MICROCAPITAL STORY: IDB Makes Donation to Billion Dollar Standard & Poor’s

The Inter-American Development Bank (IDB) will subsidize USD 405,000 of a Standard & Poor’s (S&P) project to develop a globally accepted rating system of microfinance institutions (MFIs). S&P is a rating service and a division of McGraw-Hill Companies. The actual funding will be by the Multilateral Investment Fund (MIF), a fund administered by the IDB to encourage private sector development of micro-enterprise in Latin America and the Caribbean (LAC).

The stated goal and rationale of this project is to increase capital flow to micro-banks. However, with MIF’s public money subsidizing a company with over USD 1 billion in annual profits, such justification is thin. Top micro-banks do not suffer from too little investment, but rather there is now far too much money chasing too few micro-banks. Has the IDB gotten it exactly wrong? The ratings project comprises three components: creating of specialized microfinance credit rating criteria, pilot rating of 10 MFIs to test the rating criteria, and dissemination of the results. For further details of S&P’s pilot rating program and the major players, please see the following MicroCapital story. IDB has a history with microcredit rating systems, launching the Microfinance Rating and Assessment Fund (Rating Fund) in 2001 with the Consultative Group to Assist the Poor (CGAP). IDB committed USD 1.5 million to the Rating Fund to assist MFI purchasing of rating services and to create a virtual marketplace for MFIs, rating agencies, and stakeholders. The Rating Fund reached 149 MFIs in LAC and over 429 ratings in total before being phased out in June 2007.

The S&P project will focus on credit ratings of MFIs, whereas rating agencies specializing in microfinance (MicroRate, M-CRIL, PlaNet Rating, and Microfinanza) have focused on performance ratings. “Credit” ratings measure the likeliness that an institution will default; “performance” ratings take a broader look at how well a MFI stacks up against its peers. In fact, 85 percent of ratings in LAC co-financed by the Rating Fund were performance ratings. Today they are by far the dominant form of microfinance rating since a typical microfinance investor wants to know more than just how safe his/her money is. Microfinance investors typically also want to know how effectively their funds are being put to work.

MIF will spend USD 300,000 of the USD 405,000 on rating 10 MFIs, while these MFIs will have to contribute USD 10,000 to the cost of rating. Thus S&P will receive roughly USD 40,000 per rating compared to the typical USD 15,000 that specialized microfinance raters would charge. Thus this subsidy will allow S&P to undercut prices charged by specialized raters. To compound the issue, S&P has virtually no experience rating LAC MFIs, currently rating only Banco Compartamos in Mexico.

S&P will also select MFIs with the potential to access capital markets, likely choosing 10 of the larger, more profitable MFIs, which are least likely to need such financial aid. Furthermore, the 10 will include both regulated and non-regulated MFI’s. Thus banks such as Banco Caja Social de Columbia (BCSC), with USD 2.4 billion in total assets and 15.1 percent ROE, could receive a subsidy to be rated. Even the larger non-regulated, non-profit MFIs have reached sizable profits, such as Fundacion WWB Columbia with its USD 154.1 million in total assets and ROE of 21.1 percent.

As a special fund administered by IDB, MIF’s stated mission is to promote private sector development in LAC particularly for micro-enterprises. Its financing is provided by member governments. Thus MIF’s funds ultimately are public money provided by tax payers.

While this project could improve capital market infrastructure for microfinance, MIF is still subsidizing a highly profitable company. In 4Q07, McGraw-Hill Cos. reported 3 month revenue of USD 2.2 billion and an operating profit of USD 723.2 million. For the same period, S&P realized USD 759.6 million in revenue and USD 346.7 million in profits. Furthermore, S&P’s 2006 annual operating profits reached USD 1.2 billion.

Clearly, commercial investors demand greater transparency and a standardized credit rating system with which they are comfortable. As the foremost provider of financial market intelligence, S&P could improve MFIs’ access to commercial investors thereby lowering the cost of capital. However, MIF’s grant suggest that the need for capital justifies subsidizing a Fortune 500 company. Furthermore, this subsidy puts into question the project’s goal of merely increasing capital as opposed to increasing the number of MFIs with access to capital.

Finally, the MIF grant hampers competition in the microfinance rating industry. If S&P is allowed to monopolize the largest, most profitable ratings, there is little hope of specialized MFI raters to become financially viable. The MFI ratings market has remained small and mainly unprofitable with only USD1.5 million in annual global sales volume. Thus the grant is in direct opposition to IDB’s support of the Ratings Fund, whose purpose was to provide ratings to small MFIs in remote places, and could greatly harm existing raters, who provide these essential ratings.

by Jennifer Lee

Additional Resources:

Standard and Poor’s: Home, 4Q 07 Revenue, “Microfinance: Taking Root in the Capital Markets”

Inter-American Development Bank (IDB): Home, USD 9.53 billion, 40.8 percent

Multilateral Investment Fund: Home, MixMarket

MicroCapital Story: “Standard and Poor’s to Launch Rating Program for Microfinance Institutions in Latin America”. February, 7, 2008.

IDB: “Enabling Access to Capital Markets for Microfinance Institutions”, by Sergio Navajas, November 2007.

PRNewswire: “S&P Announces Program to Develop Global Ratings Framework fro Microfinance Institutions”, February 6, 2008.

Rating Fund: “II Forum on MFI Ratings- Toward a Sustainable Market”, by Caterina Meloni and Claudia Suaznabar, October 2005.

Rating Fund: Home page | Rating Agencies | Rating Reports

Planet Rating: Homepage | Rating Methodology | MixMarket Profile

MicroRate: Homepage | MixMarket Profile