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Funding the Risk Frontier in Microfinance

The recent IPO of SKS Microfinance, India's largest microfinance institution (MFI), was a watershed event whose ripples are affecting the public perception of microfinance.
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The recent IPO of SKS Microfinance, India's largest microfinance institution (MFI), was a watershed event whose ripples are affecting the public perception of microfinance. When an organization originally founded as a nonprofit first attracts some $75 million in successive waves of private equity capital and then raises $358 million in a public offering of stock, it seems natural to ask: Is there any remaining role for donor funding -- or for nonprofit engagement -- in this industry?

Despite the fanfare associated with public listings that attract commercial money into microfinance, only a handful of the largest MFIs are traded on stock exchanges. Moreover, outside the MFIs' home exchanges (Mexico for Compartamos, Kenya for Equity Bank, or India for SKS) these shares are generally only available to institutional investors. The vast bulk of the microfinance industry relies on socially motivated funding in a mix that includes grants, loans and equity investments. Anyone who wants to support microfinance can select from a multi-hued array of funding opportunities to find one that matches his or her wishes.

For those who want to lend their money and get it back, there are socially responsible investment funds like Microplace, Calvert Foundation and Kiva. They specialize in microfinance and pursue a double social and financial bottom line. These funds often select a financial return target that varies depending on how socially focused they want to be. If these funds track the social performance of their portfolio companies along dimensions like client poverty levels, transparency, and responsibility to consumers, investors gain confidence that their money is being used as desired.

For grant makers, there are nonprofit organizations -- like ACCION (disclosure, my employer), Opportunity International and Grameen Foundation -- devoted to starting and growing MFIs that maintain a social mission. While such organizations share many aspects of best practice in microfinance, each one brings a unique development philosophy and emphasis, which allows prospective supporters to find the best fit.

With all the choices, how can a donor or investor interested in microfinance decide?

Let's assume three kinds of funds: straight commercial funds that obey the rules of the marketplace, social investment funds that explicitly combine social and financial aims, and pure grants. Each has its own niche. Two closely related decision rules suffice to sort out their different roles.

• Rule One. If the market can fund it, let it.
• Rule Two. For grant makers, find the frontier and help push it out.

These rules come from the reality that grants and social investments are scarce and need to be deployed where they will make the most difference. It helps to think back to the late 1980s when the U.S. Agency for International Development and the InterAmerican Development Bank together invested something less than $5 million to help ACCION launch Prodem, the precursor of BancoSol in Bolivia. Today, BancoSol is a commercial bank with a loan portfolio of $340 million, serving 127,000 borrowers and 254,000 savers. It would not make much sense give BancoSol a grant to cover operating expense or loan capital today. Both the bank and the microfinance field have evolved. In response, donor support has evolved -- and needs to keep evolving. Today's challenge is to figure out where today's industry frontiers actually lie. Below, a brief roadmap.

At the absolute frontier, grant funding is needed. The unfilled needs are many:

• Microfinance services for marginal groups, including rural and remote populations, the disabled and others who have not yet been served with commercial models. For example, BRAC and Grameen Bank in Bangladesh support urban beggars while CARE and Oxfam create savings groups in sparsely populated rural Africa.
• R&D to develop new products like savings, microinsurance and specialty credit products (like loans for renewable energy, home improvement or education¬).
• R&D to apply new technologies to bring services closer to clients.
• Capacity building for MFIs in countries where microfinance is lagging, such as in
central Africa.
• Development of the "infrastructure" that keeps the industry healthy, such as credit bureaus and client protection.
• Financial education for clients.

There's a second frontier that I call the risk frontier. This is the home of social investment. The risk frontier includes institutions that operate profitably but are still viewed as risky by the market, either because they are young, or are operating in difficult environments, or are testing the commercial viability of new products or client groups. There are dozens or possibly hundreds of MFIs in this category, often known as second and third tier MFIs. Also in this group are top tier MFIs that operate in frontier markets. For example, because Bolivia is regarded as a risky setting, BancoSol still works with social investors to raise debt and equity.

Off the frontier, the market can take it away. Commercial sources can now supply much of the debt and equity in top tier MFIs, either directly or through specialized microfinance investment funds. And even for second tier MFIs, especially in less risky countries, much of the debt finance can be purely commercial. Many MFIs work with a blend of pure commercial and social investors. And finally, profitable MFIs that become licensed banks, can increasingly be funded locally through deposits -- an important and fully commercial source.

Microfinance is about building in a future in which the world's poor have access to financial services. Individual donors and investors, as well as those controlling public or institutional capital, need to balance their assessment of social impact with their needs for investment returns and risk. Like any other donation or investment, a little research and due diligence beforehand can bring assurance that funders and those they entrust with their money share the same goals.