Cautious recovery global economy
The world economy showed signs of recovery in 2014. Industrialised countries are now registering modest economic growth again, mainly driven by ample availability of cheap credit and reduced government retrenchments. Financial sectors remain vulnerable to shocks, as stricter capital requirements need to be put into effect. In 2014, developing countries and emerging markets benefited from the improving economic situation in industrialised countries. They still register positive growth rates of around 5%. 1 This growth trend is expected to continue and will be driven mainly by South and South-East Asia, as well as sub-Saharan Africa.
Due to the economic expansion, demand for financial products and services in these countries and markets continues to grow. This contributed to the ongoing growth of MFIs and banks, including those represented in the portfolio of Triodos Microfinance Fund, in 2014. In most countries the quality of the credit portfolios of these institutions stabilised or improved. Over-crediting is still a risk and some institutions and countries show a slightly elevated risk. Triodos Microfinance Fund considers this an important issue.
1 Source: IMF, World Economic Outlook
Development of the sector
The stable growth of investments in the microfinance sector continued in 2014. This is confirmed by Symbiotics’ annual sector report, which states growth rates ranging from 9% in South Asia and 13% in Latin America to 17% in Eastern Europe & Central Asia and 18% in East Asia. The investments in North Africa & the Middle East and sub-Saharan Africa are much smaller in size, but an important trend is that these investments do show substantial growth, i.e. 44% and 34%, respectively. This implies that MFIs and banks still have a considerable funding requirement. International investment funds are an important source of such funding. According to the report by Symbiotics, the investments by these funds totaled USD 9.9 billion (EUR 8.2 billion); 7.6% of these total investments was provided by the microfinance funds managed by Triodos Investment Management, including Triodos Microfinance Fund.
Below the surface of these growth figures we find a wide range of developments and diversity, which we will illustrate by means of a number of examples.
Technology as an important driver of institutional and market development
In order to distinguish themselves from other market players, it is increasingly important for MFIs to take advantage of technological possibilities. Smart use of the available technology allows organisations to better serve their clients with new products, but also enables them to manage their risks and operations more efficiently. In several countries we are seeing that organisations are able to expand their product offering or improve their access to rural areas by using technology. Especially in East Africa, the growing popularity of mobile banking is putting traditional business models under pressure. Even the poorest farming families in the most remote areas can now transfer money and save or borrow small amounts of money using their mobile phones. This has a huge impact on their daily lives. Many of the MFIs and banks in the portfolio of Triodos Microfinance Fund use mobile phone technology to expand their client base. Technology also has an impact on the development of alternative distribution channels. Petrol stations and kiosks, for instance, are used as agents for MFIs, which allows less densely populated areas to be served more efficiently. In the sustainable energy and agricultural sectors technological development is also an important driver for the scalability of companies. When assessing investment opportunities, Triodos Microfinance Fund in particular considers the extent to which organisations take advantage of the opportunities provided by technology.
Regional developments in the Caucasus and Central Asia
Over the past years, the microfinance sector has evolved rapidly in the Caucasus and Central Asia. In order to bring about further growth and professionalisation, MFIs in these countries are particularly in need of equity capital. In 2014, Triodos Microfinance Fund became a shareholder in Credo in Georgia, Arvand in Tadjzikistan and KazMicroFinance in Kazachstan. Participations in the equity capital of financial institutions constitute an important pillar of Triodos Microfinance Fund’s investment policy. Such participations enable the fund to establish a direct and long-term involvement in the strategic policy pursued by those institutions. Senior staff of Triodos Investment Management represent the fund on the supervisory boards of these institutions and thus contribute specific knowledge and experience with respect to sustainable banking. This contribution of banking expertise is what clearly distinguishes Triodos Microfinance Fund from other investors in the sector.
Currently, Central Asia is feeling the impact of the economic crisis in Russia, which could cause economic growth and the expansion of the financial sector in neighbouring countries to slow down. The IMF expects the Russian economy to stagnate in 2015. Georgia has no significant ties with Russia and is expected to grow by 5%. Other countries with more extensive economies ties include Azerbaijan (4.3% growth), Tajikistan (6%) and Kyrgyzstan (5%). Especially the latter two countries have seen many labourers emigrate to Russia. Rising unemployment among the labour immigrants in Russia may well cause the monthly transfers of money to their home countries to fall sharply.
Laws and regulations offer opportunities and threats
As in Europe and the United States, governments in developing countries and emerging markets are becoming increasingly active with respect to financial sector regulation. In general, the environment in which institutions operate is steadily improving - in terms of supervision as well as infrastructure, such as credit bureaus. The revival of the microfinance sector in India is remarkable. In 2010 the Indian central bank took decisive action in reaction to a crisis in the federal state of Andra Pradesh and imposed strict regulations with respect to pricing and client protection. During the past year, however, that same central bank presented a different face when it created the opportunity for MFIs to obtain a banking licence. Triodos Microfinance Fund welcomes this development in India, because this makes it possible for clients of MFIs in India to gain access to a wider product range and thus better fill their financial needs.
Another interesting development is that in 2012, after fifty years of isolation, Myanmar opened its doors to foreign investors. Triodos Microfinance Fund has since closely followed the developments in this country and at the end of 2014 made an initial investment in a participation aimed at setting up a new microfinance institution. Given the under-development of its financial sector, the country offers many interesting investment opportunities, both from a financial as from an impact perspective.
In some countries regulation also tends to focus on MFIs’ pricing, by setting interest rate ceilings. In recent years, this occurred in Zambia, Bolivia and various countries in West Africa. This could in theory have a positive impact in an environment in which interest rates are high, but regulations are often not specific enough and therefore often also have negative side-effects for the market and the development of organisations. This could, for instance, result in institutions focusing on clients that are easy to serve, as a result of which clients in rural areas find that their access to financial services is diminished. In Colombia, the interest rate ceiling is high, so there is no pressure to reduce interest rates and in practice the ceiling appears to result in less (price) competition.
Growing interest in the SME sector
In addition to lending to micro businesses, lending to SMEs is a growing focus area. Entrepreneurs in this sector, too, often find it difficult to get a loan. It is estimated that over half of the SMEs in developing countries have little or no access to credit and financial institutions. 2 The total funding requirement of this segment is estimated at USD 1 trillion (1,000 billion). MFIs play a part here, by growing in tandem with the small businesses in their portfolios. Other financial institutions actually focus more on the SME segment. SMEs are an important source of job creation in the economy and pay taxes, which are an income source for local governments. SME banks can also make an important contribution to making the financial sector more sustainable, among other things by also focusing on sustainable energy and the agricultural sector. Triodos Microfinance Fund therefore aims to fund MFIs as well as SME banks.
2 Source: IFC/World Bank
The important role of local funding
MFIs and SME banks increasingly attract local funding because more institutions are granted a licence to attract savings. Furthermore, we are seeing that in developing countries public confidence in the financial sector is growing, as a result of which the total amount of savings is increasing. Also, more financial institutions are now able to issue bonds in their local financial markets. Triodos Microfinance Fund plays an active part in promoting the mobilisation of savings. The growing balance sheet totals of the institutions and the increase in local funding also led more and more institutions trying to cover their remaining funding requirement by calling on a smaller number of strong (international) partners. In addition, there is still a substantial demand for equity investments. Triodos Microfinance Fund and the other funds managed by Triodos Investment Management together constitute a reliable, large and long-term partner that is capable of meeting these needs.