Microfinance - the next stage

There is a very good, detailed, yet simple, research paper at the website of American Enterprise Institute for Public Policy Research, titled Building on Success: The Next Challenges for Microfinance, by Robert Eichfeld and Henry Wendt.

Tracing this history of Microfinance, from Muhammad Yunus' Grameen Bank story in Bangladesh, the paper talks about the challenges facing the Microfinance industry and how commercial funding can help in growing the microfinance sector and helping 100 million poor families by 2007.

An important turning point in the history of MFIs took place in 1997, when 2,900 delegates from 137 countries met at the first Microcredit Summit and set the goal of providing microcredit to 100 million of the poorest families in the world by the end of 2005. At that time fewer than 8 million families were being reached. As of the end of 2004, by contrast, 92 million poor and 62 million of the poorest were being helped. If the program continues to grow at its historic rate of 39 percent annually, the Microcredit Summit goal will be reached as early as 2007.

The paper talks about two key methods by which commercial funds can come into microfinance institutions, and quotes two examples. In both cases, Grameen Foundation has helped make things work.

First is loan-portfolio purchase agreement in which ICICI Bank of India purchased a portfolio of 42,500 small loans with SHARE Microfin Ltd. for $4.3 million, in January 2004. This deal was facilitated by a first-loss, collateral deposit by Grameen Foundation of $325,000 (about 8% of 4.3 million).

This money will be used by SHARE as new capital and will help provide loans to more poor people. This helps ICICI Bank to reach poorer people who it can never reach directly. SHARE will be responsible for the collection and servicing of this loan portfolio as well. The risk on non-payment is however not imposed on SHARE, but on Grameen Foundation (8%) and ICICI Bank (92%). The paper quotes Economist as saying:

Grameen [Foundation] sees its cash deposit multiply twelvefold on its way to the poverty stricken borrower.

Second scheme, developed by Grameen Foundation in partnership with Citigroup is called Grameen Foundation Microfinance Growth Guarantees. Wealthy individuals can pledge their money not as donations or grants but as guarantees to banks of their choice, which "in turn will provide letter of credit hrough Citigroup to local microcredit institutions for the specific purpose of raising leveraged local currency financing for microfinance institutions." This can help in microcredit institutions getting capital at a considerably reduced interest rate, which in turn can be used to (a) offer loans at lower interest rate to poor people (b) enable microfinance institutions to reach breakeven.

As of October 2005, Grameen Foundation Growth Guarantees has reached $31 million.

While commercial borrowing is the best way of growing the microfinance sector, Government grants and risk capital in the form of venture capital would still be the best way of starting up microfinance institutions in India (and around the world).

There will have to be dedicated micro banks for women (like SEWA Bank) across the country, which goes a little farther than a standard MFI, and perhaps possibly Dalit Banks, started with grants and VC money. After 2-3 years of performance, they should be able to tap into commercial money through loan-portfolio sale to larger banks and raise money through Grameen Foundation Growth Guarantees or similar schemes.