PAPER WRAP-UP: Will the Bottom of the Pyramid Hit Bottom? The Effects of the Global Credit Crisis on the Microfinance Sector, by the United States Agency for International Development (USAID)

By Barbara Magnoni and Olga Jennifer Powers of EA Consultants, published by the United States Agency for International Development (USAID), March 2009, microReport number 150, 54 pages, available at: 

http://collab2.cgap.org//gm/document-1.9.34169/11Will%20the%20Bottom%20of%20the%20Pyramid%20Hit%20Bottom_The%20Effects%20of%20the%20Global%20Credit%20Crisis%20on%20the%20Microfinance%20Sector.pdf

The produced report by USAID provides an assessment on the impact of the financial crisis on the microfinance sector.  The paper provides a framework for assessing the impact of the crisis on the microfinance sector by analyzing the effects on both the liabilities side (access to finance, cost of funding, financial risk) and the asset side (portfolio growth, portfolio risk, portfolio quality) of an MFI’s (Microfinance Institutions) balance sheet in order to determine the extent that MFIs may have been impacted.

The report is based on a survey of microfinance fund manager, MFIs, DFIs (Development Finance Institutions), investment fund managers, investors, industry practitioners, and senior management executives from 19 MFIs.  The 19 MFIs are from Egypt, the Philippines, Cambodia, India, Peru, Ecuador, Mexico, Nicaragua, Bosnia & Herzegovina, Senegal, Mozambique, and Nigeria.  The interviews with the 19 MFIs were conducted in order to understand the impact on the crisis of MFI portfolio quality, pressure on client repayment and growth projection. 

The Liability Side of an MFIs Balance Sheet

The report provides an overview of historic funding trends in microfinance from 2005-2008.  Microfinance Investment Vehicles’ (MIVs) assets under management from 2005-2008 grew from USD 1.8 billion to USD 6.5 billion.  The authors believe that this growth is attributed to increased interest in microfinance by institutional investors.  Initially the first investors in MIVs were largely DFIs, foundation and individual investors.  In the past 3 to 4 years, vehicle structures have met return requirements.  DFIs now comprise 18.8 percent of MIV funds.  Institutional investors have increased their participation from 14 percent to 41 percent.

Leverage ratios have increased from a median of 2.0x in 2003 to 5.1x in 2007 for the large MFIs and reaching levels 10 to 15 times in markets such as India.  Debt funding grew sharply during 2003-2007.  According to the USAID report, in 2004 the breakdown of MFI liabilities was approximately 92 percent deposits and 8 percent debt.  In 2007 MFI liabilities increased to 55 percent debt funding and only 45 percent deposits.  The co-authors believe that MFIs in countries that are closely integrated into the global financial sectors are the most vulnerable “because of additional channels of contagion through their local banking sectors.”

The report also provides an analysis of the change in the equity index of select MF (Microfinance) countries.  The analysis notes that countries with larger current account deficits and high levels of portfolio investment illustrated a greater degree of “financial contagion” when equity markets fell.  The Microfinance countries sampled showed that countries experiencing the most vulnerability (greater that a 40 percent decrease YOY) to “financial contagion” were Vietnam, Brazil, Peru, Indonesia, Nigeria, Indonesia, Pakistan, Russian and Kenya.  In addition, the level of portfolio liabilities as a percentage of GDP (“an indicator of financial integration and amount of hot investment capital at risk of being pulled out of a country”) concluded that Vietnam, Brazil, Peru, Nigeria and the Philippines have shown high levels.

There is additional concern that investors (who invested private capital in MIVs) will be forced to sell or discontinue investing in healthy assets dues to their portfolios being hit hard by the falling equity markets and investments in structured products that have been written down.  According to the co-authors, this would hamper liquidity of MFIs “which may be unable to fund their portfolio growth or even maintain their existing portfolios.”  However, funding from retail investors (as opposed to institutional high-net worth) may provide an alternative source of capital for smaller MFIs in the next two years.  The report also discusses private external capital’s flight to cash despite MF sector’s strong performance record

The Asset Side of an MFIs Balance Sheet

The coauthors believe that in order to examine the potential impact that the credit crisis will inflict on MF client’s ability to repay, one must examine the following inter-related factors (main macroeconomic risks) that can reduce repayment of microloans: 

  • Credit tightening
  • Commodity price volatility
  • Migrant flows and remittance
  • Current account pressure
  • Political risks

In the final analysis, Magnoni and Powers have concluded that both the asset and liability side of MFI balance sheets will reduce the profitability for MFIs in the next 2-3 years.  Reduced availability of funding sources on the liability side will put pressure on MFIs to reduce their growth targets on seek alternative funding sources.  In addition, default and PAR rates in MFI portfolios will lead to a reduction in growth targets coupled with higher provisioning and stricter credit standards. 

The report estimates that 37 percent of the sampled MFIs presently reported to be encountering some degree of portfolio deterioration due to the credit crisis.  In addition, an analysis of the vulnerability of countries to asset and liability risk for MFIs have concluded that countries such as Georgia, Nicaragua, Russian and South Africa face economic constraints and high exposure to foreign exchange risk.  Bosnia Mexico and Morocco have already begun to show negative effects on portfolio quality “as a result of existing over-indebtedness of clients and run up of consumer lending in recent years.”    However, the co-authors believe that MFIs who institute greater rigorous credit analysis process, solid risk management policies and efficient systems can potentially position themselves for future significant growth once the crisis subsides.  

By Zoran Stanisljevic

 

 

 

 

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