Bankable Frontier Weblog

A recent New York Times article  calls attention to a very significant factor which is likely to have a dominant effect on capital markets for the next 5-10 years. It is also starting to have a significant effect on microfinance.

It is simply that there is a glut of capital in the world today. The author of the NYT article, Floyd Norris, finds evidence for this in phenomena such as:

• long term bond rates move slowly in response to central banks raising short-term rates as they are now doing in developed countries;
• there is little yield premium in junk or risky bonds;
• Argentina could get away with its recent imposition of harsh terms on its creditors; and
• stock prices remain historically high.

Underlying this are demographic factors: until the general retirement of baby boomers in the west, especially the US after 2010, there is still a net surplus of retirement savings flowing into capital markets seeking an investment home.

Norris calls attention to some of the implications of the glut: “profit disappointments may not cause stock market to plunge, since capital will have to go somewhere, but return

on underlying investments is likely to be below what investors have expected.”

A corollary, not directly stated by him, is that capital is likely to continue to flow out of the US (and elsewhere) in search of higher yields, such as those which are offered in major emerging markets. In some of these markets, the macro-economic risk is also lower today, further encouraging the investor herd to stampede in.

What does all this mean for microfinance today?

In part, the glut explains the veritable tidal wave of capital seen to be heading south. Investors and banks in developed countries are scrambling to find the higher margins and returns which microcredit apparently offers, especially now that the microcredit movement has sanitized high interest rates of much of their previous social stigma. In fact, international banks can now argue that they are achieving positive social impact through high interest lending programs in developing countries. And they may be…

But the number of sustainable micro finance institutions (MFIs), narrowly defined, which can absorb this increased investment is still small. According to the MicroBanking Bulletin, only 45 of 60 microfinance organizations who report their performance were financially sustainable in 2002. This is an increase from 26 in 1999; but the overall number of MFIs with the ability to absorb large scale commercial investment is still highly constrained—certainly relative to the supply of funds becoming available. Apart from general investors, a recent paper identified 43 new and existing specialized microfinance investment funds and a further 16 donors or NGOs which invest in microfinance. 

The outcome of too much money chasing too few goods in the sector is sure to be the same as always:

• inflating the price of equity in the better ones such that it will be hard for new investors to earn a risk-related return (especially adjusted for currency or market risk); and/or
• creating pressures to grow MFI balance sheets by tapping the available debt and then deploying this excess liquidity into lucrative, ‘easier’ markets such as consumer finance. However, as the example of South Africa shows, lending to salaried people is not necessarily less risky than traditional microfinance; in fact, it is easy to get wrong if you ignore the fundamentals of good credit. And when a collapse comes, it will be significant since the amounts involved are typically much larger.

So, while today, investors in microfinance focus on accelerating the growth of investee MFIs in order to pick up the benefits of greater scale, where are the microfinance buyout funds ready to pick up the pieces from any local collapses? And, while consolidation of smaller into bigger MFIs has been long expected in many markets, when is the consolidation of small, uneconomic MFI investment funds going to start?