The Andhra Pradesh crisis illustrated investing in frontier and emerging markets carries a political risk, but investors also need to consider two types of default risk with microfinance. The first is the risk of end borrowers paying back their loans to MFIs late; and the second is the reliability of the payment between the MFI and the MIVs.
The Blue Orchard Microfinance has made $1.2bn of loans to the microfinance market since its inception 15 years ago, yet Jimenez Davila says that payment arrears at MFI level are only in the region of 3% to 4% per annum with loan write-offs even below 1%.
“At the fund level, we did not have a single default during the first eight years so our loans were paid back in full,” she says. “Then we saw two crises: the Nicaragua ‘no pay movement’ in 2009 when micro entrepreneurs were encouraged not to repay their loans in a politically motivated protest causing the microfinance investment industry to experience its first defaults; and the Andhra Pradesh crisis which massively impacted MFIs with portfolios in this Indian state.”
The Centre for the Study of Financial Innovation’s latest survey showed the ghost of Andhra Pradesh still haunts the industry, revealing over-indebtedness among microfinance borrowers was seen to be the most pressing risk facing the industry, followed by corporate governance, management quality, credit risk and political interference.
According to Azure Partners managing director Vincent Oswald, default rates are below 1% for most of these microfinance funds. Oswald is also quick to explain microfinance operates in “counter cyclical” industries within which people’s occupations include the likes of taxi drivers, farmers, street sellers – those not very linked to the formal economy.
“We had investments where the sovereign defaulted and we had no problem at all in our microfinance institutions,” he says.
Another source of controversy has come when a microfinance company has undergone an initial public offering (IPO), such as the 2007 IPO of Mexican bank Compartamos – the largest microfinance bank in Latin America – which raised $467m. While investors rightly seek to gain a financial return from microfinance, MFIs also have a social objective and when these institutions earn large returns for private investors out of IPOs and flow of wealth transfer is from the bottom to the top of the pyramid – that is against the principles of microfinance.
But SharedImpact’s North believes the controversy around the likes of Compartamos should be viewed in context. He explains: “There are high interest rates being charged on the ground, but you have to compare it to what is normally on the ground and the natural interest rate from the equivalent of payday lenders is horrendous, so in fact microfinance undercuts them massively, even though compared to western standards of loan rates it is quite high.”
Capacity
With the total market for microfinance weighing it at around $90bn, capacity is a particular issue. A lot of pension funds want to deploy large tickets and retain liquidity, but microfinance is illiquid because of its market size and its unlisted nature. If one large investor was to pull out it could shut down an entire fund.
Jimenez Davila says her firm can place about $50m a month into microfinance investments, which compared to a traditional bond fund is tiny. However, she argues it is enough for an investor with a long-term perspective to build an attractive risk/return profile, if necessary over a pre-defined ramp-up period of up to one year.
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