Sources of Private Capital: Advantages and Disadvantages

Sources of Private Capital: Advantages and Disadvantages

Sources of borrowed capital for MFIs

savings mobilization from clients and others
concessionary loans from foundations, multilateral banks
international socially responsible investors (individuals and institutions)
lending from affiliated apex organizations
local commercial bank loans leveraged with outside guarantees
line of credit or loans based on the MFI's portfolio
limited partnerships or limited liability companies
open-ended mutual funds; closed-end funds; venture capitalists
debt instruments issued through national securities exchanges
issuing financial instruments like CDs to obtain debt internationally
issuing commercial paper backed by MFI portfolio

Advantages:

local savers may provide less costly funds; an important habit among clients and the public is rewarded
lower interest loans provide experience for MFI in borrowed funds
local banks become familiar with MSE (micro and small enterprise) potentials
access to larger sums more quickly based on track record
allows longer term projections than grants
provides a discipline similar to that of MSE clients
Disadvantages:

higher financial costs force organizational decisions and changes
substantial initial collateral requirements
more risky as debt holders can force closure of MFI
more tricky cash flow management as principal is repaid
early negotiations require a new set of skills and contacts
local banks may not be willing to be cooperative
loans may be dollarized in an inflationary situation
too many subsidized loans can retard move to market rate

Sources of equity investment for MFIs:

donations to the MFI used for equity equity from retained earnings
apex organizations or NGOs taking an ownership position
multilateral bank investments
open-ended and closed-end funds; private placement funds
venture capital funds or enterprise funds equity or quasi-equity investment funds
limited partnerships or limited liability companies
private institutional and individual investors for social and financial returns
private institutional and individual investors for only profit goals
equity-like subordinated debt

Advantages:

usually long-term patient capital that is not amortized
local and international capital invested at often lower returns
investors willing to take risks and be paid only if MFI profitable
can leverage more debt capital
ultimately can grow systematically based on owner's resources
Disadvantages:

must be not only sustainable but profitable cost of funds much closer to market rate
requires strong financial controls and management
social aims of MFI diluted or may be lost

Minimal External Economic Conditions before MFI Borrows Internationally:

inflation below 15 percent if borrowing hard currency
a reasonably predictable currency devaluation sufficient political % land stability for clients' businesses
higher interest rates in passive savings accounts than that paid to investor
easy to convert local to hard currency legally with minimal transaction losses. small difference between street K official rates
ease of bank accounts in local and external currencies
few restrictions in importing or exporting hard currency
a large client sector that is undeserved regulatory environment not hostile to MFIs

Minimal Internal Conditions of MFI before Borrowing Capital Internationally.

good, 3-year track record of lending donated funds proves methodology is efficient
realistic and regular rating of each outstanding loan, provisioning for loan loss, and writing off bad debt
real losses of usually less than 5 percent and an ability to sustain larger losses
changes in organizational culture to handle funds that must be repaid; includes experience with and commitment to seizing the client's collateral if necessary and a commitment to charge market rates
a system of informal or formal guarantees that permit sufficient pressure so clients pay
lending to diverse economic activities to minimize risk
good management information system with reliable numbers for management
tracking late payments and real losses; deploying staff to maximize the return on resources
having reached operational self-sufficiency with a reasonable projection of when financial self-sufficiency will be reached, Otherwise, the loan may finance operating costs with no way to repay investors
moving from just covering costs to generating a surplus (profit)
commitment to staff training and paying market rate salaries and incentives
Staff clear on the MFI's core values and vision
sufficiently attractive guarantee to offer to external investors
equity of at least 15 percent of total portfolio anticipated
adequate cash reserves to insure the liquidity necessary to pay investors on time
clear definition of the MFI's lending market and good statistics
a strong commitment to expansion in order to attract investors
a detailed understanding of its competition in financial markets where operating or expanding
access by clients to training and business development services
mechanisms for mobilization of savings and other local resources
accountability to the board, donors, clients and investors
sufficient knowledge of socioeconomic impact on the clients
regular external audits and internal controls to prevent fraud and put idle cash into interest bearing accounts
link with other MFIs through an association or international organization, providing training and professional standards for MFI.

Source:
Garber, Carter (1997) Private Investmnet as a Financing Source for Microcredit. The North-South Center, University of Miami.

Hari Srinivas - hsrinivas@gdrc.org
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Sources of borrowed capital for MFIs
savings mobilization from clients and others concessionary loans from foundations, multilateral banks international socially responsible investors (individuals and institutions) lending from affiliated apex organizations local commercial bank loans leveraged with outside guarantees line of credit or loans based on the MFI's portfolio limited partnerships or limited liability companies open-ended mutual funds; closed-end funds; venture capitalists debt instruments issued through national securities exchanges issuing financial instruments like CDs to obtain debt internationally issuing commercial paper backed by MFI portfolio
Advantages: local savers may provide less costly funds; an important habit among clients and the public is rewarded lower interest loans provide experience for MFI in borrowed funds local banks become familiar with MSE (micro and small enterprise) potentials access to larger sums more quickly based on track record allows longer term projections than grants provides a discipline similar to that of MSE clients	Disadvantages: higher financial costs force organizational decisions and changes substantial initial collateral requirements more risky as debt holders can force closure of MFI more tricky cash flow management as principal is repaid early negotiations require a new set of skills and contacts local banks may not be willing to be cooperative loans may be dollarized in an inflationary situation too many subsidized loans can retard move to market rate
Sources of equity investment for MFIs:
donations to the MFI used for equity equity from retained earnings apex organizations or NGOs taking an ownership position multilateral bank investments open-ended and closed-end funds; private placement funds venture capital funds or enterprise funds equity or quasi-equity investment funds limited partnerships or limited liability companies private institutional and individual investors for social and financial returns private institutional and individual investors for only profit goals equity-like subordinated debt
Advantages: usually long-term patient capital that is not amortized local and international capital invested at often lower returns investors willing to take risks and be paid only if MFI profitable can leverage more debt capital ultimately can grow systematically based on owner's resources	Disadvantages: must be not only sustainable but profitable cost of funds much closer to market rate requires strong financial controls and management social aims of MFI diluted or may be lost
Minimal External Economic Conditions before MFI Borrows Internationally:
inflation below 15 percent if borrowing hard currency a reasonably predictable currency devaluation sufficient political % land stability for clients' businesses higher interest rates in passive savings accounts than that paid to investor easy to convert local to hard currency legally with minimal transaction losses. small difference between street K official rates ease of bank accounts in local and external currencies few restrictions in importing or exporting hard currency a large client sector that is undeserved regulatory environment not hostile to MFIs
Minimal Internal Conditions of MFI before Borrowing Capital Internationally.
good, 3-year track record of lending donated funds proves methodology is efficient realistic and regular rating of each outstanding loan, provisioning for loan loss, and writing off bad debt real losses of usually less than 5 percent and an ability to sustain larger losses changes in organizational culture to handle funds that must be repaid; includes experience with and commitment to seizing the client's collateral if necessary and a commitment to charge market rates a system of informal or formal guarantees that permit sufficient pressure so clients pay lending to diverse economic activities to minimize risk good management information system with reliable numbers for management tracking late payments and real losses; deploying staff to maximize the return on resources having reached operational self-sufficiency with a reasonable projection of when financial self-sufficiency will be reached, Otherwise, the loan may finance operating costs with no way to repay investors moving from just covering costs to generating a surplus (profit) commitment to staff training and paying market rate salaries and incentives Staff clear on the MFI's core values and vision sufficiently attractive guarantee to offer to external investors equity of at least 15 percent of total portfolio anticipated adequate cash reserves to insure the liquidity necessary to pay investors on time clear definition of the MFI's lending market and good statistics a strong commitment to expansion in order to attract investors a detailed understanding of its competition in financial markets where operating or expanding access by clients to training and business development services mechanisms for mobilization of savings and other local resources accountability to the board, donors, clients and investors sufficient knowledge of socioeconomic impact on the clients regular external audits and internal controls to prevent fraud and put idle cash into interest bearing accounts link with other MFIs through an association or international organization, providing training and professional standards for MFI.