As MFIs evolve they experience changes in funding pattern; from donor dependence to sustainable profitable institutions that are able to attract equity and mobilise deposits (Koveos & Randhawa, 2004). The push behind this change comes from the demand for broad service provision. In particular, microcredit’s expansion has raised considerable interest from the financial markets to date. As indicated by Arch (2005), there are over 500 million micro-entrepreneurs globally whose activities are sustained by MFIs (Bystrom, 2007; Zapalska et al., 2007 ). These numbers represent a growing microfinance industry and demand for financial services to the extent that traditional sources of finance for MFIs have proved to be limiting.
It is also estimated that 40 per cent to 80 per cent of the population in most developing countries lack access to formal banking services (Cull et al., 2007; World Bank, 2008). Bystrom (2007) reports that, out of a total demand of $50 billion only 4 per cent is met by MFIs. These observations indicate a funding gap which presents an enormous challenge to traditional funders of the industry, but an inviting opportunity to external providers of capital. The widening gap between supply and demand for microfinance funding and the growing market has suddenly caught the attention of many funders.
Commercial sources of finance are promising in volume and availability. It is thus argued that commercial investors can assemble massive quantities of capital for microfinance to best serve hundreds of millions, but microfinance must be an acceptable investment (Daley-Harris, 2009). While commercial capital will widen the pool of funds available to MFIs, it will also demand that MFIs operate with transparency and post positive returns. High profits enable MFIs to attract private investment capital and stop relying on donor subsidies (Lewis, 2008; Sengupta & Aubuchon, 2008; Emeni, 2008). Not only are investors attracted to the promise of high returns, but involvement with microfinance has an added appeal for those who want to be part of the fight against poverty.
Commercial orientation benefits both MFIs and micro-entrepreneurs by providing longer maturities and more diversified funding services such as bonds, initial public offerings (IPOs), venture capital, and collaterised loan or debt obligations (Bystrom, 2007; Emeni, 2008; CCAP, 2007). In their analysis of different funding options, Pollinger, Outhwaite and Cordere-Guzman (2007) concluded that sustainable organisations can handle financial leverage easily because they can generate the means to repay debt.
Callaghan, Gonzalez, Maurice and Novak (2007) argue that top-tier MFIs estimated to be 10 000 receive less than 25 per cent of capital from private capital sources. They suggest that to get more financing from commercial markets, MFIs are required to generate more returns in addition to standard financial data. Microfinance analysts also point out that a significant challenge facing
microfinance is how to serve the growing number of impoverished poor using traditional financial sources (Tulchin, 2004). From this perspective, it is understandable why microfinance institutions are wooing investors and structuring big deals. Indeed, to attract money for their continued poverty alleviation role, MFIs have to play by the rules of global capital markets. Those rules require that MFIs pursue profitability and ultimately full commercial status (Cull et al., 2008; Counts, 2008). Examples of MFIs that have gone through a process of commercialisation include institutions like BRI in Indonesia, the Grameen Bank, BancoSol, and K-Rep in Kenya (USAID, 2005; INAFI Africa, 2003). Several commercial banks have also downscaled to the microfinance market with examples in Africa such as Equity Bank (Kenya), Centenary Bank (Uganda) and National Microfinance Bank (Tanzania). Institutions emerging from this process form a new market of socially responsible institutions that are financially self-sufficient (hereafter referred to as commercialised institutions (CIs)). CIs generally have the ability to interact, contract and do business with the wider commercial market, while emphasising microfinance clients as their niche market
Collins and Porras (1994: 8-9) have shown that it is possible for visionary companies to embrace change and adapt without compromising their cherished ideals. Change and innovation is important for advancement, but it is also vital for MFIs to cling to the social value of microfinance. Social and economic empowerment to the poor serves as a basic requirement and core service of microfinance to this customer group. A re-innovation of microfinance is therefore an integral component of growth for most institutions in the so-called donor industry. This direction underscores the appropriateness of market reforms, especially in Africa and commercial intermediation of microfinance organisations.
Unfortunately microfinance industry starts from a point of weakness due to investors’ negative stereotypes about MFI’s risky operations. MFIs are often said to lack professionalism, are small in size, have a weak balance sheet, no regulation, lack good governance and clear ownership, as well as poor investment ‘fit’ (Tulchin, 2004). But on the contrary, microfinance has defied this perception and attracted private capital from a variety of sources, such as: Citi Group, the United Nations Development Programme (UNDP), United States Agency of International Development (USAID), commercial banks, developing worlds’ markets, domestic savings, social investors, and Dexia microcredit fund, and Blueorchard (Arch, 2005; Pollinger et al., 2007; Emeni, 2008; Swanson, 2007; Arvelo et al., 2008). These transactions are living evidence that there is growing strong investor demand for microfinance industry. Arch (2005) also notes that 85 per cent of developing nations’ external finance (some of which goes to emerging industries like microfinance) comes from private capital. Hence the debate is not whether microfinance can attract commercial capital, but the factors that determine that attraction.
One important barrier to microfinance success in financial markets is small deal size. As such, transaction costs, due diligence, legal expenses, and custodial arrangements are said to reduce investor returns. Investors are interested in performance and how it relates to their investment. A number of studies indicate that to attract the financial markets to microfinance, licensed and regulated institutions exhibit comparatively high levels of success (Callaghan et al., 2007). An investigation into success factors of MFIs suggests that age, size, legal form, market, ownership and location are critical for tapping capital, good performance and growth (Zapalska et al., 2007). It is suggested that profits for top tier MFIs are at an appealing stage with some MFIs like Compartamos of Mexico posting comparable returns (50% return on equity (ROE) in 2004) to Citi Group (16% ROE) (Cull et al., 2008). Lewis (2008) also found strong support for the argument that high profits enable MFIs to attract private investment capital (Sengupta & Aubuchon, 2008). Ayayi and Sene (2007) find that financial sustainability is associated with quality portfolio; high interest rates and sound management. At a regional level, a review of commercial investments in microfinance shows that high performance MFIs in Latin America, Eastern Europe and India were more successful in attracting funding unlike Africa (Daley-Harris, 2009). According to the review, Africa suffered from lack of investor attention due to perceived high risk and low-level returns indicating the importance of high returns in attracting commercial capital. The lack of access to finance for African MFIs has led the author to investigate the factors that would enable MFIs in Africa to attract investor funds.
Callaghan, Gonzalez, Maurice and Novak (2007) examine the drive towards commercialisation and conclude that Latin American MFIs are more commercial, Asian MFIs are strong performers followed by Eastern Europe. Their study found that Middle Eastern MFIs rely on equity financing while for Africa standard data was unavailable for comparison. The authors suggest that success for MFIs depends largely on well-trained loan officers, infrastructure development and better trained managers.
UNEP FI (2007) in a survey of commercial microfinance practices across Africa report that, commercial microfinance is a significantly less prominent trend than in Asia and Latin America. The study points out that, Africa attracts a relatively low share of foreign quasi-commercial investment for microfinance – 7 per cent, for example, compared to 28 per cent for Latin America and the Caribbean. The figures for purely commercial investment are predicted to be even lower. According to the report, by 2006, MFIs globally increased commercial funds for their loan portfolios on average by over 70 per cent except for Sub-Saharan Africa.
Confronted with such a situation, MFIs in Africa do not have much of a choice than to make themselves attractive to commercial sources of funding. MFIs in Africa should join the foray of capital markets (including venture capital) like their counterparts in Latin America where
commercialisation has taken root (Jansson, 2003). This includes the struggles involved in attracting commercial funds. In anticipation of strained development finance resources and constrained growth, commercialisation has become a great consideration for many (Hattel & Halpern, 2002).
Currently, external financing is needed to raise growth from current levels. While access to commercial funding is now recognised as the key to long-term survival (NEXUS, 1998: 5; Copisarow, 2001), MFIs have to establish ways of communicating to commercial market sources for additional financing. Hence continued success of the practice of microfinance rests in the commercialisation progress.
Sustainable development in the microfinance sector therefore demands access to permanent and reliable sources of credit finance (Hattel & Halpern, 2002). All other sources seem to have been stretched to the limit of exhaustion, except commercial finance, whose viability is under serious experimentation. This option is believed to have the capacity to rapidly increase the lending levels to the desired scale, as well as fund required growth. The need to close this widening funding gap provides the drive to commercialise access to microcredit finance.