Global microfinance portfolio on the wane

MANILA, Philippines - The portfolio quality of microfinance institutions (MFIs) is deteriorating, according to a study conducted by the research arm of Deutsche Bank AG. 

By the end of 2010, MFIs extended loans to over 200 million clients, impacting an estimate one billion people in emerging markets and developing countries. 

But Deutsche Bank said that the global portfolio at risk 30 (PAR 30), or the share of the portfolio for which payments are more than 30 days overdue, rose from less than three percent in 2007 to more than five percent in 2009. 

“The rise in delinquencies went along with a decline in MFI profits and a sharp fall in asset growth rates,” the report said. 

It stated that the portfolio deterioration reflected some disturbing trends in microfinance. 

The report said that the fast expansion of microfinance in some markets led “to an increase in the share of wealthier and more risky borrowers, leaving MFIs more vulnerable to an economic downswing.” 

Troubled MFIs were unable to adjust their internal structure and lending policies to keep up with fast market growth. 

“They lacked adequate risk management capacities and subordinated prudent lending to fast growth and short-term profits,” the research report said.

From a development tool, microfinance is becoming highly commercialized. 

Thus, the instruments used to overcome moral hazard and adverse selection became less effective.

This weakened incentives to repay on the part of borrowers, increasing the probability of multiple borrowing and strategic default. 

“In some cases, all three developments reinforced each other, leading to over-indebtedness of MFI clients and outright crisis in the affected countries,” the DB Research said. 

The report called for “a new balance” between the social development approach and the commercial approach, or a socio-commercial approach. 

“Central to this idea is that microfinance is not a just a business, and that social development goals have to remain at its core, which puts client needs back in the focus of its operations,” it said. 

That means putting client needs back in the focus of all microfinance operations. MFIs must designing suitable products while constantly evaluating the social impact of micro-lending. 

It also requires a culture of social responsibility among MFI owners, managers and staff.

Better training of staff and a generally intensified client focus can ensure that borrower selection and repayment incentives are adequately set.

It also means bringing client protection principles to work, strengthening market infrastructure by establishing credit bureaus, information networks etc., and improving microfinance regulation. Social performance indicators need to be further developed and the measurement of social performance goals implemented in practice. 

“These improvements are important and useful but should not distract from the task of bringing social objectives back in the focus of owners and financiers of microfinance institutions,” the Deutsche Bank report added. 

Microfinance is said to have been “born” in Bangladesh in the early ‘70s but found its way to South Asia and the East Asia and the Pacific. It is presently practiced in low-income economies, emerging markets and developing countries.

Today, 75 percent of total microfinance lending is still used for investments although the remaining 25-percent finance household needs, including education and medical requirements. 

Borrowing has steadily shifted from group to individual lending. There are also a growing number of micro-borrowers, which are actually classified as the small and middle entrepreneurs as well as relatively well-off individuals. 

Over 60 percent of micro-borrowers are located in South Asia while the largest share in terms of total assets are located in the Latin American countries. 

There are three general MFIs namely, non-government organizations (NGOs), non-bank financial institutions (NBFIs) and banks. NGOs account for 33 percent of MFIs followed by 35-percent NBFIs, while banks account for only eight percent of total count of institutions. 

But NBFIs has the biggest share of total borrowers accounting for 39-percent market share, NGOs have 30 percent market, and banks taking the smallest share. 

But banks have the largest share in terms of total assets with 52 percent, 28 percent for NBFIs and the balance by NGOs.