 2007: 58-59) microcredit borrowers often find themselves in competition with each other. And while the groups of borrowers are often called “solidarity groups,” internal conflicts over who should get loans first, or who should get the biggest loan often occur.

Without class conscientization, and without changing the broader economic system in which she is working, the successful entrepreneur may simply go on to replicate the exploitative employment practices of the bourgeoisie – paying her workers too little, offering no benefits, and demanding long hours. Indeed that might be her only chance for success. Unfortunately, little research has been done on microentrepreneurs’ employment practices, so we simply don’t know about such working conditions.

Simply serving the individual without addressing the structural causes of his/her situation also can prove problematic in times of economic volatility. The sharp increase in global food prices in 2008 is a prime example. Due in large part to speculation, free trade policies, laissez faire agricultural policies and de facto dumping of US subsidized surplus The Evolution of Thought on Microfinance | 71

grains, the prices of many staples doubled worldwide in just a few months time. The predicament caused many microcredit borrowers to withdraw savings and cut back on household spending in order to try to keep making payments on their microloans (Duflos and Gaehwiler 2008).

The microfinance institutions’ (MFIs’) high interest rates – often well above 30%, sometimes even over 50% - also exemplify the potential for exploitation in this field.

CGAP’s senior advisor, Richard Rosenberg (2002), offers the standard defense for high interest rates: In most countries, donor funding is a limited quantity that will never be capable of reaching more than a tiny fraction of those poor households who could benefit from quality financial services. We can hope to reach most of these households only if MFIs can mobilize relatively large amounts of commercial finance at market rates (11).

The most recent (and methodologically most impressive) impact assessments by Banerjee et al. (2009) and Karlan and Zinman (2009) call into question Rosenberg’s assumption of benefit, and make one wonder what better impact the MFIs might have by lending to fewer people at lower rates of interest. Furthermore, by taking subsidization off the table, Rosenberg effectively is taking pressure off governments to take responsibility for addressing the economic needs of their poor. Finally, this argument of scarcity of funds seems somewhat disingenuous when over $30 million is spent each year on microfinance conferences (Helms 2006: 13). One can’t help but wonder: if the borrowers knew that MFI funds were being used to send staff to these events in far-off five-star tourist hotels with lavish meals and various souvenirs, wouldn’t they feel exploited?

Finally, the question of microfranchising again comes up when we speak of exploitation.

This is because microfranchisers do not appear to be monitoring their sources of inputs.

For example, Jones Christensen et al. (2007) describe the Vodacom project in South Africa, which offered cell phones to low income customers through phone shop microfranchises. The authors note that the project originally sold thousands of phones made by Siemens, the same company found by reporters to engage in sweatshop labor practices in China (Chan and Ho 2009). Meanwhile, the cell phones contain tantalum, mined in slave-like conditions in the Democratic Republic of Congo (Cox 2006). Yet the microfranchise literature makes no mention of efforts to ensure the materials they procure come from safe and just working conditions. To benefit one impoverished group at the expense of another – and even to reward the corporation involved in the exploitation with a lucrative contract – seems inimical to the ideals espoused by microfinance advocates.

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Domination Domination is Marx’s most overtly political concern; but it also is deeply connected to alienation and exploitation. For Marx, exploitation and the lack of autonomy associated with alienation beget a system of values and decision-making dominated by the wealthy and powerful. It is a system Marx believes must be replaced.

Yunus, on the other hand, opts for gradualism, which Counts (1996) describes this way: In reality, of course, Grameen doesn’t match up with some of his own ideals, either. But it passes the test that guides all the major decisions in his [Yunus’] life – is doing it an improvement over doing nothing? Time and again, when people find fault with Grameen, Yunus admits its theoretical and programmatic deficiencies while defending it as superior to the status quo (308).

This approach has been quite successful for Grameen. But it does come with a cost.

Gradualism means working within a system that impels both the MFIs and their clients to follow its rules and imperatives, and more generally to accept liberal values like efficiency and individualism. Regarding the former, a current trend among MFIs that often is lauded by planners and practitioners but derided by critical scholars is the struggle for financial self-sufficiency.

MFIs’ financers, mostly Western European governments and North American NGOs and foundations, demand that the MFIs be financially self-sufficient. This has discouraged the MFIs from making investments in awareness building among their women borrowers since such activities would raise the MFIs’ operating expenses. Cloke (2000) also asserts that donor demands for MFI self-sufficiency has pushed the MFIs to exclude the poorest from their portfolios. Elyachar (2002) asserts microfinance “accords well with neoliberal ideology in that it advocates a diminution of the state and its disengagement from the terrain of economic activity” (496). She concludes that microcredit is being used as “a mechanism for ensuring that the poor discipline themselves” (509).

Yet another implication of working inside the system is the imperative for competition.

This is often regarded as a good thing among proponents of microfinance. Indeed, under proper circumstances (i.e., with proper regulation) it can impel MFIs to provide better, more appropriate services than they otherwise would. But it also can invite organizations that have little or no interest in helping the poor, and thus are more concerned with making their balance sheets look appealing, rather than truly empowering their clients.

And considering that microcredit often is disbursed in markets with relatively little regulation, this could be problematic. In other words, Yunus’ gradualism is at risk of becoming opportunism.

Finally, it is important to note that when MFIs are following the directives of funders based elsewhere, those MFIs are not able to take their own cultural, political and economic context into consideration before they begin lending. They are like the The Evolution of Thought on Microfinance | 73

economists Marx derided, who imagine their bourgeois preferences are in fact timeless universal laws of economics, which they project on all other people’s, no matter how different (1858: 346-348). As Bornstein (1996) presciently notes, In accepting credit as a development tool, most did not duplicate the process Yunus undertook to arrive at credit.

Indeed, the importance of credit as a development tool is only one of many lessons to be drawn from the experience of the Grameen Bank, and, I would argue … not the most important one (341; emphasis in original quote).

To make his point, Bornstein specifically addresses the topic of microcredit in the US: If Yunus had an American counterpart who spent four years walking around a poor urban neighborhood in the United States (presumably close to where he grew up), asking people what they needed to solve their problems, what would have emerged? Would people have talked about credit? Or vocational services? Or improved public schools? Or locally based policemen? Or better political representation? The answer remains open to speculation.

But one thing is certain: It cannot be ascertained from a distance (341-342).

Grameen’s founders were well aware of this, as is evinced by Grameen’s multiple other programs. Credit is just one of many approaches that Grameen employs, and the organization continues to innovate its services. However, other MFIs lack Grameen’s autonomy and vision, they appear to follow the narrow dictates of their funders to simply lend, lend, lend without first investigating whether or not this is the most effective and appropriate means of intervention In concluding this section, it is important to note that both liberal and Marxist theories are problematic in that Marx and Smith both imagined a male-dominated economy. Rarely did they ever mention women in their most important works, let alone consider how women’s experiences at work might differ from those of men. The next section addresses such issues.

Feminism Feminists often are credited for bringing “empowerment” into the parlance of development (Young 1997b: 371). The Gender and Development (GAD) movement of the 1980s encouraged planners and practitioners to focus more intently on power differentials and gender relations, rather than simply trying to integrate women into the mainstream economy, as was typically the aim of the Women in Development (WID) movement of the 1970s (Visvanathan 1997:17-24; Young 1997b: 371).

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While there is no single feminist definition of empowerment, there is a general agreement that it is a process – a holistic one. According to Young (1997b): [Empowerment] involves the radical alteration of the processes and structures which reproduce women’s subordinate position as a gender. In other words, strategies for empowerment cannot be taken out of the historical context that created lack of power in the first place, nor can they be viewed in isolation from present processes (372).

Radical alteration means merely targeting women for benefits is not itself sufficient. And historical context means that there is no one universal model for this process of empowerment; it varies from one community to the next. And so like Marx, feminists often are wary of mainstream economic theories that treat all people as independent units virtually independent of their social setting. This is even true of feminists who otherwise are relatively favorable to mainstream economics, such as Rebecca Blank (1993) [T]he assumption that I find most problematic in the standard economic model is that in all cases choice is taken as the most useful characterization of how individuals respond to their social and economic environment… There is not a glimmer in this basic model that any individual might ever feel dominated, oppressed, passive, stuck, ill, unsure about his or her abilities, or unaware of alternatives (141).

Young (1997a) would agree, and relating this more directly to microcredit she notes being “much less optimistic about the role of the market as distributor of benefit, and the power that stems from having ‘cash in hand’” (53).

But the above insights seem to be largely lost on the main advocates for microfinance.

Instead they confuse feminine strategies with feminist strategies, and at the same time often essentialize women by emphasizing their compliable nature and undying responsibility for children – read: they are submissive and their proper place is at home.

Meanwhile, a story of a husband or father who is chauvinistic or incapable to provide for his family often is constructed to as the straw man to explain these women’s impoverished status.

The Microcredit Summit Campaign’s (MCS) website lists “empowering women” on its homepage banner. If one clicks on a link to “microcredit success stories,” one finds 13 vignettes of women borrowers. One vignette features Gonuguntla Mariamma from India, who was married off at the age of ten. With the income from her loan she has revitalized the land her husband owns and bought more rice for her family. Another vignette is about Janet Deval in Haiti, who is using her income to send her children to school, even though her husband has been opposed to the idea. Yet another vignette features Alemnesh Geressu from Ethiopia; it explains that the money she earns from trading in the The Evolution of Thought on Microfinance | 75

market is used to buy things for her family and to send two of her children to school, something her husband could not do because he is a poor, landless farmer. And then there is Nurajahan from Bangladesh, who was abandoned by her parents as an infant.

Her neighbors raised her and married her off at the age of 12 to a man who later abandoned her while she was pregnant. With microcredit loans she has acquired land and livestock and she sends her children to school.

Reading through these four vignettes and the others, a motif emerges that is vaguely reminiscent of colonial rationalizations for Western domination: the problem of oppression is reduced to family issues. Men seem either chauvinistic or emasculated, parents uncaring of their daughters. The Western reader can feel gratified knowing he/she is not so sexist, so backward. Meanwhile, the stories have been cleansed of any notion of oppression at higher levels. And so, for example, it seems that in Haiti Janet Deval’s children aren’t going to school because of a bad father – not because the foreign powers have bolstered repressive regimes in Haiti that kept people in poverty, while international lenders have imposed austerity measures that reduced access to public services like education – measures the wealthier, more powerful countries would never accept for themselves.

Furthermore, the implication of these vignettes is that microcredit has empowered these women to be better mothers. Indeed, the fact that these women are able to better feed and clothe their children, and to send them to school is a wonderful thing. But we should not confuse poverty alleviation with empowerment. In fact, these vignettes tend to reinforce the essentialization of women as caretakers.

Evidence Supporting Microcredit’s Empowerment of Women But just because the advocates of microfinance do not grasp the concept of empowerment does not mean empowerment is not occurring. In fact, even in the aforementioned MCS vignettes, one borrower from Peru says she is president of a “mother’s club” that runs a soup kitchen for poor persons; and another borrower from Zambia has started a women’s group to help other women in need. This is getting closer to the concept of empowerment feminist scholars emphasize in their works.

Furthermore, the many studies by scholars in the field offer evidence of microcredit’s empowerment of women. Of course, operationalizing and measuring – while controlling for spurious factors – is a daunting task. But several studies have attempted to do just that. One of the first and most often cited is Hashemi, Schuler and Riley (1996), which looks at six Bangladeshi villages served by the country’s two biggest microcredit lenders, the Grameen Bank and the Bangladesh Rural Action Committee (BRAC). Their research includes a survey of 1,300 married women. Comparing women who are microcredit borrowers to other women who are not, they find that the former enjoy greater mobility outside of the home, more involvement in major decisions, and more political and legal awarness (12-13, 20, 22).

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In another widely cited study, Cheston and Khun (2001) conducted a survey of 1,200 people and find that women borrowers are more likely to defend their rights, and play more active roles in their communities than non-borrowers (12, 42-43). Borrowers also broaden their social networks (25, 35). And by participating in groups they increase their knowledge of political parties, process and channels of influence” (24).

Additionally, several studies in a variety of countries have found that women who borrow from MFIs are more likely to participate in household decision-making (Cheston and Khun 2001; Hashemi, Schuler and Riley 1996; Kabeer 2001; Mahmud 2003; Pitt and Khandker 1998).

Researchers also have noted borrowers’ improved self-esteem among borrowers (Cheston and Khun 2001, Hashemi, Schuler and Riley 1996; Kabeer 2001).

Evidence Against Microcredit’s Empowerment of Women These findings are quite impressive, but often challenged. For example, Goetz and Sen Gupta (1996) find that 38% of women with Grameen and 72% with BRAC don’t even retain full control of their loans. Kabeer (2001) and Mahmud (2003) counter that even if a woman hands over her loan to her husband, she still is empowered if doing so increases her choices or if she at least has some say over how the loan is utilized (81; 583-584).

However, the evidence suggests that women’s range of choices and the extent of their control often are quite limited. In fact, women microentrepreneurs “tend to lose control of their earnings as it increases and becomes more important in the household” (Kantor 2003: 435). And women’s increased earnings may be accompanied by a subsequent reduction of male contributions to the household (Cheston and Khun 2002: 33; Mayoux 1999: 972).

Meanwhile, Agurto’s (2002) research in Nicaragua shows that microloans have not affected intra-household decision-making, which typically was done jointly already before the loan (23). This reminds us that gender relations are culturally specific, and so we should not expect microcredit to have a uniform impact on women worldwide.

But empowerment is not only about control over money. There also is the question of control over one’s own time and labor. Here again the findings are troubling. Cheston and Khun (2002), Mahmud (2003) and Mayoux (1999) all note women microcredit borrowers have heavier workloads than non-borrower women, as they must combine household chores with their business (27; 597; 973). And Haase (2006) shows that women microcredit borrowers work longer hours than male microcredit borrowers, especially when those women are married: [A]fter explaining a daily routine that began as early as 3:00am to both prepare for her business and complete the necessary household chores before leaving for work and later returning to cook dinner, Miriam of Boaco told me, “I can rest later” – meaning when she retires in about 40 The Evolution of Thought on Microfinance | 77

years. Her dedication to her family is indubitably heroic, but it is unfair to her and inhibitive to her business (102103).

In short, women microentrepreneurs often must run their business on top of their laborintensive household chores and childcare duties. Meanwhile, the men in their lives too often do not pick up the slack and society does not offer support in the form of services like affordable childcare. Hence, “women’s businesses remain small and concentrated in less profitable sectors in large part because of the time constraints that women’s domestic responsibilities create” (Cheston and Khun 2002: 41).

This leads us to another dilemma: the limited range of entrepreneurial activities open to many women borrowers. In theory, these women could do anything they want with their loan. But in reality, gender stereotypes, societal norms and the women’s own limited human capital often set rather strict and narrow parameters on what these women can do with their loans. The result is that women tend to engage in less lucrative activities – often those associated with their traditional gender roles (Agurto and Guido 2003; Cheston and Khun 2002; Cloke 2002; Espinal and Grasmuck 1997; Haase 2007; Mayoux 1991; Monteiro 2002). Thus Kabeer (2001) finds “little evidence of any radical change in the gender division of labor. Access had increased their levels of economic activity, but not the range.” So “women remained confined to a small number of ‘female’ occupations” with workloads increased, but not options (68-69, 71-72).

And it might not be just the women borrowers who suffer, Mayoux (1999) asserts that girls are being employed in their mothers’ microenterprises while boys are getting preference for going to school (972). Even when women do educate their daughters, Kabeer (2001) notes their reasons for doing so often do not sound empowering; rather they do so to pay less dowry and to get a better husband for the daughter (78).

These kinds of problems are indicative of an approach to development that does not address the fundamental inequalities of gender relations. Upon receiving a microcredit loan, these women’s lives have changed, indeed, but if no one else around them has changed, the empowering potential of their access to credit is greatly curtailed.

Having surveyed the research on both sides of the empowerment debate, it is imperative to note a methodological problem that plagues most of these studies: sampling bias.

Most studies assessing the impact of microcredit compare borrowers to non-borrowers; they are quasi-experiments. The main difference between these studies and true experiments is that the women being studied were not assigned randomly into the two groups – borrowers and non-borrowers. Instead, borrowers were self-selected (by seeking out a microloan) and/or selected by the MFIs because they were seen as good potential borrowers. Selection bias occurs if the women who take the initiative to seek a loan or who the MFIs select are different from the women who never get a loan. Indeed, that appears to be the case, and Hashemi, Schuler and Riley (1996) acknowledge this sampling bias in their own work: women who borrow appear to already be more

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empowered; so their correlations between microloans and empowerment are exaggerated (643).

The solution to selection bias is a study where borrowers and non-borrowers are randomly assigned, not selected or self-selected. Researchers have begun employing such methods and their results so far show no benefit from microcredit for women’s decision-making power in the household (Banerjee et al. 2009). We await further such studies that look at other indicators of women’s empowerment.

In short, microfinance’s advocates appear to have overestimated the empowering potential of money. In an overly simplistic reading of liberal economic theory - where people are atomistic, wholly rational beings fixated on utility maximization – credit indeed would be expected to empower women in all circumstances. But in reality women must live within the context of families, communities, and broader social and political structures that largely constrain their options and thus their chances for empowerment. The situation is far more complex than a simple a matter of chauvinism within the household, as the MCS website implies.

Some of the aforementioned researchers recognize this reality and have concluded that loans alone are not enough to empower women (Cheston and Kuhn 2002; Kantor 2003).

Mayoux (1999) most pithily expresses this view when she asserts that microcredit “cannot have more than limited impact on women’s empowerment unless there are changes in wider gender inequalities in the broader social and economic contexts in which they operate” (27).

This is not to say empowerment through microcredit is a lost cause. After all, many women report improved self-esteem; at least sometimes women have some increased control over assets and earnings; and the lending groups give women a chance to network and to build solidarity (Mayoux 1999: 972, 975). The problem is that group lending, and the conscience-raising activities that that typically accompany it, is largely being done away with in the microfinance movement’s quest for financial self-sufficiency. For many MFIs in various countries, women’s meetings now are merely an opportunity for the MFI to collect its money, nothing else. Meanwhile, support agencies like the CGAP publish briefs lauding branchless banking via cell phones as a means to reducing operational costs – with no thought given to what might be the social impact of such strategies (Ivatury and Mas 2008). And Microfinance Information Exchange (MIX), the selfproclaimed leading information provider and setter of industry standards for microfinance, offers copious data on hundreds of the world’s largest MFIs, none of which includes any indicators of social impact. Instead the numbers relate to equity ratios and returns on assets to measure the MFIs’ economic viability. Meanwhile, CGAP’s list of essential MFI indicators that investors and donors should monitor includes portfolio quality, profitability, and efficiency – but no mention of empowerment (Rosenberg 2009). Organizations like CGAP and MIX are funded and supported by some of the largest and most influential lenders and donors in the world, including the World Bank and the Bill and Melinda Gates Foundation. Thus their influence in the microfinance

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sector should not be underestimated. So the fact that empowerment is not on the top of their agenda seems ominous for Marxist and feminist concerns.

CONCLUSION The purpose of this paper is not to dismiss or discredit microfinance as a strategy for empowerment. But applying the insights of critical theories like Marxism and feminism does raise awareness to the limitations of microcredit and microfranchising.

Furthermore, the current emphasis on financial self-sufficiency seems inimical to the goals of empowerment. This trend appears to be the consequence of a strategy that attempts to empower individuals through streamlined services, rather than engaging in more holistic involvement and striving for fundamental changes in the social, economic and political structures that oppress people.

But again, it is important to emphasis that this does not mean microfinance is completely incapable of empowering. Even in its current state, microfinance might be creating political opportunities for empowerment among the children of borrowers. For example, the US Civil Rights Movement of the 1950s and 1960s was preceded by decades of slow economic improvements that accumulated over generations for African Americans, giving them the resources and confidence they needed to initiate change from the bottom up (McAdam 1982). It is conceivable that microfinance could play a similar role in liberating poor and oppressed persons around the world. But the question remains whether microfinance is the most appropriate and effective means of doing that, especially with its current preoccupation with financial self-sufficiency.

REFERENCES Agurto, Sonia and Maria Alejandra Guido (2003). El Impacto Social del Microcredito en Nicaragua: Percepciones de Prestatarios y Prestatarias de Siete Microfinancieras.

Managua: FIDEG/WCCN. Banerjee, Abhijit et al. (2009). “The Miracle of Microfinance? Evidence from a Randomized Evaluation.” http://econ-www.mit.edu/faculty/banerjee/papers.

Blank, Rebecca (1993). “What Should Mainstream Economists Learn from Feminist Theory?” In Beyond Economic Man: Feminist Theory and Economics, edited by Marriane Ferber and Julie Nelson. Chicago: University of Chicago.

Bornstein, David (1996). The Price of a Dream: The Story of the Grameen Bank and the Idea that is Helping the Poor to Change their Lives. New York: Simon & Schuster.

Chan, Jenny and Charles Ho (2009). The Dark Side of Cyberspace: Inside the Sweatshops of China’s Computer Hardware Production. Berlin: WEED. Cloke, Jonathan (2002). “The Banking Sector in Nicaragua. Doctoral Dissertation, University of Loughborough.

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Counts, Alex (1996). Give Us Credit. New York: Times Books.

Cox, Stan (2006). “War, Murder, Rape … All for your Cell Phone.” www.alternet.org Duflos, E., and B. Gaehwiler (2008). “Impact and Implications of the Food Crisis on Microfinance.” CGAP, http://www.cgap.org/gm/document1.9.7450/Impact_and_Implications_of_Food_Crisis.pdf Elyachar, Julia (2002). “Empowerment Money: The World Bank, Non-Governmental Organizations, and the Value of Culture in Egypt.” Public Culture, 14:3, 493-513.

Espinal, Rosario and Sherri Grasmuck. “Gender, Households and Informal Entrepreneurship in the Dominican Republic.” Journal of Comparative Family Studies, 28:1, 103-128, 1997.

Fairbourne, Jason (2007). Microfranchising: Creating Wealth at the Bottom of the Pyramid. Cheltenham, UK: Edward Elgar.

Haase, Dwight (2006). Gender, Microcredit and the Informal Sector in Nicaragua.

Dissertation, University of Wisconsin-Madison.

Hamper, Ben (1991). Rivethead: Tales from the Assembly Line. New York: Warner Books.

Helms, Bridget et al. (2006). “Financial Inclusion 2015: Four Scenarios for the Future of Microfinance.” FocusNote No. 39. Washington, DC: CGAP. Ivatury, Gautam and Ignacio Mas (2008). “The Early Experience with Branchless Banking.” Focus Note No. 46. Washington, DC: CGAP. http://microfranchising.blogspot.com Jones Christensen, Lisa et al. (2007). “Vodacom Coummunity Services: Rural Telephone Access for South Africa.” In Microfranchising: Creating Wealth at the Bottom of the Pyramid, edited by Jason Fairbourne et al. Cheltenham, UK: Edward Elgar.

Kabeer, Naila (2001). “Conflicts over Credit: Re-Evaluating the Empowerment Potential of Loans to Women in Rural Bangladesh.” World Development, 29:1, 63-84.

Kantor, Paula (2002). “A Sectoral Approach to the Study of Gender Constraints on Economic Opportunities in the Informal Sector in India.” Gender and Society, 16:3, 285302.

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Karlan, Dean and Jonathan Zinman (2009). “Expanding Microenterprise Credit Access Using Randomized Supply Decisions to Estimate the Impacts in Manila.” www.povertyaction.org.

Kelley, Scott et al. (2008). “The End of Poverty as We Know It: The Profitable Alleviation of Poverty in a Globalized Economy.” In Alleviating Poverty through Business Strategy, edited by Charles Wankel. New York: Palgrave Macmillan.

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Mayoux, Linda (1999). “Questioning Virtuous Spirals: Micro-finance and Women’s Empowerment in Africa.” Journal of International Development, 11:7, 957-984.

McAdam, Doug (1982). Political Process and the Development of Black Insurgency, 1930-1970. Chicago: University of Chicago Press.

MIX (2002-2009). The MicroBanking Bulletin. Washington, DC: Microfinance Information Exchange, Inc. Monteiro, Natilina (2002). The Political Economy of Informal Markets: Restructuring Economies, Gender and Women’s Lives in Maputo, Mozambique. Dissertation, Northern Arizona University.

Pitt, Mark and Shahidur Khandker (1998). “The Impact of Group-Based Credit Programs on Poor Households in Bangladesh: Does the Gender of Participants Matter?” The Journal of Political Economy, 106:5, 958-996.

Rosenberg, Richard (2002). “Microcredit Interest Rates” Occasional Paper. Washington, DC: CGAP. _______ (2009). Measuring Results of Microfinance Institutions: Minimum Indicators That Donors and Investors Should Track. Washington, DC: CGAP. Shehabuddin, Rahnuma (1992). Empowering Rural Women: The Impact of Grameen Bank in Bangladesh. Dhaka: Grameen Bank.

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Young, Kate (1997a). “Gender and Development,” in The Women, Gender and Development Reader, edited by Nalini Visvanathan et al. London: Zed Books. _______ (1997b). “Planning from a Gender Perspective: Making a World of Difference,” in The Women, Gender and Development Reader, edited by Nalini Visvanathan et al. London: Zed Books.

Yunus, Muhammad (1992). “Grameen Bank, the First Decade.” In The Grameen Reader (Second Edition), edited by David Gibbons. Dhaka: Grameen Bank. _______ (2003). Banker to the Poor: Micro-lending and the Battle against World Poverty (second edition). New York: Persus Groups Books. _______ (2007). Creating a World without Poverty: Social Business and the Future of Capitalism. New York: Persus Groups Books.

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The Challenges of Public Equity Capitalization for Microfinance Institutions Deena Burris, Ph.D., Guilford College

ABSTRACT This study examines the large barriers faced by those promoting the joining of microfinance institutions (MFIs) and public equity capital markets as the mechanism for MFI growth.

Currently, the capitalization structure of MFIs severely limits the overall macroeconomic impact that they can have on developing nations, because as MFIs are restricted in the amount of loans they can make based on the amount of funds available for lending, entrepreneurial endeavors and growth potential are constrained. One way to broadly expand MFI capitalization is through inexpensive public equity from developed nations. Publicly traded mutual funds (PTMFs) offer a sensible method for accessing this inexpensive capital. For this research, data was collected from socially responsible PTMF managers. The findings show that large-scale change is needed in the way in which MFIs operate, the structure of the MFI industry, and regulation of MFIs in order to attract PTMF equity investments.

KEYWORDS: INTRODUCTION This research looks at the capitalization of microfinance Institutions (MFIs) in developing nations. Using a grassroots development approach, MFIs provide the financing necessary for local entrepreneurial growth that leads to community and eventually national economic growth. Currently, however, MFIs are not capitalized to the necessary degree that can have a significant impact on development.

There are four main sources of capitalization for MFIs: grant funds from private donors and NGOs, loans from local or international sources, customer savings, and equity funds. Grant funds are often limited in time, scope, and client base served. Donor funds are usually one-time gifts, leaving the MFI to search for additional support once these funds have been exhausted.

Loans, including bond issuances, constitute debt investments and must be paid back on a regularly scheduled basis. Due to the low profit margins for MFIs, obtaining capital from a lending source does not provide sufficient financial resources to develop a self-sustaining organization because much of the profit is used to pay interest on the loan. While customer savings can provide capitalization for MFI loans as proven by such models as village banking, many MFIs, due to their country’s banking regulations, cannot legally offer savings programs.

Equity, unlike grants and loans, however, provides a source for capitalization that does not require scheduled repayment or reapplication for funds. While equity does encourage More on Funding for Microfinance | 85

shareholder return with optional dividend payments, equity invested stays in the MFI and share price is based on supply and demand for the shares. Furthermore, equity provides a stable source of assets that can be used to meet increasing client demand. Because the interest income from the growing loan portfolio does not have to be used to repay debt obligations, profits from equity based MFIs can assist them in reaching financial and operational self-sustainability and thus potentially increase share prices.

This research explores the barriers that exist to publicly traded mutual fund (PTMF) investment in MFIs - particularly equity investment. While there are a number of private funds held by small groups of wealthy investors, foundations, or other non-profits that do provide equity investment in microfinance, these opportunities are not widely available to the growing numbers of socially responsible investors. This researcher interviewed select PTMF managers to determine their perceived barriers to investment in the MFIs. Because this research explores equity financing for MFIs, it is important to reference the five large MFIs that have recently issued initial public offerings (IPO). These MFIs, as identified in Table 1, have led the industry in equity investments. Their issuance of stock (equity) will be important in determining how the public capital markets will embrace MFI equity investments. However, the research performed in this study explores why more MFIs have not received equity investment from the public capital markets.

Table 1 MFIs That Have Issued IPOs for Public Investment MFI Capitec Bank Bank Rakyat Indonesia

Country

IPO Date

South Africa Indonesia

2/28/2002 11/10/2003

Equity Bank Kenya 8/9/2006 Banco Compartamos Mexico 4/23/2007 Financiera Independencia Mexico 11/01/2007 Source: Mirchandani, B. Microfinance Insights, Mar/April 2009 *Source: MixMarket.org

Loan Portfolio Outstanding as of Dec. 2008* 283,953,368 3,472,617,229 535,813,060 414,533,623 323,488,687

STUDY DESIGN Due to the detailed and individual nature of the questions being asked in this research, it was determined that personal interviews would provide the most comprehensive form of data collection. Because the goal of this research was to determine why publicly traded equity investment funds, particularly socially responsible investment funds, in developed countries are not actively investing in the global microfinance sector, socially responsible mutual fund managers were interviewed.

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Population and Sampling As described above, few of the currently active microfinance investment funds target institutional or public investors. Those that do invest have portfolios consisting largely of loans to MFIs instead of equity investment in those organizations. Because the goal of this research was to determine if PTMFs could be attracted to the microfinance sector, selecting the appropriate population for sampling – those PTMFs that have the appropriate strategy for MFItype investments – was a necessary step. (Alreck and Settle 2004). Therefore, the necessary requirements for inclusion in this study were determined to be as follows: 1. The fund must be publicly traded. That is, shares must be available on the secondary market. Hence, shares must be open or closed ended.

2. A portion of the portfolio must be devoted to equity investments.

3. The fund must have interests in developing countries.

Two sources were used to determine the research population. The first source was MIXMARKET equity investor funds. The second source was SOCIALFUNDS.COM, a database of socially responsible mutual funds. MIXMARKET provided information on funds currently active in the microcredit investment market, and SOCIALFUNDS.COM provided information on socially responsible mutual funds that are specifically interested in global community investment projects: 1. MIXMARKET Population: Between 2003 and 2007, MixMarket data reported 28 mutual funds participating in microcredit equity investmests. (MixMarket.org 2009) Based on the requirements of this study as noted above, only two of the 28 identified funds were publicly traded, and were, thus, eligible for inclusion in this research. Many of the organizations do support equity investments but are not accessible for individual public investors and instead receive their investment capital from the other non-profit and foundation investment organizations. For example, ProFund is a closed-end fund that receives its capital from other organizations such as ACCION, MicroVest, and Triodos – not directly from investors. (Profund 2006) The two eligible organizations are listed in Tables 2 and 3.

2. SOCIALFUNDS.COM Population: All funds in this database are publicly traded mutual funds (PTMF). To determine their interest in developing countries, funds were sorted by their attention to global community investment projects. Tables 2 and 3 identifies the three socially responsible international/global funds that invest in community investment projects.

(SocialFunds.com 2006)

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Table 2 Funds Meeting All Requirements for Inclusion in this Study Fund Name

Legal status

Calvert World Values International Equity A (CWVGX) MMA Praxis International A (MPIAX) & B (MMPNX) Portfolio 21 (PORTX) ResponsAbility Global Microfinance Fund Triodos Fair Share Fund

Socially responsible fund – publicly traded

Country of incorporation United States

Fund Assets (USD) as of 2008 276,560,000

Faith based investment United States fund (Mennonite) – publicly traded

93,848,232

Socially responsible fund – publicly traded Private Investor Open-ended investment fund Private Investor Closed mutual fund

United States

251,481,076

Luxembourg

298,254,000

Netherlands, The

220,766,098

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Table 3 Status and Asset Data for Selected Funds Microfinance Investment Fund (MIXMARKET) Calvert World Values International Equity A (CWVGX) MMA Praxis International A (MPIAX) & B (MMPNX) Portfolio 21 (PORTX) ResponsAbility Global Microfinance Fund Triodos Fair Share Fund

√

√ √ √ √ Microfinance Investment Fund (MIXMARKET)

Calvert World Values International Equity A (CWVGX) MMA Praxis International A (MPIAX) & B (MMPNX) Portfolio 21 (PORTX) ResponsAbility Global Microfinance Fund Triodos Fair Share Fund

Global Socially Responsible Investment Fund (SOCIALFUNDS) √

√ √ √ √ Microfinance Investment Fund (MIXMARKET)

Calvert World Values International Equity A (CWVGX) MMA Praxis International A (MPIAX) & B (MMPNX) Portfolio 21 (PORTX) ResponsAbility Global Microfinance Fund Triodos Fair Share Fund

Global Socially Responsible Investment Fund (SOCIALFUNDS)

Global Socially Responsible Investment Fund (SOCIALFUNDS) √

√ √ √ √

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Data Collection An interview instrument was developed to address all relevant variables involved in the study. The fifteen questions posed during the interviews were designed to focus specifically on the following basic topics (Alreck and Settle 2004): 1. Percentage of Portfolio Devoted to Microfinance Investments 2. Fund’s Strategy for Microfinance Investments 3. Domination of Microfinance Market by High Net Worth Investors, Institutional Investors, and International Financial Institutions 4. Conditions Necessary to Open the Microfinance Equity Market to Increased Public Investing 5. Steps Microfinance Organizations Must Take to Attract PTMF 6. Return on Investment and Critical Mass Necessary to Attract PTMF Once all interviews were completed, a master answer questionnaire was developed to track how each interviewee responded to each question. Using this tracking system, answer patterns were detected and findings were developed. (Oishi 2003)

Findings From the fifteen basic questions asked of the interviewees, seven findings were revealed.

These are as follows: Finding One: A small percentage of socially responsible fund portfolio investments is devoted to equity holdings in MFIs. Finding Two: Socially responsible funds tend to invest the Community Investment portion of their portfolio (1%) in local projects.

Finding Three: All PTMFs interviewed that invest in microcredit use external, privately held microfinance funds for the equity portion of their portfolio.

Finding Four: Investment in MFIs is dominated by high net worth investors.

Finding Five: The most important factors to consider when increasing the public trading of microfinance equity investments include the tradability of the shares, investor risk, critical mass/tradable volume, and return.

Finding Six: The return on investment (ROI) and critical mass necessary to attract PTMF to equity investments in MFIs ranges from 10 – 20% on ROI with a critical mass of USD $50 – 100 million in issuable equities.

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Finding Seven: Suggested steps MFIs and policy makers must take to attract PTMFs include establishing a system of valuation, creating a method of bundling assets, establishing a good internal management team, having a clear strategy and business plan, implementing a good information technology system, converting into a regulated institution, and hiring someone who understands the U.S. investment market.

The following sections provide a summary of the each of the basic topics identified above and the findings produced from these interviews.

Finding 1: A small percentage of socially responsible fund portfolio investments is devoted to microfinance equity.

1. Small Percentage to Community Investing: While all funds interviewed for this research considered themselves socially responsible funds, only two, Triodos and ResponsAbility, have greater than 90% dedication to MFI investments. The other funds had 1% of their portfolio dedicated to community investing, and of that none to a fraction of 1% was dedicated to MFIs. Table 4 Portfolio % Devoted to Community and Microfinance Investments Praxis % to Community Investing % to Microfinance Investments Debt to Equity % (of the % invested in microfinance)

Calvert

Triodos

ResponsAbility

1%

Portfolio 21 1%

1%

100%

100%

<1%

0%*

35%

91%**

100%

100% debt

N/A

99% debt 1% equity

90% debt 10% equity

96% debt 4% equity

*While the Portfolio 21 fund does not invest in microfinance, their investment advisory services firm, Progressive Investment Management, does advise clients on microfinance investments. **9% of the total portfolio is invested in Fair Trade projects. In addition, Triodosâ&#x20AC;&#x2122;s goal is to increase equity investments to 40% of the portfolio.

2. Debt versus Equity Percentages: Although two PTMFs are allowed to hold 10% investment in microfinance equity, they currently only hold 4-9% in equity with the remainder in debt holdings.

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Finding Two: Socially responsible funds tend to invest the Community Investment portion of their portfolio (1%) in local investments.

Socially responsible funds designate only a small percentage (1% or less) to community investments with the remainder of their investment portfolio going to socially responsible companies. Securities and Exchange Commission (SEC) regulations require that a socially responsible mutual fund listed in the United States disclose its community investment objectives in its prospectus if those investments exceed 1% of the total portfolio. (Secutities and Exchange Commission 2009) Microfinance is considered a community investment and, therefore, only receives a small portion of the socially responsible capital pool. In addition, Praxis, Portfolio 21 and Calvert invested the 1% of their portfolio dedicated to community investment in local or regional investment projects instead of global community investment projects. Investors, it was suggested, are more willing to invest in local projects with which they are more familiar. It is important to note that because they are dedicated microfinance funds and not regulated as socially responsible funds, ResponsAbility and Triodos are able invest >90% in microcredit investments.

Finding Three: All funds interviewed that invest in MFIs use external, privately held MFI funds for the equity portion of their portfolio.

Table five demonstrates that the while the publicly traded microfinance investment funds selected for this study do invest in equity, they do so indirectly through other privately held microfinance funds. Because of the due diligence and management required to make their own MFI investments, PTMFs invest the equity portion of their portfolio in other privately held microfinance funds such as MicroVest (U.S.), ProCredit (Germany), and Dexia (Luxembourg).

Table 5 External Investment Funds Used By Interviewee Organizations

External Microfinance Investment Organization(s) Used

Praxis

Portfolio 21

Calvert

Triodos

ResponsAbility

MMA Community Direct Investments; MicroVest

No MFI investments

Africap FINCA Oikocredit

Africap

ProCredit; Dexia Microcredit fund

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Finding Four: Investment in microfinance is dominated by high net worth investors.

1. Low Liquidity of Equity Holdings in MFIs: Small to Moderate Socially Responsible Investors depend upon the liquidity of their investments. Without liquidity, only high net worth investors can afford the risk and are willing to place a percentage of their portfolio into the current low liquidity MFI structure.

2. Difference between European and U.S. Investors in MFIs: Information, marketing, and exposure of microfinance in European countries is greater than in the United States. For example, h.r.h.Princess MĂĄxima of the Netherlands served as a United Nations advisor during the UNâ&#x20AC;&#x2122;s 2005 Year of Microcredit. (UN 2005) This exposure provided publicity for microcredit, particularly in the Netherlands, and organizations such as Triodos saw an increase in activity from small to moderate investors.

3. SEC Regulations and Access to the U.S. Investment Market: The model used by ResponsAbility (Switzerland) is unique in the PTMF industry for it provides for the public trading of shares on the Luxembourg financial market where small to average investors can invest in tradable securities. ResponsAbility indicated that the fund would like to trade shares in the United States (U.S.) but Securities and Exchange Commission (SEC) restrictions make this impractical given their current resources. For example, the SEC requires foreign companies listing on US stock exchanges to follow U.S. and SEC financial reporting standards often not used in foreign countries. (Secutities and Exchange Commission 2009) Thus, U.S. investors wanting to invest in PTMFs focused on MFI equity holdings must depend upon private funds or the socially responsible funds that dedicate small portions of the portfolio to MFI investments.

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Finding Five: The most important factors to consider when increasing the public trading of microfinance equity investments include liquidity, investor risk, critical mass/tradable volume, and return.

When asked if they believe it is possible, given the right circumstances, to open the microfinance equity market to increased public investing, all interviewees said yes. Given eight possible factors necessary to open this market to public investing, the interviewees were asked to rank the factors in order of importance. Table 6 identifies these.

Table 6 Top Four Conditions for Public Trading of Microfinance Funds Praxis

Portfolio 21

Calvert

Triodos

ResponsAbility

Condition 1

Tradability

Investor risk

Tradability

Investor risk

Tradability

Condition 2

Regulations

Investor return

Critical mass

Critical mass

Investor risk

Condition 3

Critical mass

Tradability

Regulations

Investor return

Investor return

Condition 4

Investor risk

Critical mass

Investor return

Tradability

Critical mass

1. Tradability of Shares: Tradability and thus liquidity is the key issue as equity investments into MFIs are easy to get in but hard to get out. High net worth individuals, particularly in the U.S., have the capacity and willingness to invest in low liquidity areas.

2. Investor Risk: The microfinance sector, noted one interviewee, still needs investors willing to take a bit more risk â&#x20AC;&#x201C; country risk, foreign exchange risk, and operational risk. Public investors have a smaller risk profile and, therefore, may be less willing to invest in developing country microfinance. This is particularly true of investments in the non- mature markets of Africa and Asia. Because mutual fund management teams seek the greatest return for the least risk, they are more willing to invest in microfinance funds found in the more mature and established regions of Latin America and Eastern Europe. Thus, more microfinance investment money is routed to these regions.

3. Critical Mass: Since microfinance loans are generally very small, the volume needed to attract the interest of a PTMF is substantial. For example, if a pension fund wants to invest even a small portion of its portfolio in microfinance equity, there would need to be a huge volume of tradable assets to make it worth their time and resources. (See Finding Six below for suggested critical mass targets.)

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4. Investor Return: From the perspective of the socially responsible (SR) fund, the returns on the community investment portion of a portfolio are already low compared to non-SR funds. In addition, investors expect that returns from equity investments to be higher than debt investments given the higher risk. Microfinance equity investments must show a solid return over the first few years that is equal to or exceeding the returns of current community investments.

5. Regulations: As discussed in finding two, SEC regulations require that a socially responsible mutual fund listed in the United States disclose its community investment objectives in its prospectus if those investments exceed 1% of the total portfolio. Thus, most SR funds will invest 1% or less in community investments such as microfinance in order to meet SEC requirements. This restricts the amount of funds available for investing in the microfinance sector.

Finding Six: The return on investment (ROI) and critical mass necessary to attract PTMFs to the microfinance equity market range from 10-20% on ROI with a critical mass of USD$50-100 million in issuable equities.

1. Return on Investment: Return on investment (ROI) is measured by taking the present value of your investment divided by the initial cost of the investment. In the case of publicly traded shares, share price determines demand. In order to increase demand for the shares of an MFI organization, management of the MFI would need to focus on increasing efficiency, increasing loans outstanding and clients served, and maximizing profits in order to become financially and operationally self-sufficient. Target ROI’s in the microfinance industry differ between the debt and equity markets. Because a fund heavily invested in debt is considered more short-term, the investor’s ROI is lower, generally from 2-6%. The Triodos 2008 Annual Report, for example, showed a return on investment of 7.5% - an expected return given that 90% of their portfolio is in debt investment. Given the risk and non-tradability of equity investments, however, the target ROI on equity is always higher than debt. While the investment funds surveyed suggested a 10-20% return on equity investments would be necessary to attract the public investor market, none could give an exact ROI on their equity investments as their investments are majority debt. (see Table 4) 2. Critical Mass: If a smaller fund such as Triodos, a dedicated microfinance fund, is investing directly in an equity opportunity, they require a minimum of USD $1 million.

However, this is an exception, as most of the funds interviewed required minimum amounts of USD $50 – 100 million investment to be more efficient with management resources. Another issue to consider is the strategy of pooling. One fund may only desire 10% of any one investment opportunity in an effort to diversify risk. Thus, the pool must be large enough to make the 10% investment worthwhile for the fund. A critical mass of USD$50-100 million, therefore, is necessary to attract larger, PTMFs. MixMarket showed that of the approximate 1,400 MFIs with reported data, only 72 (5%) had a loan portfolio of greater than $100 million, and many of those were banks - not NGOs where the greatest need for funding is often found. (MixMarket.org 2009)

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Finding Seven: Suggested steps microfinance organizations must take to attract PTMF include the following: establish a system of valuation, create a method of bundling assets, establish a good internal management team, have a clear strategy and business plan, implement a good information technology system, convert into a regulated institution, and hire someone who understands the U.S. investment market.

When asked how a group of microfinance organizations in a developing country might attract a publicly traded mutual fund for equity investment purposes, several suggestions emerged. First, each interviewee reiterated that the conditions in Finding Five (5) and Finding Six (6) are critical to making such and endeavor successful. In addition to those conditions, the following was suggested: 1. Establish a system of valuation: Limited mutual fund management resources makes due diligence on each potential investment opportunity very difficult. Therefore, mutual funds depend upon rating sources such as Standard and Poors (S & P) and Moody’s Investment Services. This type of system is currently lacking for many developing country opportunities such as microfinance, and although S&P has instituted a microfinance valuation sector, only a small number of MFIs (less than 20) have received valuation ratings. (Global Microfinance Congress 2009) While some MFI rating organizations such as PlaNet Rating, MicroRate, and MicroFinanza, have existed since the late 1990’s, they each differ in their rating tools and scale and review both quantitative and qualitative data (social and financial ratings). Mutual funds, particularly socially responsible funds, cannot easily obtain comparable, reliable, and transparent financial data on potential MFI investments. Without an easily accessible and reliable information source, microfinance investment opportunities go largely unnoticed in the publicly traded market.

2. Create a method of bundling or pooling assets: This suggestion relates to the critical mass requirements necessary to attract PTMFs. In order for MFIs, particularly NGOs, to reach the suggested USD$50-100 million, they would need to pool their loan portfolios. Because the MFIs operate at different levels—NGOs, credit unions, banks—they have different asset sizes, management structures, and regulatory requirements. Given the small size of MFI loans, organizing and pooling together the large number of MFIs needed to reach the target critical mass will be a challenging task, especially as there are no current examples of pooled MFI portfolios.

3. Establish a good internal management team and a clear business plan: As noted in the section on valuation systems above, mutual funds require easily accessible and reliable sources of information. Transparent and reliable data are the product of a good management team. Investors are interested not only in the organization’s financial data, they are also interested in the maturity, vision, and strategy of the management team. If a solid and established management team is lacking, the organization(s) will be considered young and will be overlooked as an investment option.

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4. Implement a good information technology (IT) system: In order for pool MFI assets to reach the required critical mass, a good IT system is necessary. Such a system would provide computerized data, branch networking, and reliable reporting capabilities. Not only will this give the individual MFIs better management capabilities and use of resources, it provides data that can be combined to create the investment pool.

5.

Hire someone who understands the U.S. investment market: One interviewee suggested that MFIs hire someone who understands Wall Street and knows how to attract investors that may not necessarily have a socially responsible focus. The challenge to accessing PTMFs for the microfinance equity market is knowing how to attract money that is not altruistic—turning the opportunity into an “investment” instead of just “doing good.”

Summary of Research Findings The seven findings noted above suggest that the reasons for the absence of microfinance equity funds in the publicly traded mutual fund market include: (a) lack of information and access between MFIs, mutual funds, and investors, (b) perception of high risk and low return for investors, (c) lack of the critical mass among MFIs (volume) that is necessary to attract PTMF; and (d) lack of capacity and organizational structure among MFIs. The interviews also revealed additional reasons for the lack of publicly traded equity funds, including the lack of tradability of microfinance equity investments and the 1% community investment portfolio threshold for U.S. socially responsible funds.

Implications for the Global Development Community This study on PTMF equity investment in MFIs suggests that not only are publicly traded mutual funds absent as a substantial source of MFI capitalization, the steps to achieve such a connection between PTMFs and MFIs are challenging. Global institutions and regulatory bodies would need to work together to overcome these challenges. For example, a rating system for MFIs is a large project that would require the participation of capital market rating agencies such as Standard and Poors as well as the cooperation of all MFIs and their national financial regulatory agencies. While eliminating or reducing these barriers offers tremendous opportunity to efficiently finance economic growth in developing nations by expanding the availability of capital to microenterprises, the restructuring needed to accomplish this is substantial and perhaps impractical. Although the steps to generate the necessary critical mass, create a valuation system, and list on a public stock exchange may prove to be challenging, the implications of such steps are significant from both the MFI industry and global development community perspective.

For the MFIs, access to the large capitalization pool of publicly traded equity markets would mean (1) that the industry would no longer have to rely on subsidies from donors, governments, and/or charities for operational and lending funds, and (2) that they would not be limited only to the capital investment of privately held funds. While further research is needed to determine if the steps presented are viable options for MFIs and the global development community, a path has been set to discuss accessing the publicly traded mutual fund market for microfinance equity.

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REFERENCES Alreck, P. & Settle, R. (2004). The Survey Research Handbook (3rd ed). New York: McGrawHill Irwin.

Global Microfinance Congress (2009, May). New York, NY. May 2009.

Mirchandani, B (2009). “Gauging and Hedging the Upside: The Need for a Publicly Traded MFI Index.” Microfinance Insights. Vol. 11, March/April 2009.

MIX MARKET.org. (2009, July). Obtained from: http://www.mixmarket.org/en/home_page.asp.

Oishi, S. (2003). The Survey Kit 2: How to Conduct In-Person Interviews for Surveys (2nd ed.).

California: Sage Publications.

Profund International. (2006, May 8) Obtained from: www.profundinternacional.com ResponsAbility Fund. (2006, May 8). Obtained from: http://www.responsability.ch/en/index.html.

Secutities and Exchange Commission (2009, July) “Issuer Disclosure and Reporting Obligations” http://www.sec.gov/about/offices/oia/oia_rulemaking.htm SocialFunds.com. (2006, May 7). Obtained from: http://www.socialfunds.com/funds/chart.cgi Triodos Fair Share Fund. (2006, May 8). Obtained from: http://www.triodos.com/com/international_funds/micro_finance_and_fair_trade/general/4 6181/?lang=.

UN International Year of Microcredit 2005. (2005). “About microfinance and microcredit.” http://www.yearofmicrocredit.org/pages/whyayear/whyayear_ aboutmicrofinance.asp.

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LEVERAGING MICROFINANCE AS AN IMPROVISED TOOL FOR UP-SCALING ACCESSIBILITY TO FINANCIAL PRODUCTS & SERVICES IN THE HINTERLAND OF INDIA Dr. Prasun Kumar Das, School of Rural Management, KIIT University, India

ABSTRACT With the economic resurgence of rural India, all the financial institutions be it a Commercial Bank, NBFC, MFI or Insurance company, rushing towards rural sector to exploit newer economic opportunities with their own products and services. Now the â&#x20AC;&#x2DC;opportunities at the bottom of the pyramid (BOP)â&#x20AC;&#x2122; has shifted the focus of the financial sector towards microfinance as an improvised instrument (products & services) to propel higher business growth coupled with generation of handsome revenues. India now occupies a significant place and niche in the global microfinance through promotion of Self Help Groups (SHGs) and the homegrown SHGBank linkage model. The Indian model offers a greater promise and potential to address poverty and livelihood as it focused on building social capital through providing access to financial products and services through linkage with the mainstream. Impact assessment being rather limited so far, it is hard to measure and quantify the effect of this Indian version of microfinance delivered by the formal financial institutions on improvement of livelihood but undoubtedly a lot need to be accomplished in terms of outreach and innovation to make a serious dent on the overall economic growth of the rural sector. However, the logic and rationale of SHG based microfinance have been established firmly enough that microfinance has effectively graduated from an experiment for eradicating poverty to a widely accepted paradigm of financial access for the teeming million rural populations of India through deepening of delivery channels.

KEY WORDS: Microfinance, SHG-Bank linkage, Livelihood, Outreach, Delivery channels, Accessibility to finance.

"Microfinance in India is approaching a historic 'tipping point' that could lead to a massive poverty reduction in the next five to ten years." - Grameen Foundation US in 2005.

"Microfinance is not a charity. It is a way to extend the same rights and services to low-income households that are available to everyone else. It is recognition that poor people are the solution, not the problem." - Kofi Annan, Secretary General, United Nations in 2004

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INTRODUCTION In India, we have been experimenting with various alternatives to reach the banking services, primarily credit, in rural areas through several initiatives since last forty years to bring the equality. Early initiatives in this regard were taken by building an institutional framework beginning with the focus on the cooperative credit institutions followed by the nationalization of major domestic banks and later the creation of the Regional Rural Banks (RRBs).

Simultaneously, several measures including establishment of the Lead Bank Scheme, directed lending for the Priority Sectors, banking sector's linkage with the Government sponsored programmes targeted at the poor, Differential Rate of Interest Scheme, the Service Area Approach, the SHG-Bank linkage programme and introduction of the Kisan (Farmer) Credit Card (KCC) were undertaken.

India has one of most extensive banking infrastructures in the world. However, millions of people in India do not have access to basic banking services like savings and credit. Various new and innovative banking channels including the information & communication technologies have been developed and implemented to bring maximum number of people under the formal banking system through the use of the vast network of rural and semi urban bank branches. Despite this endeavor, the fact remains that the banking services are not made available to the majority of the population residing in the rural and semi-urban areas and one glaring example of the same is that only 27% of total farm households are indebted to formal sources (of which one-third also borrow from informal sources). There may be host of reasons for this exclusion but both public and private commercial banks in India perceived rural banking as a high-risk, high-cost business i.e. a business with high transaction costs and high levels of uncertainty. Rural borrowers, on their part, felt that banking procedures were cumbersome and that banks were not very willing to give them credit.

While informal financial services have always been an integral part of the traditional economy of India, even semi-formal and formal financial services through agricultural cooperatives and nonbanking finance companies are within physical reach (less than 5 km) of perhaps 99 per cent of the population of the country. The development of the semi formal financial sector does not gained momentum until the last half of 1980s. With the introduction of the SHG-Bank linkage programme (SBLP) launched by National Bank for Agriculture and Rural Development (NABARD) on pilot basis during 1992 pointed out the huge potentialities of this sector in the rural India.

Formal financial services are, in theory, available to low income families mainly through 33,553 rural and semi-urban branches of commercial banks, 13,932 rural and semi-urban branches of Regional Rural Banks, 1,09,000 primary cooperatives, 1,000 NGO-MFIs and around 20 MFIs registered as companies (Section 25 of Indian Companies Act, 1956) and nearly three million SHGs. Even more numerous are the myriad of informal agents constituting a great range of financial service providers across the country. The rural branches of the commercial banks and the Regional Rural Banks (RRBs), in particular, were established specifically in order to meet the credit requirements of the poor â&#x20AC;&#x201C; small and marginal farmers, landless workers, artisans and small entrepreneurs and should, therefore, have emerged as a major source of microfinance. A

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total of 140,000 institutional outlets serving the rural sector, which ensure the availability of the financial and banking requirement.

In the early 1980s, the regulators of the financial sector including the Govt. of India realized the need for microfinance to provide the rural poor with savings and microcredit services. With the passage of time, there were more refinement in the objectives and vision, the RBI ensured that the loans available through microcredit schemes launched by various commercial banks were more accessible to the poor people as compared to normal bank loans. It also compared favorably with non-institutional moneylenders in terms of cost and quick availability.

This paper reviews the available channels of formal financial system for delivery of microfinance and different business models thereof. An attempt was made to find out the potentiality of micro banking in the rural market and the present scale of delivery by the different players of the formal financial system with their share holding pattern. An effort was also made to list out the enabling factors and their impact to increase accessibility and also the effective measures expected from the regulators for smooth sailing and stabilizing the system of micro banking in India.

SECTION-I: MICROFINANCE IN INDIA Defining microfinance During 1990s, microfinance was by and large understood as an activity that was adopting business principles but carried on by an “alternative sector” other than the Government & commercial sector, and done exclusively or predominantly with the “poor”. While it typically meant lending small amounts to smooth consumption, a similar loan provided by a rural branch of commercial bank or RRBs for instance was not necessarily considered microfinance. MFIs & SHGs were therefore, mainly acknowledged as microfinance providers. This ambiguity of defining the microfinance has been a stumbling block for years which was now been sorted out with the intervention of the Reserve Bank of India. According to the latest guidelines issued by the Reserve Bank of India, an amount of loan not exceeding INR.50000.00 (US $ 1250.00) to an individual or a micro-entrepreneur would qualify as microfinance.

Demand side of microfinance Traditionally, the microfinance clientele were self-employed micro-entrepreneurs for whom credit served the purpose of consumption, smoothening, investment in productive assets or working capital for income generation activities. It is estimated that in India there exist approximately 75 million poor households, out of which 60 million are rural and semi-urban and 15 million urban households. One estimate assumes that the total annual requirement of credit for the rural and semi-urban poor families would be at least US$ 5.10 billion on the basis of a minimum need of US$.85.00 per family. Another estimate for requirement of credit (excluding housing) is 26.25 billion US$ assuming that annual average credit usage are US$ 150.00 per rural household, and US$ 200.00 for poor urban household. An additional US$ 4.20 billion is estimated to be required for housing per year. Apart from micro-credit, they require savings and insurance as well, which together is a real big picture.

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Supply side of microfinance The commercial banks in India since 1970s was in the branch expansion mode and with certain restrictions imposed by the Reserve Bank of India, they were in compulsion to open rural and semi-urban network of branches to serve the rural and semi-urban clientele either in the form of farm credit or non farm credit. Apart from the banking sector since 1990s, the financial sector has witnessed changing pattern in rural finance space with the introduction of SHGs and the aggressive entry of NBFCs & MFIs at a latter stage. The key players along with the purpose and the products of the supply side providing microfinance are appended in Table-1.

Table1. Supply side of Microfinance in India

Key players

Example

Purpose

Banks

All commercial banks both All purposes under public & private sector

Meso-level NBFCs

Fullerton financial

India,

Products 1. SHG â&#x20AC;&#x201C;Bank linkage 2.MFI- Bank linkage

Citi Consumer finance, Customized products Asset finance, Productive finance

MFIs (NBFCs BASIX, SKS Fin, Bandhan & NGOs)

Small income Customized products generating activities, Consumption

Co-operative Societies

PACS*, Agri. Marketing Small income Need based products org. generating activities, Consumption

Informal sources

Money lenders, creditors

trade Consumption

*PACS- Primary Agriculture Credit Society (Source: Author, 2009)

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No products as such

Apart from the above key players in the microfinance space, Apex financial Institutions like NABARD, Small Industries Development Bank of India (SIDBI), housing organizations like National Housing Bank (NHB), Housing & Urban development Corporation (HUDCO) etc., are also encouraging the Banks, MFIs, NBFCs, SHG Federation and Housing Finance Companies (HFCs) in the private sector to promote microfinance through financial, technical and capacity building inputs.

Demand Supply Gap All said & done the fact remains that the micro-entrepreneurs (the self-employed poor) have little access to the formal financial system in developing economies like India. A study conducted in Uttar Pradesh, the biggest state of India (Das, 2009) shows that each commercial bank branch is covering a population of 26,013 with coverage of 13,634 adult populations which is the classic example of existing gap in the system. It was also estimated that at best, formal financial institutions discussed above could reach the top 35 per cent of the economically active population, which leaves the bottom 65 per cent without access to formal financial services.

Microfinance institutions (MFIs) as semi-formal delivery channel have grown rapidly to meet this demand. However, their outreach remains very small compared with the demand and it has been estimated that less than 5 per cent of those poor households had access to microfinance services. The new generation MFIs armed with the technological backing is growing at a faster rate due to the space left by the commercial banks that have the inherent advantage to serve the rural people and bridge the huge gap. As per the latest available information from the discussion with the bankers, the public sector banks are now geared to take up the challenges posed by the NBFCs & MFIs with restructuring their products & services especially for the rural clientele.

The SHG-Bank linkage, the flagship programme of the commercial banks has now been considered as a business proposition and expected to upscale the operation. In spite of the impressive figure, the supply side of micro finance in India is still recently grossly inadequate to fill the gap between de3mand and supply but it holds the promise to act as a great opportunity for the financial sector of the economy as a whole and commercial banks in particular.

Business models of microfinance Commercial Banks are playing a major role in providing microfinance through their unique business model, which has emerged as the flagship model for providing microfinance services in the country. It is a proven tool of extending to the un-banked rural clientele access to formal financial services. The whole story of the SHG- Bank linkage programme (SBLP) can be easily read from the summary Table 2 given below:

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Table 2. SHG Bank linkage programme in India (Highlights as on 31.03.2008)

Sl No 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

Particulars No of SHG linked per cent of women groups No. of participating Banks i) Commercial Banks ii) Regional Rural Banks iii) Co-operative Banks No. of States/UT covered No. of Districts Covered Outstanding Bank loan (US$) No. of Households assisted (million) Av. Loan per SHG – New (US$) - Repeat (US$) Av. Loan per family – New (US$) - Repeat (US$) Model –wise linkage in percentage (cumulative) i) SHG formed & financed by Banks ii) SHG formed by other agencies but directly financed by Banks iii) SHG formed by Banks using financial intermediaries

Cumulative as on 31.03.2008 3477965 90 per cent 498 50 96 352 31 587 2.58 billion 58.3 925.00 1640.00 66.00 118.00 17 per cent 75 per cent 8 per cent

(Source: NABARD, 2007-08) During the year (2007-08) 7,39,875 new SHGs were credit linked with banks and bank loan of US$ 880.74 million disbursed, taking the cumulative number of SHGs credit linked to 34,77,965 as on 31 March 2008. In addition 1,86,883 existing SHGs were provided repeat loan of US$ 351.16 million. As on 31 March 2007, 4.16 million SHGs maintained savings and had savings of US$ 731.80 million outstanding with the banking sector. The total loan outstanding as on 31.03.2007 stood at US$ 2.58 billion. The programme has covered more than 58 million poor households, making it the largest Micro Finance programme in the world (NABARD, 2007-08).

Encouraged by the success of the above business model, the commercial banks/Reserve Bank of India/NABARD promoted the linkage of Micro- Finance Institutions (MFIs) with the banking sector. The MFI–bank linkage model too has assumed importance because of credit support extended by banks for on lending to clients by MFIs. As per the Annual Report of NABARD, 2007-08, the commercial banks disbursed a loan of US $ 239.90 million to 334 MFIs as on 31.03.2008 and the loan outstanding stood at US $ 330.10 million to 550 MFIs.

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SECTION-II: RURAL MARKET & POTENTIALITY OF MICRO BANKING Market of microfinance The demand for microfinance services â&#x20AC;&#x201C; savings, credit and insurance â&#x20AC;&#x201C; is apparently insatiable in India. In that sense, India is perhaps the largest emerging market for microfinance services in the world. This can be proved from the following facts.

The National Council for Applied Economic Research (NCAER), India reported (2007) that the low-income population in rural India has come down from around 65 per cent during the early 1990s to 25 per cent during the recent survey.

Meanwhile, middle-income households in rural India have gone up from 33 per cent to 70 per cent. Almost 50 million households have transcended from low income to the middle income.

As per the estimates, there is an increase in the savings by rural India to the extent of 31 per cent.

The urban-rural remittances have increased largely as the migrant population began sending their earnings to the villages.

This reflected in a sudden spurt in demand from Indiaâ&#x20AC;&#x2122;s increasingly assertive and affluent hinterland. Rural India now accounts for around 53 per cent fast moving consumer goods market. Even more telling, close to 59 per cent of demand for consumer durables emanates from rural India.

These are not just statistics, rather these culminates into the potentiality and demand for micro banking in the hinterland of India and the microfinance has the potential to be the most suitable tool to tap this emerging market.

The potential and captive market of microfinance in India is really a very important area of research. In this paper, we have tried to estimate the potential market which starts with the number below poverty line (BPL) population in India and as per the most conservative estimates, the average number of BPL population will be around 57.90 to 7.73 million. To determine the amount of on lending funds requirement for these BPL clientele, on annual average loan size of US $ 100.00 to US $ 250 has been considered (Average loan size is taken from historical data of last 5 years of the MFIs). Applying these loan amounts to the BPL population identified above, the annual credit demand could go to US $ 5790.00 million to US $ 1447.50 million (Table 3).

Apart from the above estimate, if we calculate the SHG-Bank linkage programme (SBLP) of the commercial banks, the market of microfinance will be even bigger and attractive as a very lucrative business proposition.

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Table 3. Annual microfinance demand (using National Poverty Line Statistics) Av. Loan Size (Estimated) (in US $)

Potential clients (BPL) (in million)

Financial requirements (in million US $)

Financial requirements ( in INR billion)*

100 125 150 175 200 225 250

57.90 57.90 57.90 57.90 57.90 57.90 57.90

5790.00 7237.50 8685.00 10132.50 11580.00 13027.50 14475.00

231.60 289.50 347.40 405.30 463.20 521.10 579.00

* Assumed US $ 1 = INR 48

Readiness of the microfinance service providers To tap such a big market for microfinance, the commercial banks are revamping their already existing rural and semi-urban branches, which are traditionally poorly run, poorly staffed, and were an economic liability to them. Now the commercial banks with their vast network of rural and semi-urban branches are also facing the heat of the competition from the NBFCs, MFIs and NGOs who are now aggressively tapping the rural market and filling up the space left by the commercial banks.

No doubt, rural banking had a pioneering role to play in sowing the seeds of development in the agrarian society, but few of these Public Sector Banks are reaping the reach rewards now. If they do not look smart and innovate the products for catering the rural market with a cadre of dedicated manpower. They could loose the first mover advantage.

Private sector banking giants in India like ICICI Bank Ltd & HDFC Bank Ltd. has taken a different route to tap this rural market by financing to the MFIs for on lending to the individual entrepreneur and supporting the microfinance programme for its success. Out of the Public Sector Banks, The State Bank of India has implemented the Business Facilitator/Business Correspondent model for financial inclusion and taps the rural market by increasing their reach through these outsourced agents. As economic opportunities mushroom across rural India and the commercial banking sector continues to slumber, the non-banking financial companies and MFIs are awakening from the booming demand of the rural households armed with new products and services. There are also disparities in geographic distribution of the bank branches of the commercial banks and the credit extension, which is also an important bottleneck for success of micro finance movements in India.

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While studying the level of access to the financial service providers it was found that the accessibility of the formal institutional sources of financial services are low compared to the semi-formal sources like MFIs, SHGs etc. but the most accessible form of financial services are still the informal sources like money lenders, trade creditors, local shop keepers etc.

Cost of Transaction in microfinance The effective interest rate in the microcredit is ranging between 20-45% per annum, which includes various factors such as processing fees, repayment frequency and number of installments etc. This explains how a flat interest rate of 15% per annum, can amount to an effective interest rate of 38% per annum (Shamik Ravi, 2006). A study made by Yadav & Kumbhare (2008) concludes that the effective cost of borrowing in the SHG-Bank linkage model varied between 10.40 – 18.15 %. This also includes the cost of intermediation (i.e. promotional cost). Another study conducted in Uttar Pradesh, India (Das, 2009) recorded average cost of transaction at 10.05% in the commercial banks but at the same time average rate of interest being paid by the unbanked population to the informal sector was 28.67% which is pretty high..

SECTION-III: COMMERCIAL BANKS TO IMPROVE EFFECTIVENESS FOR MICROFINANCE Commercial Banks vis-à-vis microfinance Our research findings came from in-depth study of 12 major commercial banks in India reveals that initially a great deal of microfinance undertaken by commercial banks was because of government mandates to lend to this sector rather than for business reasons. The types of commercial bank involvement in microfinance can be classified as follows: • Government-subsidised lending programs channelled through the banks • Government-mandated lending targets met by banks subsidising interest rates • Government-mandated lending targets with banks charging commercial interest rates.

• Microfinance as a profitable business Microfinance- past experience of commercial banks The large majority of commercial bankers interviewed in the process had little positive experience of banking with the poor although they are in this business for last 30 years. They experience non-payment by the poor, look at the high costs, and assume the problem is with the poor rather than with the design or delivery of their bank's products. They also distrust NGOs that provide financial services to micro-entrepreneurs, because they are not-for-profit institutions and not subject to any regulation. As a result, the majority of commercial bankers perceive microfinance as risky, unprofitable and not fitting with their core business objectives. By contrast, commercial bankers with a positive perception of microfinance had seen successful microfinance in practice, undertaken a comprehensive analysis of the size and performance of the microfinance market, and designed lending and savings products that were profitable and could reach significant scale.

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Microfinance by Commercial Banks: Sustainability and scalability When assessed based on achieving both high portfolio quality and significant scale of outreach to the poor, most of the commercial bank microfinance programmes that were mandated by governments can only be considered as failures. The exceptions were those programs that charged a commercial rate of interest. They had a higher portfolio quality than other programmes but they were still not profitable. This almost universal failure is not explained by the different policy contexts across the region of the vast country like India. Further, because microfinance has not been a profitable business, government mandates have been unsuccessful in encouraging commercial banks to become involved in microfinance. The banks must have the incentive to design better products for micro-entrepreneurs, which can be acceptable across the rural people and profitable as well.

Innovation in products & services: the Buzzword in microfinance There is an immediate need to expand the range of products available in the market, both on the savings side and on the credit and insurance sides. As the micro-finance sector grows and develops, MFIs are expected to play a greater role in the times ahead. In 2000, the RBI had allowed banks to adopt their own model of lending to micro-finance and choose any intermediaries for the purpose. As a result, new models are being experimented with by banks.

The Task Force on Supportive Policy and Regulatory Framework for Microfinance had recommended the promotion of Self Regulatory Organizations (SROs), evolving from within the MFI sector.

Key success factors for commercial bank involvement in microfinance Based on our research, and corroborated by other studies, the following were found to be key success factors for microfinance in commercial banks and to tap the untapped potential of the rural market with thumping presence: • Create a small specialised bank or a separate microfinance unit within a large commercial bank.

• Treat savings as equally important to lending (now a days considered as an important resource).

• Charge interest rates to cover all the costs of the lending products (including the service charges) with a prompt service as per the convenience of the customer.

• Ensure excellent MIS and portfolio management by using latest information technology.

• Adoption of Business correspondent and Business facilitator model for increasing the outreach.

• Create a special/dedicated cadre for rural/semi-urban branches who will handle the micro banking portfolio and train/motivate them.

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CONCLUSION The most effective way for governments to encourage commercial banks to become involved in microfinance to make this programme most successful in the world then it has to ensure an appropriate regulatory and prudential framework. The elements of an optimal policy context are: • • • • • •

sound macroeconomic policies and basic infrastructure in the rural/semi-urban areas to ensure a growing economy minimal restrictions to profitable lending, particularly no interest rate caps in the microfinance. enhance the limit of microfinance from existing Rs.50000 to Rs.1.00 lakh so that the bankers find it cost effective. enhanced ability to establish a small commercial bank which can focus on this sector (such as a low minimum capital requirement) appropriate prudential regulations for this market including capital adequacy ratios, asset quality indicators and unsecured loan limits.

Concessions in regulatory capital requirement in case of taking a sizable amount/portfolio in microfinance.

Having all these elements in place will not guarantee that commercial banks in India will enhance the scale of microfinance lending. However, there certainly would not be external constraints for up scaling the microfinance movement in India through the most vibrant segment of the Financial Sector of India with special emphasis on building and streamlining Microfinance Institutions and providing enabling environment to operate.

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REFERENCES: Das, P. K. (2009) ‘Research report on Feasibility of Business Correspondent/Facilitators models for financial inclusion in the state of Uttar Pradesh, India’ submitted to Indian Institute of Banking & Finance, Mumbai, India. May, 2009 (Unpublished).

Ghate, Prabhu (2007): ‘Microfinance in India – A state of the sector Report. Book’ published by Access development services & Ford Foundation, New Delhi, India.

NABARD (2008): Annual Report. Website: www.nabard.org Ravi, Shamik (2006): Is micro-credit too costly? - Face –Off in The Economic Times, September 15, 2006. Website: www. economictimes.indiatimes.com Srinivasan, R. & Sriram, S (2003): Microfinance in India: Discussion. IIM, Bangalore Management Review, June, 2003, p-6-21.

Thorat, Usha (2007): ‘Banking in the hinterland’. Key note address at the conference on “Banking in the hinterland” organized by IBA at Mumbai on February 14, 2007.website: www.rbi.org.

Yadav, Shalini and Kumbhare, S. L. (2008): Transaction costs under SHG-Bank Linkage programme. Bank Quest .Vol 79, No. 1, p 30-34.

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ARE CUSTOMER RELATIONSHIPS THE KEY TO PRODUCTIVITY IN MICROFINANCE INSTITUTIONS? Karl Dayson and PĂĽl Vik, Department of Sociology, University of Salford, United Kingdom

ABSTRACT Increasing the productivity of loan officers is a key concern for managers of Microfinance Institutions (MFIs) as it is a key driver of overall sustainability. Yet there is a dearth of research analyzing the use of time among MFI staff. In this paper, we analyze timesheet data of staff members of four UK MFIs. We find that the MFIs whose lending staff spent a greater proportion of their time on direct face-to-face customer contact also had the greatest efficiency and loan officer productivity. This appears to contradict the experience of the mainstream financial sector which has raised productivity by decreasing the amount of face-to-face contact with its customer base. We suggest that the explanation for this contradiction lies in the differences in lending methodology. Banks rely on credit scoring technologies which allow them to process loan applications through web and telephone-based channels. MFIs rely to a greater extent on relationship lending whereby the loan officers collect and make their decision based on soft and non-codifiable information as well as hard and codifiable data. In this case the key to increasing loan officer productivity lies in increasing the proportion of time spent with potential customers and in making the interview itself more efficient.

KEYWORDS:

Staff productivity, microfinance

INTRODUCTION The productivity and efficiency of lending staff is important for the overall performance of Microfinance Institutions (MFIs) (Woller and Schreiner, 2001). Raising loan officer productivity enables MFIs to decrease the per-unit cost without passing on the cost to the consumer, which could have a negative effect on the institutionâ&#x20AC;&#x2122;s ability to compete for customers. It is perhaps of particular importance for MFIs operating in industrialized countries because staff costs, of which loan officer costs is often a considerable proportion, constitute a large proportion of operating costs (see e.g. Dayson et al, 2008).

There are three principal ways in which the MFIs may do this. First, staff incentive schemes are believed to increase the productivity of loan officers (Holtman, 2001; McKim and Hughart, 2005). Staff incentives are typically linked to the number of loans issued, number of new clients, quality of portfolio (arrears) or a combination of these (Aubert et al, 2004). Already widely used in the mainstream banking sector, survey data suggest that the proportion of MFIs with a staff incentive scheme has grown considerably over the past 10-15 years (McKim and Hughart, 2005).

The proportion of MFIs with a staff incentive scheme grew from 6% in 1990 to 63% in 2003, constituting a more than tenfold growth (McKim and Hughart, 2005). Of the 106 MFIs with staff incentive schemes surveyed by McKim and Hughart (2005), 79% reported that staff incentives had a high or very high and positive effect on the productivity of loan officers. However, in summarizing the experience of the Bolivian MFI PRODEM, Bazoberry (2001) argues that incentive schemes rewarding branches or individual loan officers stifle cooperation, increase Bonus Material

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fraudulent behavior of loan officers and branches, pressurize loan officers to pay bad loans out of their own salary and distort staff motivation. Increasingly questions are also being raised about the distorting effect of staff incentives on the business objectives in the mainstream financial sector leading to a focus on short-term profit rather than longer-term institutional viability.

Second, the introduction of IT and banking transaction technologies can increase loan officer productivity by reducing the time spent on collecting payments and inputting and processing data. The introduction of such technology has enabled the mainstream banking sector to reduce their operating costs. In the case of the US banking sector, the average transaction cost of a faceto-face transaction is reduced from US$1.07 to US$0.27 (ATM) or one penny if it is conducted online (DiDio, 1998 cf. Nath et al, 2001). In the case of Spain, Hernando and Nieto (2007) find that the adoption of internet technology in the delivery of services by Spanish banks in the period 1994-2002 resulted in a reduction in staff costs.

For the microfinance sector technological innovation has centered on reducing the time and costs associated with collecting loan repayments (Ivatury and Mas, 2008). Examples include using mobile phones to repay loans. To date, the implementation of such technology has largely been confined to “those relatively few MFIs [with sufficient] financial resources and skills” (Ivatury and Mas, 2008, p. 10).

Finally, the MFIs may introduce credit scoring systems, defined as “computer-based management tools which rely upon statistical techniques to predict the credit performance of consumers” (Leyshon and Thrift, 1999, p.444). Credit scoring is believed to increase loan officer productivity by reducing the time the loan officer spends on data collection and underwriting (Allan and Frame, 2005), and, if accurate, it may also reduce the time spent on delinquency control (Schreiner, 2003). Most credit scoring systems rely on hard and easily verifiable data generally held by credit rating agencies (Leyshon and Thrift, 1999; Dellien and Schreiner, 2005; Allan and Frame, 2005). Credit scoring is widely used in the mainstream banking sector (Leyshon and Thrift, 1999; Burton et al, 2004; Berger et al, 2009). Furthermore, if combined with IT and telephony, credit scoring also enables loans to be processed via the internet or the phone.

However, to date few MFIs have implemented credit scoring technology (Dellien and Schreiner, 2005), as it is organizationally and technically demanding for MFIs to adopt. MFIs often have inadequate databases to support the use of credit scoring (Schreiner, 2003). Moreover, credit scoring may also be an inappropriate technology for the target clients of MFIs. Credit scoring is less suitable for assessing the risk of default of joint-liability groups (Schreiner, 2003) and MFI target clients often do not have a credit history because they borrow from informal sources or companies not delivering information to credit rating agencies (Competition Commission, 2006).

In many cases, MFI target clients have a poor credit history excluding them from accessing mainstream finance.

Although loan officer productivity is often – indirectly or directly – analyzed as a driver of overall sustainability (e.g. Woller and Schreiner, 2001), there is a dearth in in-depth research analyzing time-use within MFIs. One of the few examples of such research is Dayson’s (2005) analysis of the use of time by staff members of four UK MFIs. One of Dayson’s main findings 112

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was that loan officers spent considerable time on giving money and debt advice to unsuccessful loan applicants.

In response to this lack of research, this paper presents the findings of an analysis of the use of time over a three-week period of 30 staff members from four UK MFIs. We find that the MFIs whose lending staff spent a greater proportion of their time on direct face-to-face customer contact also had the greatest efficiency and loan officer productivity. This appears to contradict the experience of the mainstream banking sector, which has raised productivity by decreasing the face-to-face interaction between loan officers and loan applicants. We suggest that this can be explained by differences in the lending model. The banksâ&#x20AC;&#x2122; use of credit scoring enables them to process loan applications via the web or the telephone, while MFIs tend to rely on collecting and analyzing soft, uncodifiable information that does not lend itself to web or telephone-based sales channels.

The remainder of this paper is organized into four sections. The first section outlines the UK microfinance sector and the second details the methodology applied. The third section presents the findings, while we discuss the findings and conclude in the fourth section.

THE UK MICROFINANCE SECTOR The non-member based MFIs in the UK (often referred to as Community Development Financial Institutions (CDFIs)) are independent and self-regulated, and most are affiliated to the Community Development Finance Association (CDFA) as a trade body.

Although some UK MFIs were set up in the 1980s, most of the over 70 MFIs currently operating in the UK were set up in the late 1990s with financial and technical support from the New Labour government. Intimately linked to the New Labour discourse on fostering entrepreneurship and self-employment in deprived neighborhoods and among low-income groups as opposed to tax-based income distribution (Affleck and Mellor, 2006), the MFIs initially focused exclusively on providing business loans to aspiring and existing entrepreneurs unable to access finance from the mainstream banking sector.

Although most MFIs still focus on business lending, a growing number of MFIs are also seeking to provide affordable credit (at subsidized rates) to credit-impaired households without access to finance through the mainstream finance sector. It is estimated that there are around 2.3 million users of high-cost licensed home credit lenders in the UK, equivalent to around 6% of the adult population (Ellis et al, 2006), constituting a target market for personal lending MFIs (Dayson et al, 1999).

The UK microfinance sector is still an immature sector. According to the latest industry survey from the CDFA, 49% had been in operation for less than 5 years and another 23% had been founded less than 10 years ago (CDFA, 2008). In 2008, the sector made over 12,000 loans for consumption, housing, small enterprise and social enterprise purposes (Table 1). The total outstanding loan portfolio was just above US$450 million.

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Table 1: The UK microfinance sector Personal loans

Housing loans

Enterprise loans

Social enterprise

Total

Number of loans

7,406

303

3,921

1,346

12,976

Total value OLP (US$ m)*

5.0

1.0

66.2

381.0

453.2

% MFIs offering…**

14

3

69

17

…

Source: CDFA 2008 survey of UK MFIs (CDFA, 2009) Notes: * Based on conversion rate of £1 = US$1.65 ** Based on CDFA 2007 survey as these figures not released for 2008 survey; OLP = Outstanding loan portfolio

METHODOLOGY Four UK MFIs were selected for the case study research (Table 2). The MFIs were selected because they were willing to participate and disclose financial and organizational data, and because combined the institutions cover the whole of the UK. Given the sensitive nature of the data disclosed the participating MFIs are assigned the letters A to D in place of their real names.

Table 2: The MFIs studied MFI A MFI B Number of employees (FT positions) Operational sustainability ratio (%) Total value OLP (US$ ‘000)* Financial products (% of OLP)

PL (74) BL (26)

Loans granted by product

PL: 1262 BL: 78

Other services Branches

SP

MFI C

MFI D

10

12

5

11

61.3

11.4

46.3

30.3

1,550’

329’

902’

723’

3

PL (37) BL (34) SEL (29) PL: 202 BL: 46 SEL: 2 DMA 2

PL (54) BL (46) PL: 310 BL: 23 ..

2

PL (58) BL (41) HIL (1) PL: 562 BL: 41 HIL: 4 DMA 2

Source: Loan portfolio data provided by the MFIs for the financial year of April 2006 to March 2007 Notes: * Assessed on March 31 2007 Abbreviations: PL = Personal loans, BL = Business loans, SEL = Social Enterprise Loan, HIL = Home Improvement Loans, SP = Savings products, DMA = Debt and Money Advice, FT = Full-time, OLP = Outstanding loan portfolio

The MFIs differ in terms of their business strategies and product portfolio. MFI A specializes in personal finance and has since April 2007 stopped offering business loans. MFI A operates in areas with large groups of the population at the margins of mainstream finance evenly spread allowing for large-scale personal lending. Conversely, MFI B, MFI D and, to a lesser extent, MFI C offer a wide range of services to households, social enterprises and small businesses, including advice and home improvement loans.

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FINDINGS In order to ascertain the level of staff productivity and efficiency staff members filled in a daily timesheet over a three-week period. In total, 30 out of 33 MFI staff members submitted timesheets (Table 3), and semi-structured interviews were conducted with 14 staff members across the three staff groups (admin, lending staff and management) from the four MFIs.

Table 3: Participating staff members MFI A

MFI C

MFI D

MFI B

Total

Total staff

7

6

11

6

30

Admin

2

1

2

1

6

Lenders

3

3

6

3

15

Management

2

2

3

2

9

The data was weighted according to the normal distribution of staff across the staff categories to ensure that non-participating staff members did not skew the results.

Overall time use by MFI Table 4 displays the weighted timesheet data according to activity by MFI for all staff members.

Each activity consists of numerous tasks. For example, making loans consist of loan interviews, reviewing application, issuing of loan and loan administration. A key distinction made is the distinction between the time spent on sustaining activities â&#x20AC;&#x201C; tasks not easily linked to the provision of financial products (e.g. office management, reporting and promotional activities) â&#x20AC;&#x201C; vs. time spent on core activities directly linked to the provision and monitoring of loans.

Table 4: Proportion of time spent by all staff by MFI (% of productive time) MFI A

MFI B

MFI C

MFI D

Average score

Loan enquiries

7.1

2.5

8.0

3.5

5.3

Money advice

1.9

0.3

0.8

0.1

0.8

No shows

2.7

0.1

0.0

1.0

1.0

Making loans

31.4

33.7

21.9

29.2

29.1

Month-end reports

4.3

1.7

4.6

2.2

3.2

Servicing loans

2.7

2.4

5.1

3.8

3.5

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Delinquency control

7.9

10.0

13.3

12.6

11.0

Promotional activities

3.5

9.7

11.5

17.0

10.4

Office management

36.6

36.9

33.9

29.1

34.1

Other activities

1.9

2.7

0.9

1.5

1.8

Notes: Reported as percentages based on weighted data Source: Timesheets submitted by MFI employees for the period 25.06.07-13.07.07

The MFIs appear to spend their time on four activities. First, tasks relating to office management constitute the single biggest activity for all the personal lending MFIs with the exception of MFI D. There seems to be a certain minimum time a MFI has to dedicate to general office tasks (a minimum of 5%), staff meetings (around 5%), queries (4-6%) and report preparation (3-5%).

Second, tasks involved in making a loan constitute the second most time-consuming category, hovering between 20 and 40% of productive time. Once the loan has been made, relatively little time is dedicated to servicing loans (2-5%). This reflects the insistence among MFIs on servicing the loans through automated bank transfers. Third, once a client falls in arrears with their payments, the MFIs display considerable willingness to invest time in chasing arrears (8-13% for the personal lending MFIs). The emphasis on delinquency control appeared to be driven by a fear that inaction on part of the MFI could foment a non-payment culture among borrowers.

Finally, MFIs also appear to invest extensive time on promotional activities (external meetings, presentations, outreach activities, marketing, liaising with partners and networking). With the exception of MFI A, the MFIs spend between 10 and 17% of their time on promotional activities.

MFI D spends the greatest proportion of its time on promotional activities largely because it has a dedicated outreach worker. Because the MFIs in the sample are still dependent on granted loan capital and other forms of subsidies, they must invest time on maintaining contracts and relations with public and private sector organizations. This may explain the time invested in external relationship management and promotional activities.

Administrator time use by MFI Table 5 shows how the administrators across the participating MFIs spend their time.

Table 5: Proportion of time spent by admin staff by category (% of productive time)

116

MFI A

MFI B

MFI C

MFI D

Average score

Loan enquiries

4.9

4.5

11.5

14.9

9.0

Money advice

0.0

1.6

3.4

0.0

1.3

No shows

0.0

0.0

0.0

0.0

0.0

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Making loans

19.8

2.9

21.4

9.9

13.5

Month-end reports

1.5

3.2

3.7

3.3

2.9

Servicing loans

13.7

15.5

16.0

23.2

17.1

Delinquency control

10.7

0.0

15.7

11.9

9.6

Promotional activities

0.0

0.0

8.9

0.3

2.3

Office management

40.3

69.9

19.4

36.5

41.5

Other activities

9.1

2.4

0.0

0.0

2.9

Notes: Reported as percentages based on weighted data Source: Timesheets submitted by MFI employees for the period 25.06.07-13.07.07

Here there is more variation than could be observed for the MFIs as a whole. This variance centers principally on the extent to which the administrators get involved in loan provision, dealing with loan enquiries and giving applicants money advice. On the one hand there are MFIs whose administrative staff members specialize almost purely on office management tasks, with very limited involvement in the MFIâ&#x20AC;&#x2122;s core activities. This is very much the case of MFI B, where the administrator spends minimal time on lending activities (with the exception of servicing loans). On the other, the administrators at some MFIs have an extensive involvement in the making, servicing and monitoring of loans, which is the case at MFI A. The rationale behind this division of labor seems to be to maximize the exposure of lending staff to clients. As we will see when looking at the timesheet data for the loans officers, the model seems to achieve that, as MFI A lending staff spend more time than the loans officer of any other MFI on dealing with potential customers.

The two above-mentioned divisions of labor may only work in larger organizations. The administrator in MFI C, the smallest MFI in the sample, has a non-specialized role getting involved in all aspects of the operation of the MFI. Manager time use by MFI Table 6 displays the use of time among managers across the MFIs. Table 6: Proportion of time spent by management by category MFI A

MFI B

MFI C

MFI D

Average score

Loan enquiries

1.6

1.2

3.8

0.7

1.8

Money advice

0.0

0.0

0.0

0.0

0.0

No shows

0.0

0.0

0.0

0.0

0.0

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Making loans

17.2

11.4

12.1

3.2

11.0

Month-end reports

12.4

4.0

7.7

6.1

7.6

Servicing loans

0.0

0.9

4.9

0.1

1.5

Delinquency control

7.4

1.7

7.6

0.9

4.4

Promotional activities

6.9

25.8

13.9

35.1

20.4

Office management

54.5

54.0

48.3

47.5

51.1

Other activities

0.0

1.0

1.7

6.4

2.3

Notes: Reported as percentages of productive time based on weighted data Source: Timesheets submitted by MFI employees for the period 25.06.07-13.07.07

One of the factors distinguishing the MFIs is the degree of management involvement in making loans. On the one hand, the management of MFI D only have very limited involvement in making loans. This appeared to be related to reliance on contractual income and the complexity of funding arrangements. On the other, there are managers who are much more involved in the loan process, particularly MFI A and MFI C. In the case of the former, the managers spend more than 6% of their time on interviews alone, which is more than the managers in all the other MFIs combined. This is largely a reflection of the organizational culture of MFI A. All the organizationâ&#x20AC;&#x2122;s activities are centered on increasing the loan book through seeing potential clients. To be able to do that, managers cover for loans officers on leave and generally offer extensive lending support.

Loan officer time use by MFI Finally, we turn to the use of time among the loan officers across the participating MFIs (Table 7). The loans officers play a crucial role in a MFI as they have the most extensive contact with the client base and often build relations with customers, vital in informing ending decisions and in limiting defaults and loan losses.

Table 7: Proportion of time spent by lending staff by category

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MFI A

MFI B

MFI C

MFI D

Average score

Loan enquiries

11.8

2.6

13.4

1.7

7.4

Money advice

4.0

0.1

0.8

0.1

1.3

No shows

5.6

0.1

0.1

1.7

1.9

Making loans

46.5

54.4

38.5

48.9

47.1

Month-end reports

0.0

0.0

0.0

0.0

0.0

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Servicing loans

0.0

0.0

0.0

0.0

0.0

Delinquency control

7.2

17.4

21.6

18.9

16.3

Promotional activities

2.8

2.9

8.7

6.9

5.3

Office management

21.8

18.8

16.9

19.7

19.3

Other activities

0.3

3.7

0.0

2.1

1.5

Notes: Reported as percentages based on weighted data Source: Timesheets submitted by MFI employees for the period 25.06.07-13.07.07

Making loans constitutes the single most time-consuming activity for loans officers for all of the MFIs. On average the loan officers across all of the MFIs also spend 20% of their time on office management. There is more variation in terms of delinquency control. Three out of the four MFIs spend around 20% on delinquency control. This activity generally involves monitoring daily, weekly or monthly bank reports of direct debits, and acting accordingly by calling, paying visits to or sending letters to the clients. The loan officers are to varying degrees supported by administrators and managers in monitoring and acting upon non-payment.

Lending staff at MFI A spend considerably less time on delinquency control than the other MFIs because of its automated arrears monitoring system. This system requires loan officers to make a call to delinquent clients, whilst all other aspects of the delinquency control (further follow-ups and debt collection) are dealt with by administrative and management staff.

This time-saving arrears reporting system combined with the way in which support and management staff are organized enables lending staff at MFI A to focus on seeing potential clients. Personal loans officers at MFI A spend around 45% of their time dealing directly with clients compared to approximately 30% (MFI C), 25% (MFI B) and 15% (MFI D) for the other MFIs. The model of MFI A centers on maximizing the loans officersâ&#x20AC;&#x2122; exposure to clients. It does this by assigning most other tasks not directly linked to the loan interviews to the administrators and to the management. The estimates on number of loans per full-time loan officer suggest that this enables MFI A interview and process 40% more loan applicants compared with the second-most productive MFI (Table 8).

Table 8: Personal loans officer productivity

Annual # of loans process per FT loan officer

MFI A

MFI B

MFI C

MFI D

Average score

440

308

205

253

320

Notes: Estimated based on number of loan applicants seen during timesheet exercise Assumes 60% success rate based on data from MFI B Source: Timesheets submitted by MFI employees for the period 25.06.07-13.07.07

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Three factors appear to explain the variation in loan officer productivity. First, the number of applicants a loans officer can interview is conditional on the availability of appropriate meetings rooms. In the case of MFI B, two loans officers and two debt advisors share one meeting room, limiting the number of loan applicants a loans officer can see in the course of a working day.

Second, the data also suggest that a high proportion of repeat business is conducive for loan officer productivity as they are considerably less costly to process and generally less risky. MFI A which displayed the greatest loan officer productivity also had the greatest proportion of repeat clients: 56% of loans issued in the financial year of 2006/2007 were to repeat customers, compared to 7% (MFI B), 33% (MFI D) and 52% (MFI C). Finally, the timesheet data suggest that there is a link between the proportion of productive time spent on seeing clients and loan officer productivity as depicted in Figure 1.

% loan officer time spent on direct customer contact

Figure 1: Direct customer contact and loan officer productivity MFI A

40.00

TIME = -1.33 + 0. 09 * PROD R-Sq uare = 0.69 35.00

30.00

MFI C 25.00

MFI B

20.00

MFI D

200.00

300.00

400.00

Number of loans made per FT loan officer per year

In summation, MFI A which puts the greatest emphasis on maximizing the time loans officers spend on interviewing, by involving administrators and managers in offering lending support, also processes the greatest number of loans per full-time loan officer position. Further, our findings suggest that part of maximizing lending staff exposure to potential customers may also lie in outsourcing administrative aspects of arrears control and possibly other areas to external companies.

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DISCUSSION AND CONCLUDING REMARKS The productivity of loan officers is an important lever for MFIs to reduce operating costs and increase income, crucially without passing on the costs to the clients. Hypothetically there are three ways in which MFIs can achieve this. First, the MFIs can introduce staff bonuses linked to the number of loans issued per loan officer. Second, the introduction of mobile phone and other banking transaction technology can decrease the time spent by loan officers on collecting loan payments and processing data. Third, the MFI can develop and implement a credit scoring methodology to decrease the amount of time the loan officer spends on collecting, verifying and analyzing client data.

The mainstream financial sector in developed and developing countries has sought to decrease the extent of face-to-face contact in order to increase productivity and efficiency. Mathematical and technological advances have enabled financial institutions to move towards internet and telephone based financial intermediation. The use of such technology has reduced the costs and increased the staff productivity among financial institutions.

However, we conducted an analysis of timesheet data of staff members of four UK Microfinance Institutions (MFIs) and found that the opposite appears to be true. The MFIs whose lending staff spent a greater proportion of their time on direct face-to-face customer contact also had the greatest efficiency and loan officer productivity. Provided there is sufficient demand for the products of the MFI, by organizing the non-lending in such a way to maximize the exposure of the lending staff and by allowing non-lending staff to step in for interviews when necessary, the MFI can raise the loan officer productivity considerably.

Our findings suggest that increasing lending staffâ&#x20AC;&#x2122;s exposure to loan applicants may also be achieved through outsourcing administrative tasks. Finally, we also found that the MFIs which displayed the greatest loan officer productivity also had the greatest proportion of repeat clients.

Repeat business involves lower transactions costs and generally constitutes a smaller risk for the MFI. How can we explain this dichotomy in raising productivity between the UK banking and MFI sector? The answer can be found in the divergent business models of the banking and the microfinance sector. The traditional MFI model is based on a relationship lending model, whereby lending decisions are based on soft, non-codifiable information (character and reliability of lender) as well as income-expenditure projections. Conversely, the mainstream bank lending model is based on transaction lending which is based on the strength of the balance sheet and income statements, or the outcome of credit scoring.

The typology developed above is simplified and in reality most MFIs operate somewhere on a continuum between the two models. In Western Europe, most lending is in the form of individual rather than group lending (Jayo et al, 2008; CDFA, 2009). However, to date few if any Western European MFIs have used credit scoring, possibly because the market gap they are covering Bonus Material

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seeks a more personalized service than that offered by mainstream financial institutions. The traditional microfinance group lending methodology is still the dominant methodology in South, South-East and Central Asia (Harper, 2007). Conversely, in South America lending is predominantly in the form of individual loans (MIX, 2008). In addition to geographical patterns, age and size is also likely to be a determinant of the lending methodology. Institutions that have reached greater maturity and that have a greater client base may be in a stronger position to develop and implement a credit scoring technology.

The implication of this is that the pathways to increased productivity may differ depending on the typology of the organization. MFIs that have moved more towards a mainstream lending methodology are likely to benefit in terms of loan officer productivity from investing in internet and telephone-based sales channels. This is especially the case for MFIs that have adopted credit scoring whose hard, codifiable data lend themselves well to such channels. Conversely, MFIs whose lending is centered on a more traditional microfinance model are more likely to increase loan officer productivity by maximizing the lending staff’s exposure to potential customers, namely reorganize staff to increase time frontline staff spend on seeing potential customers and implement time-saving outsourcing mechanisms.

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Bazoberry, Eduardo (2001). “We Aren’t Selling Vacuum Cleaners: PRODEM’s Experiences with Staff Incentives,” The Micro Banking Bulletin – Focus on Productivity, issue 6, April, p.

11-14 Berger, A. N., Cowan, A. M. and Frame, W. S. (2009). “The Surprising Use of Credit Score in Small Business Lending by Community Banks and the Attendant Effects on Credit Availability and Risk,” Federal Reserve Bank of Atlanta Working Paper, 2009-9, March, p. 1-23.

Berger, Allan N. & Frame, W. Scott (2005). Small Business Credit Scoring and Credit Availability. Federal Reserve Bank of Atlanta, March 2005.

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Burton et al. (2004). “Making a Market: the UK Retail Financial Services Industry and the Rise of the Complex Sub-prime Credit Market”, Competition & Change, vol. 8(1), p. 3-25.

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CDFA (2008). Inside Out 2007 – The State of Community Development Finance. London: CDFA. CDFA (2009). Inside Out 2008 – The State of Community Development Finance. London: CDFA. Competition Commission (2006). Home credit market investigation. Report prepared by the UK Competition Commission, November 2006.

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Holtman, Martin (2001). “Designing Financial Incentives to Increase Loan Officer Productivity: Handle With Care!” The Micro Banking Bulletin – Focus on Productivity, issue 6, April, p. 5-11 Ivatury, Gautam & Mas, Ignacio (2008). “The Early Experience of Branchless Banking,” CGAP Focus Notes, no. 46, April, p. 1-16 Jayo, B., Rico, S. and Lacalle, M. (2008). “Overview of the Microcredit Sector in the European Union, 2006-2007,” EMN Working Paper, no. 5, July, p. 1-68.

Leyshon, A. & Thrift, N. (1999). “Lists come alive: electronic systems of knowledge and the rise of credit-scoring in retail banking,” Economy and Society, vol. 23(3), August, p. 434-466.

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Leyshon, A., & Thrift, N. (1995). “Geographies of financial exclusion: financial abandonment in Britain and the United States,” Transactions of the Institute of British Geographers, vol. 20(3), p.

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MIX (2008). Latin America Microfinance Analysis and Benchmarking Report, 2008. A report from the Microfinance Information Exchange, September 2008.

Nath, R., Schrick, P. & Parzinger, M. (2001). “Bankers’ Perspectives on Internet Banking,” Eservice Journal, Volume 1(1), p. 21-36 Schreiner, Mark (2003). “Scoring: the next breakthrough in microcredit?” CGAP Occasional Paper, no. 7, January, p. 1-62 Woller, Gary & Schreiner, Mark (2001). Poverty lending, financial self-sufficiency, and the six aspects of outreach. Small Enterprise and Education Promotion Network.

ACKNOWLEDGEMENT The authors would like to thank Lloyds TSB for funding the research project and the management and staff at the participating MFIs for sharing their knowledge, experiences and innovative practices with the research team. The authors are also indebted to their colleagues Anthony Salt and Bob Paterson for their contribution to the research project.

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ISBN – 13: 978-0-615-35916-8