FT: Calls for ratings framework amid surge in microfinance

The Financial Times

By Joanna Chung in London

http://www.ft.com/cms/s/6454c890-244b-11dc-8ee2-000b5df10621.html

Published: June 27 2007 03:00 | Last updated: June 27 2007 03:00

Microfinance is quickly becoming a popular corner of the capital markets as more investment banks and investors see the business of providing small loans to low-income individuals in poor countries as potentially profitable as well as a powerful tool for development.

However, some experts say there are obstacles preventing the microfinance sector from reaching its full potential, including the absence of a global framework that mainstream investors can use to assess properly the risks associated with the sector.

A transparent and globally acceptable method for rating microfinance institutions would help to open up the asset class to a much wider universe of investors than would or could invest in unrated securities, industry observers say.

"The lack of consistent metrics for analysing micro-finance institutions has hindered investment at a time when microfinance is growing at a significant rate," says Cynthia Stone, chair of the Emerging Markets Council at Standard & Poor's.

"Despite the level of interest, mainstream investors need standard metrics before they can invest in this particular sector. By creating standard metrics the market understands, it will draw out institutional and other investors who were on the periphery or have stayed out of the market."

Ian Callaghan, head of the Microfinance Institutions Group at Morgan Stanley, says that access to a greater scale of capital is needed and that means tapping a pool of investors that do not necessarily have a social objective but are looking for diverse investments.

"Microfinance has so far been mostly funded by development banks and socially responsible investors but they do not have the access to the kind of capital that is needed to satisfy the growing industry's needs," he says.

Activity in the microfinance sector has been growing in the last few years and has involved increasingly complex deals. Last month, for instance, the first publicly rated microfinance collateralised debt obligation - which pools together packages of bonds - raised more than $100m. The deal was rated by S&P and completed by BlueOrchard, which specialises in the management of microfinance investment funds, and Morgan Stanley.

Mr Callaghan says: "It helps that investors can look at a piece of rated paper that they can compare with other rated paper that comes across their desks."

In a recent report providing recommendations for a rating methodology that can be used to rate microfinance institutions (MFIs), S&P predicted that greater transparency and globally acceptable standards could see volumes of microfinance-related securitisation deals surge.

S&P expects to rate an additional two to three microfinance CDO transactions and around 25 MFIs in the coming months, with CDO issuance levels potentially reaching $500m by the end of 2007. As the existing microfinance institutions become adept at handling new inflows of funding, and more MFIs enter the market, securitisation volumes could reach between $1bn and $3bn annually over the next decade, the agency says.

Copyright The Financial Times Limited 2007

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An interesting article on how greater transparency can translate into creating real strategic and tangible value for an industry or firm, and not just as a “nice to have”, lip service or PR ploy. The important factors here are: being upfront about and properly assessing risk factors, having a standard set of metrics to facilitate comparison, greater innovation in financial product development (e.g., structured finance vehicles like CLOs/CDOs),and to a certain extent divorcing, for lack of a better word, “passion” from capital investments decisions (i.e., admittedly simplistically put: create a business model that creates real value while supporting a social charter which can therefore stand up to the scrutiny of dispassionate investors and have a fighting chance of being sustainable). Of course, an adequate investor base and climate is a necessary prerequisite (so maybe the whole thing is moot when it comes to Bangladesh. Or not?)

While the MFI industry is clearly in need of the above, would it be a leap too far to say that other sectors in Bangladesh, including financial services, should take heed and reap similar rewards?