MICROFINANCE PAPER WRAP-UP: Microfinance and Social Investment; By Jonathan Conning and Jonathan Morduch; Published by The Financial Access Initiative (FAI) at New York University’s Robert F Wagner Graduate School of Public Service and Hunter College

By Jonathan Conning and Jonathan Morduch; published by Financial Access Initiative (FAI) at New York University’s Robert F Wagner Graduate School of Public Service and Hunter College; April 8, 2011; 30 pages; available at: http://financialaccess.org/sites/default/files/Microfinance%20&%20Social%20Investment_Conning&Morduch.pdf

This paper analyzes the current state of social and commercial investment in microfinance, by taking a “corporate finance approach” to examine the funding used by microfinance institutions (MFIs). Exploring examples from India and elsewhere, Mr Conning and Mr Morduch contextualize issues that they believe necessitate corporate involvement in a historically philanthropic sector. The authors consider a number of factors including institutional capital structures, availability of microborrower collateral and target populations. Instead of focusing on clients, Mr Conning and Mr Morduch are more concerned with the “incentives and opportunities” of various financial institutions, from the funder to the practitioner.

The authors elaborate on economic models that explain market imperfections, financial exclusion of the poorest people and the economic characteristics of these populations. Mr Conning and Mr Morduch use such a model to analyze microlenders’ level of risk, cost of funds and projected returns from lending to borrowers who are unable to provide collateral. The authors then manipulate the model to examine several ways of “expanding financial frontiers,” including reducing collateral requirements. Mr Conning and Mr Morduch test the effects of proactive monitoring by MFI staff, business training programs for clients, group lending mechanisms and the distinctions between individual and joint liability. These iterations of the model allow the authors to examine ways of selecting creditworthy clients and otherwise reducing MFIs’ risks.

Mr Conning and Mr Morduch conclude that there is a “misalignment of capital, information, and enforcement capacity” that requires the involvement of diverse stakeholders. The ability to administer and enforce retail loan contracts is critical to an MFI’s operations and performance, but also involves a range of costs associated with the intensity of enforcement, quantity of available client information and risk of default. The authors find that MFIs that serve the poorest people face the highest costs and must place their own scarce “intermediary capital” at risk. Social investors, in contrast to their commercial counterparts, are able to provide funds to these organizations, absorbing numerous risks and accepting “sub-market financial returns” in exchange for MFIs’ efforts to alleviate poverty. This multidimensional focus of social investors is exemplified by their taking on subordinated positions in capital structures in return for serving a greater number of previously under-served people.

Due to their mixture of objectives, social investors provide a unique form of support to nascent institutions. Initial financing can be difficult to raise for an institution that lacks a track record or serves a demographic perceived to carry greater risk. Unlike grants, which the authors argue cane be used to hide costs and cover inefficiencies, subsidized funding from social investors can support institutional development including improved governance, technical assistance, interaction with private sector networks and the ability to attract further capital. Social investors are thus described as involved participants that can provide inexpensive capital, “active engagement” and additional monitoring.

In a section on commercialization, Mr Conning and Mr Morduch use examples from Mexico and Bolivia to illustrate different ownership structures and their effects on performance. The relationships between NGOs, social investors, commercial capital providers and other for-profit companies are explored through examples of capital structures and various transactions. Financing from global capital markets is valued by MFIs because it can help them achieve scale through leverage. But the authors warn that commercial investment can cause serious problems including corruption, mission drift and a business model that does not mesh with social objectives. More funding may help more people, but it can also hamper the institution’s ability to serve its target demographic in a way that aligns with the original mission and vision of the organization.

Mr Conning and Mr Morduch conclude by reiterating the need for flexibility and enabling regulation for investors, particularly in the Indian microfinance sector. Because microfinance customers are so diverse themselves, their needs are well-served by a diversified set of investors, institutions and methodologies.

By Rohan Trivedi, Research Associate

About The Financial Access Initiative (FAI):
The Financial Access Initiative (FAI) is a consortium of development economists at three universities in the US, New York University (NYU), Yale University and Harvard University, who research the expansion of access to financial services for low-income individuals. The initiative, which was launched with a USD 5 million grant from the Bill & Melinda Gates Foundation in late 2006, is housed at the Wagner Graduate School of Public Service at NYU. The Initiative is led by Managing Director Jonathan Morduch of NYU, Director Dean Karlan of Yale University and Director Sendhil Mullainathan of Harvard University.

Sources and Additional Resources:

MicroCapital.org story, July 29, 2010: “MICROFINANCE PAPER WRAP-UP: Why Microfinance Take-up Rates Are Low & Why It Matters, by Dean Karlan, Jonathan Morduch and Sendhil Mullainathan”, https://www.microcapital.org/microfinance-paper-wrap-up-why-microfinance-take-up-rates-are-low-why-it-matters-by-dean-karlan-jonathan-morduch-and-sendhil-mullainathan/

MicroCapital Universe Profile: Financial Access Initiative (FAI), https://www.microcapital.org/microfinanceuniverse/tiki-index.php?page=Financial+Access+Initiative+%28FAI%29

Similar Posts: