Microfinance-Thesis Dilin Lim

INSTITUTO DE EMPRESA
Thesis
Practical Challenges of Microfinance Institutions
Dilin Lim
Master in Advanced Finance candidate
December 2009
Completed with direct supervision of:
Prof. Eloy Gracia
This research paper discusses the optimal combinations of stable funding and operating efficiency of
Microfinance Institutions to reduce interest lending levels to the Micro Entrepreneurs.
PRACTICAL CHALLENGES OF MICROFINANCE INSTITUTIONS
HYPOTHESIS:
In all models of microfinance, what are required are optimal combinations of stable funding and operating
efficiency. We will examine to what extent the operational aspects of developing an efficient lending structure,
transparency, loan follow-up and stable sources of funds contribute to the reduction of interest rates paid by
the poor i.e. the client.
INTRODUCTION
The considerable interest that has been developed in the financial world and academia for the topic of
microfinance cannot be underestimated. In fact, one of the most impressive developments in the world of
social economic development in the last few years has been the successful explosion and impact of
microfinance on society at large. Ever since socio-economic development became institutionalised in the form
of the objectives guiding development banking, the elimination of poverty has been proved elusive. However,
well known bottom of the pyramid seems to have now found in Microfinance is most effective partner.
In this analysis I intend to explore how is that microfinance actually contributes to empower those at the
bottom of the pyramid by allowing them to unleash the smaller or greater degree of creativity and
entrepreneurship inherent that is in any human being. I intend to look into some of the detail of how the
organisations that channel the funds to the micro borrowers operate and how the pecuniary costs and benefits
are or not transferred to these. Certainly, there is a wealth of information regarding micro-financing activities
in general but it becomes more difficult to obtain information when it comes to analysing a specific institution;
generally, information provided in financial statements and websites do not offer the kind of detail that would
be necessary to perform a sound financial analysis of the cost benefit relationship.
Nonetheless, based on the material available there are some interesting findings and conclusions that can
provide a worthwhile analysis. For example, by analysing the Asian versus the Latin American model of
microfinance, it can be inferred what drives each and which of the two is more profitable from the purely
financial and from the socio-economic point of view. Furthermore, within each of these two general models
there are different variations depending on memberships and partnerships. These also have an impact on their
cost structure and benefits to be pass-through to their members. In the findings, we list specific situations that
address some of these variations but, in general, these are not conclusive. Further analysis will be required
with the kind of data that was not available for this work.
The conclusion reached is given that the breath of activity in the micro-financing field, there are so many
“business” models that is not possible to reach a blanket conclusion as to which is better or worse. They all
have their own merits and weaknesses and each has to be evaluated in the context of the groups (including
owners) which they serve. Regarding the transfer of pecuniary benefits to the borrowers and beneficiaries they
all do receive them, otherwise the industry would not be as successful as it seems to be, but it can be
concluded with some certainty that there is plenty of room for additional benefits to be passed-through as a
result of more effective cost management practices and application of low cost mass communication
technology.
Professor: Eloy Garcia 1 DILIN LIM - MIAF 2009

RESEARCH & FACTUAL CATEGORIZING

MODELS OF MICROFINANCE
Microfinance since its inception has evolved in different parts of the world, where the poor experience
different needs, political, sanitary and environmental concerns. Various Entities have been setup to provide
support to the booming industry, considering just India growing at 28% to 47% from 2003 to 2007 in loan
disbursements. [1] There is a surge in setting up various types of institutions and NGOS, profitable or not-for-
profit, setup to provide direct micro loans or indirect funding to microfinance institutions. Microfinance is
among one of the very few that are experiencing growth in the current economic crisis. The main reason
driving this growth is the availability of 2.6 billion people equivalent to over 40 percent of the world’s
population that still live on less than USD2 per day and more than 2 billion remain “unbanked” (i.e., without
access to traditional financial systems). [2] A conservative estimate of the total market for micro-financing
exists for 1.5 billion people, whereby now only 10% [3] is reached, justifying the reason of high growth in
microfinance institutions. Initially, microfinance started in India as social clubs to provide social support and
funding through donations to the poor. Today, the presence of microfinance has spread to every corner of the
world, India, Russia, Afghanistan, Asia, U.S.A. and Switzerland in different forms to introduce capitalization
in the economy from the needy. There are 2 general forms of microfinance models. The first and foremost is
the Indian microfinance model that was started by Prof. Muhammad Yunus, winner of Nobel Prize Peace Prize
2006. The next is the Latin American Model that emerged due to the variation in demographics of the Latin
American compared to Asian regions.
THE ASIAN MODEL

The Asian model replicates the Grameen model of microfinance, founded by Prof. Muhammad Yunus
that advocates micro lending to the poor, especially women as they are believed to be less likely to default
compared to man due to children obligations. Lending and banking facilities are made available to women in
groups, and repayments rates are ensured through detailed business plan assessment, social and group
pressures. Financing is obtained from banks and through in-kind donations and a spread is added on top of the
cost of funding to microfinance clients. Management of MFIs targets reducing the MFI’s cost of distribution,
financing, operating efficiency to reduce interests charged to microcredit borrowers.
The Asian model of microfinance is referred as a double bottom-line company, due to its social
objective of reducing poverty and also profit seeking objective. [4] Both the goals of these organizations are
weighted equally and performance is judged through the achievement of nonfinancial mission, such as the
number of children clients are able to support through high school and universities. Double bottom-line
companies are owned by its members and micro clients, each member and loan borrower has a stake in the
1
A Primer on Microfinance in India - CGAP
2
The Microfinance Market Today – GC Capital Ideas
3
The Microfinance Market Today – GC Capital Ideas
4
History of Microfinance – GC Capital Ideas

MFI rather than just enjoying the services it provides. This structure of both member and loan borrower having
a state is more commonly seen in India compared to Asia, whereby only members have a stake in the MFI.
The Asian model replicating Grameen’s well structured establishment has very often create a strong
microfinance institution that plays a part through large scale disbursement of small amounts, consequently
incurring high administration cost in the process. Nevertheless these high costs are met by timely repayment of
up to 94% equal to that of the Chase Manhattan Bank. It is the Human Factor which Asian model/Grameen
possess as an integrated advantage that other microfinance institutions lack.
Indian MFIs range from Grameen-replicator NGOs to for-profit entrepreneurial ventures
to developmental NGOs which moved from Self-Help Group (SGHs) promotion to direct financial
intermediation. Based on asset sizes, Indian MFIs can be divided into three categories. [5] In the first category,
institutions are able to scale up their funds under management dramatically due to their ability to attract
commercial capital. Examples of these institutions are SKS, SHARE, SPANDANA, which were initiated in
the 1990s as NGOs promoting SGHs or Grameen model programs but after 2000, they converted into for-
profit, regulated entities, mostly Non-banking finance Companies (NBFCs). In the second category, both
NGOs and for-profit MFIs (mostly NBFCs) have high growth rates. NGOs transformed into regulated, for-
profit structures recently or are in the process and seek commercial equity investments. For instance Bandhan,
ESAF and Grameen Koota. [6] The third category comprises of MFIs equivalent NGOs that are striving to
achieve significant growth. There are more than 1000 of these MFIs in India that offers micro credit with
multiple developmental activities, such as micro insurance, and international transmission services. These
institutions normally face difficulties in accessing the profitability of their funds, as costs of management are
extremely high.
THE LATIN-AMERICAN MODEL

The Latin American model is conducted in the form of solitary lending (i.e. lending to individuals as
opposed to groups) focused on profit maximization and has objectives that are closely aligned with financial
institutions in developed economies. There are various variations of the Latin American model however all of
them use a common measurement of success that is largely through the financial earnings, performance and
ownership therefore it is similar to “commercial” MFIs, justified by raising significant amounts of capital
through IPOs or private equity investors. One such example is Banco Compartamos, a Mexican Microfinance
firm that had a successful initial public offering (IPO) in 2007, has been denounced by Mr. Yunus and others
for charging interest rates of close to 100% a year. [7] The Latin American model adopted by leading
institutions has a commercial orientation in its operations, driven by financial performance, financing and
ownership contract.
5
A Primer on Microfinance in India - CGAP
6
PRESS RELEASE: Indian Microfinance Institution Grameen Koota Receives $2.3m Equity Investment - Micro
Capital
7
The debate over a “bubble” in micro lending – The Economist.com

In this model, the smaller the loan size involved, the more important the character of the borrower as
the borrower’s willingness and ability to pay is the key to the approval of a loan applied. Loan officers of the
Latin American model evaluate the applicant as well as his/her business. This model is more responsive to
customer’s demand and demonstrates more adaptability in structuring its services to customers. Due to the
high commercial orientation of the model, MFIs have higher urban concentration (urban centres of developing
cities). There is a larger diversity of customers as products offered corresponds to clients needs; clients feel
valued have higher loyalty and trust in Latin MFIs, although they typically diversify their lending with a few
MFIs to have flexibility and obtain more capital. Compared to the Asian model, the Latin model has 38% of
women borrowers while in Asia and Africa, there are more than 60%. [8] Clients of the Latin model are
mainly above poverty lines, and disperse a larger average loan size. When loan sizes are measured in terms of
percentage per capita of GDP, loan size of Latin America is similar to Asia. The average loan sizes in Latin
Model are used as a benchmark for client’s characteristics and focus of the model is on sustainability rather
than poverty alleviation.
NOT-FOR-PROFIT MFI MODELS

Other types of MFIs are purely not-for-profit, they are associated with religious institutions,
community-based or social-mission focused and policies are centred at maximizing society impact of capital
deployed. By virtue of their business plans, they are also often reliant upon donor capital for support. [9]
Each of 3 main models discussed has its benefits. The Latin American model, has a higher probability of
ensuring long-term enterprise sustainability. Not-for-profits, have the flexibility in deploying its capital to the
fulfilment of the organisational objectives as they are not accountable to provide satisfaction to earnings-
driven shareholders. However, funds for Not-For-Profit MFIs are frequently subject to unpredictable donor
support. Asian MFIs or the Double-bottom-line MFIs are the most highly debated model that combines both
advantages of for- and non-profit MFI models to achieve the goal of poverty elevation. We need to examine
how the different operational aspects of the Asian and Latin models highlight their challenges in providing
Microcredit.
B1. OPERATIONAL ASPECTS INFLUENCING PROFIT AND LOSS

- Origination, Loan approval and Disbursement process
In our study of the Asian Model of microfinance, we will refer to the example of Grameen Philippines
Catarman. Loan origination starts with clients submitting their business plan, key suppliers and targeted
customers alongside with documents indicating the demographics of the loan borrower, including their family
members, educational level, work experience, financial status and a copy of all the family’s latest water &
electricity bill & local housing taxes bills.
8
An Inside view of Latin American Microfinance (Inter-American Development bank)
9
History of microfinance – GC Capital Ideas

The branch manager needs to approve the loan accessed by the loan officer and normally for clients
availing loans for the first time, the loan officer will use the profile index with verification of actual documents
such as checking on the electricity bill etc, visits the clients house for verification on the feasibility of the
business project proposed by the client and attendance in training for succeeding loan releases to clients, the
criteria is based on the performance and evaluation of project proposal. Subsequent loan requests after the full
repayment of the first loan is based upon loan repayment, saving deposit, attendance in meetings and business
project performance which can be accessed through the project notebook of the client that records weekly
business transaction.
Adopting the same example of the Grameen Philippines model, prudent loan approval measures
prevent clients to make up a name and profile to take an additional loan from a different branch or loan officer
after not being able to pay from the previous branch. In Grameen Philippine’s example, it is the centre group
that will endorse the client. The centre group observes what we call "social responsibility" that they are
responsible for the recruitment of additional members as well as the loans availed by the clients. This model is
structured to access the profiles of micro lenders in-depth. Loan officers from the local municipality are hired
to access the credit profile of the client. This helps to ensure a higher repayment rate in Asian MFIs compared
to Latin American model. There are important emphasis on both the character of clients and often integrity of
microfinance officers.
In general, the owner of Asian model MFIs gives personal attention and takes a stringent selection
process of each micro loan officers personally in order to ensure the integrity of each client assessment and
loan transaction approved. The MFI’s assistant president, at a supervisory level authorizes the loan approval
within 1month after origination, working closely with the president and performing weekly audit of all loan,
on informs the client on the application status of the loan after visiting their house and neighbourhood. This
adds another level of assurance to the loan assessment as the assistant president has more expertise in
accessing client profiles and prevents any collusion between the loan officer and clients.
Within 2 weeks of the next month, all approved new clients are scheduled for 3 consecutive training
sessions. The first session is a financial lesson explaining to client how to manage their business cash flow,
providing simple accounting tools to help them with the daily bookkeeping and explaining the importance of
business management. Loan officers will check the bookkeeping of their clients on every weekly group
meeting, to ensure consistency in cash flow balance.
Next, transparency is achieved by the assistant president explaining to clients the uses of the interests
rates/costs charged to them and also explaining how Grameen’s loan program protects the client by charging
interest on amortising loan principle recalculated weekly. Interest of 20% is charged on diminishing principal,
as principal is repaid first. Interest, calculated weekly on diminishing principal, is repaid only after the
principal is paid off, allowing for an effective interest rate of 10 to 12%, Grameen sources say. [10] At the
same time, clients are educated on the values of why they should manage their cash flow wisely and not try to
10
Lender With a Mission - Bangladesh's Grameen Bank targets poorest of poor – Grameen Bank Bangladesh

provide personal loans to their group members through real examples of how clients may enter into a credit
crisis through of excessive lending /borrowing that eventually complicates and destroy their business efforts.
Finally in the last session, clients are taught to memorise the 10 basic commandments which has been
amended specifically to meet the demographics of clients in that region. After the assistant president is
confident that all his clients know the 10 commandments which will be checked by the branch manager, in 1
week’s time, a meeting is scheduled with clients at the central office of the MFI for the loan disbursement.
To ensure safety of clients, if required state police and loan officers will escort the clients after
receiving loan disbursements. The Asian model by adopting this clear process of loan approval avoids such
problem of solitary lending as approving loans for clients with a similar name but different address, no
documentation loans, carried out by commission-paid brokers, mentioning a business to get a loan but instead
using loans to pay overdue bills and getting food for the family.
Other examples of Asian models also include 3 hours of financial literacy training during the training
classes and clients are required to pass a test indicating that they understand Interest rates, instalments, and
other product features. However, in Grameen Philippines, a test is not required due to the expertise of working
personals that provides an accurate character assessment of clients and an integrated approach of guiding
clients on financials i.e. how to handle their business problems/emotions after each loan meeting.
The Latin American model adopts solitary lending and bears similarity to the Asian model by
providing other services such as micro housing, micro insurance. Micro lending in Latin America places a lot
of emphasis on the personal integrity of its clients, and places little attention to the social economic
characteristics of its clients, and risk assessments are based on value of business assets and personal wealth.
The only non-economic Individual assessment is the character of its clients, which is key to Latin modelled
micro credit products. Loans are approved on an individual case by case basis on the faith that clients will
ensure repayment timely. Loans are disbursed at central urban areas to clients and there is lesser need to
provide security services to clients around the urban areas. The Latin American model provides a diversified
range of products available to clients; however the lack of collateral and social pressure to repay makes the job
of loan officers more difficult in recouping the loan disbursements. A recent research of mix-market shows
that Latin American models reap a higher profitability compared to Asian models as Latin modelled MFIs
adopt higher shares of consumption loans issued reaping higher yields, profitability and lower portfolio
quality. [11]
- Mechanisms of Loan management and Collections
The risks of providing Asian model of microfinance is effectively reduced by peer-group monitoring
through weekly public meetings - at which attendance is compulsory - for the repayment of loan instalments
and the collection of savings. These meetings reinforce a culture of discipline, routine repayments and staff
accountability. Day by day millions of poor has slogged to meet repayments and pushed Grameen, the pioneer
of microfinance, on the World Map. This encouraged further replication of Grameen models in other Asian
11
Does loan type matters for Microfinance Performance in Latin America – MIX Market

models. It has effectively elevated living conditions of 2 million clients approximately equals to 14 million
families with 94 percent women. The quality of the portfolio is maintained by quality managers that perform
random weekly audits to each branch of a municipality, covering at least 5 branches in a week. Penalties are
not imposed on clients for not attending loan meetings as long as clients are able to pass their loan repayments
to the leader in the group and provide a valid reason for not being able to attend. Failure to do so will deter
clients from achieving future loan draw downs.
The risks of Latin American model is that micro borrowers perform activities with limited productivity
that do not require many assets which may make them more vulnerable to market changes and business cycles,
for instance personal services such as hair dressing and providing tricycle-taxi services. Clients are given small
initial loans that are within their ability to pay, next the clients are given a larger amount if repayment was
reliable for the previous periods. There is motivation to honor obligations that is reinforced through a firm, and
lenders adopt an aggressive attitude towards arrears. Loan officers do not tend to drop a loan if it’s more than
30days overdue capital or interest repayment.
Latin American MFIs have a more decentralized management structure compared to Asian Models.
Loan officers and branch manager’s makes the majority of the decisions for individual microcredit. Successful
institutions with good credit methodologies and internal controls are able to manage portfolios of thousands of
small uncollateralized loans and achieve high recovery rates with the help of technology. The benefits of
decentralization are boundless, as branch managers with the availability of technological infrastructure such as
PDAs (Personal digital assistant) are able to provide timely information of daily frequency to inform loan
officers of repayment performance. The timeliness and reliability of information is a critical advantage
compared to the Asian model that are prone to mistakes of human error through updating excel spread sheets
of clients entry by entry manually. The Latin American Model also performs strong internal control through
routine and surprise audits so as to ensure compliance and clear reporting if any restructuring of loans are
performed. There are strong credit policies in place to prevent delinquent borrowers from organizing pressure
large scale loan rescheduling, lower interest rates, or even debt forgiveness, as what happened in Bolivia. The
Inter-American development bank has developed general best practices for credit and risk assessment of
clients summarized as follow: [12]
12
An inside view of Latin American Microfinance (Inter-American Development Bank)

Fig. I - Best practices for Credit and Risk Assessment by Inter-American Development Bank
- Human resources, promoting and marketing costs
Research by the World Bank has shown that the Asian models of microfinance are increasingly
incorporating technological advances13 to facilitate lending, expanding outreach and lowering costs. For
example, while mobile phone-based banking (also known as “m-banking”) has exploded in the Philippines,
South Africa and India, there are only a few examples of this application in Latin America, despite the
enormous opportunities in the region. [14] New operational technologies such as phone banking, smart cards
supermarket kiosks can reduce collection, loan processing and approval costs with reduced response times and
timely information. Due to the intensive involvement of loan officers with their client’s assessment, human
resources or manpower makes up the highest part of the cost in the Asian models. Promoting is usually
through the word of mouth and is seen as an effective and trustworthy source as rural populations have least
access to advertisements and have a biased view towards advertisements to be a marketing tool of capitalists
made to tap their community, therefore reputation of MFIs, word of mouth and success stories of clients are
critical as a natural promoting mechanism in Asian models. In this sense, marketing and promoting costs have
a high correlation with the way an Asian MFI is managed and is highly correlated with the non-profit
objectives of the MFI. This leaves the Asian MFI to continuously try to lower their costs of human resources,
and be able to deploy human resources more effectively by reducing human commitment in the manual entry
of each loan repayment and the problems of balancing the accounts in the month end.
13
Refer to Annex I for elaboration on technological advances in Microfinance
14
Building a dialogue to create best Microfinance practises in South America (World Bank)

Technology is used at 3 levels in microfinance, institutional level, institutional-client interface level and
sector/industrial level. [15] At the institutional level, technology is typically used for delivering (low cost)
retail solutions. A good use of technology helps to promote efficiency and client oriented products/processes
so that the overall cost of delivering market led financial services is minimized. At the sectoral/industrial
level, technology helps to provide the sector with information on various aggregate segments of individual
clients and also individual institutions, in effect it acts like a financial services information bureau. [16]
The Latin American models demonstrate innovation, flexibility and emphasizes on customer services.
Latin American MFIs adopt low-cost alternatives such as the personal digital assistants (PDAs) for computing
and information storage and retrieval, or smart cards for automated teller machines (ATMs) or m-banking in
loan collection. Technology use helps to reduce time and number of documents required, and the MFIs are
able to have a digital backup of all client data, to insure them against natural disasters or fires. One example in
Peru and Bolivia, clients such as Quechua and Aymara speakers that do not read or write and speak the
dominant language of the country are able to use smart card with fingerprint recognition technology facilitates
repayment processes. [17] Both the Latin American MFIs and clients appreciate these solutions because it
would help to dramatically reduce cost of human resources, transactions costs, including transportation and
time.
In the Latin American regions, marketing emphasizes on the ease of obtaining loans and the convenience
of loan maintenance made possible by ATMs, Smartcards, credit scoring and biometrics are part of the
packages offered to clients. Some Latin MFIs partner with retail stores and supermarkets to ensure repayment
facilities possible even at supermarkets and some major retail stores. Despite the benefits of cooperating with
large supermarket chains, the branding of MFIs and the partnering bank’s reputation might be a concern as it is
unknown if the use of supermarket chains for repayment is perceived negatively by clients. Some clients may
prefer to deal with bankers or loan officers instead of cashiers at supermarket chains. In Brazil, Lemon Bank is
an example of a completely branchless bank that provides mainly bill payments through a net work of 6,500
locations, has low brand recognition, due to the restrictions placed by regulators on brand prominence when
using agents.
From July to September 2008, CGAP conducted a survey of 152 MFIs to gather information about
how MFIs use technology today, and how they approach future technology investments and identify weakness
and opportunities in the microfinance technology market. [18] Among the 152 completed surveys, there are 48
countries, with 44% non-governmental organizations and 60% less than 10,000 clients. Research by CGAP
has shown that technology use in 2008 is more widespread that in 2004. Despite that in 2004 the survey is
based on 270 sample size, percentage of respondents that were using manual systems or spreadsheets to
15
Microfinance and Technology – Critical Issues, Lessons and Future Implications; Ramesh S Arunachalam
16
Microfinance and Technology – Critical Issues, Lessons and Future Implications; Ramesh S Arunachalam
17
Building a Dialogue to Promote Microfinance Best Practices in South America World Bank
18
2008 Microfinance Technology Survey CGAP

manage loan portfolio decreased from 46% to 18%. In 2008, 53% use custom built software and 29% use
commercially available off-the-shelf products (Refer to Fig. II).
Fig. II - Loan Portfolio Management
Fig. III - Important results in technology system types by region19
19
EAP: East Asia Pacific, ECA: Europe and Central Asia, LAC: Latin America and Carribean, MENA: Middle East
and North Africa, SA: South Asia, SSA: Sub-Saharan Africa

Fig. IV - Important results in technology system types by type of institution
Fig. V - System constrains by number of clients
Results show that the Sub-Saharan Africa, South Asia, East Asia and Pacific have the greatest number of MFIs
using manual systems and spread sheets. Among them, the majority of MFIs reporting use of spreadsheets are
NGOs and the majority of organisations with manual systems are Banks and Rural Banks. Automated systems
are widely used to manage loans deposits, remittances, client information and MIS reports. However, many
functions remain largely manual, including cost accounting, insurance, social performance and human
resources. 41% of MFIs feel that their information systems prevents them from achieving goals while 57%
report that funding is an obstacle to improving their systems, of the MFIs reporting that funding is a major
constraint, 60% have less than 10,000 clients.[20]
20
2008 Microfinance Technology Survey CGAP

Fig. VI - Advantages and disadvantage of different information systems
- Demographics & Geographic limiting factors
In a standard Asian model, MFIs work closely with local Rotary Club21 to encourage a well-balanced
distribution of different types of businesses around the municipality. This solves the problems of micro
entrepreneurs replicating existing small businesses that are already exiting. In Grameen Philippines, micro
entrepreneur’s loans will not be approved if it is used to set up “buy and sell stores” in an area with more than
5 existing within 5 kilometres in the same area. The rotary or local government regulates the agricultural
activities to prevent over cultivation of lands in a same area, therefore if micro entrepreneurs requests for loans
in such areas to build their business approval is possible only after consulting a pre-defined environmental plan
of the area. Environmental constrains, deters the poor from building business activities as sometimes it is
impossible to build or add to the existing businesses in the municipality due to frequent floods and rain. The
Asian model also takes into consideration of the overall “wealth level of clients”. For instance, the problem of
having few people that can afford “ice water” deters the business plan approval of women wanting to profit
from making ice from refrigerators. Geographic conditions also affects the cost of distribution of micro-loans
and the lack of proper infrastructure such as roads, sanitation and water are the main reasons why MFIs (both
21
An example is the Rotary Club of Manila, first Rotary in Asia and the biggest in Philippines developed to
encourage and foster the ideal of service as a basis of worthy enterprise and, in particular, to encourage and
foster poverty elevation (http://www.rcmanila.org/objectives.html)

Latin and Asian) did not reach the deserted areas. Latin American model is structured to Fight unfavourable
regulatory environment, poor economic conditions and also unfair competition.
- Training, education, and insurance services to unlock the entrepreneurial power of the
micro borrower.
The poor is unable to emerge out of poverty due to such factors as lack of access to technical business
making skills and viable business ideas that deters the proper use of borrowed funds from MFIs. The next
critical factor of the lack of capital (Dead Capital22) will be discussed in Section B2. The practice of offering
business to the poor whom have no existing business or business plan and no demonstrated business expertise,
creates further repayment problems for the client and collection problems for the Microfinance institutions as
clients are expected to not only run the business but also know accounting, financing and cash management.
The Asian model of microfinance includes the delivery of skills to micro lenders. For instance, in
Grameen Philippine Catarman collaborates with the University of Catarman to teach micro lenders
environmental friendly ways of rearing pigs and simple ways of bio-mass technology that helps to sustain part
of the electricity needs of maintaining the piggery. Grameen MFI collaborates with the local Rotary Club23 and
through allocation of business plans and proper training, for instance micro lenders are taught how to make
local delicacies, which requires techniques that are only known by family business to prepare the traditional
food and start their own local eatery for the local agricultural/construction workers that travels by foot for
more than 2 hours to their existing jobs. Other types of business techniques taught includes, clothes making,
hair dresser services, beauty parlour services, dancing expertise, tricycle-taxi services etc.
Both the Asian and Latin model of microfinance provides complementary medical and life insurance
to its clients. A good example of life insurance is TATA AIG that has conducted a pilot with CRIG Agents for
insurance premium collection – under the DFID FDCF projects. The use of technology should scale up
operations (under new, more flexible micro insurance regulations), enhance controls, and improve front-end
processes (cash collecting and receipting) – DFID FDCF24. TATA AIG, a life insurance in AIG also uses
Audio visual vans in Andhra Pradesh to promote its products to low income people in a friendly and
transparent manner as the marketing of insurance is not easy to the poor due to past bad experience of micro
borrowers.25 The provision of such services is seen as a value added factor by clients and helps to attract new
customers. TATA also has a web platform used by TATA-AIGs rural community insurance groups (called
CRIGs) to track claims and inform anxious customers who otherwise would have to wait long to know about
the status of their proposal, especially given the remoteness of some areas.[26]
22
The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else - Hernando de Soto
23
Refer to footnote 20
24
Cited and quoted from FDCF on website www.challengefunds.org
25
Microfinance and Technology – Critical issues, Lessons and Future implications; Microfinance Consulting
Group.
26
Microfinance and Technology – Critical issues, Lessons and Future implications; Microfinance Consulting
Group.

One of the secrets of microfinance in Latin America and other parts of the world is customer loyalty.
MFIs realize that for financial institutions, face time plus good service equals trust, and that translates into
loyalty. In the Latin American model, loan officers develop new products such as micro-insurance and many
more by first knowing their customers well, so that the products offered will correspond to customer’s needs
and make customers feel valued. [27]
In contrast, the Asian model expand by partnership with corporate, for instance Grameen has ventured
into a partnership with a French company Danone to supply yogurt, modified to Bangladesh taste by reaching
the poor through agents the process not only created jobs but also contributed to the development of rural areas
in the process Grameen Danone’s sales and reputation increased tremendously. This Worldwide strategy is
also adopted by Hindustan Lever Ltd in India and has proven to be successful in bring capital to the poor.28
B2. Funding aspects influencing Balance sheet
- Efficient capital structure: Donations, Bank financing and NGO financing
The most critical factor that deters the poor from emerging out of poverty is not only the lack of capital but
also being trapped in a phenomenon of Dead Capital, that is to have the capital however having no legal
title/claim to it. International funding of microfinance is in strong demand due to high growth in the
microfinance industry. Typically MFIs look for 3 conventional types of funds namely own funds such as
grants, donations or for more advanced MFIs, equity capital, or debt related funding in the form of loans debt
securities or retail deposits that are available only to more advanced MFIs allowed to collect savings. [29]
Currently, domestic sources account for 85% of microfinance funding while foreign sources account for 15%.
[30] Although 15% seems a small percentage given the amount of attention given to private entry of inclusive
finance, there is a large up surging market potential for continual growth in private inclusive financing of
MFIs. The Fig. VII below shows the huge gap between supply and demand of the actual breakdown of funds
in MFIs Source: McKinsey’s “Optimizing Capital Supply in Support of Microfinance Industry Growth”
presented October 2006, Study drew upon 2004 data.
27
An inside view of Latin American Microfinance - Inter-American Development Bank
28
Hindustan Lever Ltd Case – Tuck School of Business At Darthmouth
29
International Funding of Microfinance Institutions: An Overview, Ada Microfinance Expertise.
30
Cf. Omtrix, “Giant Leaps in Microfinance” presentation, October 2007.

Fig. VII - Demand and Supply of funding needs31
Fig. VIII - MFI Funding Sources
31
Optimising Capital Supply in Support of Microfinance Industry growth - Mckinsey

Foreign funding was initially dominated by non-profit investors like development institutions,
charities foundations and NGOs. They provide grants and subsidies usually to smaller or newer MFIs
that are accompanied by technical and equipment assistance. [32] Followed by commercial investors
entering the market the last. The first investment fund guided by dual bottom lines (financial and
social) that was not launched by private donors or development agencies was Dexia Micro-credit Fund
in 1998. [33] It is the recent 2 or 3 years that capital market structures such as portfolio securitizations,
collateralised debt obligations (CDOs) and initial public offerings (IPOs) have emerged. Banco
Compartamos is the first public offering by a microcredit lender in Latin America, the first initial
public offering by any Mexican bank, as opposed to a financial group, and one of the first offerings
out of Latin America by entities that define themselves by a social mission. Compartamos has reached
more than 700,000 poor entrepreneurs in Mexico, 98 percent of who are women, with loans averaging
$300 each. [34] A recent announcement of Deutsche Bank AG and Finca International, a microfinance
company, working to revive the collateralised debt obligation market to help provide money to the
poor in November 2009 is a justification of the start of untraditional forms of financing to MFIs. In
this transaction, $21.2 million CDO is used as leverage to finance projects in the Congo and
Azerbaijan. [35]
Structuring partnerships with commercial banks are a form of financing, it is essential to

ensure that solid business principles prevails and that no one of a company’s business will depend on
an ongoing subsidy for its success, through start-up subsidies often help reduce the risk of
experimentation, but dependence on subsidy will lead to operational hiccups and failure. [36]
Certainly, one of the main resources of these unions is a considerable gain in efficiency thereby
producing savings that maybe pass through the final micro borrower.
Commercial banks have the main advantage of access to plentiful funds which make them
potentially successful competitors in the microfinance market. An example of a highly successful
commercialized bank in microfinance is Banco Azteca that has amassed 1500 branches around the
country and becoming Mexico’s third largest banking network. [37] On the contrary to Banco Azteca
that uses a highly commercialized approach to microfinance, ANZ Bank, an Australian commercial
bank has infuses funds into the microfinance industry in a highly social manner through the
32
Cf. Omtirx, “Giant Leaps in Microfinance” presentation, October 2007.
33
Cf. ADA and P. Goodman, “Microfinance Investment Funds, Key Features” 2005
34
Press Release: Mexico's Largest Microfinance Bank Taps Global Equity Markets in the First IPO by a Latin
American Microcredit Lender.
35
Deutsche Bank to use CDO market to help assist the Poor, www.Financialtimes.com
36
Microfinance for bankers and investors - Elisabeth Rhyne
37
Banco Azteca Exports Microfinance Formula from Mexico Southward - Microcapital

development of the program mobile rural banking scheme, and at the same time ANZ is also providing
“financial training” to its clients in Fijian on topics such as savings, budgeting, and investment. [38]
Downscaling is evident in the Latin American model where existing financial institutions
deepen the reach of their financial services-particularly credit-to smaller scale businesses and lower-
income individuals. With competition increasing in the financial services industry in Latin America,
formal banking institutions have become much more interested in downscaling.39 While MFIs are
increasing the commercial equity in their funding structure, they should also have client’s needs at the
top of their minds, if financial institutions do not protect the consumers, for instance by the subprime
mortgage debacle in the US, the reputation and returns of the entire microfinance sector will be
tarnished. As a result, much focus is drawn to the recent Deutsche Bank’s use of CDO as leverage to
finance projects in the Congo and Azerbaijan.
The difference between working with banks and traditional microfinance institutions (MFIs) is
in terms of the organization, operations and product offerings of commercial banks entering the
microfinance market. As innovative practices and models materialize, MFIs partnerships have more
centralised operations and greater reliance on technology. [40]
As a result, some of the world’s best-known MFIs have transformed into banks to take
advantage of the benefits a bank structure offers for microfinance. Existing commercial banks has
proved to be profitable in the microfinance market due to branch networks, access to capital, diverse
financial products, and qualified human resources all provide banks with the fundamentals to launch
and grow successful microfinance businesses. [41] Over the past decade, banks have entered the
microfinance market, and recently a number of them have shown promising results in terms of
profitability and growth. [42] In several of these more successful cases were found in countries as
diverse as Ecuador, Haiti, Mongolia, the Philippines, and South Africa. Private banks that have
succeeded in microfinance include Banco del Pichincha and its service company Credife (Ecuador),
Khan Bank (Mongolia), Capitec Bank (South Africa), and Hatton Bank (Sri Lanka); successful public
banks include Bank Rakyat Indonesia (BRI) and Banco do Nordeste (Brazil). [43]
The high growth in microfinance sector is evident across the globe and MFIs are facing global
competition in donations, private equity, debt financing, investors such as non-governmental
organizations (NGOs), development agencies and not-for-profit organizations such as World Bank and
38
Microcapital.org Story: Australian Bank ANZ Amasses 10 million Fijian Dollars (USD 5.3 million) in Deposits
through Mobile Rural Banking Program
39
An Inside View of Latin American Microfinance – Inter-American Development Bank
40
Banks in Microfinance: Guidelines for successful partnership
41
Banks in microfinance, guidelines for successful partnerships
42
43

UNDP. In India high-performing MFIs grow at sub-optimal rates due to capital constraint and often
wholesales funds for on-lending and equity are seen as a single type of funding when judging capital
availability. [44] In India, regulations require banks to devote at least 40% of their net bank credit to
agriculture and weaker sections, historically disadvantaged communities and microcredit. Due to the
large demand for funds on growth prospects in numerous sectors, flow of domestic funds to
microcredit sector has been limited. The problem is that there are no “natural providers” of equity for
MFIs, as a result growth of MFIs were constrained and unstable. In actual fact, equity for MFI in India
is a constraint not only for microfinance but also for other small-scale enterprise and infrastructure
sectors. [45] As a result of the lack of capital, we will discuss the 3 most commonly found financing
models both in Asia and Latin America. They are namely the self-help group (SHG)-bank linkage
model, financial intermediation by the microfinance institution model, and the Partnership model with
MFI as the servicer.
The Self-Help Group (SHG)–bank linkage model is the most widely used model that
accounts for nearly 20 million clients. Under this model, the non-governmental organization (NGO)
also known as a self-help promoting institution (SHPI) helps groups of 15-20 individuals through a
preparation period before they are provided with lending by the banks after this preparation period.
The bank will provide single- or multi-period lending after the preparation period.
SHPI will incur expenses such as group promotion during the preparation period and barely
receives, if they do, below cost reimbursement from the bank or even clients. SHPI supports these
expenses of typically $35-250 per group by sources of external grant, and once the groups is linked to
the bank, the SHPI takes on a supervisory role of the MFI portfolio.
Disadvantage of this model is that there is no incentive for the SHPIs to continuously monitor
the MFI portfolio due to the fact that cost of manpower, time, cost of promotion and those of
transactions are not fully charged to the clients. As the SHPI is not a financial intermediary, it does not
allocate capital against the lending functions of MFIs. As a result, SHPIs are normally trusts funds or
societies that do not take credit risk of the portfolio. It is the bank that takes on the linkage to MFI
groups that bears the entire credit risk, in another words micro-lending has no recourse to SHPI that
initiated the group in the event of default on loans. This pose a problem as the SHPI does not have the
incentive to continuously originate high-quality groups and supervision of the portfolios are weak.
Therefore high repayment rates of SHG-bank linkage program do not reflect the problem of the
possible poor supervision due to a smaller portfolio that is not comparable to MFIs. Nevertheless there
are cases whereby NGOs raise resources from donors and other agencies to maintain a high
supervision level as repayment rates is directly correlated to the NGO’s reputation. As SHPI and bank
44
Financing Microfinance – The ICICI Bank partnership model
45
Financing Microfinance – The ICICI Bank partnership model

branches scales up in micro-lending, more funding from donors is required for supervisory control and
repayment rates are affected if funding is unavailable. Due to the limited number of rural branches, the
SHG–Bank Linkage model is not viable to cover large villages and is not quick enough for expansion
as it is seen as an initial testing ground approach to microfinance.
As the Asian model of MFIs has higher reliance on donor funds/grants compared to Latin
American models, Fig. IX below [46] justifies that MFI sustainability decreases with higher reliance
on donor funds/grants. Fig. IX - MFI Sustainability
It is also observed in Fig. X [47] below that cost per borrower is higher for MFIs that have a lower
sustainability percentage shown in Fig. IX below.
46
Table is computed based on MIX market data of all of the MFIs with over $US 1.3 million in total assets, at least a high
level of disclosure rating on MIX Market, and audited financial statements that are in English, French, or
Spanish
47
Table is computed based on MIX market data of all of the MFIs with over $US 1.3 million in total assets, at least a high
level of disclosure rating on MIX Market, and audited financial statements that are in English, French, or
Spanish

Fig. X - Average MFI Cost per Borrower
Financing Model 2: Financial intermediation by the MFI that borrows from commercial
sources and on-lends to clients (groups/individuals). There are increasing amount of participation by
commercial banks in the microfinance sector that eases the problem of lack of resources for growth in
MFIs as they cannot take deposits and face limited availability of grant funds.
Most MFIs in India started operations with grants and concessional loans and gradually made
the transition to commercial funding. [48] For instance, Bharatiya Samruddhi Finance Ltd (BSFL),
one of India’s leading MFIs, financed much of its growth in the initial years with concessional loans
from funding agencies and followed by raising equity from various domestic as well as international
sources from 2001 onwards.[49]
In this model, the same portfolio receives capital allocation at two stages during its financing
period. For instance an MFI requires a loan of $250,000 for its clients, the bank lends it to the MFI as
an “organization-based lending”, and instead of finance for the underlying pool of borrowers “Asset
based lending”. As MFI ratings are affected indirectly by the interests recovered from the poor as there
is a need to pass costs to the poor due to the low level of equity capital, this is entirely different from
traditional rating is benchmarked on historical loss rates on loans pool. MFIs is able to obtain capital
according to the quality of their rating, when the initial capital is secured for lending (in this example,
$250,000) it further allocates capital to provide for unexpected loan losses on the portfolio in order to
satisfy its internal capital adequacy requirements. This explains the effect of double accounting of
capital requirements for the portfolio of microloans first by the bank and secondly by the MFI. Prices
48
Financing microfinance – The ICICI Bank Partnership model
49

of microfinance governed by the level of interests quoted to the poor will thus include capital charges
at both of these levels. The MFI bears 100% of credit risk on the portfolio, and has the incentive to
maintain high supervision levels, while the bank’s concern is directed at ensuring the MFI’s solvency.
Financing Model 3: The partnership model – MFI as the servicer
In 2002, an internal analysis by ICICI Bank revealed that despite consistent evidence of viable
demand from clients, access to MFIs was constrained due to the organization-based financing model
adopted until then. [50] Key characteristics of the partnership model of finance includes, loan not
reflected on the balance sheet of MFIs as the arrangement of loan contract is made directly between
the bank and borrower, this is similar to the SHG-bank linkage model. As the MFI services the loan
till maturity, it has a financing structure designed differently compared to the financial intermediation
model however the operational methodology is identical. In both the financial intermediation and
partnership model, the bank relies on MFI’s sound operating policies for collection and supervision of
microloans.
The partnership model is helps to separate the credit risks of MFIs portfolio from the banks
and ensures that banks have the continuous incentive to provide funding to the partner MFI as both
entities share the same objectives. For instance in some cases, the microloan borrower took the loan
contract directly with the bank, and MFI acts as an agent in maintenance of this loan and ensures its
collection. The partnership model solves this problem that most MFIs do not have risk capital in large
amounts, which limits their ability to obtain funding from banks, despite that the there is a high
potential of the bank is able to provide implicit capital.
The important advantage of separating the credit risks of MFI operations from banks is the
factor of recourse of loans. Through direct lending to the underlying borrowers i.e. without funds
entering MFIs balance sheets, MFIs are able to have recourse to the borrowers. However if the MFI
managing the portfolio closes down the bank may not be able to recover the loan portfolio, even when
the bank can appoint other MFI agency to for its portfolio as the key factor that ensures recovery of
loan disbursed is the relationship of loan officer and loan borrower.
Another significant advantage of this model is that as the balance sheet does not reflect the
liability of funding from banks, MFIs cease to require regulatory capital. As a result, the MFI turns to
be asset based instead of organization based in its operations. This shift has crucial implications for
rating, pricing and consequent marketability of the MFI. [51]
In order to incentivize MFIs that have an agent role, to continually guarantee the portfolio
quality, the partnership model is made with a first-loss guarantee structure where by the MFI is
50
51

required to provide a guarantee (typically a “first-loss default guarantee” (FLDG)) which it shares with
the bank the risk of the portfolio up to a certain percentage typically ranging from 5% to 20%. This is
different from partial guarantees where the guarantor is liable for a fraction of losses, say 50 per cent
of all losses on the portfolio. The FLDG is a compatible strategy with the partnership model as it
forces the guarantor to prevent losses from the start and the pricing of the FLDG is dependent upon the
operating capability and maturity of the MFI. [52]
In essence, the lower the defaults the more profitable the MFI is in the long run, as there are
less penalty charges from the guarantee it provides. The MFI collects a service charge from the
borrowers to cover its transaction costs and margins. Overtime, the MFI accumulates retain earnings
and built its core Tier I capital through the partnership model.
The problem of partnership model is its ability to ensure that MFIs have enough risk capital
to provide the risk capital required in FLDG. In order to resolve the capital issue for MFIs in the
partnership model, the availability of both debt and mezzanine finance is required. The provision of
both debt as well as mezzanine finance and along with advancing the credit to meet the demand of the
clients, Banks typically provide an overdraft (OD) facility to the MFI equivalent to the amount which
the MFI is liable to provide as the FLDG.
Banks in the partnership model is able to acquire a risk-return profile that is similar to AAA
asset, as it receives a fixed pay off from the fixed interest of the loan and transfer the dynamic benefits
or losses of higher than expected recovery or losses are limited to the band defined by FLDG. With
OD facility, the MFI is able to utilize funds in the event of a sequence of defaults to prevent
insolvency and has to pay an interest rate equivalent to market rate on the OD drawdown. MFIs that
have OD facility is equivalent to have access to mezzanine equity, acquiring leverage on its wholesale
funding. In this way, MFIs are able to provide explicit capital, and implicit capital allocation by the
bank is adjusted by the OD limit advanced to the MFI. Both explicit and implicit capital is separate
from the capital that the bank provides for lending in the microfinance portfolio. This means that MFI
is has the ability to leverage its portfolio, providing an upside for the MFI profitability and return on
equity, without affecting the way operations are conducted at the ground level. [53]
52
53

The beauty of the partnership model is that MFIs are able to help themselves and also their
partnering banks grow their loan portfolio sustainably without capital constrains. In fact, this model is
widely adopted as a growth impetus in both Latin American and Asian MFIs that are maturing and
faces high client demand. (Refer to Fig. XI Equity according to size and age of MFI)54 The age of
transformation on Fig. XI depends on a number of factors highlighted in Annex II.
However the problem with heavy reliance on the partnership model will mean that
microfinance will cease to be an anti-cyclical asset and it will be tough to decouple from future capital
market trends unless the MFI has a accumulated a reasonable amount of Tier 1 capital and deposit
base.
Microfinance Investment Vehicles (MIVs) provide fixed income and equity

investments to MFIs. MIVs are managed by investment managers such as Blue Orchard, BBVA,
Calvert Social Investment Foundation, Credit Suisse, Deutsche Bank, Developing World Markets,
Microvest and Oikocredit. MIVs became increasing evident in the microfinance sector in the last five
years and currently there are 103 MIVS in operation as 11 new MIVs entered the market in 2008,
bringing the total number to 103, with a greater emphasis on equity investments and products like
micro-insurance. Total assets under management in MIVs increased from $3 billion in 2006 to $5.5
billion in 2007. More than 75% of these assets are invested in microfinance. The remaining 25% are
invested in cash, cash
Fig. XI - Equity according to size and age of MFI
equivalents and small
and medium enterprise
institutions. [55] In 2008,
MIVs recorded a 31%
growth amounting to
$6.6 billion, although
estimates show that MIV
grew a further 16% in
annualized Figures in the
first half of 2009,
manager of many MIVs
are not expecting more
than 29% growth by this
year end. [56] The
54
Optimising Capital Supply in Support of Microfinance Industry growth - Mckinsey
55
CGAP MIV Benchmarking Report 2008
56
MIV investments in 2008 grew by 31%: CGAP survey published by Microfinance Focus

largest class of MIV with over $1.8million in assets are registered mutual funds that have a steady
performance over the past 3 years returning 5.8% in 2006, 6.3% in 2007 and 5.9% in 2008. However,
returns are expected to fall below 3.5% in 2009 due to weaker demand for loans from microfinance
institutions (MFIs), and increased hedging costs due to volatility in currency markets.57 Other findings
of equity capital investments include: [58]
• International Equity investments grew by 47%, out-pacing fixed income growth of 32% for the
second year in a row. Major factors included growth in private equity funds with 13 funds totalling
$253 million in assets in 2008 and in the number and size of holding companies. This shows a danger
of bubble and overheating in the microfinance industry.
• Region wise, Eastern Europe and Central Asia attracted 47% of investment, followed by Latin
America and the Caribbean at 29.1%, Sub-Saharan Africa 6.2%, East Asia and Pacific 6.1%, South
Asia 4.7%, and Middle East and North Africa 1%.
• MIV investments remained highly concentrated, with top five countries with an exposure of 57.5%
and top five investment exposure at 40.6%.
To qualify as an MIV for the survey these entities must have at least 50% of their assets
invested in MFIs in emerging countries. 80 MIVs participated in this year’s survey, representing 93%
of all MIV assets. CGAP, the Consultative Group to Assist the Poorest, classifies MIVs into the
following peer groups: [59]
• Registered Fixed Income Mutual funds: generally subjected to standard compliance regulations
(Luxembourg, the Netherlands and the U.S.); open through share subscriptions
• Commercial Fixed Income Investment funds: generally closed limited partnership funds
• Structured Finance Vehicles (active and passive): closed special purpose vehicles (ex. CLOs)
• Blended Value funds: foundations and limited liability companies
• Holding Companies of MFIs: invest only in MFI partners
• Private Equity funds: closed limited partnership funds
In order to determine what environments best fits the commercial equity for MFIs, the
management of MFIs needs to analyze the maturity of the industry and scale of operations, whether
the commercial equity is suitable for the current regulatory environment, political and economic
57
58
59
How MFIs are Sourcing Capital Blue Orchard Microfinance Investment Managers

environments whether it is supported by equity investments and shareholder rights. MFIs must meet
the following requirements in order to accept commercial equity: [60]
Fig. XII - Commercial Equity requirements
Fig. XIII - Financial Integration and level of regulation
The development of debt capital markets for microfinance are is becoming a focus as the main
source of funding and typically MFIs have issued bonds in their local markets with partial guarantee
support from one of the development banks in their country or in the region. There have also been
private placements of Debt capital in MFIs. Other trends of debt financing including securitization are
done locally in Bangladesh and India and Structured finance transactions such as CLOs have been
done on a global basis as mentioned above.[61]
60
Unitus Equity Fund LP
61
How MFIs are Sourcing Capital Blue Orchard Microfinance Investment Managers

- DEPOSIT BASE STRUCTURE
Deposits are the cheapest funding source as it is easier to obtain compared to other forms of
debt. However, MFIs must have appropriate regulatory structure to collect and mobilize savings. MFIs
typically view deposit services as value adding to the operations and highly valued by micro
borrowers. Despite that MFIs are aware of the interest rates of fixed and short term deposits, the
problem is that not all MFIs is able to calculate the true cost to implement and manage and its impact
on reserves required by supervisory authorities. Although it is not profitable to take small deposits
amounts however these small amounts for the MFIs that have typically more than 30,000 clients help
to improve the long term viability of MFIs, as it is a value-added marketing factor used to attract new
clients, it is also a source of stable funds, it reduces debt capital requirements and serves as a platform
for cross-selling other microfinance products. [62]
In both the Asian and Latin American MFI models, those that are financed by Banks, credit
unions and rural banks can mobilize savings while NGOs and Non-Banking Financial institutions
(NBFIs) generally cannot. [63] Rural banks had the highest deposits to total asset ratio at 68%
followed by credit unions, 58%, and banks, 35.6%. [64] In Africa and Latin America and Caribbean,
the deposit to loan ratio is typically more than 50%, for the large and financially self-sufficient MFIs
(number of borrowers > 30,000 and FSS is > 100%).[65] This represents 109 MFIs in the Micro
Banking Bulletin database and almost half of all 231 financially self-sufficient MFIs. [66]
The Latin American model is more competitive as it typically charges higher interest rates and
has better returns to obtain private sources of funding to fuel growth and at the same time due to the
scale of the operations the Latin American MFIs are able to manage and benefit from a deposits
program thus achieving continual operations on a mix of deposits and equity for their funding. In
contrast the young Asian model has lower level of deposits as compared to the Latin model. However,
there are an increasing amount of matured MFIs that are able to attract and manage an increasing
amount of deposits and one example is Grameen Philippines (Refer to Fig. XIV Funding Structure
of Grameen Philippines)
62
MFI Capital Structure Decision Making: A Call for Greater Awareness 2007 CGAP
63
How are MFIs sourcing capital – Blue Orchard Microfinance Investment Managers
64
Micro Banking Bulletin
65
How are MFIs sourcing capital – Blue Orchard Microfinance Investment Managers
66
Micro Banking Bulletin

Fig. XIV - Funding Structure of Grameen Philippines
C. ANALYSIS
I. CHALLENGES IN OPERATIONAL & FUNDING ASPECTS
- OPERATIONAL ASPECT
I have identified the future challenges in the operational aspect of MFIs to be focused in the
area of training of loan officers, coupled with the usage of suitable information technology and
through providing innovative microfinance products that continually attract new clients in a socially
responsible and sustainable way to MFI operations. Another challenge directly correlated with the
training requirements of loan officers are due to the lack of readily available educated workforce in the
rural areas. The problem is that MFIs cannot hire their workforce from a different country as loan
officers need to speak the same language, demonstrate understanding and liking to the local culture of
the loan borrowers and also be educated to a sufficient level to have a high integrity, so as not to be
manipulated or be in cohorts with the loan borrowers to cause unforeseen losses for the MFI.
Training continues to be an important factor for MFIs, as they are moving into a phase of rapid
expansion with standard operating models. MFIs must continuously add quality manpower to their
operations without delaying the growth of the operations.
I believe that another challenge of MFIs is to define its legal format from the start. The MFI
has to choose a legal format that permits it to take and activate deposits for use if required in future,
assign loans, provide guarantees and retain earnings to facilitate the smooth execution of model.
Given the objective of MFI, if it is for-profit, is allowed to seek commercial equity however if it is

not-for-profit, such as the traditional Grameen model, a trust or society format will be more applicable
given its objective however self-help group (SHG)–bank linkage model are seldom use due to its
limitations in efficient outreach in terms of the small concentrated scale of the model. Choosing a
suitable legal aspect is critical to successfully integrate microfinance with commercial bank
operations, in order to take advantage of the bank’s reputation, systems, financing and human
resources. Not only that, the legal structure should also enable the participation of outside investors in
the governance structure and strategic alliances.
The most critical underlying issue for MFIs is to have a strong management system to better
support and equip microfinance lending. It is important for the MFI to have strategic clarity, staff
capacity, accountability for results, knowledgeable management and adopt the use of appropriate
instruments/technology. Hence information systems should be able to provide timely, consistent and
comprehensive information on clients and loans. In my opinion, it is evident that through the
partnership between MFIs, governments, private investors and information technology organisations,
facilitate the integration of new technologies into MFIs models, thereby reducing cost and maximizing
the outreach to clients.

- FUNDING ASPECT
The Asian model is more dependent on donor’s funds and lower flexibility due to its slower
respond to financial crisis. Also, there are constrains of not being able to meet customer’s growing
demand for services without integration into local financial and capital markets as the Asian model is
still a standalone microfinance entity that prefer ownership of the MFI or bank to be members or
micro borrowers, in order to keep the objective of serving the poor in the long term.
The Latin American model faces challenges to improve repayment rates and performance of
MFIs, due to the mechanisms of loan approval. There are still requirements to be efficient in credit
services provision to reduce costs of lending to their clients and facilitating repayment that affects the
outline of the institution eventually. The next challenge to overcome is the ability to reach un-serve
populations at the same or lower costs. As many rural areas are lacking infrastructure, security and
distribution facilities, the Latin American model of micro banking at central city areas of towns
suggests that concentration of services are target at better of clients in the rural areas. While
controversies of possibilities of money laundering in the name of elevating poverty through MFI
investments are undocumented.
In large countries, Latin American model faces high competition and risks of creating a credit
bubble. The surge in Latin American MFIs provides the availability of liquidity to micro lenders.
What happens is that lenders typically have existing businesses and finances a loan repayment by
taking another loan from another MFI by using the same name but different address to document their
loan report. As the Latin American area is big, hence it might be difficult to track for Loan officers
through solitary lending as they do not visit the house of every client and are not aware of their social
circle on contrary to the Asian model whereby local loan officer’s assessment includes the social circle
of their clients.
“This research is relevant for MFIs not just in Latin America but throughout the developing
world as we see the industry diversify and offer a wider variety of products to a larger customer base,”
stated Adrian Gonzalez, lead researcher for MIX and author of the paper. “Credit types offered by
MFIs are taking many forms and are no longer specifically to finance a micro business. Through
analysis such as this, we can better understand the trade-offs that accompany offering different product
lines and the impact it may have on an MFI’s portfolio and performance.” When compared to
microenterprise loans, higher shares of consumption loans are associated with higher yields, higher
profitability, yet lower portfolio quality. [67]
The funding model of MFIs are shifting towards the partnership model in the Latina American
region, while in the Asian region it is still more or less dominated by the traditional Grameen model of
67
Does Loan Type Matter for Microfinance Performance in Latin America? MIX Market

solitary lending. In the Latin American region, a model of financing that starts with the partnership
model of financing and culminates in securitization significantly relaxes the capital constraint that was
outlined above in section B2. [68] Institutional investor’s long-term horizon and double bottom line
perspective will deter redemptions of funds in the industry. However the general problem is flight to
quality of microfinance investment funds to larger microfinance that has caused a liquidity shortage in
the smaller funds.
The introduction of capital markets financing to MFIs has many benefits that are outlined
above, however they may also have large implications for the entire financial system. In India, the
introduction of capital market financing to MFIs will create a sustainable model to originate “priority
sector assets” that are short in supply. The development of the capital markets for microfinance ill act
as a catalyst for secondary markets. Therefore, banks with the competence to originate assets can earn
a premium for providing funds, while banks with no originating capability can rely on existing
originators without having to build branch networks from scratch. In addition to that, I believe that
microfinance securitization creates a new asset class for investors such as microfinance loans and the
overdraft facilities that mitigate risks of MFIs.
Despite that adopting a partnership model will attribute positively to the participation of rating
agencies, as ratings provides assurance to potential investors by indicating the quality of the MFI to
guarantee full payment of interest and principal timely. However, there is a pressing problem that
rating agencies through its commercial perspective in MFIs will incentivize MFIs to operate in such a
manner that is detrimental to the poor’s well being, such as increasing interest rates to improve
profitability of the MFIs at an unsustainable level for its clients. This brings us to the issue of whether
MFIs are able to disperse cost savings in the form of lower interest rates to the poor which will be
discussed in Part III of this paper.
The next point to note despite the many advantages the partnership model presents is the lack
of working capital finance for MFIs to expand into new areas or in the early stage financing of MFIs
despite that this model solves the problem of wholesale funds. If the solution of this is to encourage
venture capital companies and other investors to take the initial MFI risk, eventually MFIs will be exit
at a high price to book or multiple as capitalist attempt to price synergies of MFIs and have a negative
impact on the poor unless the poor themselves are already the shareholders of these MFIs sold. Blue
Orchard microfinance investment managers have provided information that pre-crisis valuation of
MFIs are at 1.3x-1.9x book (historical) and 7.2x – 7.9x earnings (historical), this reflects that the rise
in valuation is more of an issue of demand and supply of MFIs instead of its intrinsic value.[69] Also,
there are differences between Indian/Asian multiples versus Latin American multiples which cannot
be calibrated as MFIs should be compared with its peers in the same region.
68
Financing Microfinance – the ICICI Bank partnership model by BINDU ANANTH
69
How MFIs are Sourcing Capital - Blue Orchard Microfinance Investment Managers

The challenges of the current microfinance environment is not only to find a readily supply of
equity or debt investors but also “responsible” equity capital that accesses MFIs not solely upon its
numerical profitability such as repayment rates but also human resources and poor’s well being as the
intrinsic driver of sustainable MFIs. [70]
II. Lending to Microfinance Intermediary – savings on running more efficient

operation could be divided between micro borrower and micro lending
institution.
The ability of MFIs to allocate cost savings on running an efficient operation depends on their
prior commitment to their funders or stakeholders. Hence, it is important to draft a clause in the loan
agreement with funders specifying a limit for interest charged. Next in order to be aligned with the
objective of poverty elevation, it is important for MFIs to indicate in their statutory registry the
commitment to allocate a minimum percentage of their cost savings to their clients. This percentage of
cost savings can be in accordance with their cost structure for instance if 40% of the funds are
obtained from commercial lending, 60% of the residual cost savings should be allocated to the poor.
D. Findings
In the initial hypothesis of this paper I set out to analyze how different operational decisions
regarding funding, management, and loan portfolio follow-up of MFIs impact on their final cost of
operation, furthermore I also looked into if any savings could be produced in this end are transferred to
the final clients.
Accordingly, the general findings of my analysis are as follows:
1. Model Self Help Group may be considered a less efficient from its cost point of view because
there is no incentive to monitor the loan portfolio; while the cost of manpower is reduced, the
quality of the management and the product (i.e. loan portfolio) suffers. Certainly, it would be
expected that a non-properly supervised portfolio would incur longer cost in the long run.
2. The Partnership Model, with MFI as the servicer, seems to be the most effective as it relies on
MFI sound operating policies for collection and supervision, which adds to the cost of operation.
In the long run as micro loan defaults are kept to a minimum and so is the cost of running the
operation with attendant benefits to the users of the services.
3. MFIs in general incur a higher working capital cost and debt cost but when they take time to build
a reasonably large deposit base, compared to other forms of more costly debt can be better
positioned to pass through those savings of a lower funding cost to the borrowers.
70
How MFIs are Sourcing Capital - Blue Orchard Microfinance Investment Managers

4. There seems to be evidence that through the partnership between MFIs, government, private
investors and information technology organisations, facilitates the integration of new technologies
into MFI models, thereby reducing cost and maximizing the outreach to clients.
5. It would seem while the Latin American model is more competitive, the benefits of that
competition in the form of lower cost to the borrower is not achieved; it may be because the
competition is geared to produce a higher Return on Equity (for the benefits of the owners), not
necessary to pass through the benefits to clients in the form of lower costs.
6. In the special case of Grameen, where the bank is owned by the “Poor” (i.e. those borrowing from
it) it peculiar non-profit structure guarantees that borrowers-owners benefit directly from any cost
savings produced.
7. In a broader scope, it was also found that one major stumbling block to micro borrowers in
reducing the cost to borrowing, is the lack of legal title to property which they de facto own; this
topic has been widely researched by leading authors like Hernando de Soto in his book The
Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else.
E. Conclusion & Recommendations
In general, it can be concluded that different models of microfinance in different regions are driven by a
variety of objectives when it comes to profitability. The Asian model, with society and economic development
objective as their centre piece, seem to be more beneficial to the micro borrower when it comes to finding a
lower cost of borrowing. In other regions, given the different variations provided by several models, it may be
more difficult to arrive to a similar conclusion. To ascertain that they are better or worse than the Asian model,
would require a further more in-depth analysis that is beyond the scope of this paper. As a continuation of my
initial hypothesis, I would certainly consider researching this topic more in the future.
There is, however, an additional point that, while not central to this analysis and anecdotal in nature, I
think is worth mentioning since it came through while researching this topic. There is some concern that
hidden in the large volumes of funds that are currently being directed to microfinance by investors and other
types of providers, there may be funds of dubious origins that may be finding their way into this otherwise
public-spirited field. While difficult to research, this could be a worthwhile topic to concentrate attention on
particularly in the context of the regulatory framework of microfinance industry that is evolving.

ANNEX I
Below are some common technological tools used in MFIs operations.
- M-Banking
M-Banking is the use of a mobile phone to conduct payment and banking transactions by MFI clients.
It uses the existing rapidly expanding mobile phone infrastructure and has the potential to be
deployed rapidly and affordably to expand access to financial services among unbanked people. M-
Banking transaction costs are far less to process than a transaction at an ATM or branch so banks can
make a profit handling even small money transfers and payments.
- Smart cards for automated teller machines (ATMs)
Smart Cards are used as security measures and mobile banking transactions can be protected by a
private key stored on the SIM card. The smart card issuer will generally be an institution of a certain
size and all the participants in a smart card scheme are usually in some continuing relationship,
usually contractual, with the other members of the scheme.
E-money is in effect a conditional promise to pay any bona fide holder of the e-money in a manner
similar to a negotiable bank note or letter of credit. Its utility depends largely on other’s confidence
in the issuer’s ability to fulfil the promise to redeem the e-money at a equivalent value.

ANNEX II
• Key measures for Accessing commercial financing

An MFI is ready to access commercial financing when it has built an equity base through past
donor grants and has a positive net worth.71 MFIs can access commercial debt by borrowing
directly from commercial banks or by issuing financial paper in the market place. MFIs are
ready to access commercial financing if: (Source: Clark 1997).
1. Have perfected their service delivery methods and product design to respond to the
demands of their market in a rapid and efficient way, ensuring an increased volume
operations and repeat borrowing.
2. Have a strong sense of mission and a sound governing structure that is free from political
interference, so that they can make policy decisions that protect their financial health.
3. Have a management team that focus on efficient service delivery and productivity, on profits
rather than volume, and sets productivity goals and incentive schemes
4. Have information systems that produce clear, accurate, timely and relevant information for
management decision making and that focus on well-developed loan tracking and financial
reporting systems, reporting on costs and income both on a profit-centre basis and for the
MFI as a whole.
5. Have a record of achieving high levels of financial performance, of incorporating appropriate
pricing policies based on the full cost of delivering the services, and of maintaining the value
of the donated equity.
6. Maintain low levels of delinquency (well below 5 percent to 8 percent of outstanding
portfolio, with loan loss rates below 2 percent) to ensure optimum income and prevent asset
erosion.
71
Microfinance Handbook: An institutional and financial perspective

Bibliography
Websites
1. Microcapital.org Story: Australian Bank ANZ Amasses 10 million Fijian Dollars (USD 5.3
million) in Deposits through Mobile Rural Banking Program
http://www.microcapital.org/microcapitalorg-story-australian-bank-anz-amasses-10-million-
fijian-dollars-usd-53-million-in-deposits-through-mobile-rural-banking-program-in-fiji-
launched-in-2004-in-conjunction-with-the-united/
2. Banks in microfinance, guidelines for successful partnerships
http://pdf.dec.org/pdf_docs/PNADD684.pdf
3. Does Loan Type Matter for Microfinance Performance in Latin America? MIX Market
http://www.themix.org/press-release/does-loan-type-matter-microfinance-performance-
latin-america
4. MFI Capital Structure Decision Making: A Call for Greater Awareness 2007 CGAP
http://www.syminvest.com/market/news/microfinance/mfi-capital-structure-decision-
making-a-call-for-greater-awareness/2007/8/31/654
5. How are MFIs sourcing capital – Blue Orchard Microfinance Investment Manager
http://www.slideshare.net/svmn/blueorchard-presentation-to-svmn-20090319
6. Unitus Equity Fund LP http://www.unitus.com/about-us/unitus-strategic-affiliates/unitus-
equity-fund
7. CGAP MIV Benchmarking Report 2008 http://www.cgap.org/p/site/c/template.rc/1.26.1430/
8. MIV investments in 2008 grew by 31%: CGAP survey published by Microfinance Focus
http://www.microfinancefocus.com/news/2009/10/22/miv-investments-in-2008-grew-by-
31-cgap-survey/
9. Financing microfinance – The ICICI Bank Partnership mode
http://www4.gsb.columbia.edu/null/download?&exclusive=filemgr.download&file_id=64644
0
10. Cf. Omtirx, “Giant Leaps in Microfinance” presentation, October 2007
11. Cf. ADA and P. Goodman, “Microfinance Investment Funds, Key Features” 2007
http://www.microfinance.lu/fileadmin/media/Publications/downloads/etudes/MF_intermed
iation_overview_01.pdf
12. Press Release: Mexico's Largest Microfinance Bank Taps Global Equity Markets in the First
IPO by a Latin American Microcredit Lender
http://www.milbank.com/en/NewsEvents/PressRelArch/Mexico_Largest_Microfinance_Ban
k_Taps_Global_Equity_Markets_in_the_First_IPO_by_a_Latin_American_Mic.htm

13. Deutsche Bank to use CDO market to help assist the Poor, www.Financialtimes.co
14. Banco Azteca Exports Microfinance Formula from Mexico Southward – Microcapital
http://www.microcapital.org/news-wire-banco-azteca-exports-microfinance-formula-from-
mexico-southward/
15. Optimising Capital Supply in Support of Microfinance Industry growth – Mckinsey
http://www.blueorchard.com/jahia/webdav/site/blueorchard/shared/Resources/Press%20A
rticles/0610_McKinsey_Optimizing%20Capital%20Supply%20in%20Support%20of%20Microfi
nance%20Growth.pdf
16. Hindustan Lever Ltd Case – Tuck School of Business At Darthmouth
http://mba.tuck.dartmouth.edu/pdf/2002-2-0011.pdf
17. International Funding of Microfinance Institutions: An Overview, Ada Microfinance Expertise.
http://www.microfinance.lu/50.html?&L=1
18. FDCF on website http://www.challengefunds.org
19. Microfinance and Technology – Critical issues, Lessons and Future implications; Microfinance
Consulting Group. http://www.solutionexchange-un.net.in/ictd/cr/res06030801.pdf
20. Rotary Club of Manila http://www.rcmanila.org/objectives.html
21. 2008 Microfinance Technology Survey CGAP
http://74.125.77.132/search?q=cache:Ygi6qMkRhFUJ:cgap.org/gm/document-
1.9.4398/2008%2520Microfinance%2520Technology%2520Survey_Espanol%255B1%255D.d
oc+2008+Microfinance+Technology+Survey+CGAP&cd=1&hl=es&ct=clnk&gl=es
22. Building a Dialogue to Promote Microfinance Best Practices in South America (World Bank)
http://siteresources.worldbank.org/INTENBREVE/Newsletters/21948774/Aug08_134_Microf
inanceBP_FINAL.pdf
23. Lender With a Mission - Bangladesh's Grameen Bank targets poorest of poor – Grameen
Bank Bangladesh http://www.gdrc.org/icm/grameen-article4.html
Books
1. The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else -
Hernando de Soto
2. An Inside View of Latin American Microfinance – Inter-American Development Bank - Editado
por Berger, Marguerite; Goldmark, Lara; Miller-Sanabria, Tomás.
3. Microfinance for bankers and investors - Elisabeth Rhyne
4. Microfinance Handbook: An institutional and financial perspective - Ledgerwood, Joanna

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INSTITUTO DE EMPRESA

Completed with direct supervision of:

Prof. Eloy Gracia

Professor: Eloy Garcia 1 DILIN LIM - MIAF 2009

RESEARCH & FACTUAL CATEGORIZING

THE ASIAN MODEL

Professor: Eloy Garcia 2 DILIN LIM - MIAF 2009

THE LATIN-AMERICAN MODEL

Professor: Eloy Garcia 3 DILIN LIM - MIAF 2009

NOT-FOR-PROFIT MFI MODELS

B1. OPERATIONAL ASPECTS INFLUENCING PROFIT AND LOSS

Professor: Eloy Garcia 4 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 5 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 6 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 7 DILIN LIM - MIAF 2009

- Human resources, promoting and marketing costs

Professor: Eloy Garcia 8 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 9 DILIN LIM - MIAF 2009

Fig. II - Loan Portfolio Management

Fig. III - Important results in technology system types by region19

Professor: Eloy Garcia 10 DILIN LIM - MIAF 2009

Fig. IV - Important results in technology system types by type of institution

Fig. V - System constrains by number of clients

Professor: Eloy Garcia 11 DILIN LIM - MIAF 2009

Fig. VI - Advantages and disadvantage of different information systems

- Demographics & Geographic limiting factors

Professor: Eloy Garcia 12 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 13 DILIN LIM - MIAF 2009

B2. Funding aspects influencing Balance sheet

- Efficient capital structure: Donations, Bank financing and NGO financing

Professor: Eloy Garcia 14 DILIN LIM - MIAF 2009

Fig. VII - Demand and Supply of funding needs31

Fig. VIII - MFI Funding Sources

Professor: Eloy Garcia 15 DILIN LIM - MIAF 2009

Structuring partnerships with commercial banks are a form of financing, it is essential to

Professor: Eloy Garcia 16 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 17 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 18 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 19 DILIN LIM - MIAF 2009

Fig. X - Average MFI Cost per Borrower

Professor: Eloy Garcia 20 DILIN LIM - MIAF 2009

Financing Model 3: The partnership model – MFI as the servicer

Professor: Eloy Garcia 21 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 22 DILIN LIM - MIAF 2009

Microfinance Investment Vehicles (MIVs) provide fixed income and equity

Professor: Eloy Garcia 23 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 24 DILIN LIM - MIAF 2009

Fig. XII - Commercial Equity requirements

Fig. XIII - Financial Integration and level of regulation

Professor: Eloy Garcia 25 DILIN LIM - MIAF 2009

- DEPOSIT BASE STRUCTURE

Professor: Eloy Garcia 26 DILIN LIM - MIAF 2009

Fig. XIV - Funding Structure of Grameen Philippines

I. CHALLENGES IN OPERATIONAL & FUNDING ASPECTS

Professor: Eloy Garcia 27 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 28 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 29 DILIN LIM - MIAF 2009

Professor: Eloy Garcia 30 DILIN LIM - MIAF 2009

II. Lending to Microfinance Intermediary – savings on running more efficient

Professor: Eloy Garcia 31 DILIN LIM - MIAF 2009

E. Conclusion & Recommendations

Professor: Eloy Garcia 32 DILIN LIM - MIAF 2009