Melchior de Muralt is Vice President, Blue Orchard Finance Ltd and Partner at Pury Pictet Turrettini &Cie Ltd. Jean-Philippe de Schrevel is Director of Blue Orchard Finance Ltd.
Globalisation has revealed the widening gap between the wealthy and the poor of the world. But instead of pouring yet more aid into poverty-stricken areas, responsible investment, in particular the provision of financial services to poor entrepreneurs, has been found to be a more effective social and economic development tool – and a great way for family businesses to give back to society
Globalisation is now a fact. Our world is growing ever more interdependent, financially and culturally. This trend puts the entire world within reach of the wealthiest but it also reveals a widening gap between the haves and have-nots of this planet. International tensions will arise and the September 11 attacks in the USA are a timely reminder that if the world is to grow sustainably in the future, it will have to find a way to share benefits of its globalisation more equally. This does not mean that more international aid or charities should be poured into poor countries. We have repeatedly seen the limits of the old concept of multinational assistance to development.
The good news today is that in some specific fields, the idea of responsible investment is proving to be a very efficient social and economic development tool. It completely reverses the negative dynamics of assistance: it replaces donation with investment in a partnership where the poor person is considered to be responsible for his own destiny and where his own personal drive will get him out of poverty.
Microfinance is one specific area where responsible investment has shown excellent results. In a nutshell, it can be described as the provision of financial services to poor entrepreneurs who are not serviced by traditional banking. By allowing the economically-active poor to borrow, to lend and to insure themselves, microfinance operators give them the conditions to grow their business and to improve the welfare of their families.
Such democratisation of access to capital is a prime example that globalisation can also be beneficial to the less fortunate on this planet. It is not the panacea, and obviously more will have to be made in other areas such as health and education – and probably in the same spirit and along the lines of responsible investment. But microfinance is a very concrete and powerful way to change the way the world works – now.
Successful family businesses could see this as a unique opportunity to reconnect with their roots and to give back to mankind a little of what they received by investing precisely where they all started: at the micro and small business level. In fact, some microfinance companies have been created with the help of family business members because they feel it is such a worthwhile venture.
Microfinance is also a nice way to re-dynamise the younger generations of successful business families by making them aware of the fate of millions of poor micro-entrepreneurs and by offering them the chance to affirm themselves as responsible world citizens through concrete action and commitment in this field.
What is microfinance?
The vast majority of the populations of emerging economies still work in the informal sector of urban and rural areas. These micro-entrepreneurs, artisans and farmers are excluded from mainstream economic growth and must rely on themselves to survive. Their income often depends exclusively on the success of a small business in which they invest their frequently impressive skills, creativity and energy. Unfortunately, their ventures rarely extend far beyond the subsistence level, mostly because of lack of capital. Microfinance can be defined as an innovative and effective solution to deliver financial services (credit, savings, insurance) to this market segment.
Over the past 20 years, specialised financial intermediaries have successfully targeted this market and developed products and methodologies perfectly adapted to its needs and characteristics. They have proved that microfinance is a risk-manageable and profitable business. Micro-
entrepreneurs, who need rapid and continued access to services, borrow at market rates and boast a repayment track record that would be the envy of most commercial banks (97% on average). Experience has also shown that while microfinance is a business, it is also a powerful development tool: even very modest loans generate huge business productivity gains and contribute both to job creation and to raised family living standards (adequate nutrition, better health and housing, more education). Microfinance combines the profit-seeking motive with the priorities of social development.
It is no wonder that microfinance is now quickly gaining momentum: about 10,000 institutions are engaged in it today throughout the world. They are still a varied lot, in terms of size, legal structure and vision. However, two widespread and promising trends accompany the success of this new industry, reinforcing it structurally. The first is the increased professionalism and specialisation of its leading actors. Scale is the name of the game and profitable growth in a competitive market requires business talent.
The second trend is the close attention paid by regulators, auditors and rating agencies to those new institutions, given their growing importance in capital markets. Their involvement provides a solid legal framework for growth as well as transparency, and credibility of accounting and financial reporting. Microfinance is becoming an integral part of mainstream finance.
These trends are perfectly aligned with the goals of people and organisations focusing on poverty alleviation aspects of microfinance. Specialised know-how, profitable growth, and regulated competition and reporting are indeed the driving forces behind a sustainable and larger market coverage, control of financing and operating costs, downward pressure on retail prices and the broadening range of products and services offered, all of ultimate benefit to the target group.
Access to investment funds
Microfinance faces a huge demand and is developing along two lines. First and foremost, volume demand is growing exponentially, driven by the millions of micro-entrepreneurs who are still longing for basic financial services like working capital loans (only about 25 million of the estimated 500 million micro-entrepreneurs are now covered by microfinance institutions).
Second, new and increasingly sophisticated products (credit and debit cards, leasing, housing and education finance, insurance and transfer payments) are being introduced as the existing client needs evolve due to the growth of their business. The industry has a very strong growth potential. To put it in perspective, if each of those 500 million micro-entrepreneurs had access to the current average micro-loan of US$500, the annual market would represent US$250 billion.
Microfinance institutions need access to commercial funding. If they are to meet their projected demand, microbankers estimate that in the next five years, they will need between US$10 and US$20 billion. In this regard, they see the access to commercial funding as an essential condition for the successful coverage of the market that they target and as a crucial element in their development as financial intermediaries.
The good news is that microfinance is an attractive investment opportunity, a perfect win-win business. Microfinance has the undeniable potential to attract private sources of investment. Indeed, it offers for the very first time, in the field of social action, the opportunity to reach sustainability of impact through financial profitability. In other words, microfinance is a great opportunity for socially responsible investors to make a concrete and lasting contribution to the improvement of the lives of poor entrepreneurs and their families, while earning good financial returns. The integration of microfinance into the sphere of international capital markets holds the promise of a long-lasting, virtuous cycle of investment and growth.
A new financial asset class
Microfinance debt represents a new asset class that generates financial and social returns. It is characterised by a very attractive risk-return profile, making it worth considering in any portfolio diversification strategy. It also brings a new dimension to investing: the satisfaction to contribute concretely and effectively to the sustainable development of poor economies in the world by acting directly at an important source of value creation – the family-run micro-enterprise.
By investing in microfinance debt, one can contribute to the refinancing of specialised financial intermediaries delivering financial services of all kinds (credit, savings, insurance) to poor micro-entrepreneurs, sparking off a virtuous circle of capital accumulation and job creation. Better housing, nutrition and health, as well as better education, are among the most immediate social spill-overs of microfinance operations on the welfare of the micro-entrepreneurs' families.
But then again, the microfinance debt risk-return financial profile is attractive. The financial return generated by microfinance debt is good; it offers a better return than monetary instruments (an estimated additional 150 to 200 basis points) with only a slightly higher level of risk. It is an excellent alternative to fiduciary deposits or certificates of deposits. Also, the risk associated to microfinance debt is low. First, microfinance debt offers a lower exposure to volatility than traditional equities or bonds from emerging markets: it is materialised by instruments that are not yet quoted on stock exchanges, and its value is not influenced by hard to predict interest rates and credit spread movements.
Second, microfinance debt service is weakly correlated with political or macroeconomic events. The informal sector is by its very nature a thriving place of permanent business creation, less directly linked to the fate of the formal economy. Third, the leading microfinance institutions that are the target of our investments make for very solvent borrowers with low risk profile: their main assets are loan portfolios of very high quality, as demonstrated by their exemplary low default rate (less than 3% on average), much better than many traditional commercial banks.
Microfinance institutions have very well diversified portfolios; their own credit risk is spread over thousands of micro-borrowers and the market has such a potential for growth that this atomisation of risks will hold for a long time.
A financial and social investment
Our world is changing fast. Traditional roles and long established bearings are increasingly challenged. Threats and opportunities abound. Faster and deeper world integration reveals growing inequalities. Something in the way the world works has to change. Old-fashioned charity is increasingly giving way to a new form of altruism, a reaffirmed responsible world citizenship in which all parties involved are set on an equal footing and discuss as partners mutually beneficial relations for the greater good of mankind.
Microfinance is definitely a field of social action where the whole is more than the sum of its parts. By investing into the fast growing industry, family businesses take a leading role in demonstrating that private initiative, individual drive and leadership are worth more than half a century of public assistance.