Champions of Financial Inclusion

Tuesday, October 12, 2010

SRI inflows and the Micro finance sector - a positive development

Socially Responsible Investments are those investments that consider both the financial returns from an investment and the potential social, environmental and ethical consequences these investments might have. Broadly socially responsible investment can involve either (1) screening of the investment such that its social/ environmental impacts can be deemed “responsible” as per international standards (2) shareholder advocacy for social or environmental causes or (3) investment in communities that bring about growth in those communities. While today a majority of SRI’s are in the form  of assets held in socially screened investment funds or managed accounts ; internationally , community investments; particularly into microfinance; are enjoying strong growth rates, with such investments coming not merely from  foundations and NGOs as it used to be previously but also from individual investors and, increasingly, professional institutional investors. The importance of this trend lies in the fact that world over with greater volume of investor money flowing into what were once the territory of NGO’s and charities rapid transformations are happening in microfinance sectors forcing them to become more leaner, efficient,  transparent and by becoming more responsible, profitable

Microfinance is based on the recognition that the working poor can act in an entrepreneurial manner and are, in principle, creditworthy. In this respect it poses an attractive opportunity for investors who are pulled towards it primarily by the fact that investing in microfinance allows investors to adopt a social investment strategy geared toward poverty alleviation and social development while at the same time offering an attractive risk-return profile that is marked by largely stable financial returns, low credit default rates and low correlation to the general domestic economy. This is actively aided by fact that in many countries Microfinance institutions are themselves exploring new opportunities to obtain funding and in the process making themselves attractive to investors through means like securitizing their loan portfolios and in some cases by even going public. Critics are of the opinion that such transformations will only erode the microfinance sector and force it to become more profit centric in the process forcing it to move away from the people who constitute its customer base today. Is this true?

The answer is that it is a false argument and the advantages of the transformation process have been manifold. Firstly, it is an acknowledged fact that the microfinance sector in many countries has reached a point where the subsidized loans they are dependent on for funding is no longer sufficient to cover a large many of their funding needs. By securitizing their loans and inviting market investments into their portfolios the MFI’s are not only broadening their funding structure but also are mobilizing additional monetary resources to facilitate in the expansion of their lending activities. Secondly, external funding from investors has in most cases eliminated the disincentive that had slowly crept in to MFI operations in many countries. This disincentive wrought by subsidized money; had been forcing MFI’s to curtail many of their lending activities to meet non core requirements.

The transformation wrought by investment inflows into the MFI sector has not only forced the MFI’s to become more transparent; by virtue of the fact that investors constantly want to know where their investments are going; it has also forced them to significantly reduce the degree of bureaucratic red tape that had come to characterize their functioning; simply because investors prefer their money be spent on lending and portfolio expansion rather than on administrative expenses. Alongside the transformation has also forced the MFI’s to become more efficient and profitable in their operation; which in most cases has implied becoming leaner, more efficient  operations as they are now accountable to investors whose money is being lent.