First of all, I would like to thank you for this case. This is the most interesting exam I ever had. I see 2 different layers in this case: the problem of Unitus with debt/equity decision and the problem of microfinance industry at all. I consider these 2 problems as highly connected to each other: the understanding of the overall microfinance industry will help in solving the problem of alternatives choice. Therefore I will firstly focus on microfinance industry understanding (what are the problems here, the contemporary situation etc. , then I will explain how industry issues influence the decision process and alternatives comparison, and after all I will choose the best solution up to my mind. The goal of Unitus is to raise funds. Therefore to crack this case we need to put ourselves in position of future investor or borrower.
Both of them will first of all want to understand, where they are investing in. Microfinance The first feature of microfinance that comes to one’s mind is its huge growth potential. As stated in the case, only 20% of overall demand for microfinancing is being met. 20 million people don’t have access to microfinance according to Exhibit 5. Microfinance is believed to be rather helpful in improving people’s lives. Using the small credits, clients start their small businesses improve and their living standards which should lead to increase of life conditions in the whole country. The experience can also attract international companies to open plants and fabrics there as lack of skilled working power is one of the main constrain in FDI. However there is no clear evidence on the real impact of microfinancing on macro level.
Moreover MFIs are not transparent at all, which is a huge disadvantage from investor’s point of view. Investors want to know the business they are investing in. Secondly, there are a lot of troubles with institutional development of the countries, where microfinancing is implemented. Such problems as corruption, inflation, changing government rules may influence the outcome of the program significantly. Also we don’t know how the institute of business is organized there. If there are some unofficial organizations that control business development (like mafia or criminal), the result of small start-up projects is not very well predictable.
Though the research available show that the reasons of defaults were in most cases natural disasters, illnesses and other things, we can’t say exactly what lead to default. Sociological and culture constrains also play a huge role in understanding the market. All the countries have their own specifics and results of microfinance can’t be compared between countries. Moreover microfinance faced rebuff even in the countries where it was organized. It sometimes demolishes the existing norms of the society (like in Muslim countries) or it can be an obstacle to existing businesses (like in Afghanistan).
These are the main problems to appear on the side of “accepting” party. But there are also many problems on the “giving’ party side. First of all, the “giving” party can be separated into intermediaries (MFIs) and end investors. The “end-end” investors are people in developed countries. They can donate some money to MFIs. However even here microfinancing faces problems. A lot of people don’t believe in the positive effect of such actions. They consider poor people to be poor not because of lack of resources, but because of laziness.
Also some of the population which could contribute to microfinance programs simply doesn’t have know-how. For example, we as students get some money on a monthly basis as scholarship. We don’t need these funds straight in the beginning of the period, so we have these money left o our banks accounts. However this money could be a several-week loan for some person in Africa. We don’t donate as we want our money back, but I don’t know where I can invest them for the short period of times. So the mechanism is unclear. Also there are several issues about the overall image of the microfinancing.
Two main questions are whether it should be free or interest-beared and to whom we should lend. Some people in the society think that we can’t charge the poorest people. Others view microfinancing as a normal institute which should generate the profit. When we speak about the target group of finance aid we also should understand that there are 2 groups: the poor and the poorest. If we help mostly to the poor it is less risky for us, but the difference in level of life will grow, as the poorest will stay where they were.
If we help to the poorest, we increase the risk of default. Moreover these poorest people are very difficult to reach. The investors are represented mostly by governmental or non-profit organizations. The greatest disadvantage of them is that their funds are very limited. To invest in 420 million of people you need billions of dollars. Organizations, which could afford these billions, are institutional investors – banks, insurance companies, pension funds and hedge funds. However they don’t see microfinancing as an attractive investment opportunity.
If we look on microfinancing form their point of view, we will see, that the there actually are a lot of reasons for such mistrust. A lot of institutional investors are restricted in assets they can invest in (for example pension funds). Others see better opportunities on the market in terms of risk-return balance. From investment bank’s point of view it is better to invest in proved financial instruments. If institutions need higher returns they can invest in emerging markets. The terms are also not suitable for institutional investors.
They got used to give funds for at least several months, while poor people got used to take loans for several weeks of even less. But the greatest problem here is that there is no practice and the scheme of such investments is unclear. According to the logic, MFIs should be intermediaries in-between institutional investors + people and poor people, who need microfinance. In this case investors could use them as channels for the money flow. But MFIs should be effective and clear then. Unfortunately, we don’t see this on microfinance market. There are around 3,000 MFIs represented.
Of course there are some big players such as Grameen etc. They serve more than 100,000 clients. But the majority of MFIs (63%) are still small non-profit organizations. The level of their management is very poor, they don’t use the economies of scale and they spend a lot of human capital to serve the clients. In most cases the business schemes are not developed. All these make investments in MFIs too expensive for the investors. The poor management is understandable here. Most students form business schools don’t go to work in Africa and in developing markets, so we see a huge lack of professionalism here.
Therefore the skills of fundraising are not highly developed among MFIs employees. All these problems show us the underdevelopment of microfinance as institution. This is bad for the world, but good for Unitus. Unitus saw the opportunity on the market – the niche which is very attractive. MFIs definitely need 3 things: more money, better management and some collaboration. Unitus build its business model to serve these needs. The company finds MFIs with high growth potential, give them money and train the personal.