RI Interview: German development bank KfW’s Monika Beck on microfinance

Explaining why microfinance is a good opportunity for pension funds.

When it comes to microfinance, there is no bigger player than the Kreditanstalt für Wiederaufbau (KfW), the German development bank that is wholly owned by the country’s government. Convinced that creating a financial infrastructure in the developing world was crucial to its economic development, the German bank entered the space in the early 1990s.

It has since amassed a microfinance portfolio worth €2.4bn – most of which is long-term loans to microfinance institutions (MFIs) – and initiated several funds for private investors wanting to invest in the space.

Before delving deeper into the KfW’s microfinance story, a quick recap: Starting in the 1980s, development aid from western countries was used to support MFIs – essentially banks – so that they could lend to farmers and other small companies which otherwise would not have access to finance.

The hope is that with such capital, these enterprises can invest in their business, creating jobs and stimulating economic growth in the process. As borrowers often lack collateral and/or credit history, microfinance loans are short-term in duration (between 18 and 24 months) and costly (50% is not unheard of). Yet despite the high rates, the default ratio is below 5%, which experts attribute in part to the fact that the majority of borrowers are female.

More than three decades later, the KfW says that in development terms, microfinance has been a huge success. “Experts agree that of all the areas where development work has been attempted – education, health care, finance – we’ve been most successful with the microfinance model,” says Monika Beck, the Head of the KfW’s Division for Financial Sector Development – Africa/Global Structures, who spoke to Responsible Investor in a recent interview.

Owing to the KfW’s efforts in this space alone, 12m people in the emerging countries now have access to finance. More broadly, a recent study from an NGO called the Consultative Group to Assist the Poor (CGAP) found that in countries where microfinance was practiced, the income of the poorest 20% of the population had risen while the share of people living on less than $1 per day had decreased.Another very positive development, says Beck, is that today, many MFIs no longer depend on foreign aid or investment but instead use local client deposits to re-finance. In other words, they have developed into full-fledged banks, offering a range of services beyond microfinance, like savings accounts and insurance. Says Beck: “Today, no less one half of the €70bn microfinance market is no longer being financed externally but instead through client deposits. That’s a terrific achievement and one of the main reasons why we got involved in microfinance.” Such self-supporting MFIs can be found in places as diverse as Peru and the formerly war-torn Democratic Republic of the Congo.

“Microfinance is no longer just about development aid; it has become an asset class”

The microfinance story, however, has not always been that positive. In 2010, it emerged that several dozen people in the south Indian state of Andhra Pradesh committed suicide, reportedly because they could not pay back microfinance loans that carried interest rates of up to 50%. Recalling the event, Beck says the tragedy was caused by local MFIs seeking to maximise profits on the one hand and bad consumer protection on the other. “The event shows how important it is for development banks and microfinance funds to do comprehensive due diligence on the MFI and on the framework conditions for the market it operates in before investing.”

As for the other half of microfinance market that’s still driven by foreign money, one-third comes from budgetary funds from governments and NGOs, one-third from development banks like the KfW and one-third from private investment (the latter a more recent development).

Indeed, since the year 2000 several asset managers have emerged that specialise in microfinance funds for private investors, including wealthy individuals and pension funds. Two of the best known are Geneva-based Blue Orchard and Zurich-based responsAbility, which recently surpassed the $2bn (€1.5bn) mark in terms of assets under management.
Several Dutch houses, including ACTIAM (formerly SNS Asset Management) and Triodos are also active.

“Microfinance is no longer just a story about development aid, but has become an asset class for investors,” says Beck, adding: “That’s very encouraging, as you can mobilise a lot more capital that way than if you still had to rely on donors.”

According to Beck, private investors are getting into microfinance for ethical reasons and because it offers returns which, while not stellar, are to a degree uncorrelated with financial markets. She points to the KfW-initiated European Fund for Southeast Europe (EFSE), a microfinance vehicle for places like the Balkans, Georgia or Moldova, whose investors weren’t hit with a default despite the global financial crisis.

Private investors – mostly banks – account for around one-third of EFSE’s €963m in assets, and the fund, says Beck, aims to provide a return of at least 150 basis points above Euribor, the European bank reference rate. Since its launch in 2005, EFSE has been managed by German private bank Sal. Oppenheim.

But EFSE has so far only attracted one pension fund, which may have a lot to do with a general scepticism about microfinance: the lack of liquidity and adequate returns to compensate for the risk are just two of the issues that pension funds raise.

While acknowledging microfinance’s illiquidity, Beck feels that it is not really an issue for buy-and-hold investors like pension funds and insurers – which are among the clients targeted by the EFSE. And as far as the risk-return issue is concerned, she adds that EFSE has shown how stable it is.“Institutional investors are often sceptical about themed investments like microfinance. To overcome that scepticism, they need to be fully informed about such investments and there has to be a proven track record. This is why most microfinance funds target institutions only after they have broken even.”

To underscore her point, Beck cites the example of the Global Climate Partnership Fund (GCPF), a vehicle which the KfW started in 2011 to finance renewable energy projects in developing countries.

She says that while most of the assets for the €240m fund have come from public entities like the KfW, the Danish and British governments as well as Austria’s development bank, it won’t be long before private investors like pension funds take a close look at the GCPF.

“Again, it’s all about track record. We launched the fund in 2011 and reached the break-even point at the end of 2013 already. This year, the fund will reach its target return (150 basis points above Euribor like EFSE), so starting in 2015, we will have a good story to tell private investors,” Beck says. It seems that word about the GCPF is already getting around in Germany’s institutional market. Last year, the Deutsche Bank-managed fund won over its first big pension investor, namely an €8.8bn scheme for doctors in North-Rhine Westphalia. The scheme invested $30m.