By Arvind Ashta, Burgundy School of Business (Groupe ESC Dijon-Bourgogne)

Microfinance Focus, February 11,2011: My thanks to Kevin Day, President of Riskebiz, Sébastien Duquet and Vanessa Mendez of PlaNIS, Eugene Dani lkis at Mambu, Ben Lyon and Dylan Higgins, partners at Kopo Kopo, Casey Gheen of AVANA Microinsurance and Michael Greenberg of Fio Corporation for providing the information for this write-up and verifying its content.

It is often considered that a country is poor because it is poor and that exogenous capital is required to break the vicious circle of poverty.  Within a country, the poor may need this exogenous capital: “Nobody gives the poor the first dollar,” says Muhammad Yunus, the Nobel Peace Prize winner. Part of the reason lies in their lack of human capital and the inability to use technology, part of the reason lies in asymmetric information keeping banks from lending to them, and part of the reason lies in the small transaction size leading to high transaction costs.

Yunus foresaw that the poor could get together in groups and thus allow MFIs to overcome asymmetric information without actually getting the information (the poor know who amongst them are bad risks and therefore do not include them in groups). Similarly, technology companies are realizing that if the poor can use telephones, then that is sufficient for them to get into the field and provide them micro-services which make it possible to lower transactions costs in dealing with them. One such service is mobile payments which has grown exponentially and has features of mobile banking.

The boom of microfinance and its high profits as attested by Compartamos in Mexico and SKS in India has indeed raised investor interest in this sector. For many years, most of the private investment capital was limited to the top 150 to 200 tier 1 MFIs. However, now there is evidence that many of the tier 2 companies do become profitable with time and scale, if they are well governed. Some private equity is therefore now searching for such MFIs.

The problem with tier 3 and tier 4 funds is like that of the poor borrower: "nobody gives the small MFI the first ten thousand dollars". Yet, if it can be seen that many of these tier 3 MFIs will be young turks who will move up quickly to tier 2 and eventually to tier one, then patient venture capital could be attracted.

A host of private equity and venture capital funds are coming up to invest in this sector to serve tier 2 and tier 3 MFIs. To understand why, it is best to resume how private equity works. In general, the first consideration of these funds is to find mispriced firms and to buy cheap, add value and sell out. To do this, they invariably select high growth industries. They leverage debt, focus on cash flows and not on earnings, they reduce costs, they focus on core businesses where the target can outperform its rivals and they have a good exit strategy. In addition, they usually align managers’ incentives and make quick decisions since they are privately owned. In recent years, the guidance role of nurturing the small business to scale is being stressed.

What does this mean for microfinance? First, since microfinance sector is growing at the rate of 30% per year, private equity funds in general and venture capital funds in particular would like to enter this segment.

Their main questions are

·         Selection: In which MFIs should they invest, out of the 10,000 exiting MFIs?

·         Governance: How are these MFIs governed?

·         How will this MFI scale its business and profits?

·         Will the private equity manager be able to provide the right technical guidance?

The selection of MFIs requires partnering with a firm which already knows the local microfinance sector well and can diligence investments in order to direct the funds to well governed MFIs. This already lowers the risk of the investment fund.

The main question remaining, then, is how to ensure that the selected companies grow. Evidently, in this age of dynamic interconnectivity, any business offer becomes competitive if it uses the strengths of a large number of complimentary actors to get together to provide a rich experience to the final consumer or to the business manager. In this case, a group of organizations needs to come together to ensure that investors’ money is going to the right MFIs and that the MFI would get the necessary advice to sustainably scale its operations. This is called co-creation by C.K. Prahalad and Venkat Ramaswamy.

Increasing the profits of the MFI requires better management, new delivery channels and new products. The single most important technology for scaling is considered to be good MIS. The single most important delivery channel for the poor is using mobile telephone for payments. The new products for microfinance are microinsurance and micro-transfers of money. Any investment fund manager who wants to invest in this sector needs the capacity to bring together a team of technical advisors to simultaneously provide these different inputs to the MFI and transform it from a 10,000 client single-product company to a 100,000 client, multiple product, multiple channel company.

One fund who understand all this is Riskebiz which just launched its fundraising. Before this launch, it brought together a team of players who have the technology and the interest to develop the market for the poor. The figure below shows how the team of players will co-create value for the poor, for the MFIs and, eventually, for the investors. The thin arrows indicate movement of funds, the blue arrows indicate information flow between partners and the thick green arrows indicate impact on the system from the partners.

Riskebiz has partnered with Planis (on February 2, 2010), who is now merging with ResponsAbility, and who knows the microfinance sector very well, being associated with the PlaNet finance group, who are probably the second largest private multi-service provider to the microfinance sector. PlaNIS has been able to link private and institutional financial market players to the local microfinance sector. It aims at meeting the growing needs of developing and promising microfinance institutions, providing them with tools usually used by and reserved to other markets. PlaNIS can be viewed as a bridge between international funds and microfinance institutions. Its major fields of expertise include sourcing promising and leading microfinance institutions by geographical area; providing a high quality investment and credit risk analysis leading to professional advice; and monitoring investments through adequate financial tools. PlaNIS' projects include the development of structured financing activities through the syndication or arrangement of mandates and through more sophisticated structured transactions, such as collateralized loan obligations. PlaNis will help Riskebiz select the right institutions as well as monitor their performance.

To help the MFI scale up, to increase its efficiency and to reduce cost, attention is being focused on Software-as-a-Service . This is a model where one software solution is hosted online and provided to MFIs on a pay-as-you-go basis. This removes the burden of MIS and hardware management from the MFI and increases external trust & transparency into the MFI. Riskebis has selected Mambu as the online software application for its microfinance organizations. It is an easy way for organizations to manage their portfolio and enable their growth and success in providing financial services to the poor. The MFIs will access the Mambu software on the Internet using a web browser. Each microfinance institution will have a private, secure login access with all their information which they can access and extract at anytime. MFIs won't need to install anything or manage the technology behind the application. They don't need to worry about maintenance, backups, server hardware, databases, security or upgrades; the only thing MFIs require is an Internet connection. The use of this information system could offer investors real-time access to reports. Mambu indicates that using the SaaS model is a first for the MFI sector, which means greater transparency, quicker sharing of information and ability to react quicker to any changes within the MFI market.

The use of the mobile payment delivery channel will be facilitated by Riskebiz's partner, Kopo Kopo, who will provide the software link between MFIs and the telephone operator, also on a SaaS basis. Kopo Kopo facilitates the expansion of mobile financial services to the ‘last mile’. They leverage leading internet and mobile technology to lower institutional barriers to entry, increase efficiencies, and empower both the MFI's customers and the people they serve. Kopo Kopo offers a software-as-a-service platform that enables microfinance institutions to easily integrate their enterprise software with one or multiple mobile money systems. The service is available on a tiered subscription basis and allows enterprises to access the functionality they need without paying licensing, installation, and professional services fees to software vendors.

Several microinsurance products are being developed by Avana, which will be offered by Riskebiz's MFIs to their custsomers, thereby reducing risk in the MFIs’ loan portfolios, diversifying their revenue base, and enhancing their social impact within the community. Avana Microinsurance is a social enterprise that seeks to expand access to insurance among the world’s poor by developing and managing affordable, demand‐driven products to low income clients using risk capital of established insurance and reinsurance companies.

To make this microinsurance less risky, the health of the poor will be checked and monitored by advanced technology developed by Fio Corporation.  Fio is converging smartphone technology, biotechnology, and nanotechnology to create portable, digital diagnostics for infectious diseases at point of care in developed and developing countries alike. Designed to work with a droplet of blood and to be operated by minimally trained users in a broad range of minimal infrastructure settings, this technology supports a novel business model capable of altering how the world manages its leading cause of death, disease, and economic disruption. Fio successfully demonstrated its prototype in December, 2010 and has begun initial field tests in early 2011. The constant checks may help raise health consciousness and increase the productivity of these micro-entrepreneurs and reduce the risk of the MFI.

Thus, a multi-pronged strategy will lead to co-creation of value by combining Finance and Technology to enable the poor to get out of poverty. It’s about lowering Risk and increasing Business, says Kevin Day, the president of Riskebiz.

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About the author :

Arvind Ashta holds the Microfinance Chair of the Burgundy School of Business. He has authored a number of papers for Microfinance Focus. He has edited a book on Advanced Technologies for Microfinance: Solutions and Challenges, published by IGI Global.