71309 BRIEF Microfinance Investment in Sub-Saharan Africa: Turning Opportunities into Reality The 48 countries of sub-Saharan Africa (SSA) represent 14 percent of the world’s population and include seven of the 10 fastest growing nations in the world: the Democratic Republic of Congo (DRC), Ethiopia, Ghana, Mozambique, Nigeria, Tanzania, and Zambia. Overall, SSA is stabilizing and growing, with fewer conflicts1 and banking crises2 since the 1990s and early 2000 (Beck, Maimbo, Faye, and Triki 2011) and more foreign direct investment (FDI) flows. FDI inflows to the region rose from $23 billion in 2006 to $38 billion in 2010, according to the UNCTAD statistics database.3 The increase is due to a number of factors, including consistent gross domestic product growth rates, increased political stability, a growing middle class, and reforms that reduce barriers to entry (World Bank 2011). Yet despite healthy economic prospects, the region 2010, 193 microfinance institutions (MFIs) from SSA has the lowest share of banked households in the were reporting to MIX, with a high concentration of MFIs world (12 percent) and the highest share of poor in East Africa and West Africa. Microfinance providers people, with 50 percent of the population living on reporting to MIX in SSA reach nearly one-quarter of $1.25 a day or less (CGAP and World Bank 2010). More all depositors globally, while accounting for less than work needs to be done to expand financial access, 5 percent of borrowers. Local funding, such as deposits, and many governments and international funders are plays a dominant role in the funding structure of MFIs keen to contribute. Equity and debt capital continues (CGAP and MIX 2012). In addition, local government to be important in developing financial services for funding sources are available in many countries in the low-income populations in the region. However, local region. Government programs often operate as funds equity is not available in most countries, and local (e.g., the National Fund for Microfinance in Benin) or debt funding is scarce. SSA microfinance relies heavily are registered as companies with majority government on deposit funding, mostly composed of short-term ownership. In some countries (e.g., in Rwanda), the deposits, while many smaller institutions cannot attract government is an important player in the ownership sufficient deposits to finance growth. The region structures and boards of financial institutions. received 11 percent of global microfinance funding commitments in 2010.4 In terms of cross-border New or greenfield6 MFIs began appearing in the investment, it received among the lowest levels in the mid-1990s. The number of greenfield institutions has world—$1 billion out of a total of $13 billion as of increased rapidly in SSA over the past three years, due December 2010 (Reille, Forster, and Rozas 2011). to many reasons, including the scarcity of strong local providers that serve the low-income market. There are This Brief examines public and private foreign currently 40 greenfields in 18 countries (CGAP and MIX investment in SSA microfinance retailers, and the 2012). SSA is also a leader in mobile banking services, key challenges that limit investment. The findings are which are available in 28 countries (Wireless Intelligence based on CGAP data on cross-border funding flows, 2012; CGAP and MIX 2012)—Kenya is the global leader publicly available resources, and interviews with more with more than 18.9 million subscribers as of April than 30 investors and other stakeholders conducted 2012, according to the Communication Commission in the first quarter of 2012.5 of Kenya. Other providers such as insurance and leasing companies are increasingly serving low-income clients. Is there less demand for However, it is not possible to generalize across all of cross-border investment in SSA. SSA has four culturally and economically distinct SSA than in other regions? subregions, and even within these there is great diversity. West Africa has many financial cooperatives SSA has a large number of financial service providers, (mostly called decentralized financial systems or savings including credit unions, nonbank financial institutions and credit cooperatives). Financial cooperatives also (NBFIs), banks, savings banks, savings groups, postal predominate in Central Africa, and they tend to be savings banks, and mobile network operators. As of weak on risk indicators, such as portfolio at risk (PAR) 1 http://www.oecd.org/document/19/0,3746,en_39862406_39906520_49370195_1_1_1_1,00.html 2 There has been a decrease in the number of systematic banking crises from 15 countries in the mid-1990s to less than five countries in 2009 (http://www.mfw4a.org/events/event-details/financing-africa-through-the-crisis-and-beyond-publication-pre-launch.html). 3 North Africa data were deducted from total. 4 Global commitments were US$24–27 billion (2011 CGAP Funder Survey). 5 We define foreign investment as commercial or quasi-commercial investment in equity and debt. Cross-border funding refers to debt and equity; we did not analyze cross-border funding through guarantees, grants, technical assistance, or loans to government. Demand analysis is based on MIX data (www.mix.org). 6 A greenfield MFI is a new institution built from scratch, usually using standard operating procedures disseminated by a holding company or international network (CGAP and MIX 2012). June 2012 2 and write-offs (CGAP and MIX 2011). NBFIs tend What are the main to dominate East Africa, with a growing number of microfinance providers reaching large scale. Southern market level barriers? Africa has a smaller microfinance market than the While there is great variance across the region’s other subregions, with banks accounting for a majority 48 countries and four subregions, the lack of market of depositors and borrowers. infrastructure and market information stand out as significant barriers in most countries. For example, MFI performance lags while 26 countries in SSA have public credit registries, behind other regions only six of these cover microfinance (CGAP and MIX 2010). Also, local stock markets are weak or Several strong and well-performing MFIs operate in nonexistent, which limits equity investors’ exit options. SSA, but on average, MFIs perform worse there than in other regions, with weaker asset quality (higher PAR Progress has been made on the regulatory side. and lower reserves for delinquencies) and a higher Most countries in SSA have no restrictions on foreign cost structure. In 2010, PAR greater than 30 days investments in the banking sector.9 Seventeen was almost 5 percent, the highest of all regions, while countries have adopted national microfinance median operating costs were 32.6 percent of loan strategies, and 27 have adopted microfinance portfolio, well above that of other regions (CGAP and legislation to date (CGAP 2010d). Between 2007 and MIX 2012 and MIX Cross-Market Analysis Database 2009 alone, 14 countries drafted, adopted, or revised 2010 data). microfinance laws/regulations, including a new law for decentralized financial systems for the WAEMU SSA has a large number of smaller MFIs that are often region, which replaced the PARMEC law.10 Also, less profitable. For example, by asset size, SSA has 29 countries have specialized microfinance laws, and in fewer Tier 1 and Tier 2 MFIs.7 SSA has a total of 25 Tier 15 others, microfinance is regulated under banking or 1 MFIs compared to Latin America and the Caribbean NBFI laws. Despite this progress, some regulations are (LAC) with 105 and Europe and Central Asia (ECA) inadequate, and implementation, including licensing, with 62. This can be explained by a number of factors, remains challenging, especially in West Africa. including smaller average loan sizes, difficult operating Additional approval requirements create long delays, environments, and in many cases less access to capital branch licensing is cumbersome, and there can be for growth with small and dispersed capital markets. frequent and confusing changes in capital and other Also, a number of weak MFIs in the region are under regulatory requirements. Supervisory capacity is often government administration, including 17 MFIs in West a challenge, and weakly regulated institutions threaten African Economic and Monetary Union (WAEMU) the development of a sound market for investment.11 member countries at the end of 2011 and three in Cameroon at the end of 2010.8 Finally, macroeconomic instability, as well as political instability and interference, help to explain the Weak management and governance are other low level of investment in several countries. While important demand-side challenges. Most microfinance regional conflicts have diminished and investments providers suffer from human capital deficiencies at all are growing in stabilizing post-conflict countries, such levels, attributable largely to weak educational systems as DRC, there is still unease about investing in other and the high costs of attracting better educated post-conflict countries, such as Sudan. The overall staff. It is challenging to find skilled senior managers, business environment remains unfavorable in countries especially in finance, internal audit, and law. In terms such as Chad, Niger, Burundi, or Central African of governance, the main challenges include conflicts Republic, while issues with corruption, oil subsidies, of interest and lack of management accountability and instability hamper investments in Nigeria. (given the closeness of senior management to board members). Many of the investors interviewed cited Despite these concerns, many of the interviewed lack of transparency and insufficient reporting as investors say that they have a higher country risk some of the main challenges of doing business in the threshold for SSA and are prepared to invest region. There are poor reporting standards, limited in most SSA countries, motivated in part by their availability of information on MFIs, and concerns about development mission and their commitment to the the reliability of external audits of MFIs, which are region. In fact, some public development finance often conducted by auditors who lack microfinance institutions (DFIs) indicated that they are prepared experience. Transparency is especially challenging for to invest in almost all SSA countries at this time if younger and less sophisticated Tier 3 MFIs. they find investible opportunities. New greenfield 7 Tier 1 is defined as MFIs with assets greater than $30 million, Tier 2 assets $5–30 million, and Tier 3 less than $5 million (CGAP 2010). 8 La Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO) and the Commission Bancaire de l’Afrique Centrale (COBAC). 9 Aside from some restrictions in Nigeria and Ethiopia where the law precludes a foreign national from undertaking banking business. 10 The decentralized financial systems bill was passed in Guinea Bissau and Senegal in 2008, in Mali and Burkina Faso in 2009, in Niger in 2010, in Togo and Cote d’Ivoire in 2011, and in Benin in January 2012, according to CGAP’s Financial Inclusion Regulation Center (www.cgap.org/p/site/c/regulation_center/). 11 West Africa and Cameroon were cited by investors as particularly problematic. 3 operations in post-conflict countries, such as DRC, Cote d’Ivoire, and Liberia, corroborate this. Box 1. Making pricing work: The high costs of offering local currency loans Are international investors structured well to serve Investors have made noticeable strides in providing local currency funding to SSA financial institutions. the SSA market? However, finding affordable hedging instruments or local currency equivalent funding is often difficult. In More than 70 public and private foreign investors have particular, several investors noted difficulties finding debt and equity investments in SSA microfinance, price-competitive hedge rates for East Africa, the compared to 94 in LAC and 64 in ECA. Public DFIs subregion where microfinance investments had been account for about two-thirds of the roughly US$1 billion concentrated to date. Recently, high inflation in Kenya of total SSA cross-border investment. Several DFIs and Tanzania has dramatically pushed up interest rates, have direct investments in SSA retail providers, and and consequently hedging costs. In Kenya, the inflation they also provide wholesale funding to microfinance rate quadrupled to 18.9 percent during 2011. SSA had the most volatile hedge rates over the year ending investment vehicles (MIVs) that invest in the region. September 2011 (MFX Solutions 2011). Private investors include MIVs and other intermediaries, such as holding companies. Oikocredit, Blue Orchard, High hedging costs have contributed to a recent reduction Triodos, responsAbility, and Regmifa managed the in the volume of loans closed for East African MFIs. Larger largest microfinance investment portfolios for the and more sophisticated MFIs are taking hard currency region, with individual portfolios ranging between loans at lower rates, while smaller MFIs with less access US$40 million to US$72 million at year end 2011, to local funding are forced to pay much higher rates on according to CGAP research. Some of the funds properly hedged loans. Most investors anticipate that (e.g., Oikocredit, Norwegian Microfinance Initiative’s the cost of hedging in East Africa, and in a few other SSA countries, will not return to reasonable levels until 2013. Frontier Fund, Regmifa, etc.) and the DFIs also provide technical support alongside their investments.12 Debt represents a large part of the total direct present in the region, and more about the demand investments in the region (38 percent for DFIs and and market issues noted earlier. Also, many countries 70 percent for MIVs, as of December 2010), with receive little or no foreign investments: DFI and MIV a growing portion of funding in local currency. For investments are reaching less than half of the region’s example, in 2010, 49 percent of all direct DFI debt 47 countries. Over half of all DFI direct MFI investments investment was in local currency, and this figure in SSA go to 10 institutions, and 56 percent of all direct has risen since. Also, most MIVs have more than DFI investment is concentrated in five countries. For 50 percent of their SSA portfolio in local currency example, Kenya received 22 percent of the total DFI (compared to 30 percent globally), and several have investment and 40 percent of known MIV investments.15 a strategy to increase such funding to 100 percent, according to our research. Minimum investment thresholds For some DFIs (e.g., FMO, Proparco, IFC), equity preclude investments represents more than 50 percent of the volume of their SSA portfolio and is higher than the overall share of Given the less developed nature of several SSA country equity on their global portfolio. This higher proportion of microfinance markets, the institutions often need smaller equity investments is driven by two main factors: (1) these transaction sizes, which can be less attractive to investors DFIs want to provide patient, longer term capital to help who are concerned about maximizing staff productivity. MFIs develop into larger and stronger institutions, and Also, many unregulated institutions usually have (2) greenfields, which are the main investment targets of ownership structures that investors cannot buy into for some DFIs, require significant equity capital. equity participation, and such institutions pose a higher risk because they are not supervised. On the other Despite a high growth rate,13 SSA investment is only hand, in some parts of the region (e.g., West Africa), a small part of the global microfinance portfolios of cooperatives are the main service providers16 and capital international investors, with investments in the region investments are challenging or often not possible. accounting for only 9 percent and 5 percent, respectively, of the DFI and MIV global microfinance portfolios.14 The Many specialized funds have a focused SSA strategy lower level of funding in SSA compared to other regions and are willing to make smaller investments, as low as is less about the number of public and private investors US$500,000.17 Whereas several of the leading global 12 Technical assistance programs tend to focus on management capacity, management information systems, MFI transformation, new products, and risk management systems. 13 Fifty-one percent and 58 percent for the DFIs and MIVs, respectively, in 2010 (2011 Funder Survey, 2011 Symbiotics MIV Survey). 14 In contrast, LAC accounts for 19 percent of DFI investments and 35 percent of MIV investments; ECA accounts for 32 percent of DFI investments and 40 percent of MIV investments (CGAP 2011 Funder Survey and Symbiotics 2011 MIV Survey). 15 CGAP Cross-Border Funder Survey 2010 and CGAP MIV Survey 2010 and 2009 data. 16 Twenty percent of SSA MFIs reporting to MIX are cooperatives, particularly prominent in West Africa. 17 Investors interviewed noted that investments in SSA are commonly $500–750,000. 4 June 2012 All CGAP publications are available on the fund managers with significant SSA portfolios seem References CGAP Web site at to favor a business model that targets larger or Tier 1 MFIs and MFIs that are members of microfinance Beck, Thorsten, Samuel Maimbo, Issa Faye, and Thouraya www.cgap.org. networks or holding companies, some of the newer Triki. 2011. “Financing Africa: Through the Crisis and and specialized regional niche funds are targeting Beyond.� Washington, D.C.: World Bank. CGAP smaller or emerging MFIs. But incurring transaction 1818 H Street, NW CGAP. 2010a. “CGAP MIV Disclosure Guidelines.� MSN P3-300 costs for the sake of a small deal raises issues of cost- Washington, D.C.: CGAP. effectiveness, and managing small transactions spread Washington, DC over many countries heightens the challenge. Among ———. 2010b. MIV Survey 2010. Washington, D.C.: CGAP. 20433 USA transaction costs, due diligence in the field is more ———. 2010c. Cross-Border Funder Survey 2010. Tel: 202-473-9594 expensive for investees that are less transparent. Washington, D.C.: CGAP Fax: 202-522-3744 Overall, the investors noted that their interest rate spreads are about the same in SSA as in other regions, ———. 2010d. “Policy Issues in SSA Region.� http://www. so the high cost of doing business in the region means cgap.org/p/site/c/template.rc/1.11.131908/1.26.3123/ Email: that their net returns are lower. One of the largest cgap@worldbank.org ———. 2011. Cross-Border Funder Survey 2011. private microfinance investors in SSA is a global fund, Washington, D.C.: CGAP © CGAP, 2012 Oikocredit, with a decentralized structure and local presence in more than 12 SSA countries. Oikocredit has CGAP and MIX. 2011. “Sub-Saharan Africa Microfinance successfully built a cost effective way to reach smaller Analysis Benchmarking Report 2010.� Washington, D.C.: Tier 2 and Tier 3 MFIs in SSA. Keys to its success have CGAP and MIX. been a commitment to the region and to reaching ———. 2012. “Analysis of Key trends: 2011 SSA Africa Regional underserved markets, a strong regional presence with Snapshot.� Washington, D.C.: CGAP and MIX, February. 12 SSA offices, and a flexible business model that allows it to consider small transactions in the short CGAP and World Bank. 2010. Financial Access 2010. term with the hope of growing these relationships Washington, D.C.: CGAP and World Bank. and making them more profitable in the longer term. According to Oikocredit, it has made loans as small as GSMA. 2012. Wireless Intelligence Mobile Deployment Tracker. http://www.wirelessintelligence.com/mobile-money/ €50,000, while its average microfinance loan size in SSA is €540,000. MFX Solutions. 2011. “MFX 2011 Benchmark Analysis Report.� Washington, D.C.: MFX Solutions. Conclusion MIXMarket. Cross-Market Analysis data. http://www Given the macroeconomic and microfinance trends for .mixmarket.org/profiles-reports/crossmarket-analysis-report SSA, the future looks promising. The estimated growth OECD and Economic Commission for Africa. 2011. “Mutual rates for several SSA economies are among the highest Review of Development Effectiveness in Africa Report.� globally, which should also lead to increased demand OECD and ECA. for microfinance and growth of the industry. This will inevitably result in an increased demand for local and Reille, Xavier, Sarah Forster, and Daniel Rozas. 2011. “Foreign international capital to respond to such opportunities. Capital Investment in Microfinance: Reassessing Financial and Public and private microfinance investors interviewed Social Returns.� Focus Note 71. Washington, D.C.: CGAP. for this research are expecting a 20–30 percent increase Symbiotics. 2011. “Symbiotics 2011 MIV Survey Report.� in their SSA portfolio in 2012. However, turning Geneva, Switzerland.: Symbiotics. this opportunity into reality and bringing more access to finance for poor people will require tackling all of the World Bank. 2010. “Investing Across Borders 2010 Report.� market challenges discussed in this Brief. Washington, D.C.: World Bank. Given the smaller size of many SSA MFIs, market ———. 2011. “Global Economic Prospects: Maintaining Progress Amid Turmoil (Regional Annex).� Volume 3, June. fragmentation and the high transaction costs of Washington, D.C.: World Bank. doing business in the region, investors will either have to accept lower returns, or find business models The authors would like to thank Mayada El-Zogbi, that can lower the cost of handling large numbers Antonique Koning, Alexia Latortue and Rich Rosenberg for of small transactions. Investors are recognizing this, their invaluable inputs and guidance. We would also like to and more private investors are opening local offices acknowledge the contributions of Djibril Mbengue, Anna in SSA to lower costs, better understand local issues, Nunan, Moses Ochieng, and Corinne Riquet. Finally, we and improve market penetration. thank the investors who contributed to CGAP’s research. AUTHORS: Jasmina Glisovic, Senayit Mesfin, and Louise Moretto