After a selection process, InFiNe.lu has awarded 2 scholarships to its members to attend the Boulder Microfinance Training 2016 in Turin. Anita Kover (Innpact) and Olivia Fechner (ADA) got selected, but who are they? Find it here.
Abd what are they learning during this 3-week training?
As investment officer for ADA/LMDF, I chose to participate into the Rural and Agricultural Programme to improve my ability to analyse the agricultural risk linked to investment operations into very rural and agriculture oriented MFIs.
The first sessions of the Master Class, which will take place every morning during the 3 week of the programme, aimed at analysing the needs of a very specific segment: the rural smallholder households.
Stakeholders in the microfinance industry generally agree on the fact that reaching smallholder households could improve financial inclusion, however, little is known about this massive client segment. In order to understand better their needs and financial behavior, Jamie Anderson, a Financial Sector Specialist focused on smallholder families at CGAP, presented us a study recently realised by the CGAP, entitled “Understanding Demand, Driving Innovation – Smallholder Households and Financial Services”. The CGAP conducted this study in order to understand better how the smallholder households manage their financial lives and what tools they need or use.
This study was based on national surveys in various countries, but also on smallholder diaries reports, which are interviews conducted every 2 weeks during one year with each household out of a sample of 90 households in 3 countries, in order to assess how they manage their wallet over the year, taking into consideration the cash flow variations related to agriculture cycle.
This paper also reviews the various factors that can influence rural poverty and the wellbeing of smallholder households, and in what extend they are related to demand for financial tools of various types. It also analyses some extra agricultural needs, the main one being financing schooling fees for children.
One of the conclusions of this survey is the proposal of a new segmentation of smallholder households based on 6 main variables: Educational attainment, socio economic status, access to emergency funds, mobile phone ownership, attitude toward the future and experience of unexpected event.
It was really interesting, during these sessions, to compare what were the expected results according to the Boulder trainees (thanks to a voting system in live) to the actual result of the study. For instance, it was really surprising to learn that, according to the survey, in Mozambique only 7% of the total cash income that rural smallholders get within a year comes from agriculture, as the crops are mainly used for own consumption (this proportion increases to 26% in Tanzania and 42% in Pakistan).
2 of the elective courses chosen by Olivia:
This course was conducted by K. Maurer (30 years of experience in microfinance, currently Chairman of the Board of Finance in Motion, an alternative fund management company based in Frankfurt/Germany). This class aimed at distinguishing sources of risk in agriculture and therefore the risks faced by the financial services providers such as MFIs and what tools/strategy they can use to manage it.
Farmers deal with very specific risks:
Farmers can mitigate these risks at their own level through prevention (to reduce the probability of an adverse event occurring), mitigation (to reduce the potential impact of an adverse event) and coping (to relieve the impact of an adverse event once it has occurred) mechanism. For instance they can implement some technical strategies as crop rotation, or try to integrate themselves into a value chain. In many cases, it also exists informal arrangements and solidarity mechanisms within the farmer’s community.
When it comes to the MFIs level, we distinguished two main risks:
1.The principal risk, which is the risk of non-repayment linked to the client financial capacity but also to its willingness to pay back the loan. Every financial institution faces this risk, not only the ones working into the agricultural segment. We passed under review the main challenges that the MFIs have to deal with to address this principal risk:
For each of these challenges, MFIs have to implement appropriate tools to mitigate the non-repayment risk.
2.The specific risk, linked to the agricultural activity (see above). First MFIs should analyze in what extend farmers mitigate these risks at their own level through prevention, mitigation and copping mechanism. At the institution level, it is crucial that MFIs rely on agricultural experts to conduct a proper and accurate analysis of the farmer’s situation during the appraisal process. Then, the specific risk has to be managed through portfolio mitigation and implementation of exposure limits (geographies, crop sector, borrower’s categories…)
During this course, we also reviewed risk transfer and insurance mechanisms for medium and large risk. Although crop insurance mechanism are available in many countries, they are normally not affordable/available for smallholders (same issues as in the microfinance industry: fix transaction costs are too high in comparison with the small amounts considered). To reduce the transaction costs, some index based insurance initiatives have emerged: instead of analyzing the situation of each person, indemnity payments are based on an index, for instance the cumulative rainfall in a specific area…. Some projects have been implemented in some countries and have been quite successful, although insurance companies still have to deal with the basis risk (payout are triggered by an index which may not correspond with the losses a farmer actually incurs… it can be transformed into a big reputational risk for the insurance company) and with the fact that farmers are often reluctant to pay for such abstract services (subscribing to an insurance product is like buying a promise for the future…)
The last session was about the cost of risk management for financial providers… all MFIs have to make tradeoffs between risk management and cost management.
In conclusion, financing agriculture is riskier than financing other sectors, but all these risks can be mitigated through proper risk management mechanisms.
This course was conducted by R. Verberk, an experienced agri banker, ex-team manager and director of the agri finance department of some of Rabobank’s largest local branches, currently Senior Consultant for RIAS specialized in the organization of agri finance departments at banks in developing and emerging countries.
The idea of financing farming activities through value chain models is to assess the payment capacity of the farmers/cooperative by looking at its delivery record rather than its credit record. The value chain financing models are based on transaction streams and relationships within the value chain. It should create a win-win situation for the farmers (access to working capital and mitigate the risk related to price volatility), the traders/processors (access to higher /more stable volume and better quality) and the bank (reduce the credit risk).
During this course, we first analyzed the characteristics and risks of the food and agri chain, the main ones being its dependence to natural conditions, its seasonality, the perishable nature of its products and the quality of the contracts within the value chain (selling contracts…).
The value chain can be more or less complex and integrated but is normally composed of:
Agro dealers (input providers) –>farmers –>Cooperatives –>Traders and processors
The most integrated and organized is a value chain, the less risky it is to finance its components (producers, byers…). Each component is associated with specific risks and needs that the financial services providers have to understand well in order to provide adequate services and to reduce its risk. As the farmers cooperatives are often considered as too risky to be the only counterparty of the financial institutions, banks/MFIs often chose to provide funding through a tri partite contract (Financial providers – cooperative – traders). In this case, the selling contracts (farmers agree on a specific quantity/price with the traders at the beginning of the agricultural cycle) is often a substitute to other kind of collateral.
Farmers can be categorized by segments (large farmers and agri business / medium size farmers / commercial smallholders / semi commercial smallholders), depending on various variables:
If banks/institution choose to finance directly the farmers, their approach should be different for each of these segments. For the biggest exploitations, a strong individual analysis based on the economic and financial situation of each client should be conducted by the financial institution. For the smaller ones, to reduce the transaction costs it can be a good option to finance them through join liability groups or/and to design a proper scoring system which we allow the institution to conduct the analysis in a very short time and at a lower cost.
The objective of the Poverty lending and viability class was to discuss about strategies and designs for reaching in an economically viable manner the most vulnerable people, who may be excluded not only from the traditional banking sector, but also from the traditional microfinance sector.
Through case studies on financial diaries of people living in extreme poverty, we learnt how complex the financial lives of the poor were as they have to align their small, irregular and uncertain revenues with their small and regular expenses interspersed with periodic large payments, both expected and unexpected.
Based on results of behavioural economics studies, we discussed how people do not make the same choices in situations of scarcity as in situations of abundance. In fact, studies show that scarcity reduces “cognitive bandwidth”, meaning attention, cognitive ability and self- control, which may lead us to take decisions that will affect us negatively in the long term.
We then turned to practical examples of product design. In working groups we discussed concrete strategies (risk management for the poor, savings groups, graduation model and agricultural value chain) that the National Rural Support Program of Pakistan (NRSP), several representatives of which were actually participants to the class, could implement or improve.
This class was different from others also because of our professor, Larry Reed, an acclaimed industry expert with 30+ years of experience and the director of the Microcredit Summit Campaign, whose commitment and humility was especially touching and inspiring to me.
Finally, below is a list of must-reads that I added to my reading list thanks to this class, and that the reader of this blog may find interesting, too.
Behavioural Economics:
Opinions diverge on whether microfinance really works, but the summary of a set of randomized control trial studies on the actual impact of microfinance may bring some clarity:
Elective course chosen by Anita : Financial Analysis (group)
The financial analysis course used a case study that ran throughout the week to illustrate how to interpret financial statements; adjust financial statements for benchmarking; and calculate key ratios to measure and evaluate portfolio quality, efficiency, profitability and the effectiveness of asset and liability management.
From an investment perspective, I found particularly useful the adjustments (namely for subsidies and inflation) that can be done to financial statements in order to reflect the true performance of microfinance institutions and compare the performance of different microfinance institutions across the world.
Having spent the week looking into figures and formulas, our professor Petronella Chigara-Dhitima, with 20+ years of experience in microfinance technical assistance mostly at Accion in Sub-Saharan Africa, concluded the course by one question: Is the key to profitability for MFIs is to charge high interest rates? A debate followed driven by the diversity of backgrounds of the participants at the course: microfinance practitioners mainly from Nigeria, India, Pakistan, Jordan and Egypt; representatives of central banks/regulators from Sierra Leone, Tanzania, Uganda; and finally representatives of development finance institutions and networks, such as KfW, FMO, GIZ and CGAP. MFIs charge on average between 24-36% effective annual rate to their clients, which is explained by a series of characteristics that set them apart from traditional financial institutions, some of which were evoked during our discussion summarized below.
Although it seems counter-intuitive, micro-businesses generate high margins. This assertion can be explained by a basic principle of economics theory, that of diminishing marginal returns that says that when an enterprise invests more, it will produce more output, but each additional unit of capital will bring smaller incremental gains. When a tailor buys his first sewing machine, his production can double. The implication is that the poor entrepreneur has a higher marginal return to capital and thus higher ability to repay lenders than richer counterparts. Consequently, MFIs may, for the reasons of capital scarcity that its potential customers face, charge higher interest rates than what would be common in the traditional banking sector.
Microfinance practitioners noted that higher interest rates can be the key to increasing outreach. In fact, the more socially-oriented the MFI is, the more it will try to increase its proximity to the poorest and least served segments, the more expensive its services will be. Especially in the case of greenfield MFIs, finding the balance is difficult: on the one hand, clients should not be overburdened by the inefficiencies inherent in a structure that is ramping up; on the other hand, in order to make sure the institution can reach a sustainable scale, generating revenue streams by sufficiently high interest rate is key, and efficiencies can be passed on to the clients at a later stage.
We concluded the discussion by stressing the importance of transparent pricing, going back to our figures and formulas, calculating the effective annual rates (taking into account the rate calculation methodology – flat or declining, commissions and fees as well as the effect of compulsory savings) through the examples of microfinance institutions in Nigeria and Pakistan whose representatives participated to the course.
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