Looking Beyond the Financial Crisis: Vulnerabilities Related to Fast Growth in Microfinance

WASHINGTON, February 24, 2010 - Recent repayment troubles in four rapidly-growing microfinance markets do
not stem from the financial crisis, according to a new report by CGAP, a
microfinance group based at the World Bank, but from the way that
microfinance operates in fast-growth markets. The authors examine recent
repayment troubles in four rapidly-growing but disparate microfinance markets
– Nicaragua, Bosnia and Herzegovina, Morocco, and Pakistan — and conclude
that the problems observed are closely associated with the growth phases each
country experienced from 2004 to 2008.

Far from being the root cause of the problems in these countries, the
authors argue that microfinance globally has weathered the difficulties of
the financial crisis relatively well, giving observers confidence that
microfinance will emerge strong from the crisis.

The report, Growth and Vulnerabilities in Microfinance
(www.cgap.org/p/site/c/template.rc/1.9.42393 ), distills three
weaknesses at the heart of the repayment crises in these countries: excessive
lending concentration by MFIs and multiple borrowing by their clients;
overstretched back-office capacity within the MFIs; and a loss of credit
discipline as MFIs pursued fast growth.

"Experience shows that microfinance can maintain asset quality, and pay
impressive returns, both in terms of profits to investors and as well as
improvements in people's lives," says co-author Xavier Reille of CGAP.
"Nevertheless, a few countries do show signs of stress and remind us of the
need for a much stronger focus on sustainable growth and re-commitment to
asset quality."

Over the past 10 years, globally microfinance has grown at an impressive
rate, providing access to financial services for millions of poor households.
This growth has been driven by ambitious MFIs and fueled by abundant credit.
Local and foreign investors alike have been eager to support the growth of
the sector. "The next decade should focus on sustainable growth with renewed
attention to client services and asset quality," says Reille.

CGAP argues that three developments could bolster the next phase of
microfinance expansion: an improved balance between growth and the quality of
client services at MFIs; expansion in the number and use of credit
information bureaus; and better market information allowing managers to make
more accurate decisions about where to extend their services most
effectively.

The authors found that in each of the four countries MFIs had followed
one another into specific localities, neglecting to spread their services out
more evenly. Greater lending concentration and competition brought some
benefits to clients. At the same time it increased the chances that borrowers
took on larger amounts of debt from more sources, and it changed their
repayment incentives.

In chasing new clients and asset growth, many MFIs in the four countries
were unable to maintain the quality and efficiency of staff, the focus of
middle management, and the adequacy of internal controls.

Thirdly, credit discipline itself began to suffer. MFIs began to take
more risks to secure new clients, and expanded their product offerings
without appropriate adaptation and strengthening of internal controls.

The four countries examined in the report offer lessons for a wider
industry that remains reasonably strong, according to the authors. They raise
the question of whether fast-growing countries like India, where asset growth
has significantly outpaced other countries, could see a rise in the same
vulnerabilities. "MFIs will need to have a far better grip on their internal
controls and also an improved understanding of their clients and markets,"
Xavier Reille says. "Credit information bureaus would be an ally in this
respect, helping MFIs avoid over-saturated markets and identify sensible
opportunities for growth, providing the kind of financial access mapping that
can guide future expansion."

The authors emphasize that the recommendations in the paper are not in
themselves panaceas to all possible and future microfinance problems, but
that, taken together, they could significantly buttress the sector from
repeating past mistakes.

About CGAP

CGAP (The Consultative Group to Assist the Poor) is the world's leading
resource for the advancement of microfinance. CGAP provides the financial
industry, governments and investors with objective information, expert
opinion, and innovative solutions to effectively expand access to finance for
poor people around the world. More information: www.cgap.org

Una Gallagher Pulizzi of CGAP, +1-202-473-8869, upulizzi at worldbank.org