How Uncertainty Impacts Funding for Microfinance Organizations by [email protected]

Wharton’s Adam Cobb and Tyler Wry discuss their research on funding microfinance organizations.

Microfinance has proven to be an important tool in helping lift people out of poverty by providing low-interest loans to those who don’t have access to traditional lending. Many studies have looked at the outcomes for loan recipients, but few have examined how microfinancing organizations raise capital, especially in times of political and economic turmoil in a country. In their latest research, Wharton management professors Tyler Wry and Adam Cobb, along with Indiana University professor Eric Zhao, focus on funding for microfinance organizations.

Wry and Cobb recently talked with [email protected] about their paper, “Funding Financial Inclusion: Institutional Logics and the Contextual Contingency of Funding for Microfinance Organizations,” and its implications.


Microfinance Organizations
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Microfinance Organizations

An edited transcript of the conversation follows.

[email protected]: In this research, you were looking at funding for microfinance organizations. What were the key questions you were trying to answer?

Tyler Wry: Adam and I have been looking at microfinance in different capacities for a while now, and Eric has as well. One of the things that is a little bit surprising about the space is that you’re making loans to poor people. But the money used to finance those loans, it’s not like a typical bank where they mobilize their deposits to then lend out the money. In microfinance, you count on upstream funders, and the microfinance organizations themselves are more of a flow-through. No one had really looked at how this upstream funding works. We managed to get access to really great data through the Microfinance Information Exchange, and it gave us a chance to look at how the upstream funding works as a way to analyze downstream impact.

The literature suggests that microfinance in a nation works best when you have a really robust ecology of different kinds of microfinance lenders. You want to have big, established, more commercial, profitable organizations. But you also want to have smaller, less profitable organizations that aren’t quite financially sustainable yet [because] maybe they’re doing a little bit more outreach. You need to have funding go to all of these organizations to ensure you’re getting sustainable outreach, good competition and a healthy sector overall. So, we were looking at how funding flows to these different types of microfinance organizations and who the different funders are. It turns out, about $30 billion a year that we can track flows into microfinance around the world each year. It comes primarily from two sources. One is commercial lenders, mostly in Western Europe and the United States, and they have commercial goals. They want to get their money back. They might want a little bit of a social return on the investment as well. But really, this is risk capital. They’re going to lend this money out, but they want to see it returned. On the other hand, you have development banks and multilateral aid agencies. They’re more interested in funding development in the sector.

When things are working well, you have the commercial lenders funding the big, established commercial microfinance organizations, and you have the public organizations funding the smaller, not-yet-sustainable ones. No one had analyzed this. So, our top-line analysis was just to see if this held up in practice because some people suggest it doesn’t. What we found is, in fact, it does. In a steady state, you see this ecology work the way it should. It all kind of lines up nicely. But when you start to look at uncertainty in a country — political uncertainty, financial uncertainty, when things get volatile and it’s a little less clear how previous investment strategies are going to work — you see all of the funders retreat to a safe harbor in the largest microfinance organizations. This is public and commercial funders, and this is tied to a lot of very adverse outcomes in the microfinance sectors of a country. This is really the gist of the paper and the big thing that we uncovered.

[email protected]: You started out with a number of hypotheses about microfinance organizations and how they’re funded. Some of them held up, and some of them held a little bit of surprise. Tell us about the key takeaways from this paper.

Adam Cobb: One of the things that was a takeaway for me is that it wasn’t so clear whether this would map out the way we expected. In particular, there is a little bit of work, mostly anecdotal evidence, that suggests that there’s a lot of competition between these more public funders and these commercial funders, and that they are both targeting really large, sustainable, profitable organizations. If you look at the microfinance literature right now, the evidence suggests that they’re targeting the same types of microfinance lenders. At least in a steady state, that doesn’t seem to be the case. Just uncovering that was a nice thing to discover. They’re actually doing what they professed to do and probably what they should be doing. But at the same time, even things that are a little bit further away or of higher level, like political uncertainty or financial uncertainty, are affecting these decisions being made by these commercial and public funders half a world away. They’re actually paying attention to these things and making conscious strategies. That wasn’t exactly what a lot of people would expect.

“Anything that microfinance lenders can do that make them appear less risky is going to help ensure that the microfinance lending structure holds in place during times of uncertainty.”–Adam Cobb

We got a chance to talk to some of these people, and they said, “Yeah. This is totally what we do. It doesn’t make a lot of sense to invest in these smaller, less sustainable microfinance lenders if the economy’s really turning poorly and these entities might disappear anyway. It fulfills our social mission.” Another surprising thing is that they still feel like they’re holding to this social mission even though they’re changing their lending strategy, which is something that we wouldn’t expect. That’s seen as more of a change in your ideology or a change in your strategy. They don’t see that a change in investment behavior is tied to a change in strategy. They see those two things being compatible.

[email protected]: But does this change in investment behavior have implications for people who receive loans or to the organization itself? In terms of this paper, what are some of the practical implications? If I’m a microfinance organization, especially if I’m a smaller one or one that is located in an uncertain climate, what can I do?

Wry: There’s the implications for the organizations, and there’s what they can do and what they should do. Building on what Adam was saying, one of the really striking things about our finding is that under these conditions of uncertainty, if you were a small microfinance organization, even one that’s managed well and turning a reasonable return on your investment, there’s a good chance that if things become uncertain, you’re going to lose this funding. And

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