Deployment of impact investments in private credit has largely been to date via Development Finance Institutions to microfinance organisations in emerging markets.
Whilst most of the developed world takes banking services and access to credit for granted, the World Bank estimates 2.5 billion adults are financially excluded worldwide. Seventy five percent of the world’s poor lack basic financial services due to poverty, cost, distance and the often burdensome requirements of opening an account. It may seem obvious but being “unbanked” is directly correlated with income inequality – the richest 20% of adults in developing countries are more than twice as likely to have a formal bank account.
The Need for Microfinance
Access to credit has a massive impact in developing countries in several ways:
- It helps families build assets, manage risks, and smooth consumption. Research shows that access to financial services leads to increased income and improved health and education, allowing children to have more days in school and allowing families to have more regular meals.
- Micro, small and medium-sized enterprises (MSMEs) are collectively the largest employers in developing countries. Their growth is often restricted by a lack of access to credit and savings services that enable them to invest in fixed capital, increase turnover and employ more people. About 200 million businesses in developing countries lack the financing needed for growth, a financing gap of $2.5 trillion.
- Spurring growth and reducing inequality, which is aided by integrated and universal financial systems. The G-20 has made financial inclusion a permanent policy priority by establishing the Global Partnership for Financial Inclusion (GPFI).
Microfinance institutions bridge the gap between formal financial institutions and the poor by providing rural villagers, microentrepreneurs, impoverished women and families with loans, sometimes alongside other services such as insurance or a deposit facility. The emergence of ‘for-profit’ MFIs, sometimes referred to as Non-Banking Financial Companies (NBFC), is growing around the world:
MFIs originating from NGOs or other such organisations can undergo commercialisation, a change in legal status from an unregulated nonprofit into a regulated, for-profit institution. Regulated, transformed organisations are held to performance and capital requirement standards and usually supervised by a financial authority, typically the central bank of the country of registration.
The microfinance sector focuses on understanding the needs of the poor and devising better ways of delivering services to meet their requirements, using the most efficient mechanisms available to deliver finance to the poor. The growth rate of the sector has been helped by continuous efforts towards automation of operations to steadily improve MFI efficiency.
Microfinance Investment Vehicles
Initially, international microfinance funding was provided by donor organisations, such as public development agencies and private foundations. As the sector gained traction, private capital flows allowed MFIs to scale beyond what was possible with donor money alone. Private investors and donor agencies thus joined forces in creating microfinance investment vehicles, referred to as MIVs or microfinance funds. MIVs act as the main link between MFIs and capital markets, raising capital from public, institutional and private investors and providing financing (usually debt) to MFIs located in developing countries. As of 2018 MIV’s have $15.8 billion of assets under management, and the sector is somewhat concentrated with the largest 5 MIVs managing 40% of all assets.