In Case of Emergency:
Break Glass

An Innovative Fund Helps MFIs Respond to All Kinds of Disasters

The tsunami of December 26, 2004, which killed more than 200,000 people and displaced another 2.2 million in four Asian countries, generated an extraordinary wave of solidarity around the world. Public and private donors promised unprecedented sums to help the victims. In their eagerness to channel resources to the most affected communities, some began promoting micro-credit as a tool to help local economies recover more quickly.

However, those good intentions ran into insurmountable obstacles: the remotest areas lacked microfinance institutions (MFIs). And the areas that did have MFIs suffered the effects of the catastrophe’s impact: missing clients, impassable roads, lost documents, destroyed equipment and unusable installations. The MFIs themselves needed to be saved, beginning with recovering their liquidity in order to resume operations.

For the donor community, this presented new dilemmas: Should they rescue all the MFIs? If some were weak before the tsunami, they probably wouldn’t survive, and resources would be lost without attaining a multiplier effect. But how to tell which institutions were worth supporting? Such evaluations cannot be made overnight, and less so in places that have just been wracked by the sea. In fact, the most detailed reports on MFI operations in areas hit by the tsunami weren’t released until mid-2005.

Half a year passed before the institutions were able to present their projects to donors, who in turn needed time to study the proposals before deciding whether to disburse funds. With the advantage of hindsight, we can say that it would have been simpler to provide the MFIs with a lender of last resort, one capable of responding rapidly to the liquidity needs that result from catastrophes, regardless of whether they are caused by nature or man.

Plan, Prepare and Proceed

In fact, such a mechanism does exist, but it operates only in Latin America and the Caribbean. It is the Emergency Liquidity Facility (ELF), which specializes in providing short-term loans to pre-qualified MFIs that encounter liquidity problems caused by exogenous factors. The list of possible calamities is seemingly endless: hurricanes, floods, earthquakes, droughts, freezes, forest fires, famine, epidemics, blackouts, industrial disasters, financial panics, terrorist attacks, social disturbances and political uncertainty. The ELF has been able to respond to clients in a matter of days, instead of months. The secret, according to manager Juan Carlos Pereira, is to have evaluated the MFIs beforehand. If it hadn’t previously appraised its clients, the ELF couldn’t act with such agility and speed. “Evaluating an affected institution in the middle of a crisis could take weeks or months,” says Pereira. “I believe that’s what happened with the tsunami in Asia. A lot of goodwill existed among the agencies to inject resources into the microfinance institutions, but it takes time just to get to know them, evaluate them and see what their needs are, and thus the money arrives late.”

It’s no accident that the idea for the ELF was born on the heels of a natural disaster of enormous proportions: Hurricane Mitch, which lashed Central America in late 1998. As did the tsunami, the floods and mudslides unleashed by that hurricane affected the lives of millions of people and swept away roads, bridges, buildings, vehicles, livestock and crops. Mitch also hurt countless microenterprises and the institutions that provided them with microcredit. As with other organizations in the international community, the Inter-American Development Bank’s Multilateral Investment Fund (MIF) realized the urgency of helping the Central American MFIs get back on their feet in order to participate in the reconstruction process. Nevertheless, as does any organization that depends on public sector donors, the MIF must comply with rules and procedures before it can disburse significant sums of money. Projects must be conceived, designed, analyzed, approved and documented, a cycle that can take many months, especially when it involves complex negotiations with numerous beneficiaries, different executing organizations, multiple ministries and other cooperative agencies or financial institutions. By the time the MIF obtained approval for its program to strengthen the MFIs that had suffered Mitch’s fury, nine months had passed. The MIF managed to provide support to 33 institutions, but for others, the help arrived too late.

The hard lesson of that experience resulted in a call within the MIF to create an independent fund with the capacity to disburse resources in a minimal amount of time to meet liquidity needs that result from factors unconnected to the MFI’s management. Its clients would be institutions that are mainly dedicated to microfinance and known to be sustainable. Loans from the fund would be short term, with market interest rates, so as not to become a substitute for the MFIs’ usual funding sources. The new mechanism could channel resources from different donors, which would contribute funds for the operations, and in the process avoid costs and paperwork. The fund also would provide technical support to help clients improve their disaster risk management and strengthen their preventive measures, a soft spot for most MFIs.

For Troubled Times

The Emergency Liquidity Facility was established in August 2004 with nearly US$2.2 million of capital and US$8.5 million of contingent lines of credit. Its shareholders were not limited to cooperative agencies, but included private sector organizations, philanthropic institutions, nongovernmental organizations and specialized funds. In addition to the MIF, capital was provided by the Swiss State Secretariat of Economic Affairs (SECO), the Open Society Institute, the Argidius, Calmeadow, Calvert and Rockdale Foundations, the specialized NGO ACCION International and the Gray Ghost Microfinance Fund. The credit lines were provided by the MIF, Oikocredit, Gray Ghost, the U.S. Government’s OPIC, SECO, SEDF and the Spanish Agency for International Cooperation (AECI). In addition, the MIF, SECO, Rockdale, OSI and Argidius provided a total of US$780,000 in donations for the technical support facility. The ELF’s administrator— Omtrix of San José, Costa Rica—manages other funds, which further lowers the operational costs.

“In the past decade, more than 40 specialized funds have appeared in microfinance institutions, but their resources are mostly available during good times, with financial stability, good growth perspectives, low default rates and high returns,” notes Tomas Miller, who represents the MIF on the new facility’s board. “The ELF was created for hard times, when funds are scarce and risks increase. When the others are trying to get out, the ELF is ready to move in.”

Once the new facility’s structure was complete, a database of Latin American and Caribbean microfinance institutions was compiled (MIF’s charter limits its operations to this region). Of the more than 200 MFIs identified, ELF managers selected 96 that were able to meet the requisites for clients: to have been in operation for at least three years, and have more than half of their loan portfolio in microcredit, good solvency, reasonable levels of default and adequate performance. “The goal was to support wellmanaged, solvent entities that had suffered an external shock,” explains Pereira. “It’s no good to lend money to institutions so weak that the crisis could make them disappear.”

Upon passing the region’s MFIs through that first filter, Pereira and a consultant began to visit the selected sites one by one, traveling to 11 countries, to convince them of the advantages of being an ELF client. Oddly, it took some time for the message to soak in. Pereira speculates that people were suspicious of an idea that had yet to be put to the test. There is also a natural resistance to thinking about emergencies until one happens. “It’s like going to the dentist. Nobody likes to do it, so they postpone and postpone. But when your molar hurts, you have no choice but to go,” comments Pereira. Once the first MFIs signed up, though, others soon became interested and requested more information. In just over a year, the ELF recruited 35 organizations in Bolivia, Colombia, Ecuador, El Salvador, Guatemala, Haiti, Honduras, Mexico, Nicaragua, Paraguay and Peru.

Since its creation, the ELF has had various opportunities to act. The first was in Bolivia, as a result of the social explosion that would cut short the presidency of Carlos Mesa. The protests included prolonged roadblocks that affected the clients of microfinance institutions. In order to ensure liquidity and assist its borrowers, one of the MFIs received the first ELF loan. Thanks to a facility’s pre-qualification and periodic monitoring of clients, the only delay in disbursement is the time it takes to determine an affected MFI’s solvency and liquidity needs. On average, it takes two weeks for resources to reach institutions, although it has taken the ELF as little as one to disburse.

ELF loans are for six-month terms and can be renewed for equal terms for an accumulated maximum of two years. However, the interest rate increases with each renewal so as not to create a dependency on its resources. Though the ELF tries to ensure profitability in order to cover costs and obtain a modest margin of earnings for its shareholders, the interest rates of its loans are set according to the rates of the applying MFIs’ financial markets prior to the crisis. Until they use credit from the ELF, the MFIs need merely pay a one-time fee to cover the cost of evaluating their organizational structure and financial status. Like a fire station, the facility awaits the next emergency. During calm periods, it concentrates on monitoring MFIs and efforts for disaster prevention and mitigation.

When the ELF first assesses an institution, its consultants identify areas of disaster-related risks that can be corrected with technical assistance. Generally, MFI risk management means taking steps to avoid operational problems or protect assets such as equipment and databases, Pereira explains. In recent years, many institutions have had to improve their emergency plans at the demand of regulators. But when it comes to disaster risk, aside from a few institutions that suffered the effects of Mitch, few MFIs have dealt with it.

Part of ELF’s mission is to strengthen client capacity to prevent and manage risks from external factors. With the facility’s technical assistance component, consultants map areas vulnerable to threat or catastrophes, for both MFI offices and areas where clients are concentrated. Based on lessons learned and best practices from international experiences, they set up emergency plans and prepare the institutions for the moment when they have to confront an external crisis. All this so that they can protect their assets, stabilize their loan portfolios, and evaluate their own and their clients’ liquidity needs to help them overcome the crisis.

Speedy Recovery

Salvadoran MFI Apoyo Integral is a typical case. It received ELF technical assistance shortly before two almost simultaneous natural disasters in October 2005: Hurricane Stan and an eruption of the Ilamatepec Volcano. Flooding after five days of torrential rain killed 73 people and forced more than 70,000 to abandon their homes in the capital and several regions in the country. Volcanic ash from Ilamatepec’s eruption caused landslides in several municipalities, forcing yet more people to become refugees. Losses and damage to the country’s economy were calculated at US$335 million, including housing, farms and infrastructure. According to Apoyo Integral’s financial manager, Imelda Zaldivar, the microfinance institution had already begun to implement the contingency plan developed with ELF assistance. They took preventive steps to protect their installations and fixed assets, as well as to ensure the safety of personnel. Afterwards, they evaluated damage suffered by their clients. Of the approximately 20,000 micro and small businesses with which Apoyo Integral works, 1,620 were directly affected, representing some US$900,000 of a total of US$14.5 million in the loan portfolio.

Disaster victim

When natural disasters hit, microfinance institutions can expect a surge in demand for credit from their clients, as well as an increase in withdrawals and delays or interruptions in payments due to transportation problems or paralysis of commercial and productive activities. Often there is an urgent need for liquidity that, if not satisfied, can force an MFI to reduce or even stop disbursing funds, affecting not only the ability of its clients to recover, but of local economies as well. In anticipation of such a surge in demand for resources, Apoyo Integral obtained a loan from ELF for US$750,000. Based on the inventory of the disaster’s impact on its clients, the MFI negotiated arrangements individually: it pardoned interest, suspended punitive fees, extended payment terms and granted grace periods, according to each case. As a result of such emergency measures, Apoyo Integral not only managed to mitigate the increase of default in its portfolio, but also was able to provide clients with additional credit to speed up recovery.

The ELF will operate for four years, after which its shareholders have to decide whether or not to extend its charter. During its first year, the facility managed to cover its operating costs, thanks mostly to its administration of treasury resources. According to Pereira, if there is a low demand for emergency loans in the next few years, the ELF’s shareholders at the very least will avoid losing their investments. Paul DiLeo, CEO of the private Gray Ghost Microfinance Fund, expresses satisfaction with its participation in the ELF. That fund, created by a family of real estate investors in Atlanta, Georgia, has a portfolio of US$75 million. Their decision to participate in the ELF resulted from contact with other sponsors of the facility and their interest in supporting initiatives that could open the door for more private investors to become involved in microfinance. Gray Ghost works primarily with investment funds specializing in microfinance institutions, which typically make long-term allocations to support the development of selected MFIs. The ELF is an exception to this rule because its operations are short term, but it plays a key role in serving a true need of MFIs. “Certainly we don’t want there to be more catastrophes in the region,” stresses DiLeo, “but we would like to think that, simply by virtue of the ELF’s existence, microfinance is now seen as a more robust industry within the financial sector, because it has the kind of mechanisms that can increase the stability of its institutions. We haven’t taken polls to show that this is the case, but we are confident that the ELF contributes to a stronger infrastructure for the industry, and we are very pleased that this has taken place.”

For DiLeo, one of the most attractive aspects of the ELF is its technical support facility, which receives resources from the Rockdale Foundation, an institution linked to Gray Ghost’s investors. “Perhaps it isn’t a terribly striking subject, because it doesn’t involve crisis or emergency loans, but technical assistance that prepares microfinance institutions to prevent catastrophes and mitigate their effects will probably be the accomplishment of the ELF that has the greatest impact. In the long term, it will be as important as, if not more important than, its financial operations.”