DFIs Continue to Crowd Out Commercial Funding for Microfinance

> Posted by Julie Shea
The microfinance rating agency MicroRate recently published “Role Reversal Revisited,” which charges that government-funded Development Finance Institutions (DFIs) continue to crowd-out private funding for microfinance.
The premise of “Role Reversal Revisited” is that DFIs should invest where private sources of funding don’t yet dare go because the risk is too high and the process too time-consuming; they should pave the way for private resources rather than competing with them. DFIs have historically been a major source of funding for global microfinance, but as the industry matures and proves itself as an investable asset, private lenders have displayed an increased willingness to channel funding into microfinance institutions (MFIs). The development community widely acknowledges that if microfinance is to continue to grow, there is no alternate to private funding, because public funding from DFIs is limited.  DFIs’ main task should be to create conditions that will attract private funding to MFIs, for example by seeding the next generation of MFIs and promoting microfinance infrastructure.
“Role Reversal Revisited” is a follow-up to the controversial “Role Reversal” (MicroRate, 2007), which uncovered a pronounced tendency for DFIs to lend to the most creditworthy MFIs, forcing private microfinance investment vehicles (MIVs) to invest in smaller and riskier institutions. These claims caused considerable controversy and a consequent pledge from DFIs to change their behavior. “Role Reversal Revisited” finds that DFIs have in fact done the opposite of what they promised – they’ve increased their share of foreign loan financing to the largest MFIs and become even more risk averse than they were in 2007. DFIs are not crowding out potential investment dollars; rather they are pushing aside actual investment dollars, as evidenced by high levels of over-liquidity among MIVs during this period. Two notable patterns of behavior emerged in the study – subsidized pricing is being used to compete with private funders (i.e. DFIs offer loans at below-market prices which private funds can’t match) and there continue to be signs of “trophy lending” (lending motivated by a desire to show a microfinance portfolio on the balance sheet rather than by borrower need for funding).
There is an explanation for DFIs’ reluctance to fund small and risky MFIs – most lack the staff, resources, and capability to actively seek out immature MFIs. However, even if crowding-out can be explained, it remains highly problematic. The authors of “Role Reversal Revisited” use the example of Compartamos, the largest MFI in Mexico, to raise the pointed question of whether DFIs are actually hindering the deepening of financial offerings to the poor. Despite being highly profitable and capable of accessing capital markets, in 2010, Compartamos received a US$64 million loan from two DFIs, translating into a 5 percent net increase in DFI share of liabilities from 2009. Compartamos has held a banking license since 2006, but has not raised funds from retail deposits, which leads to the question – does DFI funding not only crowd-out private funding but also provide a disincentive for raising deposits?
While “Role Reversal Revisited” found that publically funded DFIs continue to displace private capital, there was also evidence that they have responded to the 2007 publication with some positive changes. They have made local currency lending easier by developing mechanisms to cover foreign exchange risk and have promoted microfinance infrastructure by supporting local credit bureaus. Moreover, DFIs have been instrumental as “lenders of last resort”, meaning that they have been able to step in when necessary to stabilize unsettled microfinance funding markets – an important role in an unstable economy.
In addition to specific recommendations made to DFIs, “Role Reversal Revisited” offers two broad recommendations for the sector as a whole – to create an effective dialogue between private funds and DFIs and to encourage DFIs’ boards of directors to address this issue and ensure that their institutions begin to actively support private funding of MFIs, rather than crowding it out.
To read the press release from MicroRate, click here.
To read the study from MicroRate, click here.
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