Raising Funds Online: What MFIs Should Know

February 15, 2009    

Online platforms are changing the way we engage with the world. Web sites like eBay and Facebook link people, ideas, products, and markets. So it’s no surprise that online philanthropy is changing the nature of how and where people give. Social investing through online platforms like Kiva.org and MicroPlace.com has become wildly successful in raising funds for microentrepreneurs from individual online “lenders” and “investors.”

As the phenomenon of online social investing evolves, CGAP has released a focus note entitled “Microfinance Managers Consider Online Funding: Is it Finance, Marketing or Something Else Entirely?”. The paper highlights some important issues microfinance institutions (MFIs) may want to keep in mind before borrowing online.

The success of online lending and investing
Generally, online lending platforms lend money raised from Internet users to MFIs that, in turn, onlend to the microentrepreneurs listed on the platform’s Web site. Some platforms offer a financial return for these funds; others, like Kiva.org, offer no financial return to their online lenders. In spite of this absence of financial return, Kiva has used this model to raise over US$49 million since its launch in 2005. This stunning success has grabbed the attention (and wallets) of social investors eager to invest as little as US$25 or US$50 in microfinance. And the number of online lending platforms for microfinance is growing.

What this means for MFIs
Online lending platforms can seem like a terrific bet for an MFI in search of loan capital. These platforms can deliver substantial funds in very short periods of time – sometimes just hours – at highly subsidized interest rates, and they can generate valuable positive publicity for MFIs profiled on the platforms’ Web sites. Indeed, the perceived size of this online audience is so large that some MFIs view online borrowing first and foremost as an important marketing opportunity and only secondarily as a source of funding. But what risks do MFIs face when borrowing online?

What to look for
Choosing among online lending or investing platforms can be tricky, because they operate through many different business models, in varying legal forms, from a range of home country jurisdictions with varying regulatory and legal requirements, and with widely divergent business and social objectives – all of which impact the products, services, and nature of these platforms’ funding patterns, costs, and partnerships. However, what makes these issues all the more pressing for an MFI when it contemplates online funding is that many of these online platforms are very new, so they do not have a meaningful track record of experience.

Here are eight questions MFIs should ask themselves when considering attracting funds through online lending and investing platforms.

1. Which online platforms can be counted on to provide funding in the amount and at the time when needed, and what additional support do they offer to help the MFI?
Before borrowing from an online platform, MFIs need to conduct due diligence about the stability and support offered by the online platform. This due diligence should include asking the online platform (and other MFIs that have used that platform) questions like:
- Has this online platform consistently been able to provide funding in a timely manner and in expected amounts?
- How “loyal” to the platform are its online lenders and investors?
- Does the platform have all the regulatory and government approvals from its host jurisdiction to raise funding online?
- What other valued services does the online platform offer its partner MFIs (technical assistance, positive publicity, etc.)?

2. What is the cost and currency of the online funding, and who bears the foreign exchange risk?
The cost of online funding to an MFI is not always easy to quantify. So it is important for MFIs to look at the cost of the reporting and other requirements that it may need to meet to receive online financing. One important potential cost is the foreign exchange risks that some online platforms impose on MFIs. While online lending platforms may be best equipped to manage foreign exchange risks, few of them have come to this conclusion thus far. Until they do, the borrowing MFI should take concrete actions to mitigate these risks.

3. What are the reporting requirements for the MFI?
Many online lending platforms prize the personal connections that can be made from online “lenders” to the microentrepreneurs profiled on the platforms’ Web sites. However, MFIs must hire staff or consultants to develop and update these microentrepreneur profiles regularly.

4. How will the MFI manage abrupt and perhaps unpredictable shifts in funding patterns?
It’s not clear yet whether online lending platforms are a stable, recurring source of funding. An abrupt shift or slowdown in funds – due to global financial troubles, changing attitudes toward microfinance, or even problems within a platform itself – could make for a rude awakening for an MFI that suddenly finds itself with a liquidity problem. However, at least two online platforms – Kiva and MicroPlace – appeared to be enjoying growing sources of funding in late 2008, even as more traditional sources of funding to microfinance have slowed.

5. How do more traditional lenders to the MFI view borrowing from online sources?
Traditional lenders might develop concerns about currency, short duration, and refinancing risks, as well as the soundness and debt management expertise of the online lending platform itself and its documentation requirements. They may also worry about how an online platform will collaborate with an MFI’s other lenders or what additional support it can provide if the MFI faces repayment or other financial difficulties.

6. What management information system is adequate to meet microcredit portfolio reporting needs?
Some online lending platforms may require MFIs to specifically report on the portion of their microcredit portfolio that is being funded with online financing. MFIs will need to assess if they have an appropriate management information system to do so.

7. What customer privacy and consumer protection concerns are posed by posting client information online?
MFIs should help inform online lending platforms ensure that they are responsible in protecting the privacy of customer data – particularly when sharing sensitive data about client credit and repayment history online.

8. What due diligence about online platforms should the MFI conduct to satisfy anti-money laundering and anti-terrorist financing rules?
MFIs that are subject to anti-money laundering and combating the financing of terrorism (AML/CFT) regulation must make sure they are not exposed to any suspect sources of funding when they tap online funds. Because the origin of online funds is not always transparent, the MFI must be able to trust that its online lending platform has conducted adequate due diligence about its users.

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The well-publicized successes of platforms like Kiva and MicroPlace are likely to generate a surge in new online lending platforms aimed at microfinance. But as the field grows, MFIs should view online borrowing not just as a marketing opportunity, but as a serious funding decision.