Engaging the Financial Sector: Some Considerations On The Need and Prerequisites to Increase the Private Financial Sector's Role In Microfinance

This paper discusses the need and prerequisites to increase the private financial sector's role in microfinance. The paper explains that commercial financial sector has been cautious in engaging in microfinance because of:

• High perceived risk and illiquidity of equity investments in microfinance;
• Perception that interest rates for debt investments in microfinance do not sufficiently reflect risk;
• Relatively high transaction costs for microfinance investments.

The paper points out that there is an incentive for commercial players to enter the microfinance sector as:

• Capital for microfinance is primarily provided by donors and international financing institutions (IFIs) at present;
• Existing international sources of finance and domestic commercial debt capital markets are insufficient to meet the full potential of the microfinance sector;
• Well-managed microfinance institutions (MFIs) have proven that microcredit can be provided on a financially sustainable basis and can earn a positive return on capital.

The paper concludes that to ensure a higher engagement of commercial investors in microfinance there is a need for:

• Large number of mature MFIs capable of engaging in larger and more sophisticated transactions;
• Coordinated decision of the larger donors and IFIs to subsequently pull out of the top segment of most mature MFIs so that the commercial financial sector can step in.