2.V enture Capital A venture capital is defined as a capital invested in a project in which there is a substantial element of risk, typically a new or expanding business. In other words, a venture capital is financing that investors provide to start-up companies and small businesses that are believed to have long-term growth potential. Venture capital generally comes from well-off investors, investment banks and any other financial institutions that pool similar partnerships or investments. Do you remember our lesson on development banks and wholesale banks? 3. G rants and Donations The minority of the microfinance institutions get their funding from grants and donations. These donations come from foundations, NGOs, charities and some social enterprise organizations that will like to contribute to the development of micro financing in some specific areas. Some private organizations/companies also do it through what is called Corporate Social Responsibilities (CSR). These grants and donations are called Donated Equity in the books of the recipient MFIs. Others will also treat is as capital grants – grants towards the purchase of fixed assets or specific projects. In this wise, the grants are amortized over the period of the grant. 4. B ank Loan Borrowing to augment the capital of the business is the normal thing in banking and financial services industry. Banks lend among themselves and lend to other institutions in their brackets other than outsiders. With this, MFIs do borrow from the banks to expand their loan portfolios and also meet critical fixed assets and operational needs. But the majority of these MFIs only borrow to fund their loan portfolios. This is done after they have exhausted their shareholders’ capital or need a bridging finance. A bridging finance is used when expected fund is delayed and a quick fund is needed to cover the gap between the shortfall now and the time of receiving the expected fund. 5. C rowd Funding Crowd funding is the practice of funding a project or venture by raising monetary contributions from a large number of people. Normally this is internet based appeals or proposals for many people to contribute towards a particular cause, for example, raising money to help flood victims or to provide social funding to a poor community. Funding of this sort could come in the form of donations or 98 CU IDOL SELF LEARNING MATERIAL (SLM)
equity. Now, there are a number of websites promoting these kinds of funding for businesses and individuals alike. But these strategies of funding call for marketing and selling of the ideas to the wider public. 6. P rivate Equity Investment A private equity is a type of equity and one of the asset classes consisting of equity securities and debt in operating companies that are not publicly traded on a stock exchange. A private equity investment will generally be made by a private equity firm, a venture capital firm or an angel investor. Referring to the points above on Shareholders equity and venture capital, the private equity is from private investment firms that have made an equity towards the business. An angel investor (also known as a business angel, informal investor, angel funder, private investor, or seed investor) is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. While venture capital is a subset of private equity, there are differences between the two. The most notable difference is that venture capital funds raise capital from investors to specifically invest in start-ups and small- and medium-size private companies with strong growth potential. Private equity is generally interested in continuing businesses, not start-ups! 7. P eer to Peer (P2P) Lending Peer-to-peer lending, sometimes abbreviated P2P lending, is the practice of lending money to individuals or businesses through online services that match lenders with borrowers. Since peer-to- peer lending companies offering these services generally operate online, they can run with lower overhead and provide the service more cheaply than traditional financial institutions (Wikipedia). This also looks like the crowd funding strategy. But there is a great difference. P2P is organized in such a way that, lenders and borrowers are put on a platform. Lenders give out their loans under specific conditions and the borrowers can choose to accept the terms or contact another lender. Alternatively, the platform has a set of agreed interest rates, repayment periods and other conditions. In the crowd funding, however, the platform is generally for numerous individuals who could even contribute as little as US$1 towards a cause, and it is not for loan purposes. There is, however, an equity element introduced recently by some of the crowdfunding platforms SUMMARY •W hile some people will tell you that money grows on trees, financial experts will say money 99 CU IDOL SELF LEARNING MATERIAL (SLM)
grows after a careful planning. Before the MFIs go into business, a careful planning is needed. A business plan worth the salt is needed and that must be updated from time to time in order to determine where the institution comes from, where it is now, where it is going and how to get there! •I n order to improve the quality of microfinance services some technical innovations may be introduced. A number of electronic devices are being used in different countries to expand the outreach and to improve the microfinance functioning. •S ome of these devices are mobile phones, ATMs, processor cards, computers etc. Mobile phone provides the rural poor borrowers with the communication facility. ATMs are helpful to facilitate saving, payment and loan transactions in the remote rural areas where it is difficult to open bank branches. Processor cards are used to keep the record of group activities such as savings, loans and other financial transactions. It helps to reduce paper work and saves time for the bank officials. A computer with an operator helps the illiterate group members to maintain the records of group financial activities. •T hese computers can also be used to provide important information related to weather conditions, crop inputs, product prices, land records etc. in the villages. Though some of such projects have been started by NABARD on pilot basis, but there is enough scope to use such innovative techniques in microfinance sector in India. •I n India, the penetration of insurance services among rural poor people is very limited and there is a great potential for the same. Moreover, poor are very much vulnerable to the natural uncertainties and insurance is necessary for them. The network used for microfinance programme can be used to tap the potential of insurance in rural markets. Non-Government Organizations, Microfinance Institutions and Self-Help Groups can be used as micro- insurance agents. They can offer target specific insurance products at a relatively lower cost, for a lower coverage of amount. It may be envisaged that micro-insurance would facilitate penetration of insurance to rural and remote areas. •H owever, some of the NGOs are providing accident, life and crop insurances in India but such type of services needs to be expanded. •C urrently, various entities such as co-operative societies, mutual benefit societies or mutually aided societies etc. are engaged in the activity of microfinance. They are guided by different 100 CU IDOL SELF LEARNING MATERIAL (SLM)
laws under which they are registered. Lack of a single regulatory authority restricts the orderly growth of microfinance sector. Keeping in view all the regulatory problems, the Government of India has proposed legislation and formulated a bill for the development and regulation of microfinance sector. This bill is under consideration of the Parliament. This bill will provide all the regulatory powers to NABARD; and all the MFIs will come under a single formal statutory framework. In case of any offence by microfinance organizations, the redressal mechanism and settlement of disputes have also been discussed in this bill. The legislation, however, is yet to be enacted. KEYWORDS • Bad Debt: - A debt that is not collectible and is therefore worthless to the creditor. • Balance Sheet: - Financial statement presenting measures of the assets, liabilities andowner's equity or net worth of business firm or non-profit organization as of a specific moment in time. • Bank: - A licensed financial intermediary regulated by a state banking supervisory agency. It may provide any of a number of financial services, including: deposit taking, lending, payment services, and money transfers. • Bankable: - Bankable people are those deemed eligible to obtain financial services that can lead to income generation, repayment of loans, savings, and the building of assets. LEARNING ACTIVITY 1. Explain the challenge Over-Indebtedness 2. Note on funding in MFI UNIT END QUESTIONS Explain Discuss A. Descriptive Questions State 1. the challenges faced by Microfinance Institutions 101 2. capital sources for MFI 3. meanings of venture capital CU IDOL SELF LEARNING MATERIAL (SLM)
4. Illustrate P2P Lending with relevant examples Describe 5. crowd funding B. Multiple Choice Questions (MCQs) 1. as a capital invested in a project in which there is a substantial element of risk, typically a new or expanding business a. VC b. Sharehold ers` Equity c. Crowd funding d. P2P Lending 2. The minority of the microfinance institutions get their funding from a. VC b. Sharehold ers` Equity c. Grants & donations d. P2P Lending 3. A Bridging finance is used when expected fund is delayed and a quick fund is needed to cover the gap between the shortfall now and the time of receiving the expected fund a. True b. False 4. is the practice of funding a project or venture by raising monetary contributions from a large number of people a. VC 102 CU IDOL SELF LEARNING MATERIAL (SLM)
b. Sharehold ers` Equity Crowd P2P c. funding d. Lending 5. P2P is organized lending True a. False b. d 2. Answers: 4. c 5. a 1. c 3.a SUGGESTED READINGS • Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications. • Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc. • Hirschland, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc. • Sapovadia, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India. • Ledgerwood, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006. • Rutherford, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 103 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT -8 CAPITAL MARKETS Le arn Structure ing Ob CU IDOL SELF LEARNING MATERIAL (SLM) jec tiv es Int rod uct ion Ro le of cap ital ma rke ts in mi cro fin anc e Hu rdl es tha t M FIs fac e in acc ess ing the cap ital 104
ma rke ts Str ate gie s for ov erc om ing tho se bar rier s Tra nsf or ma tio n of M FI int o the cap ital ma rke t Op por tun itie s an d ris ks inv olv ed in fun din 105 CU IDOL SELF LEARNING MATERIAL (SLM)
g thr ou gh the cap ital ma rke ts Su m ma ry Ke yw ord s Le arn ing Ac tivi ty Unit End Questions Suggested Readings LEARNING OBJECTIVES After studying this unit, you will be able to: • Describe the relationship between capital markets & MFIs • State the role of capital markets in MFI • Explain the strategies involved in overcoming the barriers of capital markets INTRODUCTION In what ways is microfinance linked with capital markets in the world today? Reddy and Rhyne (2006) have identified three main ways – through the use of local microfinance bonds, the use of international microfinance bonds, and through the use of equity funds. ACCION Investments is an example of the use of equity funds in microfinance. Blue Orchard issued a collateralized debt obligation (CDO) in the amount of $108 million in 2007 (Reuters, 2007). This CDO combined the loans made to more than twenty MFIs who had in turn issued loans to more than 70,000 people. All the MFIs were in thirteen different emerging markets and the result was excess demand by investors for the CDO. This result indicated that investors are 106 CU IDOL SELF LEARNING MATERIAL (SLM)
ready and willing to subscribe to microfinance backed bonds, as they consider the returns and investment grades of these bonds to be above those of other instruments based on emerging market assets. 107 CU IDOL SELF LEARNING MATERIAL (SLM)
Mexico’s Banco Compartamos (the largest MFI in Mexico) had a very large IPO organized by Credit Suisse (Davis and Dubitsky, 2008). Earlier in 2002, the same MFI had issued $68 million microfinance bond (Krauss and Walter, 2009). Richard Rosenberg of CGAP (2007) discusses how the Banco Compartamos 2007 IPO was hugely oversubscribed and in fact excess demand caused the share price to rise more than 20% on the initial trading day. In 2006, RSA Capital and Citi Group (among others) securitized Bangladesh’s BRAC Bank’s microcredit loans with an AAA rating (Citigroup, 2006). This allowed BRAC to expand its loan offerings significantly. ROLE OF CAPITAL MARKETS IN MICROFINANCE When properly conducted, microfinance is a profitable, low risk and expanding financial activity. For example, the 26 widely dispersed microfinance institutions (MFIs) in Microfinance Securities XXEB, a $60 million collateralized debt obligation sponsored by Developing World Markets in 2006, have an average return on equity of more than 20%, a portfolio at risk (payment delays beyond 30 days) of only 2.5%, and are growing their loan portfolios by more than 30% per annum. Already, the number of borrowers served by MFIs is estimated at 100 million. With an average loan size of $170, the total market size is estimated at $17 billion. Yet the potential demand is 15 times the current market -- estimated at 1.5 billion, or half the 3 billion global working poor. Thus microfinance represents a total commercial market of more than $250 billion. (Market size data in this paragraph and the next two comes from “Optimizing Capital Supply in Support of Microfinance Industry Growth”, a presentation by McKinsey & Company to the Microfinance Investor Roundtable in Washington DC on 24 October 2006). Currently more than ¾ of the $17 billion funding total is raised from domestic markets. However, this number is skewed by the amount – almost $6 billion – coming from deposits in the few countries where MFIs are allowed to take deposits. Most of the estimated 10,000 existing MFIs are not deposit- taking institutions, and are unlikely to become so, given the cost and complexity of complying with regulations typically applied to institutions taking deposits from the public. Future funding for MFIs is thus unlikely to be sourced mainly from deposits. Domestic emerging country commercial banks, which should be major funding sources for MFIs, are typically averse to lending to them (see “Local Currency”). Moreover, capital markets in most developing countries are thin and the major institutional players are averse to or legally constrained from significant investment in microfinance. For these reasons, it is unlikely that domestic sources in emerging countries will generate more than a fraction of the more than $200 billion that will need to be raised to satisfy potential demand. Moreover, while non-commercial investors account for 80% of the $4 billion in funding now coming from international sources, this is a legacy of the origin of microfinance in charitable and officially sponsored development activity. As MFIs’ appetite for capital grows exponentially, it is unlikely that 108 CU IDOL SELF LEARNING MATERIAL (SLM)
government agencies and non-profit organizations will increase their flow of funding proportionately: first, they will be faced with competing demands for assistance; and, second, they will begin to question whether their mission is best served by funding financial enterprises that are profitable and are increasingly transforming into privately owned companies able to attract commercial investment. (However, this realization may not have begun to sink in yet -- see discussion of “role reversal” below in “The Contribution of Non-Commercial Investors”.) The only available source of funding for commercial lending of this magnitude is the international capital markets. Already, microfinance investment vehicles, which typically include private sector institutional investors, are growing their investment portfolios at 233% per year, more than twice the rate of growth of microfinance investment from official development agencies (according to a survey by a consortium of development agencies called Consultative Group to Assist the Poor—CGAP). For the international capital markets, funding a $200 billion industry is routine. HURDLES THAT MFIS FACE IN ACCESSING THE CAPITAL MARKETS Mainstream investors & commercial banks are used to deal with regulated entities organized as profit-maximizing firms that operate in a well-defined legal environment. In order to facilitate MFI‘s role as a middleman and facilitate their contact with mainstream financial institutions, they need to increase their scope of regulation. Macro policy and government regulation need to be modified to accommodate commercial micro lending. Stable currencies & predictable inflation rates are required for feasible microfinance. There are still several countries which have interest rate caps & other regulatory hurdles in place In order to tap international markets, the MFI‘s/investors should be able to hedge the foreign exchange risk when they lend/borrow in foreign currency. Unfortunately in countries which require maximum amount of microfinance, there are no effective means for reducing this risk STRATEGIES FOR OVERCOMING THOSE BARRIERS Although the microfinance sector is plagued by a number of problems but there is a way out for the problems faced by this sector. Improvements are required from the side of government, Microfinance institutions and individual clients. Some of the suggestions are: 1. T he concept of Micro Finance is still new in India. Not many people are aware the Micro Finance Industry. So apart from Government programmers, we the people should stand and create the awareness about the Micro Finance. 109 CU IDOL SELF LEARNING MATERIAL (SLM)
2. M icrofinance programmes and group formation should be handled by trained personnel in a professional manner. 3. L eading banks and industry developments must be taken into consideration for district-wise and block-wise economic opportunities and resource mapping. 4. T here are many people who are still below the poverty line, so there is a huge demand for MFIs in India with proper rules and regulations. 5. T here is huge demand and supply gap, in money demand by the poor and supply by the MFIs. So there need to be an activate participation by the Pvt. Sector in this Industry. 6. O ne strict recommendation is that there should not over involvement of the Government in MFIs, because it will stymie the growth and prevent the others MFIs to enter. TRANSFORMATION OF MFI INTO THE CAPITAL MARKET Across the world microfinance has emerged as a tool of financial inclusion at bottom of the societal pyramid which is evidenced through a plethora of studies published during last two decades. Among them few studies on transformation and sustainability of microfinance institutions (MFIs) have also surfaced (Ledgerwood and White, 2006; Particularly in the context of India, except an earlier study where the drivers of transformation were discussed (Sriram and Upadhyayula, 2004) a comprehensive study on the linkage of various facets of transformation with sustainability indicators is yet to emerge. Since the Indian microfinance industry has undergone several transformations during the last decade a fresh look into these issues is warranted. Starting from legal status changes to leverage moderation Indian MFIs have been experiencing varied challenges from different quarters. As corollary of these changes issues of sustainability have surfaced during the last decade by putting renewed emphasis on double bottom line. As defined by CGAP sustainability in MFIs is the ability of a provider of micro finance to continue and expand its operations without need of further subsidies. It involves two elements: Operating revenue (excluding subsidies) is sufficient to cover all financial and administrative costs loan delinquency or default does not exceed the levels industry experience has shown to be necessary to avoid eventual collapse of repayment discipline among clients (CGAP, 2006). This definition encompasses the dimensions of financial sustainability. It is to mean full cost 110 CU IDOL SELF LEARNING MATERIAL (SLM)
recovery or profit making, and is associated with the aim of building MFIs that can last into the future without continued reliance on government subsidies or donor funds (Conning, 1999). The other aspect of sustainability, i.e., social is rather popularly captured in outreach – breadth (wider clientele) and depth (reaching to the poorest with small loan). The long term ability of the institutions to carry out their operations and remain financially profitable is sustainability. Operational self-sufficiency ratio (OSS) and financial self-sufficiency ratio (FSS) are commonly used for computation of sustainability (SEEP, 1995). These ratios indicate on the ability of MFI to cover its financial expenses, operational expenses and loan loss provision through the operating revenue. Since, FSS is more rigid by definition OSS is predominantly used. Along with OSS, return of assets (ROA) which is an indicator of profitability is also used to ascertain overall financial soundness of the institution. Social sustainability which was the initial idea of microfinancing mostly emphasizes on the ability of the institution to continuously focus on the poor section of the society with small loan size. Any departure from these criteria is considered as drift from its enshrined mission (Mersland and Strøm, 2010; Kar, 2013). Number of active borrowers (NAB) for breadth and average size of the loan (ALS) for depth are the common measures. Although financial sustainability remains as the corner stone of micro financing it is only the means to achieve outreach. It is not the end in itself (Rhyne, 1998). With the transformation of micro finance sector in India, over the years the inclination of MFIs towards financial sustainability is a cause of concern. The venturing of MFIs into capital market with the direct access to IPO market, which started with the issue of equity shares to the public by one of the most successful MFIs in India, i.e., SKS in the year 2010 followed by few more in recent years is a hint of commercialization and thus posing a serious question on their intention to address the financial needs of poor. These above aspects motivated us to look into the various facets of transformation in the context of India and to establish their possible relationships, if any, with sustainability indicators, where we have found some significant results. OPPORTUNITIES AND RISKS INVOLVED IN FUNDING THROUGH THE CAPITAL MARKETS In the most developed areas the global trend of microfinance development is starting to resemble formal financial institutions, mainly through the quality of services they provide. At the same time, there are also a number of changes that may lead not only to new opportunities but threats, as well. The most remarkable change in all regions is the effort of transforming NGOs into profitable institutions. The main goal is to make the private and institutional investors more interested in these institutions. Reaching this goal is extremely important as the subsidy policy of governmental authorities is not sustainable in the long haul and the further development requires private capital. It 111 CU IDOL SELF LEARNING MATERIAL (SLM)
is generally true that the long-term subsidy policy supporting MFIs leads to „aid fatigue “and results in their inefficiency. The benefits of having creditors or investors as supporters of these institutions lies in them putting a great emphasis on financial efficiency in the form of cost reductions, and an additional emphasis on risk reduction and profit maximization. On the other hand, economists fear that a bigger emphasis on financial efficiency would prevent from helping the most needy, low- income people. Financial institutions may prefer creditworthy, less risky clients, who will most certainly repay their debt. Another attribute is the substantial expansion of the product portfolio. The original scope of services provided by MFIs was limited to low-volume loans granted to certain business purposes, generally in agriculture. The subsidy policy of governments influenced the choice of this industry to a great extent, because they wanted to have their budget spending under control. In some regions, respectively states (particularly in Latin America and Southeast Asia) it was allowed to receive extra depository services. Over time, thanks to the competitive environment and the increasing demands of clients a new type of loan was created. Nowadays mostly corporate loans, consumer credits, loans for households or start-ups are offered. In the meantime, instead of group lending rather personalized types of loans started to be promoted16, meeting the specific needs of lenders. Clients begin to appreciate an individual approach connected with a higher quality of financial services. Therefore, a lot of institutions offer, for example, life or non-life insurance, credit and debit cards or M-Banking17 as complementary products. Although it is expected that these services will continuously play an important role, several countries mainly in North Africa, where the local MFIs are not trustworthy, prevent them to be offered. Additionally, costs are equally important. As we have already mentioned before, such a cost-effective model is gaining prominence these days which aims to reduce the operating costs associated with credit processing and credit portfolio management. Haqq M., Skully T. M. and Pathan S. (2009) found that MFIs have higher level of efficiency on the resource rather than production side. To reduce operating costs connected with the sales of financial services is rather demanding due to the high variable costs of labor18. Numerous processes still need manual activities to be able to operate. Often the needed know-how to manage cost reduction is missing. From this perspective, the introduction of technological innovations play a major role as they help in streamlining some of the processes, thus reducing the variable costs. Hassan, K. M. and Sanchez, B. (2009) analyzed the technological maturity in some regions and they found out that South Asia had the best results, outperforming Latin America and the countries in the MENA regions. Simultaneously, they discovered that from a technological perspective formal financial institutions are more developed than the informal ones, mainly due to their bigger sources of capital. The future development of microfinance will largely depend on the speed of implementation of innovative elements into the already existing processes. Microfinance is becoming an effective tool to improve the living standards of low-income people in 112 CU IDOL SELF LEARNING MATERIAL (SLM)
developing countries. Loans for education or business development begin to be financially more effective, therefore the formal financial institutions and investors start to take a deeper interest in them. This results in a growing number of new MFIs and an increased competition. The impact study of McIntosh and Wydick (2005) shows that the increasing competition on the microfinance market is favorable for the lender as it leads to lower interest rates and a bigger availability of credit. Other advantages may include improved financial services or the expansion of the existing product portfolio. On the other hand, lenders tend to indebt themselves and often they have loans at several MFIs at the same time. In response to this problem, there is a global effort from the side of MFIs to create credit bureaus, thus minimizing the potential asymmetrical information related to the insolvency of debtors. Furthermore, Assefa E., Hermes N., Meesters A. (2012) offer some interesting findings. They claim that intense competition has a negative effect on the overall performance of the MFIs. Besides, a rising number of new institutions on this market do not lead to a larger outreach of MFIs, but controversially to their decline. Due to the escalating competition, plummeting profits and increasing number of debtors going bankrupt, MFIs give priority to strengthening their positions on the already existing market rather than focusing on exploiting new opportunities. Another research on the effects of MFIs on the competitive environment was carried out by Hermes N., Lensink R. and Meesters A. (2008). They have reached the conclusion that the social effectiveness of these institutions is highly affected through the growing competition. Consequently, the management prefers to adhere to the financial indicators rather than to fulfill the main goals of microfinance in order to maintain their position on the market. Hence, we can observe a change in the behavior of the debtors. They could reduce their screening efforts and start to leave their lending rules when they are confronted with severe competition. Such a behavior can be justified assuming there is a stable economic growth and MFIs have sufficient amount of capital reserves. However, the vast majority of developing countries face long- term economic and social problems, which are even more severe due to the financial crisis and may indicate possible future hazards. Through their benevolent credit policy, MFIs may deteriorate the quality of their loan portfolio, which might lead to high losses and credit write offs in the future. Opportunities • Opportunity for exchanges to set up operations and offer services for a wide range of securities such as equities, commodities, equity derivatives, debt, currency & index-based derivatives, etc. • P rovide a platform for Indian companies to raise foreign currency capital •P 113 CU IDOL SELF LEARNING MATERIAL (SLM)
rovide a platform for foreign companies to raise foreign currency capital •P rovide a wide range of securities to Indian investors looking to invest in the exchanges that set up in the IFSC •P rovide a wide range of securities to foreign investors looking to invest in the exchanges that get set up in the IFSC •T he provision of Securities Contracts (Regulation) (Stock Exchanges) Regulations, 2012 that every recognized stock exchange shall credit 25% of its profits every year to the Fund, of the recognized clearing corporation(s) shall not be applicable to the stock exchanges operating in IFSC •A ll the transitory provisions or relaxations that were provided to the stock exchanges to comply with Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2012 shall not be applicable to stock exchanges operating in IFSC •C hapter V of Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations 2012 shall not apply to stock exchanges in IFSC • P rovide opportunity for corporates to raise capital including Indian corporates • A ttract investors from around the globe and also Indian investors (as per LRS) Risks M Any investment in stocks or bonds comes with the following types of risks: • R 114 arket Risk •I ndustry Risk • egulatory Risk CU IDOL SELF LEARNING MATERIAL (SLM)
• B usiness Risk 1. T he market risk defines the overall risk involved in the capital market investments. The stock market rises and falls depending on a number of issues. The collective view of the investors to invest in a particular stock or bond plays a significant role in the stock market rise and fall. Even if the company is going through a bad phase, the stock price may go up due to a rising stock market. While conversely, the stock price may fall because the market is not steady even if the investor’s company is doing well. Hence, these are the market risks that the stocks investors generally face. 2. T he industry risk affects all the companies of a certain industry. Hence the stocks within an industry fall under the industry risk. The regulatory risk may affect the investors if the investor’s company comes under the obligation of government implemented new regulations and laws. The business risk may affect the investors if the company goes through some convulsion depending on management, strategies, market share and labor force. SUMMARY The rush of capital markets investment in microfinance is unprecedented and it is wise to question its sustainability. Certainly, risks to continued growth abound, and we have noted a number of them, including: • eventual exhaustion of investment opportunities at the well-known and accessible tip of the MFI pyramid • structural obstacles to providing investors with direct exposure to microloans via securitization • scarce track record of equity exits • lack of clarity regarding the role of non-commercial investors underdeveloped local capital markets, coupled with insufficient hedging tools for foreign currency investment • illiquidity, sparse data and small volumes slowing the journey toward achievement of “asset class” status • “mission creep” eroding MFIs’ distinctive risks and returns, and lessening their value in reducing portfolio volatility •M any of these risks reflect the fact that microfinance has only recently been introduced to capital markets. They should ease over time as investors accumulate exposure to this asset, even if the currently torrid growth rate slows. By extrapolating current trends, we can foresee that financial 115 CU IDOL SELF LEARNING MATERIAL (SLM)
products will become more numerous, more standardized, and more fitted to capital markets norms. At the same time, secondary markets will come into existence, and ratings agencies and researchers (both commercial and academic) will focus more attention on the sector. Specialized hedging tools will ease the distortions of too much lending in foreign currency. These developments should abet liquidity and help to give investors comfort that microfinance is suitable for regular allocations of portfolio investment. In effect, investor demand for assets itself will become an important and self-fulfilling driver of progress in microfinance. •M oreover, as MFI owners and managers grow accustomed to an environment in which a deep pool of commercial funding is available for the well-run, expanding MFI, we can expect strategic transactions – mergers, acquisitions, buy-outs, roll-outs, listings, etc. – to become integral elements in the lifecycle of successful MFIs. This will result overall in stronger, more efficient and more skilled institutions better serving clients’ needs. •O f course, too rapid growth could also lead to speculation, overheating, and a crash, as we have seen many times before in financial markets, from junk bonds to high tech. And certainly some MFIs will expand too quickly and lose control of their costs and their loan books, or cut rates too aggressively for competitive reasons, or push too much money into the hands of their clients too soon. Microfinance is no more immune to excess than any other business activity. But the inherent robustness of the microfinance business model lays down a strong foundation for solid growth, and the sizable potential market ensures absorption capacity for substantial fresh financing. •O verall, the distinctive focus of microfinance on “banking the unbankable” – bringing financial services to customers outside the formal financial system – gives it a unique and attractive profile of risk and reward that can draw institutional investors seeking diversification and absolute return -- even those who are unmoved by the prospect of promoting social values. •O ver the last decade, the growing importance of microfinance has undergone substantial changes, which bring a lot of opportunities but also threats along. The overall development of the microfinance industry is making continuous effort to provide the low-income citizens with high- quality financial services that are comparable to formal institutions. The historical problem of the lack of stable sources for funding MFIs or the problem of liquidity risk has been replaced by the concern about strong competition between MFIs and conventional banks. Some studies already indicate a potential threat due to the lack of credit policy, which in case of non-compliance with strict rules creates the problem of indebtedness and the deterioration of loan portfolio quality. The fierce competition and the pressure from the side of private and institutional investors largely 116 CU IDOL SELF LEARNING MATERIAL (SLM)
affect the social objectives, upon which microfinance was established (mission drift). In this regard, the next evolution of microfinance will be thus considerably affected by the regulation strategy of governmental authorities. •A lthough the microfinance industry has been severely shocked by the financial crisis, when many regions recorded high percentage of write off loans from credit portfolio, some signs of recovery are already present. From the available sources we have found that the more developed regions of LAC, EAP and ECA show gradual growth of indicators ROE and ROA from 2010. An improvement also emerges on the side of funding. The current growth in the share of deposits and borrowings is complemented by alternative ways of funding through the issue of bonds and shares. Even though this source is preferred especially in Latin America, we predict that it will affect the performance and outreach of MFIs in other regions, as well. •T his method of funding offers certain advantages/benefits in terms of costs, risk reduction or the entrance of a strategic investor, which are otherwise inaccessible. KEYWORDS • Capital Adequacy: - A quantitative and qualitative measure of an institution's level ofequity versus the risk it incurs. This measurement shows a program's ability to absorb loan loss. • Capital markets: - The market for trading long-term debt instruments (those that mature in more than one year). • Capital Markets: - Those financial markets, including institutions and individuals, that exchange securities, especially long-term debt instruments. • Capital: - Broadly, all the money and other property of a corporation or other enterprise used in transacting its business. • Capitalization: - Long-term debt, preferred stock and net worth. The loan capital of a community development loan fund; includes that which has been borrowed from and is repayable to third parties as well as that which is earned or owned by the loan fund (i.e. \"permanent capital\"). LEARNING ACTIVITY 1. Write note on capital markets in MFI 2. Explain the hurdles that MFIs face in accessing the capital markets 117 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT END QUESTIONS State the Describe A. Descriptive Questions Discuss 1. Explain role of capital markets in microfinance. What is 2. the strategies for overcoming MF barriers Who 3. SEBI the opportunities & risk involved in funding through the capital markets. RBI 4. IRDA the hurdles that MFIs face in accessing the capital markets. NABAR 5. the transformation of MFI into the capital market? B. Multiple Choice Questions (MCQs) 1. controls the capital market in India? a. b. c. d. D 2. Which of the following is component of capital market? a. Equity Market b. Debt Market c. Derivative market d. All of these 3. In capital markets, which of the following are the major suppliers of trading instruments? 118 a. Liquid corporations b. Instrumental corporations c. Manufacturing corporations CU IDOL SELF LEARNING MATERIAL (SLM)
d. Government and corporations 4. Money market where debt and stocks are traded and maturity period is more than a year is classified as which of the following? a. Short term market b. Capital Market c. Counter markets d. Long term markets 5. What is an Indian depositoryreceipt? a. A deposit account with a public sector bank. b. It is a depository account with any of the depositories in India. c. An instrument in the form of depository receipt created by an Indian depository against underlying equity shares of the issuing company. d. It is an instrument in the form of deposit receipt issued by Indian depositories. Answers 1. a 2. b 3. b 4. b 5. a SUGGESTED READINGS • Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications. • Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc. • Hirschlan d, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc. • Sapovadi a, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India. 119 CU IDOL SELF LEARNING MATERIAL (SLM)
• Ledgerwo od, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006. • Rutherfor d, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 120 CU IDOL SELF LEARNING MATERIAL (SLM)
• Le arn UNIT -9 DEBT CAPITAL MARKETS FINANCING ing Ob Structure jec tiv CU IDOL SELF LEARNING MATERIAL (SLM) es Int rod uct ion M FI mi cro loa ns an d cre dit s be fin anc ed in the de bt cap ital ma rke ts Re qui re me nts of 121
the de bt cap ital ma rke ts for M FI pro du cts Ro le of rati ng age nci es M- CR IL` s Fin anc ial Rat ing M- CR IL` s So cia l Rat ing Su m ma ry Ke yw ord 122 CU IDOL SELF LEARNING MATERIAL (SLM)
s Le arn ing Ac tivi ty Un it En d Qu esti ons Su gg est ed Re adi ngs LEARNING OBJECTIVES After studying this unit, you will be able to: • Describe the relationship between debt capital markets & MFIs • Explain the Requirements of the debt capital markets for MFI products • State the role of rating agencies INTRODUCTION In the past three years, international capital markets have awoken to the attractiveness of investing in microfinance. Approximately $500 million has been raised in one-off transactions –collateralized debt obligations, private placements and direct securitizations of microloans. In addition, private sector debt and equity microfinance funds have sprung up -- for investors who prefer to give discretion to professional managers-- and are now thought to control more than $2 billion. While traditional microfinance funders -- non-profit organizations, governmental development agencies and individuals -- are behind much of this surge of investment, the big change since 2004 is the introduction of private sector institutional investors seeking full market returns. These mainstream commercial investors, most located in Western Europe and the USA, are driving the opening of capital markets to microfinance. 123 CU IDOL SELF LEARNING MATERIAL (SLM)
How and why commercial mainstream investors have come into microfinance and the likely evolution of capital markets funding for microfinance is the topic of this paper. (Note that by “capital markets” we mean transactions or funds in which all or a major portion of the investment is raised from private sector institutional investors seeking fully risk-adjusted returns.) MFI MICROLOANS AND CREDITS BE FINANCED IN THE DEBT CAPITAL MARKETS The debt moratorium given by the Reserve Bank of India till August during the covid-19 pandemic is a major relief for borrowers. This gives a breather for poor households facing wage cuts and job losses, but as research shows, could go on to disrupt the microfinance model of lending. In an Ideas for India article, Georgia Barboni of the University of Warwick and Misha Sharma of Dvara Research say microfinance institutions (MFIs) in India could be in trouble since they themselves have not got the moratorium from their own lenders, mostly banks. So the relaxation given to their borrowers could result in a liquidity crunch for them and credit ratings downgrades. A large share of poor households depends on small loans from MFIs. According to industry body Sa- dhan, around 85% of the borrowers have already opted for the moratorium by May-end. The mounting interests during the moratorium period pose a huge challenge for the sustenance and profitability of MFIs. In normal times, borrowers typically make repayments on a bi-weekly or monthly basis. The current situation can affect that repayment discipline and can also be mistaken as loan waivers bycustomers, the article says. Microfinance has been crucial in providing credit to the poor and the unbanked, but the scenario can result in MFIs pressurizing borrowers for repayments, the authors add. This could push poor households towards costlier and informal lending, thus getting into a debt spiral. In past crises such as the 2018 Kerala floods and demonetisation, the MFI sector recovered from the debt trap in six to nine months. However, this time, the sector needs to rethink its strategies and adopt technological solutions for collection of dues, maintaining customer relations and helping them plan repayment strategies, say the authors. REQUIREMENTS OF THE DEBT CAPITAL MARKETS FOR MFI PRODUCTS Microfinance Institutions (MFIs) are in the process of diversifying their sources of funding by tapping the Non-Convertible Debentures (NCD) market. Though bank funding still contributes a larger share of funding for these MFIs, a growth in NCD issuances over the last few years has been the trend. 124 CU IDOL SELF LEARNING MATERIAL (SLM)
Data from IFMR Capital shows that in the last fiscal, MFIs had issued NCDs worth Rs 576 crore, recording a growth of 162% year-on-year while in the current fiscal they have already raised a little over Rs 300 crore. Bulk of the issuances are seen in the last quarter of the fiscal. “Their investments in long term NCDs issued by MFIs reflect the increased confidence in the microfinance sector by Developmental Finance Institutions (DFIs) over the last 6 months. The alternative source of funding will help MFIs diversify their borrowing sources, reduce concentration and meet their business plan requirements in a more efficient manner,” said Kshama Fernandes, CEO of IFMR Capital. According to data, during FY13 only 4 MFIs were able to secure funding through the NCD route while FY14 saw 17 MFIs issuing NCDs. NCD issuance as a proportion of total debt funding to MFIs has marginally increased from 3.4% in FY12 to 3.8% in FY14. However, NCD issuances in Q1 FY15 total almost 50% of the total volume of FY14 issuances. “Banks remain the dominant funding channel and enjoy priority sector lending benefit on their lending to MFIs. The NCD route for fund raising is relatively new and, at present, quite limited in its relevance to MFIs. It, however, does represent a significant shift in the funding strategy adopted by MFIs,” said Alok Prasad, CEO of the Microfinance Institutions Network (MFIN). ROLE OF RATING AGENCIES M-CRIL was established in 1998 to mitigate investors’ lack of knowledge and experience of microfinance institutions (MFI) and to facilitate an increased flow of funds into the microfinance sector. The purpose behind setting up M-CRIL was both to sensitize the formal financial sector to the micro finance environment and also to assist prospective lenders and investors by providing a rigorous, standard and objective assessment of MFI creditworthiness. In a sector where rating was unheard of, the initial patronage of institutions like Ford Foundation, the Swiss Agency for Development and Cooperation (SDC) and Small Industries Development Bank of India (SIDBI) was critical to M-CRIL’s success. Over time, M-CRIL became well-known in South Asia, expanded to South-east Asia, and is now a knowledge partner of MFIs throughout the continent of Asia. M-CRIL has been instrumental in the recognition accorded to rating as a key factor in raising resources for microfinance. M-CRIL basically provides an assessment of the performance of institutions providing financial services to low income families, namely, microfinance institutions, NBFCs, rural and cooperative banks as well as commercial banks with a focus on micro-finance. This rating evaluates the creditworthiness as well as strengths and weaknesses of the MFIs or banks on a 10-point scale. It also assesses the risks associated with lending to the institutions. Evaluation of external risk, credit risk, market risk and the risk of fraud form the basis of its assessment. It also looks into the institution’s ability to effectively use grant funds received from various donors. The rating recommendations keep 125 CU IDOL SELF LEARNING MATERIAL (SLM)
in view the long-term prospects of the rated institutions, although the ratings are valid for one year only. M-CRIL periodically publishes a summary analysis of rating results in the M-CRIL Microfinance Rating Review. The MFIs rated by M-CRIL span a variety of organizational forms, from NGOs to cooperatives, NBFCs and commercial banks. The most important rating assignments undertaken include those from ADB, Blue Orchard, DFID, SDC, Hivos and SIDBI. It engages in constant introspection to improve its rating methodology and practices and is in regular dialog with other microfinance rating organizations to bring about a standardization in microfinance rating practices all over the world. M- CRIL and Micro Rate, the two largest microfinance rating agencies in the world went into an alliance to form Micro Rating International in February 2007. Together, they represent the largest pool of microfinance rating know-how covering 70% of the microfinance ratings conducted globally. Apart from providing financial advisory and business evaluation services, M-CRIL offers two types of rating services, namely, financial rating and social rating. M-CRIL’s Financial Rating M-CRIL’s credit rating is a business information service for institutional and financial performance assessment of MFIs. M-CRIL aims to widen access to funding, complement regulatory oversight, to enable management to take corrective actions and enhance trust and market confidence in micro- credit sector. It uses a comprehensive rating tool comprising three categories of indicators: ■ Governance and Strategy: The evaluation depends on the nature of the board composition, its role and overall organizational strategy. ■ Management Systems: It is rated on operational efficiency, quality of human resources, value creation expertise of management, strength of accounting and management information systems. ■ Financial Performance: It is measured in terms of profitability, capitalization, liquidity, asset- liability management and efficacy of internal control system. M-CRIL’S Social Rating M-C RIL has pioneered the concept of social rating in India in 2005. Most of the MFIs run with a social mission such as to provide financial services to the underprivileged who were previously excluded from the banking sector to support their micro and small enterprises but contributes to the empowerment of poor, especially women. But such mission statements are hardly backed up by evidence of whether they have actually been achieved. Social rating addresses this gap by contributing to greater transparency about what the MFIs achieved. M-CRIL’s social rating is an assessment of MFI’s missions, namely clarity, alignment of strategy and operational systems to the stated missions, social responsibilities and poverty outreach. External social reporting by MFIs and client feedback are compared for the assessment of their social performance. 126 CU IDOL SELF LEARNING MATERIAL (SLM)
By March 2008, M-CRIL had undertaken 525 financial and social ratings covering over 300 MFIs in 27 countries of Asia, Europe and Africa (M-CRIL, Annual Report 2007-OS). It has spread its operation in a host of countries such as Afghanistan, Azerbaijan, Bangladesh, Cambodia, East Timor, Georgia, Indonesia, Kazakhstan, Myanmar, Nepal, Sri Lanka, Philippines and Russia. M-CRIL has undertaken work for world’s leading organizations which include ADB, ILO, UNCTAD, UNDP, Ford Foundation, SIDBI and NABARD. SUMMARY Debt Capital Markets (DCM) groups are responsible for providing advice directly to corporate issuers on the raising of debt for acquisitions, refinancing of existing debt, or restructuring of existing debt. These teams operate in a rapidly moving environment and work closely with an advisory partner – the Investment Banking Division (IBD). Being part of such a team means being extremely up-to-date on fixed income markets, including, bonds, treasuries, money market instruments, and more. Debt securities provide an income stream (hence the name “fixed-income”) as well as capital preservation (in most cases) for investors. The level of risk measured against the level of reward is something that all investors take into account when making investment decisions, and different investors have different risk tolerances. Some investors like the concept of high risk / high reward and seek out opportunities in the equity capital markets. However, for those looking for a lower risk, fixed-income investment, debt securities in the debt capital markets are usually more attractive. KEYWORDS • Debt Service Reserve: - Term used to refer to cash reserves set aside by a borrower, either by internal policy or lender covenant, to repay debt in the event that cash generated by operations is insufficient. • Debt Service: - Amount of payment due regularly to meet a debt agreement; usuallya monthly, quarterly or annual obligation. • Debt: - An amount owed for funds borrowed. The debt may be owed to an organization's own reserves, individuals, banks, or other institutions. Generally, the debt is secured by a note, bond, mortgage, or other instrument that states repayment and interest provisions. The note, in turn, may be secured by a lien against property or other assets. • Default: - A failure to discharge a duty. The term is most often used to describe the occurrence of an event that cuts short the rights or remedies of one of the parties to an agreement or legal dispute, for example, the failure of the mortgagor to pay a mortgage instalment, or to comply with mortgage covenants. • Default: - Failure to make timely payment of interest or principal on a loan, or to otherwise comply with the terms of a loan. 127 CU IDOL SELF LEARNING MATERIAL (SLM)
LEARNING ACTIVITY 1. What are the examples of debt financing? 2. How do microfinance institutions get money? UNIT END QUESTIONS A. Descriptive Questions 1. State how MFI microloans and credits be financed in the debt capital markets. 2. Discuss Requirements of the debt capital markets for MFI products. 3. What is Role of rating agencies? 4. Explain M-CRIL’s Financial rating. 5. Describe M-CRIL’s social rating. B. Multiple choice questions 1. Who has made credit rating is mandatory for any debenture that has maturity of more than 18 months? a. Governm ent of India SEBI b. RBI c. IRDAI d. 2. How many credit rating agencies are there in India? Four Five a. Six b. Eight c. d. 128 CU IDOL SELF LEARNING MATERIAL (SLM)
3. What is the India’s first credit rating agency? a. CARE b. ICRA c. CRISIL d. ONICRA 4. Which organization is the main promotor of the CRISIL? a. ICICI Ltd & UTI b. SBI & PNB c. ICICI & SBI d. ICICI & PNB 5. ICRA is the India’s second credit rating agency, what is the full form of I in the ICRA? a. Investment b. Information c. Indian d. Investment information Answers 2.a 3.c 4.a 5.d 1. b SUGGESTED READINGS • Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications. • Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc. • Hirschland, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc. • Sapovadia, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India. • Ledgerwood, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006. • Rutherford, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 129 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT -10 EQUITY CAPITAL MARKETS FINANCING Structure Le arn ing Ob jec tiv es Int rod uct ion M FI mi cro loa ns an d cre dit s be fin anc ed in the eq uit y cap ital ma rke ts Re qui re me nts 130 CU IDOL SELF LEARNING MATERIAL (SLM)
of the eq uit y cap ital ma rke ts for M FI pro du cts Ro le of rati ng age nci es Su m ma ry Ke yw ord s Le arn ing Ac tivi ty Un it En d Qu esti ons Su gg est 131 CU IDOL SELF LEARNING MATERIAL (SLM)
ed Re adi ngs LEARNING OBJECTIVES After studying this unit, you will be able to: • Explain the relationship between equity capital markets & MFIs • Describe the Requirements of the equity capital markets for MFI products • Explain the role of rating agencies INTRODUCTION Equity capital is raised in many ways; the major types of equity capital are unlisted equity, listed equity and hybrids. Equity capital market practices traditionally advise on a full range of equity, debt equity-linked, hybrid, asset-backed, credit-linked and derivative products that are offered in capital markets. The equity capital market (ECM) is where financial institutions help companies raise equity capital and where stocks are traded. It consists of the primary market for private placements, initial public offerings (IPOs) and warrants; and the secondary market, where existing shares are sold, and futures, options and swaps are traded. MFI MICROLOANS AND CREDITS BE FINANCED IN THE EQUITY CAPITAL MARKETS MFIs secure funding from a variety of sources, which depend in part on their status. In this way, money granted through microloans may come from: 132 CU IDOL SELF LEARNING MATERIAL (SLM)
• g rants and subsidies, particularly during the MFI’s creation, •m ember and customer deposits, for MFIs organized as cooperatives or mutual funds, as well as microfinance banks that also offer savings products, • t he MFI’s own capital, generally supplying a small portion of funding, • l oans granted by one or more partner banks, •f unding from public investors, typically comprising bilateral or multilateral organizations like the European Investment Bank (EIB), IFC, KFW, AFD, Proparco, etc. •p rivate investors, supplied directly or through investment funds specializing in microfinance (microfinance investment vehicles, or MIVs), which serve as the intermediary between the MFI and investors searching for a socially responsible investment. The latter two options provide a source of long-term funding. REQUIREMENTS OF THE EQUITY CAPITAL MARKETS FOR MFI PRODUCTS The microfinance sector in India as well as across the globe have made headway in capital markets because MFIs are expanding their operations and are moving into newer geographies, with a significant increase in their funding requirements. The ever-expanding businesses of the MFIs have directed them towards capital markets to tap into the mainstream investor community and to benefit from new funding opportunities available in the capital markets. There has been a sense of optimism among MFIs as well investors that MFIs can be part of mainstream investment activity. The continued flow of funds from the capital market and its participants into the microfinance sector is an indication that this sector is a potential source of profitable investment opportunities. The entry of the microfinance sector into capital markets would enhance the liquidity of investors by providing them with an alternative route to exit and by widening/diversifying their investment portfolio. For MFIs, their debut in the capital market would provide better and transparent governance. Unlike traditional asset classes, the microfinance sector is still not accepted as a reliable asset class due to the paucity or even absence of historical prices and performance information about MFIs. This lacuna would gradually be filled once market value information is generated by MFIs, since foraying into capital markets would require MFIs to maintain and manage such information for meeting statutory and 133 CU IDOL SELF LEARNING MATERIAL (SLM)
investor requirements. It will also set the benchmark for similar institutions looking to access capital markets and for potential investors. The increased emphasis on capital markets as the source for funding of MFIs can be attributed to two peculiar reasons. Firstly, the microfinance sector has given positive returns to investments made during an economic downturn; secondly, the overall industry trends for the microfinance sector are positive, and the microfinance industry experienced double- digit returns over the last 30 years. A comparison of the performance of the microfinance debt fund indices with that of the major indices for the period 2003–2013. The performance of microfinance funds compared to that of the other indices was quite impressive—annualised returns were 3.87% against volatility of 0.61%. Microfinance funds have established themselves as an alternative to money market plus strategies—they have low returns compared to global bond returns, but they are associated with lower volatility. ROLE OF RATING AGENCIES Rating agencies assess the credit risk of specific debt securities and the borrowing entities. In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations. Large bond issuers receive ratings from one or two of the big three rating agencies. In the United States, the agencies are held responsible for losses resulting from inaccurate and false ratings. The ratings are used in structured finance transactions such as asset-backed securities, mortgage- backed securities, and collateralized debt obligations. Rating agencies focus on the type of pool underlying the security and the proposed capital structure to rate structured financial products. The issuers of the structured products pay rating agencies to not only rate them, but also to advise them on how to structure the tranches. Rating agencies also give ratings to sovereign borrowers, who are the largest borrowers in most financial markets. Sovereign borrowers include national governments, state governments, municipalities, and other sovereign-supported institutions. The sovereign ratings given by a rating agency shows a sovereign’s ability to repay its debt. The ratings help governments from emerging and developing countries to issue bonds to domestic and international investors. Governments sell bonds to obtain financing from other governments and Bretton Woods institutions such as the World Bank and the International Monetary Fund. SUMMARY The equity capital market is a subset of the broader capital market, where financial institutions and companies interact to trade financial instruments and raise capital for companies. Equity capital markets are riskier than debt markets and, thus, also provide potentially higher returns. Equity Capital Markets (ECM) is the team / group that is responsible for providing advice on equity, equity-linked 134 CU IDOL SELF LEARNING MATERIAL (SLM)
and equity derived products, including shares, futures, swaps and options. An ECM group will work closely with a client to organize transactions, structure the equity offering, and to improve valuation. KEYWORDS • Empowerment: - Impact of design for political participation, legal awareness, abilityto exercise personal and socio-political rights and freedoms. • Endowment or Trust: - A fund that contains assets whose use is restricted only to the income earned by these assets. • Environment: - Impact of programs on the natural environment, creation of environmental initiatives. This literature includes environmentally-focused loan funds. • Equity Participation: - An ownership position in an organization or venture taken through an investment. Returns on the investment are dependent on the profitability of the organization or venture. • Equity: - The value of property in an organization greater than total debt held on it. Equity investments typically take the form of an owner's share in the business, and often, a share in the return, or profits. Equity investments carry greater risk than debt, but the potential for greater return should balance the risk. LEARNING ACTIVITY 1. What are Private Placements? 2. Why Secure a Rating? UNIT END QUESTIONS 135 A. Descriptive Questions 1. Discuss MFI Microloans. 2. Describe the equity capital market. 3. State the requirements of the equity capital market for MFI products. 4. Analyse the role of rating agencies? 5. Illustrate how MFI microloans and credits be financed in the equity capital markets. CU IDOL SELF LEARNING MATERIAL (SLM)
B. Multiple Choice Questions 1. How much percentage of the net credits of small finance banks should be in priority sector lending? a. 75% b. 25% c. 30% d. 70% 2. Which of the following was launched the first small finance bank? a. Capital local area bank b. Ujjivan small finance bank c. Disha Micro fin private Ltd d. Equitas Holdings Private ltd 3. What is NOT a potential limit of group lending? a. Monitoring group members can be costly for borrowers b. Group lending uses social sanctions instead of collateral foreclosure c. Group lending brings added risks for borrowers, those of others members’ default. d. Exclusion of all group members after one of them default is too harsh a punishment. 4. What does the microfinance model NOT predict: a a. homogen decrease in interest rates when repayment is regular and in time self- b. None of ous risk groups c. selection of the best borrowers d. these 5. What option block the poor to get bank loans? Absence a. 136 of collateral CU IDOL SELF LEARNING MATERIAL (SLM)
b. High rates of interest Complexi None of c. ty of procedure d. these Answers 1.a 2.a 3.b 4.c 5.a SUGGESTED READINGS • Branch, Brian & Janette Klaehn. (2002). Striking the Balance in Microfinance: A Practical Guide to Mobilizing Savings. Washington: PACT Publications. • Dowla, Asif & Dipal Barua. (2006). The Poor Always Pay Back: The Grameen II Story. Bloomfield, Connecticut: Kumarian Press Inc. • Hirschland, Madeline. (2005). Savings Services for the Poor: An Operational Guide. Bloomfield CT: Kumarian Press Inc. • Sapovadia, Vrajlal K., (2006). Micro Finance: The Pillars of a Tool to Socio-Economic Development. New Delhi: Prentice Hall of India. • Ledgerwood, Joanna and Victoria (2006). Transforming Microfinance Institutions: Providing Full Financial Services to the Poor. World Bank, 2006. • Rutherford, Stuart. (2000). The Poor and Their Money. New Delhi: Oxford University Press. 137 CU IDOL SELF LEARNING MATERIAL (SLM)
UNIT -11 MICROFINANCE INVESTMENT VEHICLES Structure Le arn CU IDOL SELF LEARNING MATERIAL (SLM) ing Ob jec tiv es Int rod uct ion M FI Inv est me nts as an As set Cla ss & Mi cro fin anc e Inv est me nt Ve hic le Ve ntu re Ca pit al (V C) 138
S M E So cia l Im pac t Inv esti ng Im pac t Isn' t Iso lat ed Su m ma ry Ke yw ord s Le arn ing Ac tivi ty Un it En d Qu esti ons Su gg est ed Re adi ngs 139 CU IDOL SELF LEARNING MATERIAL (SLM)
LEARNING OBJECTIVES After studying this unit, you will be able to: • Describe the MFI investment vehicles in detail • State the concept of venture capital • Explain the SME Social Impact Investing INTRODUCTION Assessing whether investments result in the desired non-financial performance is a key concern in the fast-growing field of impact investments, including microfinance. The social performance of the institutions that offer financial inclusion services to underprivileged populations has come under increasing scrutiny, whereas the social performance of the investment vehicles that in turn finance these institutions is researched less. Drawing on methods from empirical social science and the literature on non-financial ratings of firms, we develop formal quality criteria that the selection of individual social performance indicators and their aggregation into a single metric need to satisfy. MFI INVESTMENTS AS AN ASSET CLASS & MICROFINANCE INVESTMENT VEHICLE • The MIV’s growth rates have been driven by active distribution, financial innovation, and high involvement from International Finance Institutions and the private sector; 140 CU IDOL SELF LEARNING MATERIAL (SLM)
• Economie s of scale appearing with 13 funds have total asset of more than US$20million; • The fastest growing MIVs are the largest and over 70% of growth comes from just 6 MIVs; • Geograph ically, MIV microfinance portfolio is heavily concentrated in Latin America; • Commerc ial MIVs tend to invest in debt financing; • The highest growth rates are registered by those MIVs which have better resource placement in MFIs; • There exists tremendous diversity. Only a small number are funds others are specialized investment vehicles like Collateralized Debt Obligation (CDO). Finally the study concludes with the trends and implications: • Shift to more commercial source of funding will continue and accelerate; • As MIVs grow they will have to deal with social investors seeking real double bottom line returns; • More information on MIVs would be required to compare performance and judge MIVs; • MIV’s are a fast growing industry with eagerness for microfinance which might result in increased bad investment decisions. The MIV (Microfinance Investment Vehicle) Rating provides an independent and expert opinion on: • T he soundness of the MIV governance and structure to ensure stability and viability of the business •T he consistency and adequacy of the investment approach of the fund, compliance with investor’s expectations and soundness of its risk management approach in relation to the investment strategy •T he MIV distribution strategy, implied risk exposure and the stability of the funding structure •T 141 CU IDOL SELF LEARNING MATERIAL (SLM)
he performance of the Fund in terms of profitability and efficiency •T he MIV capacity to manage its social performance and the responsibility of its investments The MIV rating is an effective management and reporting tool that is used to: • E nhance reputation, accountability and transparency, build trust • S trengthen institutional governance and decision-making, risk management, systems and performance • Q ualify for hedging accounts and transactions with MFX VENTURE CAPITAL (VC) Micro venture capital is money invested to seed early-stage emerging companies with amounts of finance that is typically less than that of traditional venture capital. In contrast to traditional venture capital which is money used to invest in companies looking to fund growth (also referred to as a Series A round of funding), micro venture capital consists of smaller seed investments, typically between $25K to $500K, in companies that have yet to gain traction. In the United States, the number of micro venture capital firms have continued to rise rapidly over the last 5 years, and have become an important source of finance for startup companies. Micro venture capital generally shares certain characteristics: •I nitial investment at the seed stage •I nvestment on behalf of 3rd party Limited Partners • M ost commonly have fund sizes that are less than $50MM Most micro venture capital firms pursue startups that are at their seed stage because of their lower initial cost basis. Though there is a high probability that the majority of these startups will not survive long enough to reach a Series A round of funding, micro venture capital firms are willing to make the investment because startups generally do not require large sums of capital to bring a product to market, and because they believe that it requires only a few successful companies for them to see profitable returns. 142 CU IDOL SELF LEARNING MATERIAL (SLM)
SME SOCIAL IMPACT INVESTING Impact investors stand to leave a mark both by investing in fintech’s that provide software (or a platform) related to loan origination, underwriting, disbursement, monitoring and collection for SMEs, or by utilizing financial technology to directly invest in impactful SMEs. Unlike mobile money, this is a path appropriate even for retail investors, with companies like Rabble allowing socially-motivated startups to crowdfund from investors who purchase equity or debt securities. Figure 11.1 SME Social Impact Investing Some SME finance lenders may provide similar services to the microfinance institutions now past their prime, but the technological component of fintech fundamentally changes its reach. Between more granular data (which informs better decision making to more candidates) and decentralized, trust-less ledgers to bridge the supply chain credit gap faced by SMEs who are often parting with their product in good faith, the next frontier of SME finance far exceeds that which is currently possible by microfinance. 11.4.1 Impact Isn't Isolated Infrastructure uniquely underpins the potential of fintech, and Mobile Network Operators are key to scale. While traditional financial inclusion investments still require infrastructural inputs (like 143 CU IDOL SELF LEARNING MATERIAL (SLM)
physical branches and employees), fintech applications instead incorporate more remote (and internet facilitated) features. Mr. Wilson contended that many investors and companies not accustom to working in developing markets drastically underweight the friction caused by poor infrastructure. He cited the example of an East African company that developed a solar panel productized for an everyday consumer, but when first released, was financially out of reach for the average family. It wasn’t until later innovations in mobile money and pay-as-go financing were interwoven that the average African could afford the US$100 panel. The company subsequently became one of the largest solar companies in the region. Disentangling and grasping the underlying forces of a region, like infrastructure, is perhaps more crucial to impact investors than to regular investors. Durreen Shahnaz, Founder and CEO of IIX, an organization that has supported investors and enterprises in impact investing for over a decade, pointed out that, in contrast to investors that have no 'skin in the game' if their successful investment collapses two days after they pull their money, impact investing is much more focused on the long term: IX looks not only at innovative solutions that may bring greater financial inclusion, but also the long- term sustainability of those solutions in achieving the UN Sustainability Development Goals. For this reason, impact investors must first focus on fundamental social and environmental needs, and then see if there is a role for technology to play in solving those challenges. But these extra ecosystem challenges could also reap extra reward. Emerging market telecom infrastructure paired with investments in financial technology also offer a promising path towards financial return. Industry analysts have been warning of telco market saturation and praising opportunities in cross-industry partnerships (mobile payments, mobile health, etc.), so these frontiers where telcos are tied to fintech’s are prime investment opportunities. Unbridled eagerness on the part of fintech’s without proper due diligence, however, could be a recipe for disaster. Ameya Upadhyay, a Principal at Omidyar Network, emphasized that while there are obvious opportunities for fintech startup-mobile network operator partnerships, fintech’s must approach such opportunities mindfully. The sales cycles of MNOs often outlive fintech startups’ cash flows, and the difference in size and influence gives the MNO leverage (even entrepreneurs just cinching a meeting with MNO decision makers is difficult). If fintech’s can understand the contingencies of such partnerships, Mr. Upadhyay sees potential for very productive innovation. SUMMARY •F oreign capital investment in microfinance is surging. Cross-border investment has more than tripled in the last two years to reach US$1.4 billion in 2006. Two main players are driving this phenomenon: international financial institutions (IFIs)-the private-investment arm of public 144 CU IDOL SELF LEARNING MATERIAL (SLM)
development agencies-and private investment funds, known as microfinance investment vehicles (MIVs). •I FIs have played an important role in commercializing microfinance by providing seed capital to young microfinance institutions (MFIs) and bridging the gap between grant funding and domestic funding. IFIs were behind the creation of most of the early MIVs, which offered IFIs a more efficient way to invest in the sector than direct MFI investments. Now, MIVs are gaining ground and finding other investors, including private investors. •A new CGAP survey shows that while IFIs’ microfinance portfolio (including investment in MIVs) more than doubled from US$1 billion in 2004 to US$2.3 billion in 2006, MIV portfolios grew more than threefold during the same period, from US$600 million to US$2 billion. •T his note summarizes the survey findings and explores the implications of the rapid growth of MIVs for the microfinance industry. This Brief is based on two studies conducted in the last quarter of 2006: a CGAP study on IFI microfinance portfolios and a joint CGAP-Micro Rate research on MIV trends. •S mall- and medium-sized enterprises (SMEs) are considered to have potential innovation capabilities and can create new market opportunities. Venture capital can financially support entrepreneurial activities for economic growth and governs and nurtures the growth of the SMEs. The aim of this study is to investigate the influence mechanism of venture capital on the development of SMEs in agri-food industry. Based on the enterprise growth theory, this study constructed an evaluation model, consisting of technological innovation, profitability, development capability, and solvency, to examine the effect of venture capital on the growth of agricultural SMEs. Using data of 40 agricultural SEMs from the SME and ChiNext boards in China, the empirical analysis has been conducted with the multivariate regression analysis method. The results show that the venture capital can significantly improve the technology innovation, profitability, and growth ability of SMEs. For the solvency of SMEs, the promoting role of venture capital is not obvious. •T his review created an evaluation model to investigate the impact of venture capital and the share ratio of venture capital on the growth of SMEs in agriculture based on enterprise growth theory. These findings can help the entrepreneurs of SMEs set a reasonable development plan to attract venture capital. We found that the venture capital in China has its own 145 CU IDOL SELF LEARNING MATERIAL (SLM)
characteristics in selecting investee and promoting the development of SMEs. First, the venture capitalists prefer to invest in large-scale SMEs with stable operation, low debt ratio, low ownership concentration, and stable returns. Second, the venture capital can improve the technological innovation, the profitability, and the development ability of SMEs. Third, the venture capital has no significant impact on the solvency of SMEs. KEYWORDS • Gross Loan Portfolio: - All outstanding principal for all outstanding client loans, including current, delinquent and restructured loans, but not loans that have been written off. It does not include interest receivable. It does not include employee loans. • Group Lending: - Grameen lending is a well-known form of group of groups lending. It utilizes a combination of peer group methodology and village banking. • Group Lending: - Lending mechanism which allows a group of individuals - often called a solidarity group - to provide collateral or loan guarantee through a group repayment pledge. The incentive to repay the loan is based on peer pressure - if one group member defaults, the other group members make up the payment amount. • Guarantee Fund: - Also known as bridge funds. A guarantee fund can provide the organization's initial access to the formal financial sector, strengthen the organization's capabilities as financial intermediaries and provide important leverage in terms oflending capability. • Guaranteed Loan: - A pledge to cover the payment of debt or to perform some obligation if the person liable fails to perform. When a third party guarantees a loan, it promises to pay in the event of a default by the borrower. LEARNING ACTIVITY 1. Write note on investment vehicles. 2. Write a short note on MIV rating UNIT END QUESTIONS 146 A. Descriptive Questions 1. Illustrate Venture Capital with relevant examples. CU IDOL SELF LEARNING MATERIAL (SLM)
2. Explain SME Social Impact Investing 3. Describe MIV? 4. Explain the concept of MFI Investments as an asset class. B. Multiple Choice Questions (MCQs) financing. Commerc 1. ial MIVs tend to invest in Debt a. Equity b. Capital c. All of d. these 2. The highest growth rates are registered by those MIVs which have better resource placement in MFIs a. True b. False 3. Initial investment at the seed stage a. True b. False 4. Most micro venture capital firms pursue start-ups that are at their seed stage because of their initial cost basis. a. Higher b. Reasonab le c. Lower d. None of these 5. round funding Initial funding is also referred as 147 CU IDOL SELF LEARNING MATERIAL (SLM)
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