Sources of Private Capital: Advantages and Disadvantages

Sources of borrowed capital for MFIs
  • savings mobilization from clients and others
  • concessionary loans from foundations, multilateral banks
  • international socially responsible investors (individuals and institutions)
  • lending from affiliated apex organizations
  • local commercial bank loans leveraged with outside guarantees
  • line of credit or loans based on the MFI's portfolio
  • limited partnerships or limited liability companies
  • open-ended mutual funds; closed-end funds; venture capitalists
  • debt instruments issued through national securities exchanges
  • issuing financial instruments like CDs to obtain debt internationally
  • issuing commercial paper backed by MFI portfolio

  • local savers may provide less costly funds; an important habit among clients and the public is rewarded
  • lower interest loans provide experience for MFI in borrowed funds
  • local banks become familiar with MSE (micro and small enterprise) potentials
  • access to larger sums more quickly based on track record
  • allows longer term projections than grants
  • provides a discipline similar to that of MSE clients

  • higher financial costs force organizational decisions and changes
  • substantial initial collateral requirements
  • more risky as debt holders can force closure of MFI
  • more tricky cash flow management as principal is repaid
  • early negotiations require a new set of skills and contacts
  • local banks may not be willing to be cooperative
  • loans may be dollarized in an inflationary situation
  • too many subsidized loans can retard move to market rate
Sources of equity investment for MFIs:
  • donations to the MFI used for equity equity from retained earnings
  • apex organizations or NGOs taking an ownership position
  • multilateral bank investments
  • open-ended and closed-end funds; private placement funds
  • venture capital funds or enterprise funds equity or quasi-equity investment funds
  • limited partnerships or limited liability companies
  • private institutional and individual investors for social and financial returns
  • private institutional and individual investors for only profit goals
  • equity-like subordinated debt

  • usually long-term patient capital that is not amortized
  • local and international capital invested at often lower returns
  • investors willing to take risks and be paid only if MFI profitable
  • can leverage more debt capital
  • ultimately can grow systematically based on owner's resources

  • must be not only sustainable but profitable cost of funds much closer to market rate
  • requires strong financial controls and management
  • social aims of MFI diluted or may be lost
Minimal External Economic Conditions before MFI Borrows Internationally:

  • inflation below 15 percent if borrowing hard currency
  • a reasonably predictable currency devaluation sufficient political % land stability for clients' businesses
  • higher interest rates in passive savings accounts than that paid to investor
  • easy to convert local to hard currency legally with minimal transaction losses. small difference between street K official rates
  • ease of bank accounts in local and external currencies
  • few restrictions in importing or exporting hard currency
  • a large client sector that is undeserved regulatory environment not hostile to MFIs
Minimal Internal Conditions of MFI before Borrowing Capital Internationally.
  • good, 3-year track record of lending donated funds proves methodology is efficient
  • realistic and regular rating of each outstanding loan, provisioning for loan loss, and writing off bad debt
  • real losses of usually less than 5 percent and an ability to sustain larger losses
  • changes in organizational culture to handle funds that must be repaid; includes experience with and commitment to seizing the client's collateral if necessary and a commitment to charge market rates
  • a system of informal or formal guarantees that permit sufficient pressure so clients pay
  • lending to diverse economic activities to minimize risk
  • good management information system with reliable numbers for management
  • tracking late payments and real losses; deploying staff to maximize the return on resources
  • having reached operational self-sufficiency with a reasonable projection of when financial self-sufficiency will be reached, Otherwise, the loan may finance operating costs with no way to repay investors
  • moving from just covering costs to generating a surplus (profit)
  • commitment to staff training and paying market rate salaries and incentives
  • Staff clear on the MFI's core values and vision
  • sufficiently attractive guarantee to offer to external investors
  • equity of at least 15 percent of total portfolio anticipated
  • adequate cash reserves to insure the liquidity necessary to pay investors on time
  • clear definition of the MFI's lending market and good statistics
  • a strong commitment to expansion in order to attract investors
  • a detailed understanding of its competition in financial markets where operating or expanding
  • access by clients to training and business development services
  • mechanisms for mobilization of savings and other local resources
  • accountability to the board, donors, clients and investors
  • sufficient knowledge of socioeconomic impact on the clients
  • regular external audits and internal controls to prevent fraud and put idle cash into interest bearing accounts
  • link with other MFIs through an association or international organization, providing training and professional standards for MFI.

Garber, Carter (1997) Private Investmnet as a Financing Source for Microcredit. The North-South Center, University of Miami.

Hari Srinivas -
Return to the Capacity Building Page
Return to the Virtual Library on Microcredit