The impact of microfinance

They are the kind of sums an investment banker in Amsterdam or Frankfurt or London might spend on a taxi to the airport: €50, €60. But to a village entrepreneur in a country like Bangladesh or Bolivia, whose income is likely to be equivalent to only four or five euros a day, they represent, literally, a small fortune. Frequently these tiny sums are all that is needed to transform their business: to enable someone to buy goods that they can resell for a profit, and go on in a virtuous cycle to build up a profitable retail operation, or to let a village baker, say, buy a bicycle that enables them to reach a much wider circle of customers. In the developing world, however, where much of life is hand-to-mouth, getting access to such life-changing, though tiny, amounts of capital has been impossible.

Until, that is, the growth of what have become known as microfinance institutions. These are operations set up in developing countries specifically to lend tiny sums of money precisely where they will do the most good. Their clients are people whose assets, income levels and/or cash flows are usually too small for local commercial banks. It is simply not financially viable for a normal bank to try to serve these clients. The pioneer of such "microfinance" was Muhammad Yunus, a professor at Chittagong University in Bangladesh. He and the organisation he founded in 1983, Grameen Bank, which now has 6.2 million borrowers and a gross loan portfolio of not far short of $500m, were awarded the Nobel Peace Prize in 2006.

Now we are talking about sums that investment bankers can get interested in. There are, according to Theo Brouwers of SNS Asset Management whose headquarters are located in Utrecht, 10,000 microfinance institutions like Grameen Bank operating in the world, and the estimated loan volume of the microfinance sector at the moment is about $25bn. Obviously there is an extremely long "tail" of tiny organisations far below the size of Grameen Bank, or Ashak, also from Bangladesh, with its five million active borrowers and a loan portfolio of $305m. But there are, Mr Brouwers says, some 500 microfinance institutions that are "interesting" from the point of view of commercial funding. These are operations that the big financial institutions of Western Europe and North America can lend to, which then pass on the cash in the tiniest amounts to their village borrowers.

Successful operation
SNS Asset Management already has one investment fund specialising in microfinance institutions. After the success of that operation, it is now launching a second. The Netherlands is a good market to convey the idea of a positive investment as it is open to these kinds of new products. It easily adopts new initiatives and supports them, Mr Brouwers says. Pension funds, trades unions with funds to invest and private individuals all interested in "socially responsible" investments. But the fact is that these microfinance investments are, as they have to be, good investments in their own right, with returns equivalent to those of other asset classes.

Brouwers has been a director of SNS Asset Management since April 2006. Previously he worked for 18 years for the big Dutch bank ING, "where I was general manager, investment and also involved in socially responsible investment and corporate social responsibility activities," he says. "I started the socially responsible investment department at ING in 1999 with three people. We built it to a very professional team with eight people and about €3 billion assets under management – which is very, very low if you compare it to the rest of ING." Socially responsible investment, he says, is "still a small proportion of investment in the Netherlands, although it's rapidly rising. It depends on how you count it, but it's still less than 10 percent. Sometimes I get figures of three percent, sometimes of eight. There's still much to gain."

Then Brouwers was headhunted to SNS Asset Management, part of SNS REAAL a Netherlands banking and insurance services provider with a total balance sheet of € 103 bn (figures per 31-12-2007). "One of the main reasons why I joined is because SNS Asset Management is the company typically chosen for responsible investing – they are the specialists in that field of investment class," Brouwers says. SNS Asset Management became involved in socially responsible investment in 1996. One of the predecessors of SNS AM, the Hollandse Koopmansbank was already very involved in socially responsible investment – "in fact we have the oldest socially responsible investment fund, which was started by the predecessor of SNS Asset Management."

Because of Brouwers joining SNS Asset Management, he says, "microfinance became a hot topic. When I was at ING I was already involved in microfinance. I started, together with the United Nations Capital Development Fund and Oikocredit [a co-operative established by the World Council of Churches to offer microfinance in developing countries] a microfinance support programme. We delivered practical assistance to microfinance institutions in their own countries. I was also looking at investing and doing research on microfinance exposure from an investment point of view.

"I noticed there was hardly any possibility to get exposure to microfinance at an institutional level. So we made a survey on behalf of an institutional client of SNS Asset Management on how to get exposure to microfinance. And the conclusion was that this was very difficult, against high fees and low volumes. So we started ourselves one and a half years ago, and that was the start of the SNS Institutional Microfinance Fund."

Specific infrastructure
First of all, Mr Brouwers says, "We selected an investment manager. You can't do it yourself, you have to have a specific infrastructure and people who know the microfinance institutions, an investment manager who is doing the selecting work. We came up with Developing World Markets, a company based in Connecticut, which has a long history in the microfinance industry. We did some good work together at ING. The people at DWM are all from mainstream institutions, and they have a very institution-minded way of looking at microfinance."

The fund, which closed at €161m, was set up "with a structure so that 70 percent of the portfolio was debt and 30 percent, maximum, was equity. We structured it so that we are the sponsor, and fund manager and do all administration and the desk research into microfinance institutions. They [Developing World Markets] are selecting, visiting, doing the due diligence and they put the proposals before the investment committee, of which I am the chairman. We look at the country specifics, the currency specifics and also ask, 'is this the right microfinance institution?' and then it goes to disbursement. It's a very time-consuming process, but that's the microfinance industry."

The size of loans, Brouwers says, "depends on who we are aiming at. It's purely microfinance; we are very keen on microfinance institutions who stick to their mission. If we look at microfinance institutions that tend to go for loans of €10,000, that's not attractive. That's a totally different business that has a much higher risk profile. Besides that, it also has a lower social effect. So we are really looking at an average loan size of much below €1,000. It depends on the country; it depends on the microfinance institution. Sometimes we have microfinance institutions that have an average loan size of less than €100, sometimes it's an average loan of €300 or €500. These are real personal loans to entrepreneurs who are setting of businesses in their own villages – the 'entrepreneurial working poor'. Who are in principle credit-worthy, since they have to pay back the loan."

Because of the small size of the loans and the high administrative costs, the interest rates charged by microfinance institutions are very high. They vary from around 20 percent to 70 percent a year, depending on the country. "You need to travel to remote places, intensively advise cases," Brouwers says "But the risks are not that high – the vast majority of debtors, 99 percent, pay off their loans. The reason is, they start their own business with their own local market knowledge, and get very high returns. They buy something for 10 ruppiah, or whatever, and sell it for 30 or 40 ruppiah. Their own returns are very, very high. The loans are paid back in a very short time, sometimes within a month, in general within six months. This is seed money for them to get on their feet – and then they get a second loan to expand their business."

Biggest markets
Microfinance institutions are operating all over the globe – "Eastern Asia, Central Asia, Eastern Europe, Pacific, Latin America, Middle East, Africa, South Asia," Mr Brouwers says. "The biggest markets are Latin America and Asia. In terms of countries, it's India, Bangladesh, Kampuchea, Bolivia. Worldwide there are about 10,000 microfinance institutions with about 100 million micro-borrowers. But the total potential demand is estimated at one billion micro-borrowers, which tells you something about the huge, huge opportunities. The sector grew enormously in the past two to four years and will continue to grow fairly fast."

The first institutional microfinance fund had a target return of six to 11 percent, because of the equity element in the portfolio, Brouwers says. In 2007 "we had the highest returns of all microfinance funds, a net of 6.8 percent purely on the debt element – mainly because we have the lowest fees in the market. We also have hedged our dollar exposure risk to more than 100 percent."

Now, "because we got a lot of attention with the launch of this fund, we are launching a second fund with the same structure, aims and investment manager." It will only be open to institutions, not to retail clients. "Many pension funds have shown their interest. They are not only looking for a solid financial return - which they have to do because they have a fiduciary duty - they are also looking to combine it with a social return. That's why we are very keen to keep it microfinance, keep it local, and also why we are very keen on learning and sharing our experience and knowledge with our investors. That's why we organise study tours to developing countries, to look at the microfinancel institutions, the micro-entrepreneurs. We are also organising investors meetings where we invite key personnel from microfinance institutions."

About the microfinance institutions themselves, "sometimes they're run by traditional Western financial people. But more and more often you see people who are born, for example, in India or in Ghana, doing their studies in America at Harvard, or whatever, getting experience at Citigroup or Barclays and then returning to their own countries and running the microfinance institutions. Returning to their country and doing the best with their experience and skills.

"It is still necessary for them to have technical assistance. For example: the ING microfinance support programme, which I set up, is lending people to the microfinance institutions like marketing people, risk managers. These people are helping the MFIs with risk management systems, or helping them to attract the best local people. It's about passing on skills that can then be passed on. That's what I like about this business. I love to visit microfinance institutions and look at how they work and see them sharing their knowledge and experience with other microfinance institutions.

"It's a very interesting industry which has a combination of grant, of supranational institutions which are looking at the bottom of the pyramid of microfinance institutions. For example UNCDF (United Nations Capital Development Fund) plays an important role by developing skills and giving technical assistance together with commercial organisations who are funding it."

Niche asset
In five years' time, Mr Brouwers says, "the microfinance institutions will evolve to a real, if small, niche asset class which will attract retail as well as institutional investors as part of their portfolio diversification. I think the institutional side will grow ten times in five years. At the moment there's about €4bn or €5bn of commercial money in the microfinance sector. I expect that this will grow enormously in the coming years. We've invested in our own company by starting a development investment department which consists of microfinance analysts. We had two people and now we will grow to four. We will also attract a legal adviser. In the mid office we will attract two people dedicated to administering loans, equity deals in those sorts of countries, because it's not very simple – it's difficult.

"If you look at the microfinance industry itself, the growth figures for the microfinance institutions will stay for the coming three to five years. That means that the proportion of equity will become increasingly important, because of regulators, central banks and so on insisting they have more equity and less debt behind them as they grow. There will be consolidation, mergers, so that there will be fewer than 3,000 microfinance institutions in five years. Some microfinance institutions will transform themselves into regular banks and take deposits themselves. There will be a lot of consolidation at the top, and between the tier 1 and tier 2 microfinance institutions. And there will be clear winners among the microfinance institutions."

Meanwhile, as well as launching its second fund, SNS Asset management is also trying to find answers to a couple of specific, important questions. It is helping pay for two research projects at the University of Groningen, one to research the role of microfinance in a portfolio. "Let's prove that it makes sense to have an exposure to microfinance from an investment point of view," Mr Brouwers says. The other will be a study of the social impact of microfinance, "just to make sure it's having an impact, not only for the micro-entrepreneur but also for the family and the village and the country as a whole. There's no research yet on what impact microfinance has on a country's GDP. We would like to see if we can fill up that gap, find some evidence of the impact of microfinance."

For further information:
Tel: +31 610 981 289
Email: theo.brouwers@snsam.nl
www.snsam.nl 

Leave a comment

Your name
Your email (will not be published)
Your comment
Rate this article