Transparency In SME Investments: We’re Not There Yet
In November 2012, CGAP completed a scan of funding flows from development finance institutions (DFIs) to small and medium enterprises (SMEs). A subsequent study (unpublished, but discussed here) revealed that the main objectives for supporting SMEs cited by most DFIs were to accelerate growth, economic development and job creation. Our 2011 survey found over 300 SME funds with total cross-border commitments estimated at $21.9 billion.
One of our in-depth interviews with members of the DFI community yielded this statement: “What is clear is that the DFI community is being challenged to justify our existence. We need to prove that we serve a role beyond the private capital, we should not shy away from frontier markets and we must be at the forefront of providing the risk capital needed.”
Do DFIs’ investments really complement private capital in the SME space? Do DFIs influence the SME funds to produce social outcomes that go beyond financial returns? What indicators do they track? How do they measure the impact?
Photo Credit: Andi Sucirta
For the first question, we are not aware of any research to directly answer this contentious question related to DFI investments in SMEs. A 2011 paper entitled “Role Reversal Revisited” by MicroRate did look at DFI investments in the microfinance sector and found that, while considerable achievements can be shown, DFIs have become “more risk adverse – just 10 large microfinance institutions absorbed nearly half of all DFI lending between 2008 and 2010.”
Based on CGAP’s long engagement with DFIs, we can say that DFIs have strong desires to complement rather than compete with private capital. We have reasons to believe that in the SME lending space, DFIs provide catalytic funding in areas that many local commercial banks find too risky. According to our study, most public investors do not favor one sector over another as long as commercial viability and development impact criteria are met. Beyond financial indicators, surveyed DFIs most commonly track job creation, women's employment, rural client coverage, governance structures, diversification of source capital, and portfolio quality indicators - such as non-performing loans or portolio at risk - at the SME funds where they invest.
There are some concrete examples of DFIs tracking impact. For example, the International Finance Corporation (IFC) tracks development impact of SME investments through a formal system of reporting that includes a development matrix and environmental, social and governance (ESG) reports. such as The Asian Development Bank uses baseline indicators when they enter investments and they measure them after exiting. CDC, UK’s DFI, tracks funds at five years and again at 10 years looking at financial, economic, ESG and private sector development indicators.
Despite evidence of financial and impact tracking, most DFIs do not disclose data on financial performance. When they do, they often provide only anecdotal examples. Reporting on social impact is even harder to obtain. Part of the reason is that most SME funds supported by DFIs do not themselves collect or track impact indicators in a systematic way that would allow for suitable comparisons. We are still a long way from full transparency.
There is hope, however. All DFIs have established indicators to track the impact of their investments. The challenge is for DFIs to first agree on a common set of impact indicators, then collect and disclose the data. Many DFIs are currently engaged in the debate around the Principles for Investors in Inclusive Finance (PIIF) which provide a framework for responsible investment.
Among the DFIs, only FMO so far has signed on to the PIIF. More optimistically, 50 asset owners and investment managers have signed on including several that received DFI direct investments beyond those from FMO. We hope that more DFIs will come around and sign on to PIIF which, through its Principle 5, commit the signatories to “promoting transparency in all their operations”. Only then and with hard impact data that DFIs will have no fear to “justify our existence”.
------ The author leads CGAP's workstream on MSE.
This blog post launches a series focused on informal MSEs (micro and small enterprises) featuring both CGAP and external contributors. Our goals are to draw attention to this huge underserved market segment, foster discussion around access to finance issues and highlight practical innovations that contribute to reducing the financing gap for informal entrepreneurs.