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In Search of
Solid Funding
How Should microfinance Institutions Best Fund Themselves?
By Glen Westley and Peter Bate
A few years ago, when no one was yet referring to microfi nance as an “industry,” microcredit organizations relied on funding from government-subsidized loans, international donors and philanthropic foundations. As microfi nance developed professionally and donations became less common, a key issue was how In Search of Solid Funding How Should microfi nance Institutions Best Fund Themselves? to offer and recover loans in order to become sustainable. While these continue to be aspects in managing microfi nance institutions (MFIs), funding sources have proliferated to the point that it’s worth analyzing which are MFIs’ best funding alternatives.
Which is better: To attract deposits? Borrow money? Issue bonds? Sell stock? Such questions were the subject of a broad Inter- American Development Bank (IDB) study and also a seminar at the Inter-American Forum on Microenterprise in October 2005 in Santa Cruz, Bolivia.
Today, savings deposits are the main source of MFI funds, according to statistics from the database on 61 regulated MFIs in nine countries (Bolivia, Colombia, Ecuador, El Salvador, Honduras, Mexico, Nicaragua, Paraguay and Peru).
Funding sources have proliferated to the point that it’s worth analyzing which are MFIs’ best funding alternatives.
Altogether, the MFIs had US$1.9 billion in liabilities at the end of 2003. Deposits (US$1.2 billion) represented 65% of the total; loans (US$517 million) 27%; and bonds (US$33 million) 1.7%. The MFIs’ total assets reached US$376 million, or close to 20% of total liabilities.
At the end of 2003, the deposit/loan ratio reached 76% in the MFIs studied. At the same time, borrowing has become less important in the institutions’ financial structure. Bond issuance, a promising mechanism, is still rarely used. Although concrete data are scant, Latin American MFIs almost never issue stock. Instead, the institutions’ capital base has grown mainly due to profi t reinvestment.
Deposits. MFIs have attracted funds from the public with time deposits (74% of the total captured at the end of 2003), savings accounts (26%) and checking accounts (0.1%), a new source of funds. Time deposits offer clients a higher fi nancial yield. For the MFIs, these deposits are more stable, at least in the short term, and have lower operating costs, advantages that counterbalance their greater sensitivity to the interest rates paid.
Evaluation of the savers shows that MFIs have attracted a high number of depositors, thereby expanding and diversifying their principal liability. A majority are small savers who contribute a tiny fraction of the captured deposits, as opposed to the intermediate segment of bigger depositors.
Borrowing. Analysis of the MicroRate database on borrowing by 23 regulated MFIs in seven Latin American countries shows that at the end of 2003, the public sector was the single most important source (providing 47% of total funds). Donors held second place (21% of total funds), followed by local commercial banks and other domestic sources (18%) and international social investors and other foreign sources (14%).
Borrowing from public institutions and donors allows MFIs to enjoy interest rates and maturities that would be difficult to obtain from other sources and to reduce liquidity risk or term mismatches. Also, these sources tend to charge near market rates, which prepares the MFIs to access more commercial financing.
Borrowing also affects the risks faced by MFIs in other ways. When MFIs have credit lines that are not fully utilized, liquidity management is greatly facilitated since these funds can be mobilized quickly to deal with short-term difficulties. Exchange rate risk is also aggravated, given that a substantial portion of MFI borrowing is in foreign currency, while most MFI loans are in local currency. Interest rate risks also increase, given that most MFI borrowing is at variable rates (especially borrowing from government second-tier facilities, donors and social investors) and most MFI loans are at fixed rates. Finally, borrowing may increase concentration risk, by leading MFIs to depend on a small number of creditors.
Costs. A study on financial and operating costs of the four funding sources focused on 10 MFIs representing a range of sizes and financing combinations, factors that influence costs of different instruments.[1]
The study concludes that capital is generally the most expensive resource, while total costs of other resources vary according to the MFI’s size. The cost ratio between deposits and borrowing largely depends on the degree of subsidized borrowing, especially for large MFIs, which usually enjoy greater economies of scale in capturing deposits.
Glenn Westley, IDB"
The 10 MFIs examined attract deposits through two basic products: savings accounts (SAs) and time deposits (TDs), in both local and foreign currency. Of the institutions studied, nine MFIs offer both products. According to data on financial and operating costs, the average cost of savings accounts is 15% vs. 12.2% for time deposits. Operating costs for SAs are much higher and reach an annual average of 11.4% of the amount deposited, while the average cost of TDs is 2.4%. The interest rates offered for deposits reflect the difference between total costs and operating costs, and are 3.6% for SAs and 9.8% for TDs. For TDs, whose main costs are the interest rates paid and not operating costs, it is important to set rate levels so funds can be captured at the lowest cost. However, many MFIs do not give this task priority because their wide financial margins allow them to absorb these costs easily.
Given these statistics, MFIs should give priority to time deposits since their total costs are less. TDs have another advantage: they are easier to manage and more stable in the short and medium term, and potentially they help term match between assets and liabilities.
The lower operating costs of TDs are mainly due to the average size of these accounts, almost 20 times larger than SAs (US$7,396 vs. US$399, respectively). The decisive factor is not that the SAs have many more transactions than TDs. The monthly operating cost per account is much larger for TDs than for SAs in all MFIs, and on average is more than three times higher (US$12.40 per month for TDs vs. US$3.50 per month for SAs). It appears that the highest cost per account for TDs comes from the attention that agency heads give to the biggest clients. While SAs generate more transactions, lower-paid employees handle them.
The study’s comparison of the two smallest MFIs with the two largest provides evidence in support of economies of scale. For SAs, the two smallest MFIs have an average monthly unit cost of US$5.95, compared to US$3.20 for the two largest MFIs. With respect to TDs, the average monthly unit cost for the two smallest MFIs is US$13.70 vs. US$4.40 for the two largest MFIs.
The other six MFIs don’t show evidence of such economies of scale. These medium-sized institutions show the lowest average unit cost for SAs (US$2.20 per month) and the highest average unit cost for TDs (US$14.57 per month). However, it may be difficult to detect economies of scale in data such as these, except between extreme cases such as the smallest and the largest MFIs. This is due to difficulties in assigning a number of important operating costs to each product and to differences in management efficiency among MFIs.
Microsavings. Accounts with balances under $100 make up 74% of the total number of accounts in small MFIs and 76% in large MFIs. Their balances represent 2.5% and 3.0% of total captured, respectively. These small deposits also concentrate 30% and 59% of the transactions in each case. Annual operating costs of these accounts reaches 200% or more of the amount in each deposit, implying that the clients with small balances are subsidized by other clients.
MFIs generally opt to subsidize small savers as part of their social mission. The cost of this subsidy is rarely calculated or rationalized. Competitive pressure can cause MFIs to be more selective with these clients, setting higher minimums in opening accounts, paying interest on balances, charging for each transaction or imposing monthly fees for account management. Another option is to expand the base of microsavers to reach a critical mass of clients who can be tended to more economically by automatic tellers and who can choose from a wide range of financial products to facilitate transactions and recover costs. Prodem and Banco Sol in Bolivia have found that automatic tellers have greatly reduced the cost of deposits, improved client service and mobilized additional deposits.
The fact that borrowings have lower total costs should not lead small MFIs to give them priority over attracting savings. In selecting a funding source, MFIs should consider the following factors:
- The amount an MFI can borrow is restricted by limits the lenders place on the amount of credit they are willing to extend to each intermediary.
- A significant amount of borrowing concentrates funding risks and may make the MFI overly reliant on government and donors. As a result, liquidity management and the ability to do medium-term planning would be adversely impacted.
- Deposits diversify funding sources and offer much greater stability to overall liabilities. MFIs depend less on governments and donors, and thus achieve greater self-sufficiency.
- Increasing the volume of deposits can help reduce their average operating costs since it is possible to spread fixed costs over a greater volume and generate economies of scale.
Attracting deposits presents other significant advantages such as the possibility of knowing the clientele better through examination of their liability operations, greater integration of local and regional economy, more prudent management and greater possibilities for cross-sale of other financial products such as credit, transfers, credit cards, debit cards and microinsurance.
The relationship between borrowing and deposits is more one of complementarity than of substitution. In the medium term, it would be good if deposits are the main funding source, supplemented by borrowing to lengthen the average maturity of the MFI’s liabilities and reduce total costs. Later, these sources can be complemented by access to local capital markets, through bond issuance.
[1] Of the 10 MFIs, six are in Peru (the Municipal Savings of Arequipa, Piura, Pisco and Chincha, and Rural Savings of NorPerú and Señor de Luren), two from Bolivia (FIE and Banco Los Andes ProCredit), one from Colombia (Finamérica) and one from Nicaragua (Confía/Procredit). The emphasis on Peruvian and Bolivian MFIs is due to their preponderance in the study: 47 of the 61 MFIs are from those two countries, which together hold 78% of total deposits.
