Debt and Equity Financing
The long-term viability of the microfinance industry requires the adoption of institutional business practices that assure institutional sustainability and soundness, as well as facilitate integration into national and international financial markets. Market discipline, including efficiencies motivated by private investors, is a critical element in the transition from a subsidized sector to a viable global industry of significant scale and impact. Current conventional wisdom argues that as microfinance institutions (MFIs) become financially self-sufficient, they can and will finance expansion through a combination of savings, commercial domestic and international debt, and equity investment. Donors can then focus resources on new MFIs and on market innovation.
The global supply of donor capital is clearly insufficient to meet the aggregate funding needs of MFIs. Moreover, although playing a critical role in terms of innovation, donor funds are typically distributed according to non-market criteria and often undermine the gains realizable through competitive market-based financing. Market-driven capital (i.e., private ownership), by contrast, tends to encourage and speed the adoption of transparent accounting practices, standardized reporting, and the introduction of best management practice. Market capital can also encourage sector rationalization and contribute to institutional expansion, product innovation, service quality, and downward product price pressure. Without consistent access to private sources of debt and equity financing, it is unlikely that the microfinance industry will grow significantly or achieve broad-based sustainability. Private capital is vital if the microfinance industry is to continue providing sustainable financial products and services to millions of low-income persons, particularly women microentrepreneurs worldwide.
There is little formal research on mechanisms for financing MFIs or their integration into private capital markets. It is widely acknowledged that while financial market integration and graduation from donor capital is desirable, how and at what stage of MFI development it should take place remains unclear. Aside from deposits, even some high-performing MFIs have had difficulties raising private capital. This experience contrasts with the conventional wisdom that argues that MFIs will finance expansion through savings, commercial debt, and equity investments. This contradiction yields two fundamental research questions: What market conditions (supply and demand) hinder MFI access to and use of private capital? And, what investment vehicles and industry interventions are critical to supporting capital access?
USAID’s Microenterprise Development office (MD) has sponsored research addressing these two overarching questions. Research activities stem from the following hypotheses:
Hypothesis 1: Supply and Demand for MFI Finance
MFIs’ financing needs change as institutional lifecycles evolve. How an MFI is financed influences its outreach potential, its best practice management and governance discipline, and its ability to attract private capital. Hypothesis: An MFI can structure its finances to attract different types of capital at different points in its lifecycle while improving its current or future access to private capital.
Hypothesis 2: Market Environment and Regulatory Conditions
Differences in the enabling environment affect MFI access to both local and international private capital. Hypothesis: The identification of key micro and macro barriers and opportunities will help regulators, MFIs and other sector support stakeholders to develop strategies to increase access to private capital.
Hypothesis 3: Investor Knowledge
Private capital providers do not have sufficient information to properly assess MFI investments relative to competing investment opportunities, risks, and prevailing market and regulatory constraints and opportunities. Hypothesis: Access to quality MFI and market environment information will help private investors increase investments in MFIs.
KNOWLEDGE AND PRACTICE
In the first two years of this work, the research team presented the context for financing MFIs and the transition to private capital. The team then assessed specific opportunities and barriers to private capital among local investors and lenders, within MFIs, and those borne of regulatory and market environment conditions. Research focused on supply and demand, as well as regulatory constraints to MFI investment, with its primary focus at the level of the investor and MFI. In addition, the role of private voluntary organizations in MFIs’ transition to private capital was investigated and discussed in a one-day workshop. Most recently, a template was published to assist MFIs in developing their financing strategies, accompanied by several case studies of MFI financing strategies.
Reports in progress include:
• Microfinance and the Double Bottom Line in the Post Social Enterprise Era – Examination of the double bottom line MFI, focusing on the pressures, tensions, trade offs, and related considerations surrounding accessing commercial capital
• Case Studies on the Double Bottom Line – Four short case studies analyzing experiences of MFIs that have made
significant use of private capital (primarily equity capital)
• Double Bottom Line Checklist – A checklist that will identify the major double bottom line management considerations MFIs should be aware of in the transition to private capital.