Written by Nicolas Krauss of the Department of Politics, New York University and Ingo Walter of the Stern School of Business, New York University, this paper analyzes the correlation between microfinance and international and domestic markets. Analyzing the sensitivity of microfinance institutions (MFIs) with global capital markets in terms of income and assets, the study discusses whether the correlation (or lack thereof) positions microfinance as a useful asset allocation technique for fund managers seeking portfolio efficiency and diversification. The 33 page document was published by New York University in January, 2008 and the full text of the report is available here.
What follows below is a summary of the paper:
Microfinance, which was traditionally supported by aid agencies and non-profit entities, has in recent years witnessed a shift in its sources of funding. Non-profit donors and lenders have declined as broader sources of funding are being accessed, including raising funds in capital markets, client deposits of bank-related micro-lenders and refinancing via inter-bank deposits and commercial loans. The factors (p5) in favor of the commercialization of microfinance are the low default rates, potentially low general risks, reasonable returns and good growth rates. Earlier studies by other researchers show that top MFIs are nearly twice as profitable as leading commercial banks in their local environments. However, despite the improved operating efficiency of MFIs and establishment of industry standards, investors perceive microfinance as excessively risky relative to the returns it generates.
To identify the potential of microfinance as an asset allocation technique, the report analyzes the risks associated with microfinance as an asset class. The standard approach (p7) to analyzing the risk of an asset class is to calculate the returns of an asset class over a certain period of time against the returns (ROA) of a benchmark index. However, this approach is possible only for publicly traded financial institutions and since almost all MFIs are non-listed with no market-to-market valuation, this analysis is not possible. Hence, this study instead observed changes in earnings of the MFIs to changes in earnings of the market over a comparable period. In addition to earnings, changes in the following key financial variables were also observed: return on equity (ROE), profit margin (PM), change in total assets (TA percent), change in gross loan portfolio (GLP percent) and loan portfolio at risk (PAR).
Key financial indicators of 325 MFIs in 66 emerging market countries were compared to global market indicators over an eight year period (1998-2006) to analyze their correlation to fluctuations in the global market. In addition, MFIs were also compared to potential emerging market investments – equities of listed emerging market institutions (EMIs) and equities of listed emerging market commercial banks (EMCBs). Standard and Poor’s 500 index, Morgan Stanley Capital International (MCSI) World index and MCSI emerging market equity index served as indicators for global market fluctuations. Domestic GDP served as a determinant for domestic market risk. Emerging market commercial institutions (EMCI) were obtained from ORBIS, a database compiled by Bureau van Dijk on 51 million private and public companies worldwide. To make the dataset on EMCIs comparable to the MFI dataset, only the top 325 (in terms of 2006 earnings) emerging market firms, based in 23 emerging market economies were included. The dataset for emerging market commercial banks (EMCBs) included the top 325 banks (in terms of 2006 earnings) in 49 emerging market economies (obtained from BankScope, a Bureau van Dijk database).
The results (p23) of the study show that MFIs do not have any significant relationship with global market movements. With regard to exposure to domestic GDP, however, MFIs showed highly significant correlation with all parameters analyzed except net operating income. Thus, MFIs are not insulated from changes in the domestic economy. Comparing market risk of leading MFIs with leading EMIs, MFIs showed significantly less sensitivity to global capital markets in terms of income and assets. No significant difference with regard to profitability measures was found. Comparison of global market risk of MFIs with EMCBs shows significantly less sensitivity for all parameters analyzed – with the exception for net operating income. Overall, EMIs and EMCBs showed greater correlation to global market fluctuations than MFIs.
The difference (p17) in market risk between microfinance and other emerging market institutions is due to the generally non-public ownership structure which reduces dependence on capital markets, lower international exposure of microfinance clients as well as lower operational costs and financial leverage. Further, the shorter average loan maturity, close ties to and knowledge of borrowers and lending to women (who typically have greater repayment discipline) are also likely to provide some insulation. Based on the results of the study, Dr. Walter and Mr. Krauss conclude that microfinance should be able to reduce portfolio volatility for international portfolio investors with the ability to diversity country risk. But they do warn that MFIs are not totally insulated as the results do not show negative or zero correlation with global capital markets. On a concluding note, the report says that as the microfinance industry matures, market risk associated with MFIs would increase. But the nature of MFI clients (who have lower international exposure and are not integrated into the formal sectors of the economy), will most likely keep the risk to a lower level than for most other emerging market investments.
By Bharathi Ram, Research Assistant.
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[…] Microfinance, which was traditionally supported by aid agencies and non-profit entities, has in recent years witnessed a shift in its sources of funding. Non-profit donors and lenders have declined as broader sources of funding are being accessed, including raising funds in capital markets, client deposits of bank-related micro-lenders and refinancing via inter-bank deposits and commercial loans. The factors (p5) in favor of the commercialization of microfinance are the low default rates, potentially low general risks, reasonable returns and good growth rates. Earlier studies by other researchers show that top MFIs are nearly twice as profitable as leading commercial banks in their local environments. However, despite the improved operating efficiency of MFIs and establishment of industry standards, investors perceive microfinance as excessively risky relative to the returns it generates… [click here to read the rest of this article…] […]