Looking Beyond the Financial Crisis: Vulnerabilities Related to Fast Growth in Microfinance

WASHINGTON, Feb. 24 /PRNewswire-USNewswire/ -- Recent repayment troubles in four rapidly-growing microfinance markets do not stem from the financial crisis, according to a new report by CGAP, a microfinance group based at the World Bank, but from the way that microfinance operates in fast-growth markets. The authors examine recent repayment troubles in four rapidly-growing but disparate microfinance markets -- Nicaragua, Bosnia and Herzegovina, Morocco, and Pakistan -- and conclude that the problems observed are closely associated with the growth phases each country experienced from 2004 to 2008.

Far from being the root cause of the problems in these countries, the authors argue that microfinance globally has weathered the difficulties of the financial crisis relatively well, giving observers confidence that microfinance will emerge strong from the crisis.

The report, Growth and Vulnerabilities in Microfinance, distills three weaknesses at the heart of the repayment crises in these countries: excessive lending concentration by MFIs and multiple borrowing by their clients; overstretched back-office capacity within the MFIs; and a loss of credit discipline as MFIs pursued fast growth.

"Experience shows that microfinance can maintain asset quality, and pay impressive returns, both in terms of profits to investors and as well as improvements in people's lives," says co-author Xavier Reille of CGAP.  "Nevertheless, a few countries do show signs of stress and remind us of the need for a much stronger focus on sustainable growth and re-commitment to asset quality."

Over the past 10 years, globally microfinance has grown at an impressive rate, providing access to financial services for millions of poor households. This growth has been driven by ambitious MFIs and fueled by abundant credit. Local and foreign investors alike have been eager to support the growth of the sector. "The next decade should focus on sustainable growth with renewed attention to client services and asset quality," says Reille.

CGAP argues that three developments could bolster the next phase of microfinance expansion: an improved balance between growth and the quality of client services at MFIs; expansion in the number and use of credit information bureaus; and better market information allowing managers to make more accurate decisions about where to extend their services most effectively.

The authors found that in each of the four countries MFIs had followed one another into specific localities, neglecting to spread their services out more evenly. Greater lending concentration and competition brought some benefits to clients. At the same time it increased the chances that borrowers took on larger amounts of debt from more sources, and it changed their repayment incentives.

In chasing new clients and asset growth, many MFIs in the four countries were unable to maintain the quality and efficiency of staff, the focus of middle management, and the adequacy of internal controls.

Thirdly, credit discipline itself began to suffer. MFIs began to take more risks to secure new clients, and expanded their product offerings without appropriate adaptation and strengthening of internal controls.

The four countries examined in the report offer lessons for a wider industry that remains reasonably strong, according to the authors. They raise the question of whether fast-growing countries like India, where asset growth has significantly outpaced other countries, could see a rise in the same vulnerabilities. "MFIs will need to have a far better grip on their internal controls and also an improved understanding of their clients and markets," Xavier Reille says. "Credit information bureaus would be an ally in this respect, helping MFIs avoid over-saturated markets and identify sensible opportunities for growth, providing the kind of financial access mapping that can guide future expansion."

The authors emphasize that the recommendations in the paper are not in themselves panaceas to all possible and future microfinance problems, but that, taken together, they could significantly buttress the sector from repeating past mistakes.

About CGAP

CGAP (The Consultative Group to Assist the Poor) is the world's leading resource for the advancement of microfinance. CGAP provides the financial industry, governments and investors with objective information, expert opinion, and innovative solutions to effectively expand access to finance for poor people around the world. More information:  www.cgap.org

SOURCE CGAP