Credit crunching the numbers: How MFIs are being affected by the crisis and using deposits to help

Back in September of 2008, I wrote a piece titled on On Bailouts, Boons and Bill Clinton that attempted to explain how the onset of the credit crisis will affect the microfinance industry and as a result restrict the poor from access to financial products. Eight months later, we have an opportunity to look to see how things have actually shook up and also take a stab at how things will continue to unfold going forward. In that original piece, I spoke to how the growing dependence of established microfinance institutions (MFIs) on outside sources of capital will inevitably result in them being affected by the credit crisis, regardless of how insulated the industry claims to be.

Well unfortunately it appears as though that is coming true. On May 20, 2009, Dave Richards at Defeating Global Poverty wrote about his visits with various MFI leaders throughout India and their ability to weather the funding storm. One of his observations is that the industry is not being hit evenly when controlling for size and recognition, as the largest MFIs like SKS Microfinance are still able to secure funding from investors. In addition to this, these larger MFIs are able to go out and securitize such loans in order to mitigate the risk underlying them. But smaller MFIs are definitely struggling to obtain outside funding, which is a problem because as Richards notes these are often the type of entities that are being the most innovative and risk-taking. Given the risk-averseness of the continuing funders these fringe groups in the space are likely to be the first ones to be hit.

One of the more significant points he raised is that in India the government still does not allow for MFIs to accept deposits as a source of capital. In a report by USAID, one of the points highlighted is that MFIs that are unable to utilize deposits as a source of lending are harder hit than those that can. This fact is unsurprising as enabling MFIs to use their deposits for capital, as traditional banks do, would provide a hereto untapped pool of cash for lending. It is also unsurprising then that India’s MFIs are struggling if they are not in the top quartile of size. Nevertheless, while the report recognizes that deposits are unlikely to shrink in the crisis, they are also a part of a long-term strategy and will be of little help to alleviate the current crisis.

This is a constraint that poses a problem to the MFI industry before, during and even after the crisis. As long as deposits are not allowed to be used as a source of capital, much of the demand for microfinance loans will be unmet especially during these tight times. Muhammad Yunus has been quoted questioning this economic model that forces MFIs to be dependent on outside capital for all loans. This same article in the IndiaKnowledge@Wharton estimates that Rs 480 billion ($12.06 billion) is the size of unmet loans in India (this was written in 2007).

Here is Yunus speaking on how Grameen focuses on the deposits as a critical part of their business model:

Grameen in the past depended on donor money to bridge its funding gap. Now it relies on deposits from its poorest customers to provide the resources needed to disburse $500 million a year. "That’s the only way to become self sufficient — as all grants and donations come with some strings attached," Yunus says. Yet to ensure that people do not abuse the system, he says a dedicated regulator for the sector is required.

Unless India gets serious about issues like this, microfinance will continue to be limited in its reach to those who need it most.