Review of Banana Skins Report 2011
I decided to dedicate this weekly blog to the Banana Skins report that was released by the Centre for the Study of Financial Innovation in February 2011. This is the third Banana Skins Report and it has attracted the greatest amount of responses so far with 533 participants from 86 countries. The report ranks degrees of risk in microfinance as they are perceived by practitioners, investors and regulators. Each risk is shown as a banana skin- hence the title. The report goes further to show how participants from various geographical areas rate risks in microfinance. Finally, report compares differences in responses this year with those of the last year. In this blog post I want to summarize the report and highlight findings that I considered the most interesting.
The first banana skin this year went to "credit risk", which was ranked as the highest risk for the industry by both practitioners and investors. Last year, in the midst of economic recession, credit risk was also the first banana skin, but for completely different reasons. In 2009 there were fears that people would not be able to repay their loans due to lack of liquidity and low funding, while now the fear of default is caused by the tarnished image of the industry. The latter is much harder to repair and therefore, "reputation" was ranked as a second risk for the industry. Practitioners tied credit and reputation risks together because, as most of the responders stated, borrowers do not want to repay their loans because they do not trust MFIs.
Practitioners consider both reputation and credit risks to be caused by intense competition in the market, with commercial banks now scaling down to provide micro loans. Since commercial banks have more capacity, stricter governance, and better trained staff, they can provide a wider range of services than most MFIs. Therefore, in order to stay competitive, many MFIs started to utilize more aggressive lending practices, which in turn resulted in clients' over-indebtness and the tarnished reputation of the MFIs. While some investors think that competition with mainstream finance can be healthy, most of the practitioners find it "unfair".
Among risks ranked highly by the investors were also "political interference" and "corporate governance." Political risk ranked highest in Asia and did not even make it to the top ten in the CEE region. Interestingly enough, investors did not rank "funding risk" highly, which means that they are still willing to invest in microfinance.
Finally the top ten risks (banana skins) included "mission drift" and "unfulfilled expectations." Some responders stated that mission drift started to take place when MFIs diversified into consumer lending instead of sticking strictly to loans for micro-entrepreneurs. Others thought that such diversification should be considered "product extension" and could be very healthy as long as there are better mechanisms to monitor such lending (which goes back to the problem of underdeveloped technology and low capacity). The majority of the responders agreed that profitable IPOs are damaging to the industry's reputation and that profits should come from increased administrative efficiencies - which requires better capacity and governance - and not from higher interest rates.
The bottom line, according to the report's findings, is that the turmoil in the industry was caused by microfinance's rapid growth without sufficient capacity (e.g., trained staff, clear strategy, cutting-edge technology) to handle the high volume of loans. As the result, MFIs loaned too much money to people who could not repay or to those who already had too many loans. Now that the industry is no longer in the infant stage, it is time to address these issues and maybe refocus with more emphasis on customer services, lower volumes but higher qualities of loans, and clear corporate governance. The microfinance sector right now has 150 million borrowers with an estimated demand of 2.7 billion and while it is important to reach out the unbanked, such expansion should not come at the expense of quality of services.
Finally, this week I ran accross the Speakers Corner that was recorded in May 2006 to discuss Thomas Dichter's article on "Hype and Hope: The Worrisome State of the Microcredit Movement." I thought it might be timely to revisit that discussion and you can find the Speakers Corner #10 summary in the Microlinks Library.