by the MicroCapital Team - Trends/Challenges -

GUEST EDITORIAL: “Coping with a Crisis” by Christian Ruehmer, Reprinted From Europe and Central Asia’s Microfinance Centre (MFC)

The world of developed financial markets seems broken. Eighteen months ago the “subprime crisis” started, and a few banks were failing. Since then, bad news on the markets has been published daily. However, over the last weeks, the situation escalated with banks failing on a daily basis, Iceland’s financial system collapsing and liquidity disappearing completely.Logo

What do microfinance institutions (MFIs) have to do with this? According to studies, microfinance is uncorrelated with other financial markets. Portfolios grow fast and public interest increases. Investors were chasing MFIs to allocate their funds and conferences were organized all over the world. Microfinance is deemed to be different. The worst-case expectation is that the crisis might slightly increase funding costs and provisions.

The dangerous nature of this crisis is that it spreads slowly. But when it hits, it hits hard and the consequences are brutal. Stock markets remained relatively stable for months into the crisis, but suddenly they fall worse than ever. Banks file for bankruptcy over weekends. It is no longer just a “subprime crisis.”
Let us assume that MFIs are not as unaffected as commonly expected. What will happen? Here are some potential trends:

1) Private funding sources do not slow down; they dry up completely! Currently the best companies in the world have problems finding liquidity, even short term. Existing microfinance funds will have problems raising more debt. New investors will be unable to convince their committees to invest in microfinance, as this is not the time to broaden investment horizons. Therefore, do not expect major new fund inflows for the next 18 to 24 months.

2) Remittance payments will shrink. According to FOMIN/BID 2008 remittances to Latin America have shrunk by 1.7 percent in real terms (“BID estima flujos de remesas a AmÄrica Latina y el Caribe para 2008”, 3 October 2008).

3) In line with the overall economy, clients’ defaults increase. Also due to the crisis, clients will feel less obliged to pay loans.

Given those trends, the following can be expected:

1) More banks will be failing. This will also happen in developing countries. Depending on the quality of crisis management, bank runs are likely.

2) Similar to the US and Europe, also in developing countries “bail-outs” will happen. Nationalization becomes an option.

There is no time to complain about the situation. Let others be distracted with that. Act now with a series of prudent measures. As a qualified microfinance banker, you need to be able to sail not only on bright days but also in storms. This is the chance to show that your MFI is useful to your clients even in bad days. I suggest acting along the following lines:

1) Acknowledge that there is a serious crisis of incomparable size. Don’t only look at defensive tactical solutions. Also focus on more-strategic ways to solve shortages. Socially responsible funds might be able to support you in the short term as market-based funding ceases, but the industry’s growth plan was based on the supply of market-based funds. Alternatives need to be developed.

– Improve long-term liquidity planning. Ensure you negotiate extensions of funding early enough in order to avoid surprises. Some funding sources, like collateralized debt obligations, might not be extendable.

– Client deposits tend to be a less volatile funding source. If your regulatory environment allows it, start planning to introduce savings or term deposits.

– Be open for business combinations. An actively pursued consolidation can be positive for all participants and can result in a stronger MFI. A forced consolidation is often too defensive.

2) Don’t be fixed to past growth goals, which were set under different macro-economic conditions.

– There is no need to push organic growth, if opportunities are unavailable. If the economic conditions become too risky, temporarily halt. There is no obligation to lend if the economic basis is not given. This is also true for nonprofit/charitable microfinance.

– By accepting more moderate or even zero growth, you also reduce pressure on your employees and avoid a decline of portfolio asset quality.

– It might be a good time to review indirect cost. Usually, phases of high growth beget indirect expenses. A review of those expenses and streamlining is necessary.

3) Intensify collaboration with your clients in order to better understand their financial situation and to support them.

– Offering additional services like financial education and risk management might be helpful to manage through critical situations.

– Products like health insurance can mitigate some problems during times of distress.

4) Get support through your network or through experienced consultants. Nobody expects you to be a natural born crisis manager. An external expert can serve as coach and can help in steering though a crisis and to avoid losing focus because of a myriad of day-to-day issues.

At this stage it is difficult to estimate to what degree the crisis in the developed markets will spill over to your institution. The severity might also be different from country to country and institution to institution. Yet, it was never more necessary than today to make prudent decisions about how to protect your institution and thus ensure that your clients, the ultimate reason for being a microfinance institution, suffer as little as possible.

Christian Ruehmer has worked in microfinance since 2001. He is the founder of Perfect Point Partners (PPP) and focuses on risk management and efficiency management projects. The company has worked on several projects over the last two years in Europe and Central Asia. This article is reprinted with permission from the Microfinance Centre (MFC) Newsletter “Microfinance in Central and Eastern Europe and the New Independent States”, Issue Number 3, 2008.

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