Microfinance urged to raise standards

from the Financial Times

By Delphine Strauss in London

Microfinance institutions urgently need to improve management and corporate governance to cope with growing competition and a flood of capital that threatens to erode lending standards, a think-tank warns in a report published on Monday.

Born of philanthropy, microfinance – making tiny loans to the very poor – has come into vogue among commercial banks and international investors, inspired in part by the Nobel prize-winning Muhammad Yunus, founder of Bangladesh’s Grameen Bank.

The sector is growing quickly. The number of lenders is rising by 25 per cent a year, and the stock of ­foreign capital investment trebled to $4bn (€2.6bn, £2bn) from 2004 to 2006, according to the survey by the Centre for the Study of Financial Innovation. Expansion is bringing new pressures as rivals jostle to win business and poach staff.

Analysts responding to the survey identified poor management skills and corporate governance as the greatest risks facing the industry.

“Microfinance institutions tend to be dominated by ‘visionaries’ who are strong on charisma but less so on management skills and strategic flexibility,” the report said.

Practitioners who responded were more worried about well-heeled competitors. Some fear commercial entrants will destroy the sector’s social ethos. Many think a glut of capital is fuelling irresponsible lending that will raise debt burdens and the risk of defaults.

Others warn that developing country lenders risk replicating the conditions of the credit boom and bust plaguing developed economies.

Some investors said the credit crunch could save the sector from overheating. Microfinance has in the past been insulated from global economic trends. If it now proved more vulnerable and the cost of capital rose, institutions would need other merits to attract investors – which might be healthy in an overfed industry, one respondent argued.

Others thought competition would have more beneficial effects. Microfinance institutions have traditionally charged relatively high interest rates, reflecting the cost of labour-intensive, small-scale lending. But since microfinance borrowers are not always sensitive to rates, high charges might also have reduced the urgency of keeping costs down, which practitioners view as their second biggest risk. They can also increase the risk of a political backlash, which one respondent described as “the dark side of Nobel prizes”.

“The facts are that commercial banks, money lenders and consumer finance companies are taking advantage of low entry barriers ... bringing market forces to bear on hitherto sacrosanct lending margins,” the CSFI said.

The survey of practitioners, analysts, investors and observers was conducted in October and November last year, focusing on about 350 of the bigger microfinance institutions that are seen as capable of commercial growth.