CGAP’s focus note Facilitating Market Development to Advance Financial Inclusion is quite timely and useful to funders that provide concessional loans to partner governments, such as the Japan International Cooperation Agency (JICA), where I am currently serving as a visiting senior advisor. JICA also supports governments with grants and technical assistance, and private entities using debt and equity.
These funders that extend loans to governments often provide a credit line to apex agencies in partner countries. A microfinance apex is an organization that channels funding (grants, loans, guarantees) to microfinance institutions (MFIs), which in turn extend credit to a targeted group of clients, such as the urban and rural poor, or micro/small enterprises. In some countries, the central bank takes the role of an apex.
Photo Credit: Subarata Biswas
This practice is justifiable when affordable private funds are unavailable, or when the number of capable financial institutions is limited in spite of strong demand for financial services by the poor and financially excluded. However, public funding should not crowd-out private funds and providers. Once the private financial market is well-developed, public funding should be gradually phased out. Even when public funds are temporarily used to fill market gaps, these funds should be aimed at catalyzing private investment at an affordable price and crowding-in more private financial providers. For example, an interest rate charged from private/public financial institutions by an apex agency should be market-based, or if not, a subsidy component should be utilized for public goods’ purpose for market development such as on information flow and capacity building at the macro, meso and micro levels.
Another possible way to crowd-in private funds is co-financing between public and private sources. However, this is unlikely in the case of microfinance given the small size of loans needed by most microfinance institutions.
The formation and implementation of policy measures and capacity building to facilitate market development could be attached as a condition to the loan, supported in the form of technical assistance, or provided in parallel as a grant.
This arrangement between public funders and apexes carries several risks. First, financial institutions might only be attracted to the subsidized funds provided by an apex agency. The cheap and easy access to apex funds usually discourages savings mobilization since most of these financial institutions may not be eager to adapt their capacity to offer multiple products and services tailored to the needs of the poor. Second, an apex agency might not be able to initiate and implement reforms aimed at creating an enabling regulatory environment and an innovative financial infrastructure to support inclusive finance. Third, both funders and their partner government might be more interested in quick disbursements to the poor and satisfied with filling a financial gap among a targeted group rather than medium-term market development. In some cases, official loans could be extended even without properly assessing the present state of financial markets development in a partner country from the perspective of expediting financial inclusion.
In order to minimize these risks, funders providing loans to governments, policy makers, regulators and industry leaders in a partner country should form a longer vision towards inclusive financial market development, conduct a market assessment, and detail out necessary policy actions and capacity building initiatives. As this focus note rightly points out, the important role of a “market facilitator” and the methodologies of measuring market development have to be well studied and understood. By so doing, the medium- and long-term impact or “additionality” of official loans could be maximized. Technical assistance or loan conditions for the development of inclusive financial markets should be the pivot of official loan operations. Furthermore, concessional loans should only be regarded as an incentive for related stakeholders to gain a reform momentum, or a transitional measure before and during a reform, not the other way around.
Kazuto Tsuji is Chair of the CGAP Executive Committee and a Visiting Senior Advisor at JICA.