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January 11, 2008

Microfinance: Catch the Swelling SRI Wave
    by Anne Moore Odell

The microfinance sector offers socially responsible investors a growing arena to create positive social and financial growth according to a new Deutche Bank study. -- Microfinance is at an exciting and pivotal point in its development. As microfinance moves from a donor-backed model where microfinance institutes (MFIs) are run by non-profit organizations to being based actively in capital markets, microfinance offers many new opportunities to institutional and individual investors. And, importantly, as microfinance grows, so do the opportunities to help finance the businesses of its clients.

Please support
our sponsorsA new study released last month by Deutsche Bank (ticker: DB) entitled "Microfinance: An emerging investment opportunity" projects the rise of microfinance into its own investment niche. The study anticipates a growth in microfinance to $20 billion by 2015 from the $4.4 billion that was invested in microfinance in 2006.

"Microfinance has undergone a significant transformation in recent years," said Dr. Norbert Walter, Chief Economist at Deutsche Bank. "This study has demonstrated that the steadily growing popularity of microfinance has reached a global audience and continues to be a key facilitator in helping to fight poverty in both developing and developed countries."

The demand for microfinance capital is enormous the study postulates. The study's author Raimar Dieckmann estimates that the microfinance sector worldwide has a total outstanding loan volume of $25 billion. However, it is only a small percent of the funds that could be used to fulfill the needs in areas served by microfinance. Dieckmann puts the funding gap at $250 billion. Involving the private investment sector to help close this funding gap is one of the goals of the microfinance sector.

The study's numbers do point to a massive growth in microfinance. Between 2004 and 2007, public and private investments in microfinance institutions doubled. Dieckmann suggests that microfinance investments will continue to rise due to a number of factors, including the rising interest in socially responsible investing over all.

Another factor driving the growth in microfinance is that microfinance is increasingly being seen as a positive way for a wide array of investors, not all necessarily social investors, to diversify their portfolios. The other important factor leading to the increase in microfinance investment is the creation of more MFIs that are able to use international funding.

Currently, there are over 10,000 MFIs globally ranging from banks, credit unions, NGOs to cooperatives. The study divides MFIs into four tiers, the highest being mature, regulated financially sustainable MFIs which only make up 1-2% of the all MFIs. The second tier MFIs are close to becoming microfinance banks and are nearly profitable. The third tier MFIs are NGOs that approach profitability. However, the majority (70%) of MFIs are placed in the lowest tier and are classified as start up MFIs and are largely unprofitable.

The study focuses on the two main types of foreign investors in MFIs. The first are international financial institutions (IFIs), such as the World Bank and the European Bank for Reconstruction and Development. The second type of MFI investors are private, both individual and institutional investors. Getting more investors to invest in the tier one and tier two MFIs would be the first step in closing the gap between demand and capital.

Dieckmann writes in the report, "IFIs might focus on providing riskier funding to smaller tier 2 MFIs while, over time, an increasing number of institutional investors might become willing to invest in more junior tranches of collateralized debt obligations (CDOs) and, hence, crowd in further social and commercial investors for less risky parts of a CDO that invest in tier 1 MFIs in the long term. From a normative point of view, the full development of local financial systems should be aimed for that would enable MFIs to refinance themselves from retail deposits, bank loans and access to domestic capital markets."

Although MFIs expanded their customer base in 2006 on average 23%, the microfinance industry is can still only meet the needs of a small fraction of its potential borrowers. To put this in perspective, MFIs currently serve an estimated 100 million borrowers, while the total potential demand is roughly estimated at one billion people the study reports.

The study itself is a very readable primer for investors interested in learning about microfinance and how MFIs operate. The creditworthiness of the working poor who qualify for microfinance loans is extremely high. One example of the information offered in the study is its explanation of why traditionally women have made up the vast majority of MFI borrowers.

"The predominance of women reflects the fact that women are more reliable debtors because, due to stronger social and family ties, they often follow a more conservative investment strategy which in turn results in lower default rates for MFIs," Dieckmann writes. "This lower credit risk is further supported by a relatively low degree of labor mobility of female clients (due to strong family ties women tend to work from home) which decreases the cost of monitoring debtors for an MFI."

The study also includes the top 50 microfinance institutions. The top 5 microfinance institutions listed are Grameen Bank, Bangladesh; ASA, Bangladesh; VBSP, Vietnam; BRAC, Bangladesh; and BRI, Indonesia. The rankings are based, in part, on the number of borrowers, gross loan portfolio and return on equity.

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