Reflection: Coordinating Responses to Microfinance Solvency Challenges

As CGAP’s briefing paper, “Microfinance Solvency and COVID-19: A Call for Coordination,” points out, when COVID-19 hit, it did not take long for questions to emerge about whether the pandemic posed an existential threat to the microfinance sector. Monitoring solvency continues to be important, particularly as the reverberating effects of the pandemic reveal weaknesses in certain segments of the microfinance sector – by tier and region.

Here, we offer three key reflections on common threads that emerged from commentators’ responses to the paper and propose areas where further coordination among microfinance stakeholders is likely to become increasingly necessary.

Reflection 1: Vulnerable populations deserve (and depend upon) resilient providers of microfinance

Any discussion of the challenges currently confronting the microfinance sector needs to start with a reminder of what is at stake — the well-being and livelihoods of the vulnerable people in the world who have come to rely on access to financial services, and of those who still do not have access to financial services but could benefit from such access.

These vulnerable populations deserve resilient and robust providers of finance. Unfortunately, the credit risk of microfinance portfolios, uncovered by loan loss reserves, is currently soaring at rates as much as five to six times higher than in pre-pandemic times. While this expanding risk has not presented itself as a liquidity crisis, there is reason to be concerned that insolvency risk is growing among certain segments of the microfinance sector. Particularly vulnerable are Tier 2 and 3 microfinance providers operating in Sub-Saharan Africa. These are also the providers that often bring financial services to the poorest populations, and if these institutions fail the impact on access to finance will be severe.

Reflection 2: Sound and timely data is a necessary precondition to responding appropriately to solvency challenges in the microfinance sector

Generating sound and timely data about the state of microfinance portfolios has been particularly challenging during the pandemic. Clarity, which can be challenging in even the best of times, has suffered due to a number of pandemic-related factors, ranging from the imposition of payment moratoria by regulators to variances in how restructurings are accounted for on the books of microfinance providers.

The availability of good quality and appropriate (timely and comparable) data is important at all levels. Big picture data at a regional or global level is crucial to how regulators and other microfinance stakeholders garner the resources to respond in a timely fashion to solvency challenges within a market. Accurate data about the portfolio quality of individual microfinance providers is vital for managers’ ability to operate, as well as for informing the investment decisions of existing and potential debt and equity investors.

We need platforms for generating and sharing information, enabling regulatory environments for data sharing that protect the interests of customers, and investments in building strong, reliable and cost-effective underlying infrastructures—the servers, the connecting fibers and the wide range of distributive and storage hardware that underpins it all.

Reflection 3: Blended finance approaches need to be developed before, not after, solvency challenges surface in the microfinance sector

Appropriate funding mechanisms are required to provide solvency support. No single source of financing is sufficient or appropriate for responding to the solvency challenges surfacing in the microfinance sector. The time is now (not after the fact) to develop approaches for blending public, private and donor funding to minimize the damage that insolvency poses to microfinance providers and, importantly, their customers. Deliberate risk sharing across multiple funding sources can include the creation of instruments to address pricing issues (variable, performance related returns), loan structuring needs (longer grace periods and tenor, sculpted repayments), security ranking issues (subordination, payment waterfalls, exit mechanisms) and last, but not least, the ability to provide local currency finance and reduce the downward pull of uncovered foreign exchange risk.

Development finance institutions (DFIs) have an important role to play here given their long histories in responding to regional market failures and challenges. Moreover, relative to more commercial sources of funding, many DFIs have relatively cheaper sources of capital, longer investment horizons, mandates that encourage appetites for greater risk-taking in return for the achievement of development goals, capacity to produce big ticket investments, and important connections with sovereign (publicly owned) donors. But they need to work in close collaboration with private sector investors that bring speed, agility and an ability to structure financing facilities that distribute risks according to parties’ capacity to mitigate or manage such risks, which is one of the key principles of any public-private partnership. Donors (private and public) also have an important role to play as they can support appropriate risk allocation among investors and help microfinance providers to make better use of (or even attract) needed investments from public and private sector funders.

Call for increased coordination

Key to responding to all the above is a renewed call for concerted efforts by microfinance stakeholders to partner and coordinate their response. Not every microfinance provider facing a solvency crisis should be rescued. But to avoid working at cross purposes, there needs to be agreed criteria for determining what and when support should be provided. Similarly, regional contexts need to be identified so that the financing mechanisms created are fit for purpose – by region and by institution.

The recent pandemic is not the first, nor will it be the last, crisis to challenge the microfinance sector. Catastrophic events caused by climate change or new health scourges are sure to come. Advances made today will help the microfinance sector weather challenges in the future. This is the time to bring creative responses to improving the reliability of data about microfinance portfolios, advancing appropriate digitization within microfinance providers, and developing regional financial facilities that blend capital from public and private sources for those microfinance providers that warrant additional support.