The main theme of this project is the facilitation and development of microfinance, which is the "provision of loans, savings, insurance, payments, and other basic financial services to low-income populations" .
The project is dedicated to identifying and evaluating existing options for microfinance institutions (MFIs) who wish to access the funds necessary to take advantage of the huge potential market for microfinance. This topic is particularly important as the current lack of funds remains the major growth constraint for the microfinance industry.
Global capital markets would enable MFIs to raise capital for lower rates and longer terms than local financing. Ways for MFIs to access global capital markets are therefore explored in details. The following three sources of commercial financing are then outlined and evaluated in the context of MFIs: bonds, securitization and (quasi-)equity.
However, although microfinance can be profitable, investors remain reluctant to invest in MFIs. We identify the main concerns preventing substantial investment in this area as: concerns over the inadequate risk-return profile, a lack of expertise or experience in the area, operational problems such as pricing, liquidity and legal issues and the perception of microfinance primarily as a form of charity. We then propose ways to deal with these concerns and promote investment in microfinance.
We demonstrate not only how microfinance can offer a relatively low level of systematic risk through its low volatility and weak correlation with political and economic events, but also how it offers a good opportunity for diversification. After showing certain comparability between investments in venture capital and microfinance, we suggest targeting venture capital investors as a priority in gaining access to equity capital.
Having explored and concentrated on the financial aspects of microfinance, we then remind the reader of huge benefits it represents in terms of poverty reduction in under-developed countries.
We conclude by mentioning some further challenges faced by microfinance, such as risk hedging, especially in the context of exchange rate risk, and achieving the three factors that determine a country's ability to manage microfinance efficiently: political stability, economic security and cultural readiness.
[...] The risk-return profile in venture capital is probably different to that of microfinance equity. However, while a venture capital can expect only two investments out of ten to be significantly successful, a microfinance investor could reasonably expect ten positive returns. And the average total return of venture capital is therefore very comparable, as illustrated below. Fig Venture Capital vs. Microfinance Return Profile Investors may then argue that exiting an investment in microfinance is difficult. But once more, there is no reason to think it would be more difficult than in venture capital operations. [...]
[...] Although it should not be one of the main arguments for a commercial investor to enter the microfinance field, we should bear in mind the huge benefits poor people draw from it. By providing financial facilities to low-income people around the world, microfinance acts as a very effective tool to reduce poverty. Investors acknowledging this fact could “push the frontiers of international finance”[19] and, at the same time, provide thousands of people with opportunities for better lives in terms of business development, education, health, housing, nutrition and so on. [...]
[...] SECTION Overcoming the limitations of the current financing model As we have seen, microfinance can be profitable and international capital markets offer different financing options to MFIs. So why are investors still reluctant to substantially invest in them? What actions can MFIs implement to attract investment? Addressing investor's main concerns John Wilson, director of Socially Responsible Investing at Christian Brothers Investment Services Inc[15], outlined ten main reasons for not investing in MFIs, from an investor's perspective. On the basis of his work, we identified four main categories of concerns which we are now going to discuss. [...]
[...] SECTION Accessing the Global Capital Markets Although microfinance is now generally considered as a success, the lack of funds remains the major growth constraint, according to recent surveys[7]. The traditional approach to rising financing is thus not sufficient anymore to sustain the high growth rate and the huge and still untapped potential market, estimated at more than $300bn[8] Financing Environment Traditionally, the microfinance community has essentially been supported by the international donor community. This is particularly true for more than 90% of the market, consisting of young and mostly unprofitable institutions (Stages I and II in Table 1). [...]
[...] However, on the other hand, international financial markets do not offer many so-called “free-lunches”. When a profit opportunity arises on a risk-adjusted basis, investors usually react very rapidly even if they first have to acquire expertise in a new field. We therefore think this lack of expertise is no longer an excuse for a general misunderstanding of the risk-return profile developed above. Operational issues. Pricing, liquidity and legal issues are the main operational problems faced by international investors. These issues are certainly valid as far as equity financing is concerned. [...]
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