The Case For Private Equity Investment in Microfinance

Much has been accomplished since the early days of modern microfinance when NGOs and organizations such as Grameen Bank started lending to industrious, but poor, communities in Bangladesh. The sector now touches well over 100 million people worldwide and boasts a total loan portfolio in excess of US$40bn. Although significant growth was originally catalyzed by grant-led initiatives, such scale would likely not have been possible without the participation of commercial capital. In fact, with billions of individuals still lacking access to basic financial services, representing an estimated demand of US$300bn in loans, the future role of commercial capital will be even more critical. The reality is that it is impossible for microfinance to achieve its full potential without the participation of private equity and debt investment. Quite simply, there is nowhere near enough grant capital available to meet the funding requirements of the world’s microfinance institutions (MFIs) as they continue to scale. 
 
A role for grant capital in microfinance, however, still exists. Indeed, there are many initiatives that simply fail to offer much potential for a commercial return, but are still critical to the continued development of the sector. These include programs for conducting social impact analysis or the development of microfinance products for “ultra-poor” clientele. In this respect, both commercial and grant capital can work hand-in-hand as the sector continues to evolve and bring more of the world’s poor into the formal economy.  
 
Private equity in microfinance is mostly invested in the form of early stage start-up or growth capital. This type of investing is very different from the large-cap private equity techniques employed in the developed world, where investee companies are often over-leveraged and streamlined in the pursuit of a short-term exit and return on capital. In contrast, private equity in microfinance often serves to strengthen HULT PRIVATE CAPITAL balance sheets, not to weaken them, and the greater corporate governance requirements of such investors inevitably results in stronger organizations. An increasing flow of this type of capital will not only allow the sector to scale, but will also lead to greater accountability and transparency.
 
As an emerging sector within the global financial services landscape, microfinance stands to substantially benefit from the increased participation of private equity investors. Through the provision of risk capital, such investors will actively support new business models and lending methodologies. With this in mind, consider the interesting parallel of the positive role played by private equity in other emerging sectors, where it has often resulted in the financing of hundreds of innovative young companies. Not only have these companies generated attractive returns on equity, but many have also contributed considerable social value by improving productivity, health, and access to information, not to mention the many new employment opportunities they have brought to the market. Examples include technology, telecommunications, biotechnology and, most recently, clean technology, all sectors that would not have achieved the same level of success without the risk capital, strategic support and commercial networks that private equity investors provide.
 
While the volume of private equity invested in microfinance to date has barely scratched the surface of the sector’s requirements, there are already a number of examples of the positive role that this capital has played. In India, a series of notable investments has provided the foundation for increased outreach, greater geographic diversity, the introduction of new products and improved mechanisms to attract and retain high quality talent. Over the past two years, the five largest MFIs in the country have been the beneficiaries of approximately US$180m in private equity investment, which has helped them to grow their combined active client bases from 2.2 million to over 4.7 million, a compound annual growth rate of 45%. Four of these organizations are now serving well over a million active clients each. Furthermore, numerous new business models have been launched as a direct result of investor support. Of particular note are the branchless banking technologies currently enabling millions of previously unbanked individuals to efficiently access deposit accounts, government disbursals, insurance products, and even secure payment platforms.

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