Microfinance Faces Changing Risks: Banana Skins 2011

February 2, 2011    

With growth in some markets moving at a fast pace, the microfinance sector faces changing risks. The latest Microfinance Banana Skins 2011 report shows that microfinance institutions must confront new realities to sustain the good reputation the microfinance industry has enjoyed in recent years. The survey measured the risk perceptions of more than 500 practitioners, investors, and close observers of microfinance in 86 countries.

According to the survey, threats to the industry’s reputation are now seen as one of the fastest-rising risks facing micro-lenders. In the rankings, reputation risk has risen from 17th place in the last survey conducted in 2009 to second place in today’s survey. This is the largest leap recorded by a “Banana Skin” since the series was launched in 2008, and reflects recent controversies over microfinance lending practices in various markets, particularly India.

In some local markets, the rapid rate of growth and outreach means that microfinance is confronting the same forces of competition, credit cycles, and growth and consolidation seen in other sectors. In a few markets or sub-regions, particularly where there are numerous microfinance institutions serving the same communities, some respondents to the survey expressed concern about an oversupply of credit and over-indebtedness. The potential for loan losses is seen to be high in some markets, showing a striking departure for an industry that has always prided itself on its “99 per cent” repayment record.

The volume of concern may be amplified by recent events in a few markets, most notably in the Indian state of Andhra Pradesh. In many markets, MFIs and investors have already taken notice of the changing risks. MFI growth has slowed, lending standards have been strengthened, and more attention is being given to social performance. In several countries, the rate of increase in non-performing loans at MFIs is easing and more sustainable growth models are emerging.

Although political risk is confined to a few specific markets, it is feared to be spreading. Another riser is the risk of “mission drift” (up from No. 19 to No. 9). The results also show a strong rise in concern about competition (up from No. 9 to No. 3. Institutional risks such as weak corporate governance and poor management quality remain in the Top Ten.

However many risks, particularly those associated with the financial crisis, have eased, notably liquidity risk (down from No. 2 to No. 16) and funding risks which are now close to the bottom of the scale.

Responses also reflect an industry that is at different stages of market development in different regions of the world. The 46-page report provides a commentary on each of the 24 risks that were identified, and breaks down responses by type and region, providing detailed views of the concerns by geography and different classes of respondent. These show that risk perceptions vary considerably between markets. For example, reputation risk is seen to be much higher in Asia (No. 2) than in Latin America (No. 8) even though both these regions have highly developed microfinance industries.

Microfinance institutions’ capacity to manage fast growth is an issue that CGAP has been researching, and a year ago CGAP published a Focus Note, Growth and Vulnerabilities in Microfinance that warned about potential growing pains in some markets. But it is also worth bearing in mind that while fast growth may be high on the radar screen, the microfinance industry is still only reaching 180 million borrowers worldwide--a fraction of the global need. More than 2.7 billion people in the world still have no access to the full range of formal financial services that are cheaper and more reliable than the informal alternatives.

A vision of financial inclusion that encompasses the majority of the world’s population goes well beyond what is captured in this one report. Banana Skins 2011 offers one set of perceptions that can be used to understand the changing risk landscape so that the industry can take heed, and also take advantage of new opportunities in a way that will improve outcomes for poor people.

The survey was conducted by the Centre for the Study of Financial Innovation (CSFI) and sponsored by Citi and the Consultative Group to Assist the Poor (CGAP) with support from the Council of Microfinance Equity Funds (CMEF).