By Elisabeth Rhyne
Thanks to the COVID-19 crisis, many microfinance borrowers can’t repay their loans. That in turn means that microfinance institutions (MFIs) won’t be able to fulfill obligations to their investors. And that means that microfinance investment vehicles (MIVs) will have trouble maintaining obligations to the ultimate funders, who are often large, well-financed Development Finance Institutions (DFIs). So, there’s a value chain that often looks like this: Customers < MFIs < MIVs < DFIs. And if the chain breaks down, customers end up alone and without support.
In the current economic environment, MFIs should ideally be supporting their clients by offering moratoria on loan repayments, access to client funds on deposit, and, when reopening begins, fresh loans. But the many MFIs, funded in large part by international loans, can only extend these benefits if their own creditors also offer moratoria, liquidity and eventually, replenishment of capital. The Microfinance Coalition, a group of microfinance providers brought together to address the COVID-19 crisis, is urging investors to provide this kind of support. This brings us to the previous link in the chain, the MIVs, which provide debt and sometimes equity to MFIs. Could they be leaders in ensuring that benefits reach clients? The MIVs are private investment funds, which are in turn at least partly owned by the development finance institutions (more on them below). The MIVs ought to share some of the costs, but ultimately the DFIs need to step up to shoulder the burden.
The Conundrum for MIVs
Recently a group of MIVs, now sometimes referred to as the Big 9, signed a Memorandum of Understanding on their treatment of microfinance institutions during and following the pandemic. With a large share of total assets in the microfinance investment vehicle space, an agreement among these nine organizations is likely to strongly influence other investors. Unfortunately, this MOU illustrates just how constrained the MIVs are by the relationships that in normal times make the chain work. Instead of putting together new emergency facilities to assist MFIs, the MOU is about minimizing the inevitable losses and figuring out who will bear them. The maze of interconnections with other investors makes it difficult for any one MIV to generously provide lifelines to MFIs and, through MFIs, to their needy clients.
A typical debt-funded MFI manages an often-complex portfolio of loans from various creditors, each with its own repayment dates, renewal criteria, covenants and reporting requirements. Failure to meet some covenants may trigger a call to repay a loan immediately. When financial performance begins to deteriorate, the funders must talk among themselves to sort out the best path forward. These conversations are often time-consuming and fraught. No funder wants its fresh capital to end up in the accounts of a more hardline player.
The MIVs that have come together in this MOU know each other well. They invest alongside each other in many MFIs, and they have been through workout situations together from time to time. But now, rather one or two problem companies at a time, they face the potentially overwhelming catastrophe that every MFI in their portfolio will need some form of workout negotiation.
Accordingly, the MOU takes on two main tasks. First, it provides a triage rubric for placing MFIs into one of four categories based on their financial health, from MFIs that can safely be extended forbearance and other support, to those that are failing. For each category, elements of the appropriate response are laid out. Second, the MOU states principles for creditors to voluntarily move in concert rather than jockeying for position. By creating a dominant bloc of investors that have already agreed on their approach, and that communicate transparently with each other, these principles aim to cut through the laborious and stressful process of herding investors.
The MOU is a positive and necessary step for these MIVs. Such a process was not in place when the 2008-2009 financial crisis hit the microfinance sector. Learning from that experience, the MIVs have perhaps acted faster this time. Early action plans for institutions in the healthier categories may avert the failure of some MFIs.
However, the MOU also exposes the difficulty in creating a truly positive response from the MIVs. One might ask why investment funds that gather their capital from the wealthy of the world cannot take the lead to provide extraordinary support— a lifeline —to low income people through MFIs. Any MIV that offers an extraordinary benefit for its investees—say an emergency liquidity fund – risks having their initiative implicitly prop up other investors instead of being extended to clients. Further, since MIVs bear fiduciary responsibility to the funds of their investors, they must follow prescribed rules of behavior, including rules imposed by local regulators. Moreover, many non-MIV investors, especially local investors, may not want to or be able to go along. In this kind of game, the behavior of the least generous significant creditor can end up carrying extraordinary weight.
The Role DFIs Need to Take
Given these constraints, attention turns to the previous link in the chain – the DFIs. With their public sector backing, DFIs are better positioned to offer liquidity, guarantees or even extraordinary debt forgiveness. However, we have not yet seen a bold or coordinated response from the DFIs, although as investors many of the MIVs that signed the MOU, they give the MOU tacit support. Some of my contacts in the MIV world note that the DFIs have tended to focus during the crisis on their larger holdings, not holdings in the microfinance sector and that they have at times offered extra support on a case-by-case basis, rather than supporting the market as a whole. Paul DiLeo and Ira Lieberman, have called for emergency liquidity facilities and similar forms of leadership by DFIs. Among European DFIs, talks are underway to create such facilities, but these are not yet finalized or public. In the meantime, some contacts call the DFIs “missing in action.”
Throughout the world economy, a vast set of negotiations are taking place about the fair distribution of the inevitable losses that the economic slowdown imposes on nearly every player in any value chain. In the microfinance value chain, the people least able to bear losses are the low income people who borrow from MFIs. As we move up the chain to MFIs, MIVs and DFIs, we also see the limits of what MFIs and MIVs can bear and their scope for action. Ultimately, the public sector institutions need to step up more boldly and at a broader level. Although they were unable to create a real time response in the first phase of the crisis, now, as economies begin to reopen, they could take action to create facilities that provide new funding or guarantees to support the economic recovery of the microfinance value chain— all the way down to the customers.