Funding Microfinance – a Focus on Debt Financing

Why is debt financing important for microfinance?

Microfinance institutions (MFIs) have three main sources to fund their growth: debt, equity, and deposits (for those allowed to mobilize deposits). In this review, we will focus on the role of debt financing and our current knowledge about this source of funds for MFIs.

For the past three years, debt comprised over one-third of the total funding of MFIs, increasing by 7 billion USD during the same period. However, by 2010, the share of debt shrank and volumes remained constant as investors retreated from markets that experienced internal crises as well as those affected by the global financial crisis.

Figure 1: Funding Structure Evolution, 2007-2010

Source: MIX Market, 2007-2010. See data in Cross-Market Analysis.  

Figure 2 shows the funding structure of MFIs according to their region and charter type. In most regions debt represented at least one-third of the funding sources of MFIs. NBFIs and especially NGOs are reliant on debt as a source of funding since deposit mobilization for these institutional types tends to be more limited, with the exception of Africa.

Figure 2: Funding Structure of MFIs by Region, 2010

Source: MIX Market, 2010. EAP = East Asia and the Pacific, ECA= Eastern Europe and Central Asia, LAC = Latin America and the Caribbean, MENA = Middle East and North Africa, S.Asia = South Asia.

Table 1 shows the top 20 countries by the amount of their outstanding debt as of 2010 (in USD). MFIs operating in these markets reached 84 percent of all borrowers reporting to MIX Market in 2010. India and Bangladesh alone accounted for 59 percent of the global borrower base. While in some countries, like Bangladesh and Peru, much of this outreach as enabled by deposit mobilization, for MFIs operating in countries with low deposit volumes (such as India, Mexico, Morocco) debt financing played a key role in expanding access to credit for the poor.

Table 1: Top 20 Markets by Amount of outstanding debt

 Source: MIX Market, 2010.

The importance of debt financing for MFIs raises a number of questions about how MFIs fund their operations.  What types of actors lend money to MFIs?  What instruments are used to finance them? How prevalent is cross-border funding? In which countries can MFIs access local market debt and why?  How much do MFIs pay to borrow and what are the terms of their loans? How have funding flows, terms and costs changed now that investors have adjusted to higher risk in the aftermath of the global financial crisis and some leading markets’ internal crises (e.g. Bosnia and Herzegovina, India, and Morocco)?

To answer these questions, MIX began collecting data from individual MFIs on the lender, origin, pricing, maturity and outstanding amount of each of their non-deposit liabilities with external parties, in 2007. MFIs have been reporting these data for four years (2007-2010), which gives us a unique opportunity to gauge how investors have adjusted to the changing nature of the microfinance industry. The data collected comprises a representative sample from all MFIs that report financial indicators to MIX.

This data is publicly accessible via the Funding Structure Reports that can be found in the Profile & Reports section on MIX Market. The Funding Structure Reporting tools allow users to filter and group the data in a variety of combinations in order to answer questions about the funding landscape in a given region, for a type of lender or a microfinance institution or about the price and terms of debt. Furthermore, users can print, share and download the results of their queries.

What types of actors provide debt financing to retail microfinance institutions? 

In order to assess the funding situation in different markets, first we need to understand who the providers are. What are their primary objectives for lending (commercial, social, mixed, etc.), who are their constituents (taxpayers, institutional or individual investors, etc.), and are they cross-border or local providers of funds?  In 2010 alone, MFIs had debt outstanding from close to a thousand different individual counterparties.  These lenders ranged from small local NGOs to large international funds, from government programs to local banks. MIX classified each counterparty with the goal of understanding the major sources of debt financing for MFIs, and establishing a baseline for analyzing trends in future years.  The categories allow for analysis of integration into local financial markets, the role of specialized funds, and the support of government and development financing in funding MFI portfolios (see Table 2).

Table 2: MIX Funders Typology

Having a lens through which to analyze the hundreds of counterparties that lend to retail MFIs, we can now see which are the most active in the industry. Using the Funding Structure Reports, we see that in 2010 financial institutions provided the bulk of funding at 5.7 billion USD and comprised 38 percent of total debt financing, followed by DFIs and funds at 2.8 and 3.3 billion USD or 19 and 22 percent of the total, respectively. Government and other sources (including NGOs, foundations and individuals) funded MFIs with 1.7 billion USD and 1.2 billion USD. It is important, however, to take the regional context into consideration when analyzing the funding landscape of the microfinance industry. For example, 47 percent of funding provided by financial institutions was  concentrated in South Asia, driven primarily by the Indian market (Funding from financial institutions in India was 2.36 billion USD in 2010, where legislation prohibits foreign investment and requires Indian banks to invest in “priority sectors” for development, with microfinance serving as one such sector. In contrast, cross-border funding from DFIs and funds is concentrated primarily in ECA and LAC.