The Changing Role of Foreign Direct Investment in Microfinance Capital and Measurement of Financial and Social Performance

Paper commissioned by the  Microcredit Summit Campaign in 2006.The paper summarizes key developments in microfinance capital markets and makes observations and recommendations primarily for managers of microfinance institutions (MFIs) in developing countries.The paper identifies:

• Three ways by which commercial banks are increasing their involvement in microfinance – through loans and investments, strategic alliances and the purchase or direct operation of MFIs.
• The types of institutional investors in microfinance - conventional investors, commercial, and social investment funds and donors acting as investors/lenders.

The paper discusses current trends in microfinance capital markets and states that:

• The majority of the new capital in the microfinance industry is debt;
• There is investment only in the ‘top tier of MFIs;
• Difficulty in attracting capital is due to the lack of scale.

The paper recommends:

• Less donor investment in the top MFIs;
• Expansion of the pool of investable MFIs;
• The creation of credit bureaus;
• Products to diversify risk and price foreign exchange risk at acceptable levels;
• Secondary markets for microfinance to provide a steady source of capital.

The paper recommends the following roles that the donor community can play:

• Invest in second and third tier MFIs;
• Encourage transparency and regulatory quality;
• Train managers;
• Provide equity capital;
• Help maintain the MFIs mission.

The paper concludes that MFI managers will find it difficult to meet their needs for capital, unless they have a strong business model, a growing market and clear communication with both commercial and social investors.