How to assess the real strength of a microfinance institution?
- Saturday, August 22, 2009, 15:25
- Featured News, Financial inclusion, Investments, Microfinance Ratings
- 6 comments
David MacDougall, Director of Risk Management, BlueOrchard
Microfinance Focus, Aug. 22, 2009: There have been startling losses in microfinance institutions that have wandered too far from their original microfinance mission due to fierce competition or of profit-minded management, writes David MacDougall, Director of Risk Management at Swiss microfinance fund manager BlueOrchard.
Servicing traditional microfinance clients is expensive because loan sizes are small and the number of people required to service clients. But it was caried out with a goal and motivation. When competition deters the MFI from charging higher interest rates and absorb losses more frequently, it leads to higher loses, explained MacDougall in an article written for the August issue of Microfinance Focus magazine.
“I’ll admit that I have my own spreadsheet full of ratios; however, I principally use them to gauge trends. Often the levels they indicate have limited meaning, and analysts must understand when they do and when they don’t. A key consideration is whether the institution is mission-driven, rather than profit-driven. Many MFIs are non-profits or at least not profit-maximizers. They often charge just enough to cover their expenses and build the portfolio,” he wrote.
MacDougall, who was formerly an Executive Director of the ASA Foundation, a microfinance organisation in Bangladesh that focuses on providing technical assistance, said ASA’s operational self-sustainability dropped from 240% in 2006 to 185% in 2007. “Far from being an indicator of weakness, this reduction was the result of the management’s decision that it was making more than enough to meet its growth needs. So it lowered lending rates,” he noted.
RISKS AND REWARDS
There are many forms of support available to MFIs which they are unable to maximize, he said. A broad array of aid agencies and philanthropic investors are ready to help institutions that can make a difference in under-privileged communities. Such institutions often tend to take care and mitigate the risk factor in their portfolio, which investors should assess.
But in case of an MFI that failed to fully hedge its foreign exchange risk, the crisis turned this error into an emergency for the MFI. With a large portion of its equity gone, lenders could have accelerated the loans and forced the MFI into bankruptcy. The situation forced lenders and networks to look for ways to find ways to get the MFI through the rough patch because its record of providing services to a large number of very poor women was excellent, said the director of risk management at Blue Orchard.
NOT IN SPREADSHEET
Finally, the MFI’s key strength – its management – will surely not be found in a spreadsheet. Managing a MFI requires leaders with a rare combination of skills. Amongst other things, they must have a thorough understanding of their immediate environment while keeping sight of the wider financial context, and they must be quick to adapt to any changes. They have to train staff to the peculiar business of microfinance and reaching out to clients who may have only the most limited understanding of managing their finances, said MacDougall.
At the same time such leaders must communicate transparently with aid agencies and philanthropic or commercial funders. “In brief, those looking to gauge the viability of MFIs must set aside their sophisticated models and focus instead on understanding the activities, context and management of a MFI. They must acknowledge that strengths in these areas can see a MFI successfully through troubled times and lead it to flourish,” he commented.
A spreadsheet with numerous ratios and graphs serves as the standard tool. Unfortunately, such efforts can lead to erroneous conclusions because their focus isn’t wide enough. The answer isn’t in the spreadsheet. The fundamental strengths of MFIs lie in the nature of their business itself. International enthusiasm for microfinance was inspired by the fact that MFIs offer an essential service where main-stream banks will not provide it: they grant credits, the possibility to save money and other financial services to those previously excluded.
While MFIs face a host of challenges, their socio-economic mission endows them with special advantages. “We should expect MFIs to succeed where they continue to operate in underserved markets. Analysts should therefore examine whether an MFI’s mission and programs focus on traditional microfinance or not,” advised the author who was a consultant at Deutsche Bank working on microfinance and other innovative socially responsible investments before joining BlueOrchard.
(Disclaimer : The opinions expressed in this report are based on an article by the author and they do not necessarily reflect BlueOrchard’s views.)
***********************************
Microfinance Focus August 2009 Issue .
© 2009, Microfinance News. All rights reserved. 2008-09
6 Comments on “How to assess the real strength of a microfinance institution?”
Write a Comment
Gravatars are small images that can show your personality. You can get your gravatar for free today!
In addition to mission drift, damage is being done to relatively healthy microfinance institutions by inexperienced or unrealistic stakeholders (including board members and management) in hasty pursuit of their own ‘success’, typically quantified using industry standard measures. Understanding how to create and sustain conditions for lasting success, while maintaining commitment to mission as Mr. MacDougall has insightfully noted, are fundamentals worthy of remembrance as MFI’s define their goals and seek their realization. Thank you.
A broad array of aid agencies and philanthropic investors are ready to help institutions that can make a difference in under-privileged communities. Such institutions often find access to technical assistance and below-market rate funding. The leaders have to train staff to the peculiar business of microfinance and reach out to clients who may have only the most limited understanding of managing their finances.
From inception MFI needs to be adequately capitalised to achieve not only the minimum required legislative capital (if applicable) but to support its first 12 – 18 months growth strategy. Is there any indication that long term financial self sustainability will be achieved, this is to raise capital through local markets and not be reliant on possible ‘soft funding / technical grants etc.
What is in the strategic plan to diversify product range beyond the first 2-3 years of operations. Is credit extension the only product in place or in the pipeline.
Secondly review of annual financial statements from inception should reflect that profitability is reached within 18 to 24 months – if not why invest? Management team plays a vital role in the strength of the business; This strength is reflected through policies and procedure manuals in place; portfolio at risk measurement; knowledge as a team of the indigenous and local capital markets. How well does management manage cost to income ratio, is there scale of economy reflected as portfolio grows over time.
Then the operating platform (is it scalable to growth and development: i.e. not Excel of some other briefcase type software).
Kenneth A (Ken) Corsar
New Business Development and Product Specialist at Select Advisors Limited
First of all that is an excellent blog by David, that there is life beyond just ratios in assessing the strength and viability of MFI’s.
I think the real question posed ought to be how closely aligned are MFI’s to their mission of serving the “unserved”, “underserved” or “unbanked”.
Given that most operate as non-profits, yet in a good number of instances they have strayed towards seemingly greener pastures of higher loans amts whether those be consumer or SME type loans to seek profitability.
This is the Achilles heel for the MFI’s. At lower loan amts one has to have scale, and unless one has scale, i.e.in terms of number of active customers, it is very difficult to turn a profit, and this in turn affects their ability to attract investments from the investment community.
A number of MFI’s (with active accounts in the range of 2K to 20K) are confronted with these realities, and in some instances this is the result of being badly managed, however in other instances this occurs despite having good management.
And to what Ken says, I agree on one hand but would argue that strict focus on profitability ought not to be the sole marker but to use other markers such as cost per loan acct, cost per unit of money lent, % of fixed cost to variable cost, PAR, customer churn, staff churn, etc … Not being a financial maven I will leave it to David MacDougall and others to come up with KPI’s that make sense.
My point being that donors and social investors can help MFI’s by setting KPI’s to measure their operational, financial and risk management excellence.
Just this past Friday, Sept 25th, The Rockefeller Foundation committed funds at the Clinton Global Initiatives forum for the creation of just such a standard/framework.
Jiten Patel
Technology & Program Management Executive with excellent global experience
With our feet in the investor pool at the moment we are finding access to capital quite challenging; the times of the last fews years where funds flowed freely to ‘non profit’ based MFI’s – I see that efficiency based models are becoming more important to the funding pool. So we have a double edged sword to appease, social based lending with commercial returns. This cannot be achieved unless management and policy are set, management remain dynamic to changes, products are aligned to deliver market needs. We align ourselves towards banks and the KPI that are manifested in the formal financial service industry; this is where all MFi should be or aspiring to be. Access to capital will continue to be hard to come by, soft or grant based lending is almost dead following GC08 (Global Crisis 2008)
Kenneth A (Ken) Corsar
New Business Development and Product Specialist at Select Advisors Limited
Mr. David Mac Dougall has made a fantastic write-up and has equally stir “the bees“ nest. I am a Nigerian from Africa Continent. There is no gain-saying that most MFIs strenghts lies in their Mission/Goal/Motivation, but the big question is how are the MFIs encouraged to do the needful???. The MFIs investor are over-emphasising ratios instead of impact of their credit provision to the “unbanked“ poor. The small borrower at the end of the day will end up being impoverished. The ratios are always full of growth in Earnings/Returns on Equity& Assets; Dividend (cash) Payments/Bonus issues, etc. Is this not exploitation at the detriment of the “underserved“ poor ???. The idea and motives of microcredit was to empower the poor and the unbanked women who has ability/strenght but lacks credit that will drive his/her dream and liberate them from the tanacious hands of poverty. This dream will be shartered if they can not have access to smaller loan, at a below market interest, and at a reasonably longer period. The donors and investors in MFIs should please safe the poor borrowers from the profit-driven, ratios-managed Institutions.