Saturday, January 3, 2009

Transformation of MFI s and other risks in microfinance

Source: Raimar Dieckmann, Senior Economist, Deutsche Bank AG

Currently, an increasing number of MFIs are transforming themselves into regulated MFIs or even niche banks. While this process allows MFIs to improve their access to funding by taking deposits and to expand their client base, incorporation as a regulated entity also entails risks of inappropriate management and governance systems. In practice, internal control systems of MFIs are often not well equipped for this transformation and enhanced regulatory requirements often pose additional challenges. In rare cases, MFIs even drift away from their original target, which is the low-income customer base. Other MFIs have moved upmarket, serving the growing financial needs of middle-income clients. By doing so, they often enter into direct competition with traditional retail or commercial banks. A recent survey conducted by CSFI and sponsored by CGAP and Citi confirmed these conclusions and ranked poor management and corporate governance structures as the greatest current risks in microfinance. The strong rise in private-sector investments also entails some risks, as foreign investments are concentrated on the 200 largest MFIs. In addition, they focus on the well developed microfinance markets in Latin America and South Asia, leaving African and other Asian markets underdeveloped. This situation leads to risks for investors as some MFIs expand their client base too rapidly, potentially impairing the quality of their loan portfolios as a result. In addition, strong competition amongst leading MFIs drives down not only interest rates for MFIs but also those charged by MFIs to micro-borrowers. While this is at first glance good news it might also impede MFIs’ profitability and, thus, ultimately their ability to repay loans to foreign investors. Consequently, risk-adjusted returns become less attractive in some countries and the increased leverage ratios of MFIs point to limits on further borrowing in certain markets. This situation will ease in the medium term when a broader range of will become capable of absorbing foreign debt finance.

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