Copyright: Asian Development Bank 2004 All rights reserved. Nimal A. Fernando is Lead Rural Finance Specialist in the Regional and Sustainable Develop

Transcription

1 Micro Success Story? Transformation of Nongovernment Organizations into Regulated Financial Institutions Nimal A. Fernando ASIAN DEVELOPMENT BANK Regional and Sustainable Development Department June 2004 i

2 Copyright: Asian Development Bank 2004 All rights reserved. Nimal A. Fernando is Lead Rural Finance Specialist in the Regional and Sustainable Development Department of the Asian Development Bank. The views expressed in this paper are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank, or its Board of Governors or the governments they represent. The Asian Development Bank does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequences of their use. Use of the term "country" does not imply any judgment by the author or the Asian Development Bank as to the legal or other status of any territorial entity. This publication is available on the Asian Development Bank's microfinance web site: ISBN Publication Stock No Published by the Asian Development Bank, ii

3 CONTENTS Page Abbreviations Foreword Abstract iv v vi I. Introduction 1 II. The Expectations 3 III. Have the Transformed Institutions Met the Expectations? 7 IV. Conclusions 29 Appendix: NGOs Transformed into Regulated Financial Institutions 31 References and Web Sites 41 iii

4 ABBREVIATIONS ACLEDA - Association of Cambodian Local Economic Development Agencies ACP Acción Comunitaria del Perú ADB - Asian Development Bank ADC - Andean Development Corporation ADEMI - Asociación para el Desarrollo de Microempresas ASA - Association for Social Advancement BRAC - Bangladesh Rural Advancement Committee CARD - Center for Agriculture and Rural Development CDC - Commonwealth Development Corporation CGAP - Consultative Group to Assist the Poor CLA - Caja Los Andes COFIDE - Corporación Financiera de Desarollo CONFIA - Corporación Nicaragüense Financiera EDPYMEs - Entidades de Desarrollo para la Pequeña y Micro Empresa EMT - Ennathian Moulethan Tchonnebat FFP - Fondo Financiero Privado FIE - Fomento de Iniciativas Económicas FINAMERICA - Financiera America FMO - Netherlands Development Bank IIC - Inter-American Investment Corporation MFI - microfinance institution NBFC - nonbank finance company NGO - nongovernment organization OMB - Opportunity Microfinance Bank PRODEM - Fundación para la Promoción y el Desarrollo de la Microempresa RFI - regulated financial institution SHARE - Society for Helping Awakening Rural Poor through Education SML - SHARE Microfin Limited SOFOL - Sociedad Financiera de Objeto Limitado USAID - United States Agency for International Development NOTE: In this report, "$" refers to US dollars. iv

5 FOREWORD The microfinance industry is undergoing significant global change. Shareholder-owned, regulated microfinance institutions that provide a range of financial services to poor and low-income households and their microenterprises were not a general characteristic of this industry until the late 1980s. Microfinance, or microcredit to be more accurate, was largely an operation of nongovernment organizations (NGOs) and state-sponsored programs. This has changed during the last two decades, mainly through transformation of NGOs into regulated microfinance institutions in various countries, particularly in Asia and Latin America. The number of such institutions remains low but their catalytic effect and overall influence on the industry are disproportionately high relative to their position in the industry. In some countries, transformed institutions have performed much better than conventional financial institutions both in terms of profitability and outreach. Many of these institutions have established themselves as robust, permanent financial institutions with a social mission to serve the poor. This study examines the ownership structure, expectations, and achievements of transformed institutions in Africa, Asia, and Latin America. The study is based on data and information painstakingly collected from many sources about their equity capital, ownership structure and the evolution, scope of operations, and breadth and depth of outreach. The Asian Development Bank hopes that this study will inform and improve understanding by microfinance stakeholders of the nature of the transformation of NGOs into regulated financial institutions, and enrich and encourage discussions on the issues among stakeholders and potential investors. It is hoped that the study will help transformed institutions to improve their operations to serve larger segments of the poor more effectively. Finally, the study should enable NGOs considering transformation into regulated financial institutions to make more informed decisions to ensure their sustainability and social mission. Geert van der Linden Vice-President Knowledge Management and Sustainable Development Asian Development Bank v

6 ABSTRACT Nongovernment organizations (NGOs) began microcredit operations because conventional financial institutions were not providing financial services for the poor and low-income households and their microenterprises. Over time, NGOs began to play a significant role in providing microcredit services in many countries. Ironically, increasing numbers of NGOs have transformed themselves into regulated financial institutions since the first such transformation, that of the NGO Fundación para la Promoción y el Desarrollo de la Microempresa into BancoSol in Bolivia in With transformation, these institutions expected to increase the breadth and depth of their outreach, primarily through better access to commercial sources of funds and public deposits to finance their growth. A review and analysis of operations of transformed institutions show that many of these institutions have been able to achieve positive results, as expected, in four fundamental areas: an ownership structure with shareholders to maintain a balance between social mission and profitability/sustainability, increased access to loanable funds from commercial sources, broader range of services including voluntary deposit services, and increased breadth and depth of outreach. However, more intensive research on transformed institutions, particularly on their governance, operational efficiency, and poverty outreach is necessary to improve our understanding of the impact and emerging issues of transformation. vi

7 I. INTRODUCTION 1 Amajor characteristic of the microfinance industry in many developing countries is the extensive involvement of nongovernment organizations (NGOs) in providing microcredit services. This is the experience in Asia and the Pacific, Latin America, and other regions. In some developing countries, NGOs have become, and continue to be, the dominant source of institutional microcredit. For example, in Bangladesh 656 NGOs had 9.46 million active loan accounts with an outstanding total loan amount equivalent to $513 million at the end of 2002 (Credit and Development Forum 2003). The Bangladesh Rural Advancement Committee (BRAC) disbursed $294 million in loans to some 2.9 million clients during 2002, while the Association for Social Advancement (ASA), also in Bangladesh, disbursed about $345 million during 2003 and had about 2.13 million active borrowers at the end of NGOs, funding agencies, and many other stakeholders are now paying increasing attention to limitations of the NGO modality, particularly those arising from the lack of owners. Recognition of the limitations or perception of limitations has resulted in the transformation of microfinance NGOs, funding agencies, and many other stakeholders are now paying increasing attention to limitations of the NGO modality. NGOs into regulated financial institutions (RFIs) in some countries. This process, which started with the transformation of Fundación para la Promoción y el Desarrollo de la Microempresa (PRODEM) into BancoSol in Bolivia in February 1992, has continued in recent years, both in Bolivia and in other countries around the world. In 1993, NGO-Corposol in Colombia transformed itself into an RFI called Finansol. The number of cases of transformation gradually increased over time, as shown in Figure 1. Based on available information from the literature, Internet sites, and financial networks, at least 39 NGO Figure 1 Cases of Transformation of NGOs into Regulated Financial Institutions, by Year of Transformation No. of Cases Feb The author gratefully acknowledges the information provided by In Channy (ACLEDA Bank), Udaia Kumar (SHARE Microfin Ltd.), Sunil Khanal (Nirdhan Utthan Bank), Shankar Man Shrestha (Rural Microfinance Development Center, Nepal), Bijaya Nath Bhattarai (Nepal Rastra Bank), Joji Tokeshi (Asian Development Bank, Vijay Mahajan (Basix), Syed Hashemi, Alexia Lartortue, Brigit Helms, and Veena Jayadeva (CGAP), Didier Thys (Microfinance Information exchange), David Gibbons (Cashpor Inc), M. Kalyanasundaram (INAFI-India), Elissa McCarter, and Elizabeth Abrera (Catholic Relief Services), John Owens (USAID), William Steel (World Bank), and Perry Cartera (Opportunity Microfinance Bank). Also, the author acknowledges the information drawn extensively from Drake and Rhyne (2002) and Rhyne (2001) to discuss the issues relating to BancoSol in Bolivia and Mibanco in Peru. Comments of Tor Jansson, Nimal Sanderatne, and John Whittle are gratefully acknowledged. Research assistance was provided by Patricia Calcetas and secretarial assistance by Inna Arciaga. The paper was edited by Jay Maclean. The author is responsible for any errors of omission or interpretation in the paper. Introduction 1

8 microfinance institutions (MFIs) were transformed between 1992 and February The transformations occurred in 15 countries, of which the largest number was in Peru. Six countries in the Asia region account for 15 of the 39 cases. Details of the transformed institutions are given in the Appendix. Rhyne (2001, p.117) claims the process of transformation has been one of the major contributions of Bolivian microfinance to international experience. This development in the NGO microcredit subsector is ironic NGOs began microcredit provision initially because of the failure of RFIs, both state-owned and private development banks and commercial banks in particular, to serve poor and low-income households. In general, NGOs claimed that the business culture and physical setup of formal financial institutions were intimidating to the poor and incompatible with their socioeconomic characteristics. These factors coupled with banks profit motive, it was argued, would continue to keep formal financial institutions from serving the poor with appropriate financial services. Thus, transformation of NGOs (Box 1) into RFIs represents a dramatic change in perspective on financial services for the poor. Some observers now consider transformation of NGOs as an essential stage of movement toward a more commercialized microfinance industry. For MFIs that adhere to the financial system approach, White and Campion (2002, p.23), for example, consider transformation into an RFI as a natural progression. In Stauffenberg s (2002, p.19) terms, why exchange a life free from taxes and undisturbed by regulators for the regime of a formal financial intermediary? The proponents of NGOs claimed that the business culture and physical setup of formal financial institutions were intimidating to the poor and incompatible with their socioeconomic characteristics. Box 1 How is Transformation Defined? Transformation is defined to mean establishment of a regulated financial institution (RFI) by a nongovernment organization (NGO) or a group of NGOs by transferring its loan portfolio to the RFI completely or partially. According to this definition, it is possible that the NGO or the group concerned may continue credit operations under the NGO modality even after the establishment of the RFI. This was the case of Fundación para la Promoción y el Desarrollo de la Microempresa (PRODEM), the first NGO that was transformed into an RFI, in After establishment of the RFI (BancoSol) through transfer of its loan portfolio, PRODEM continued to operate in rural areas of Bolivia for several years until it was transformed into another RFI, Fondo Financiero Privado (FFP) PRODEM, in December The Center for Agriculture and Rural Development (CARD) NGO transferred part of its loan portfolio to establish an RFI, CARD Bank, in 1997, but continues to operate to date as an NGO and transfer its loan portfolio from time to time. NGO Procredito in Bolivia ceased operations after it was transformed into FFP Caja Los Andes. transformations, in general, expected positive results. This paper elaborates on these expectations and examines the extent to which they have been met by the transformed institutions. The next section describes the expectations. Section III takes up the question of achievements in relation to the expectations and Section IV presents some conclusions. 2

9 II. THE EXPECTATIONS What did the NGOs expect to achieve? What motivated NGOs to transform themselves into RFIs? Broadly, they expected an ownership structure with shareholders who would maintain an appropriate balance between their social mission and profitability, and who would provide incentives for better management and governance; increased access to funds from commercial sources; a broad range of services, particularly deposit services for the poor; and increased breadth and depth of outreach. A. Ownership Structure with Risk Capital and Improvements in Governance At the early stages of growth in the microfinance industry, many people considered NGOs as the most suitable institutional modality to reach poor households with microcredit. It was widely believed that they would provide a solution to government failure and the market failure that eventually left poor households without access to credit because NGOs ideally have a social mission to help the poor and are not driven by the profit motive or vested interests that favor the well-to-do. Given the success of many NGOs in reaching the poor with a wide array of services and relatively successful stories of NGOs with microcredit services, it was also presumed that they had a significant comparative advantage in providing credit to the poor, particularly to women who were thought to be suffering disproportionately from the credit market failure. However, the suitability of the NGO modality to provide microcredit in general and microfinance in particular, on a large scale, began to be questioned over time. The issue of ownership and governance of NGOs and their ability to leverage an adequate amount of funds The suitability of the NGO modality to provide microcredit in general and microfinance in particular, on a large scale, began to be questioned over time. to reach significant numbers of potential clients figured importantly in these questions. As Rhyne (2001, p ) explains, the structure of NGOs differs from that of any formal financial institution because NGOs, however well-endowed they may be, have no owners with capital at risk. Lacking owners, their accountability structures are not up to being entrusted with what bankers call other people s money. An NGO s assets cannot easily be seized in case of default, and thus provide little security to lenders. The solution, as Rhyne notes, obvious in retrospect but radical in the early 1990s, was to transform the NGOs into RFIs with a shareholder ownership. Such an ownership structure was expected to simply put each shareholder s capital at risk and generate incentives for some oversight by shareholders on the activities of the transformed institutions and improve governance. The new shareholders and the institutional structure with improved governance and accountability and increased equity were expected to remove constraints on expected rapid growth to achieve the social mission on a sustainable basis. In most cases, the expectation was to get social investors to take a significant stake in ownership, with some involvement of private sector investors at the discretion of the founder NGO. This is important because most founder NGOs generally held the view that dominance of pure private capital in ownership may dilute the social mission and drive the operations of the new institution away from its original target groups. Thus, these NGOs were not looking for just any potential investors in the equity of the transformed institutions; they were looking for investors who were seeking a double bottom line maximum social returns with a reasonable level of profit. The Expectations 3

10 The transformations were also, in a few cases, expected to provide an opportunity for the members of the NGOs to become owners of the transformed institutions. This was a primary driver in the transformation of the Center for Agriculture and Rural Development (CARD) in the Philippines into a rural bank. According to the founding president and chairman of CARD NGO, his vision was to create a bank owned and managed by poor landless rural women through share ownership and representation in CARD Rural Bank s board (Alip 2003, p.2). Similarly, the Society for Helping Awakening Rural Poor through Education (SHARE) expected to achieve its vision of a viable community-owned institution with its transformation into a nonbank finance company (NBFC). In addition, some NGOs expected to provide their employees an opportunity to become part owners in the transformed institution, although this has not been a primary factor in transformation in any of the cases. B. Access to Loanable Funds from Commercial Sources Microcredit NGOs were funded largely by external funding agencies. As the NGOs began to grow, many encountered funding limitations from these sources. These limitations had different aspects. First, the amount of funds that they could expect from donors was considered inadequate, given the expected growth in the programs. Second, donor funds were characterized by a great deal of uncertainties and delays (Rhyne 2001, p.105). Some NGOs have embraced independence from donors as a matter of principle (Ibid.). 2 However, microfinance NGOs have typically found it difficult to borrow more than the equivalent of their equity for various reasons (MicroRate 2002). These factors, as a whole, constrained their ability to grow at desired rates. NGOs that opt for transformation into RFIs expect to leverage their equity to obtain commercial funds. Transformation was expected to resolve these problems and provide easy access to both equity capital and commercial borrowings to facilitate rapid growth. For example, this was the case with PRODEM s transformation. PRODEM had some access to commercial loans from banks, but these were too limited to maintain its desired rate of expansion, according to Rhyne (2001, p.107). In Bolivia, the associates of the NGO Fomento de Iniciativas Económicas (FIE) had to mortgage their personal properties to gain access to funds from local commercial sources (Ramirez 1999, p.387). FIE also had to convince socially minded individuals and institutions sympathetic to its cause to make long- and short-term savings deposits with banks willing to lend to FIE to enable the banks to onlend these funds to FIE. Although FIE was not established with the intention that it would be transformed into an RFI, the difficulties that FIE experienced in funding its rapid growth compelled the founders to transform it. In the Philippines, both CARD NGO and the NGOs that eventually formed the Opportunity Microfinance Bank (OMB) had some access to funds from commercial banks but with many difficulties and personal guarantees from influential members of their boards of directors rather than on the basis of the financial strength or performance of the NGOs. NGOs in Cambodia experienced, and continue to experience, similar difficulties in borrowing from commercial sources. Transformation of an NGO into an RFI provides it with more capital, which then can be leveraged to access funds from commercial sources. Thus, NGOs that opt for transformation into RFIs expect to leverage their equity to obtain commercial funds. In some countries, transformation has been essential because the laws do not permit nonprofit organizations to borrow from commercial banks. This is the case in Mexico (MicroBanking Bulletin 1999, p.14): Compartamos 2 The Association for Social Advancement in Bangladesh has not accepted grants from some funding agencies during the last 4 years as a matter of principle, according to its Managing Director, Md. Shafiqual Haque Chowdhury. 4

11 in Mexico had to transform itself into an RFI to access funds from commercial banks and capital markets to finance its rapid growth. NGOs in many countries, particularly in Latin America, have also expected to have easy access to funds from government or donor credit lines, apex institutions, and central banks through transformation to expand their operations. C. Broader Range of Services Including Voluntary Deposit Services Most NGOs operating in the microfinance industry are microcredit rather than microfinance providers. NGOs in most countries do not have a legal charter to mobilize voluntary deposits. As a result of this restriction, some NGOs have not provided voluntary deposit services, despite the strong demand from the community including their target group of clients; some others have provided this service because bank regulators and governments have chosen to turn a blind eye to their voluntary deposit mobilization activities. 3 However, offering this service illegally has not enabled them to harness their maximum potential. Illegality of their deposit operations has often made these NGOs seriously vulnerable to political interventions. NGOs that have recognized the significance and added value of voluntary deposits to their social mission and wanted to offer the service legally, have found this to be a powerful reason for transformation into an RFI. However, it is important to note that in some cases, gaining access to public deposits has not been a factor in the transformation decision. Cases in point are SHARE Microfin Limited (SML) in India and Financiera Compartamos in Mexico. SHARE was transformed into an NBFC without NGOs that have recognized the significance and added value of voluntary deposits to their social mission and wanted to offer the service legally, have found this to be a powerful reason for transformation into an RFI. permission to mobilize savings from members or the public and, hence, SML does not offer savings products. Compartamos was transformed into a so-called Sociedad Financiera de Objeto Limitado (SOFOL), which is not permitted to capture deposits. In Peru, several NGOs have been transformed into Entidades de Desarrollo para la Pequeña y Micro Empresa (EDPYMEs), with a lower amount of capital than required to obtain a legal charter for deposit mobilization. In Kenya, the desire to get direct access to voluntary deposits of its clients to finance microenterprise lending activities figured significantly in the Kenya Rural Enterprise Program s (K-Rep) decision to become an RFI. K-Rep did not like channeling its deposits through traditional banks that in turn used the deposits to finance wealthier sectors of the economy (Rosengard et al. 2000, p.1). The same reason has figured in the transformation of Asociación para el Desarrollo de Microempresas (ADEMI) in the Dominican Republic, Acción Comunitaria del Perú (ACP) in Peru, Association of Cambodian Local Economic Development Agencies (ACLEDA) in Cambodia, and in many others. However, many transformed NGOs appear to have considered voluntary savings more as a potential source of capital for their operations than an important service for their target clients in its own right, at least initially. With transformation, NGOs have also expected to provide other services such as money transfers, leasing, and payment services, for which they have neither an institutional capacity within the NGO structure nor a legal charter. It appears that some NGOs have recognized the significance of these services for their growth and achievement of their social mission, and expected to obtain a legal charter through transformation to provide 3 In Bangladesh, several well-known NGOs provide voluntary deposit services, without serious problems from the regulators. Perhaps this may partly explain why these institutions have not seriously considered transformation into RFIs. The Expectations 5

12 such services in the future, if not immediately after transformation. D. Increased Breadth and Depth of Outreach A major expectation of transformation has been sustainable increase in both breadth and depth of outreach. NGOs have expected that the new ownership structure with equity capital, potential for greater access to commercial borrowings, and legal charter for voluntary deposit mobilization and other services, would together enable a rapid increase in both breadth and depth of outreach. In particular, they have expected a greater depth in outreach due to both increased access to a larger amount of loanable funds than before and improvement of efficiency in operations arising from economies of scale and broader scope. 6

13 III. HAVE THE TRANSFORMED INSTITUTIONS MET THE EXPECTATIONS? To what extent have the transformed institutions been successful in meeting the expectations? What factors explain the gap between the promise and performance so far? Can this gap be narrowed in the near future? A. Ownership Structure with Risk Capital and Improved Governance? The transformation of NGOs into RFIs has, in most cases, resulted in an ownership structure consisting of multiple owners with risk capital, partly because that was required for compliance with the legal requirements relating to RFIs. However, in some cases mostly in Peruvian NGOs that were transformed into EDPYMEs transformation has not brought a significant change in ownership structure. Transformed institutions have been able to increase their equity over time (Table 1). In Fondo Financiero Privado - Caja Los Andes (FFP CLA), total equity increased from about $2.0 million at the end of 1996 to $11.7 million at the end of Financiera Compartamos reported the most dramatic growth in equity where the amount increased from $5.7 million at the end of 1999 to $30.6 million at the end of The MIBANCO and ACLEDA Bank also reported a significant growth in their equity. The initial increase in equity, greater opportunities created by the transformation, and rapid growth in operations have resulted in continued growth in total equity of these institutions, as expected by the proponents of transformation. The actual ownership structure of most of the transformed institutions does not seem Table 1 Growth of Equity a/ of Transformed Institutions ($ 000) Nirdhan SHARE End of FFP Caja Banco Financiera FFP EDPYME Utthan Hattha ACLEDA XAC Microfin Year BancoSol Los Andes ADEMI Compartamos FIE Mibanco Edyficar Bank c/ Kaksekar Bank d/ EMT Bank Ltd. e/ , , , , ,490 1, ,696 2, ,152 3,901 5,933 2,320 14,050 1, ,456 4,460 12,389 5,740 4,014 14,570 2, , ,641 5,871 16,001 10,823 4,385 15,310 3, , , ,177 6,572 11,244 4,613 18,240 4, ,688 2,329 2,467 1, ,800 6,985 18,350 5,360 23,380 5, ,023 5,137 2,840 2,620 1, ,810 11,697 30,585 6,252 25,740 b/ 1,162 15,935 3,378 2,860 1,433 a/ Includes reserves b/ As of 31 March c/ As of 30 June d/ Does not include subordinated debt. e/ As of 31 March = data not available Sources: SHARE Microfin Ltd., and ACLEDA Bank. Have the Transformed Institutions Met the Expectations? 7

14 to differ much from the generally expected structure. This is true for both Latin America and Asia. As shown in Table 2, in Latin America, the founder NGOs have retained an ownership of 45% or more in 5 out of 10 cases for which there are detailed data. The ACP retained 60% ownership in Mibanco at the time of the transformation. At least in three cases FFP FIE, FFP CLA, and Mibanco the founder NGOs had increased their ownership shares from initial levels by the end of In contrast, in BancoSol and Financiera Calpiá, the share of the founder NGO has declined. In one exceptional case, Corporación Nicaragüense Financiera (CONFIA) in Nicaragua, the founder NGO's initial share ownership in the transformed institution was completely sold to a specialized fund. The founder NGOs of most EDPYMEs in Peru currently hold over 90% of the ownership in their respective EDPYMEs, with the exception of Crear Arequipa where the founder NGO's share is only 24%. However, most of these NGOs plan to reduce their share to 51% over time. Some founder NGOs have retained a relatively small share in ownership from the beginning. The founder NGO of Banco ADEMI in the Dominican Republic owns only 24% of the bank's equity. Table 2 Ownership Structure of Selected Microfinance Institutions in Latin America (%) FFP Financiera Caja Los EDPYME Banco EDPYME Financiera BancoSol Calpiá Andes FFP FIE Mibanco Edyficar ADEMICONFIA CONFIANZA Compartamos Owner Jun Sep 00 Jun Founder NGO International NGOs 16.0 a/ Other NGOs 19.7 b/ Employees 20.0 Mulilateral Agencies/ Public Development Banks/ Bilateral Donors 50 c/ 43.7 d/ 10.0 e/ f/ NGO/RFI Board Members 39.0 Specialized Funds 26.7 g/ 39.0 h/ 22.9 i/ Commercial Investors 32.0 j/ 13.3 k/ 17.0 l/ Private individuals Other 5.4 m/ 15.0 n/ 20.0 o/ 11.2 p/ Total a/ ACCIÓN International b/ Three local NGOs (Calpiá Foundation; Salvadoran Foundation for Development and Minimal Housing, and Chalatenango and Morazan Local Development Agencies c/ Banco Centroamericano de Integración Económica (25%) and the Multilateral Investment Fund (25%) of the Inter-Amercian Development Bank d/ Details not available e/ Switzerland Agency for Development Cooperation f/ International Finance Corporation g/ Profund (19.68%) and Accion Gateway Fund (7.0%) h/ Profund International (26%) and IMI/IPC (13%) i/ Profund (5.8%) and Accion Gateway Fund 17.1%. j/ B.H.N. Multibanco, Inbosa, Banco Industrial, BISA, Banco Boliviano Americano, COMSUR k/ Banco Weisse Sundameris (6.66%) and Banco de Crédito del Perú (6.66%) l/ Banco Europeo de Inversiones, Luxembourg m/ Ecos Holding Ltda. n/ Fundacion Johnson - Bolivia o/ Triodos-Doen Foundation (19%) p/ The Guilles Foundation (Belgium) and ALTERFIN = not applicable NGO = nongovernment organization; RFI = regulated financial institution Sources: Jansson (2003); executives of Financiera Compartamos, FFP FIE; 8

15 The founder NGOs have also retained a significant share ownership in transformed institutions in Asia, as shown in Table 3. The founder NGO of Ennathian Moulethan Tchonnebat (EMT) initially (at the end of 2001) had an ownership share of 81%. Even after the introduction of two new owners in 2002, its ownership stake was 60% (EMT 2003). The ownership share of the founder NGOs is 44 51% in the case of CARD Rural Bank, ACLEDA, OMB, First Microfinance Bank, and Hattha Kaksekar. However, in ACLEDA Bank, the founder NGO's stake is gradually declining: as at 1 December 2003, it was only 40.1%. In some other cases, the founder NGOs have from the beginning retained relatively small share ownership in the transformed institutions. For example, Nirdhan NGO owns only 12% of the equity of the Nirdhan Utthan Bank. Although transformed institutions have attracted equity from different sources, the new equity has come mainly from a limited number of social investors: public sector development banks, multilateral and bilateral organizations, international NGOs, and specialized funds, "which in turn are largely funded by donors" (Jansson 2003, p.14). For example, 50% of Financiera Calpiá's initial equity came from the Central American Bank for Economic Integration and the Multilateral Investment Fund of the Inter- American Development Bank, while 59% of CONFIA's equity was from Profund International, 4 Internationale Micro Investitionen AG (IMI), 5 and Triodos-Doen Foundation. About 49% of the equity of OMB in the Philippines came from social investors. Profund and ACCIÓN International's Gateway Fund together accounted for 26.7% of the total equity of the Mibanco at the end of The new equity has come mainly from a limited number of social investors. The Shorebank Inc. accounts for 13.4% of the share capital of K-Rep Bank while 47.8% of K-Rep Bank's equity is held by the International Finance Corporation (IFC), African Development Bank, FMO (Netherlands Development Bank), and Triodos-Doen Foundation. Deutsche Investitiosund Entwicklungsgesellschaft (DEG), IFC, FMO, and Triodos-Doen Foundation accounted for 49.0% of ACLEDA's total equity. 6 Although they were absent initially, over time the Inter-American Investment Corporation (IIC), the Andean Development Corporation (ADC), and the Commonwealth Development Corporation (CDC) became significant equity investors in BancoSol. CDC alone acquired 20% ownership of this bank in 1998 when IIC and the NGO PRODEM sold their shares and owned 22% at the end of As Rhyne (2001, p ) notes, some institutions such as IIC, ADC, and CDC that transformation brought into microfinance as investors were "previously uninvolved in microfinance. These public-sector development banks operate on mainly commercial principles, albeit under multilateral backing. They share characteristics of both public and private institutions. As dual-personality institutions they have a natural affinity with microfinance institutions and have been influential in introducing the microfinance field to private-sector standards of operation. Yet, fundamentally, they must be considered a part of the donor world." The ownership data for transformed institutions in Asia, however, indicate that the multilateral agencies, bilateral donors, and public development banks have not taken up any equity in 10 cases, while specialized funds have no equity, at least in the 13 cases reported in Table 3. Commercial institutional investors have also harnessed the equity investment opportunities 4 Profund is a for-profit investment fund that provides equity and quasi-equity to microfinance institutions. However, 76% of its share capital is from multilateral and bilateral organizations, 16% from NGOs, and only 8% from private investors ( 5 IMI is an investment company focused on equity participation in microfinance banks in transition and developing countries. Multilateral/bilateral organizations account for 51.5% of its share capital, DOEN Foundation 16%, and NGO ProCredito 6%, with the remaining 26.5% owned by a private consulting firm ( 6 ACLEDA Bank Limited received a commercial banking license from the National Bank of Cambodia on 1 December Have the Transformed Institutions Met the Expectations? 9

16 Table 3 Ownership Structure of Selected Microfinance Institutions in Asia (%) First CARD Nirdhan DEPROSC Chhimek SHARE Micro- Thaneakea Rural ACLEDA Utthan Bikas SB Bikas Microfin Vision finance XAC Hattha Phum Bank Bank Bank Bank Bank Bank Ltd. OMB Bank Bank Bank EMT Kaksekar Cambodia Owner May 02 Dec 01 Mar 03 Jul 01 Jan 02 Nov 02 Mar 03 Jul 02 Apr 03 Dec 02 Dec 01 Dec 02 Dec 02 Feb 03 Founder NGO q / International NGOs 27.9 b/ Employees a/ 32.5 Multilateral/ Bilateral Agencies/ Public Development Banks 36.8 c/ 24.3 d/ 12.0 e/ Board Members Specialized Funds Commercial Investors 36.0 f/ g/ 51.0 Private Individuals Clients Others 12.2 h/ 11.0 i/ 14.0 j/ 17.0 k/ l/ m/ n/ 28.0 o/ 19.3 p/ 10.0 Total a/ Through ACLEDA Staff Association b/ Opportunity International Network (24.72%); Opportunity International Australia (3.14%) c/ IFC, FMO, and DEG (each 12.25%) d/ IFC e/ PROPARCO (a subsidiary of AFD, the French Development Agency) f/ Himalayan Bank Ltd., Nabil Bank Ltd., and Everest Bank. Ltd. (each 12%) g/ Nepal Investment Bank, Nabil Bank Ltd., and Himalayan Bank Ltd. (each 17%) h/ Triodos-Doen Foundation i/ Grameen Trust Bangladesh j/ Agricultural Development Bank of Nepal k/ Women Cooperative Society Ltd. l/ Gordon and Helen Foundation m/ Aga Khan Fund for Economic Development n/ XAC Bank had only one shareholder, XAC-GE Group, which is a holding company, at the end of However, this holding company is owned by seven shareholders: Mercy Corps (47%); the Liberal Women s Brain Pool (9.41%); Mongolian Women s Federation (8.71%); Soros Foundation (11.59%); National Association of Mongolian Agricultural Cooperatives (9.41%); Local Governance Development Foundation (7.29%); and Rotary Club of Ulaanbaatar (6.59%). As of December 2001, employees had a share ownership of 13%, but Mercy Corps was holding this on behalf of the staff because an employee trust is not permitted to hold shares in a bank. o/ Societe d Invertissement et de Developpement International (14%) and La Fayette Participations (14%) p/ Societe d Investment et Development International (SIDI) q/ Catholic Relief Services is the founder NGO DEG = Deutche Investitiosund Entwicklungsgesellschaft; FMO = Netherlands Development Bank; IFC = International Finance Corporation; NGO = nongovernment organization Source: Data obtaned from executives and websites of respective institutions created by the transformed institutions in a few cases. In BancoSol, 32% of the equity came initially from such investors. Two of the largest private commercial banks in Peru Banco Wiese Sudameris and Banco de Crédito each contributed 6.6% of Mibanco's total equity capital initially. However, in both cases, these investors sold all their shares completely by the end of Transformation, with a few exceptions, has not led to significant private risk capital investments in these institutions. However, it is important to note that lack of significant private risk capital continues to be a characteristic of most other types of shareholder-owned microfinance institutions as well (Kaddaras and Rhyne 2004). Although "true private investors" did not invest in BancoSol initially (Rhyne 2001, p.111), a private investor purchased 7% of BancoSol's equity sometime after the transformation. This investor is considered to have been "the first 10

17 genuine profit-motivated private investor in BancoSol," though some observers point out that he was also "seeking prestige and social recognition" (Rhyne 2001, p.130), rather than a competitive return on his investment. Private individuals owned 10.7% of the total share capital of this bank at the end of Although private individual investors accounted for 18.7% of the total equity of FFP CLA at the time it was established in July 1995, their share declined to 6.4% by the end of In the case of FFP FIE, private individual ownership declined from 15.5% in 1998 to 6.8% at the end of 2002 (FFP FIE 2003). Few institutions stand out in terms of private risk capital investment. A private bank Banco Europeo de Inversiones held 17% of the equity of the Banco ADEMI in the Dominican Republic in mid Private individuals held 30.5% of the equity of Financiera Compartamos in Mexico at the end of 2002, 41% of the equity of the Nirdhan Utthan Bank in Nepal at the end of March 2003, and 32% of the equity of Chhimek Bikas Bank in Nepal at the end of November Whether the lack of significant purely private risk capital investments in most transformed institutions indicates a sign of failure is, however, questionable. First, if founder NGOs have funds to take a high share of equity using their accumulated reserves and assets, there is no reason that they should not do so initially, although that may limit the room for others to invest, as was the case with Mibanco. This is particularly true when the founder NGO intends to cease its operations after transformation. Second, equity investments in an MFI by private parties depend, among other things, on countryspecific factors, risk-adjusted relative profitability expectations, and the opportunities for easy exit, which in turn depend on the stage of the equity market development. Third, when there are social investors and public development banks seeking investment opportunities in financially sustainable NGOs that are willing to transform, the incentives for founding NGOs to seek pure Many transformed institutions did not seek significant private risk capital for fear of potential mission drift. private risk capital are not strong. For example, the data indicate that specialized funds gained significant equity ownership in BancoSol (33.8%) and Financiera Calpiá (28.5%) by the end of 2002, while they had no equity stakes in these institutions initially. In CONFIA in Nicaragua, the share of specialized funds increased from 39% at the end of September 2001 to 81% at the end of August Fourth, it is not reasonable to expect quantum leaps in private investments in an industry that most private investors find difficult to evaluate for lack of benchmarks and transparent data. More importantly, many transformed institutions may have had reservations about the desirability of high levels of private risk capital participation in their institutions. As Schmidt and Zeitinger (1996, p.251) pointed out, "financial entrepreneurs are likely to find other market niches to be more profitable than small and microenterprise lending. This might lead them to turn to other groups of customers and thus give up the target-group orientation which would be desirable from a development-policy standpoint." Many transformed institutions did not seek significant private risk capital for fear of potential mission drift. Thus, Rhyne (2001, p.111) notes that at the initial stage, the founders of BancoSol "did not seek such investors. They were leery at this stage of allowing partners who would not be as dedicated to BancoSol's social mission as they were to its bottom line." The leaders of NGO FIE articulated these concerns about private investors clearly and "sought out individuals and organizations interested in making a profit and at the same time dedicated to sharing the nonprofits' mission and vision" (Ramirez 1999, p.391). According to Jansson (2003, p.15), "the management of Financiera Calpiá feels quite satisfied with the current ownership structure. It values shareholders who are business oriented but not guided solely by profit motives, and consequently is not courting any pure commercial investors or local banks." Jansson, on the basis of his Have the Transformed Institutions Met the Expectations? 11

18 examination of the ownership structure and its evolution of BancoSol and Financiera Calpiá in Latin America, concludes that "perhaps over time ownership in these institutions will show a trend toward more private sector for-profit involvement, but so far there is little evidence of it" (Jansson 2003, p.15). The data on evolution of ownership in a sample of six transformed institutions in Latin America, presented in Table 4, confirm Jansson's observation. Many Asian NGOs that transformed into RFIs also did not seek significant private investments, for example, ACLEDA Bank, CARD Rural Bank, OMB, SHARE Microfin Ltd., and XAC Bank. In Asia, only in Nepal is there a significant private risk capital involvement in transformed institutions. Thus, 36% of Nirdhan Utthan Bank, 51% of Chhimek Bikas Bank, and 37% of DEPROSC Bikas Bank equity have come from purely private banks. In addition, private individuals have significant share ownership in both Nirdhan Utthan and Chhimek Bikas banks. However, this is because of the legal requirement that public companies registered under the Company Act 1997 of Nepal should allocate 33% of the share capital to the general public. Thus, for most transformed institutions the issue appears to have been not one of seeking the maximum level Table 4 Evolution of the Ownership Structure of Selected Microfinance Institutions in Latin America (%) BancoSol Financiera Calpiá FFP FIE Mibanco CONFIA FFP Caja Sept Aug Los Andes Owner Founder NGO International NGOs 16.0 a/ 13.3 a/ Other NGOs 19.7 Employees Multilateral/Bilateral Agencies/ Public Development Banks 22.0 b/ d/ g/ 3.8 i/ m/ NGO/RFI Board Members Specialized Funds 33.8 c/ 28.5 e/ j/ k/ 25.0 n/ Commercial Investors Private Individuals Others f/ h/ l/ 2.0 o/ Total a/ ACCIÓN International b/ Commonwealth Development Corporation c/ Profundo International (23.17%) and ACCIÓN Gateway Fund (10.63%) d/ IFC (12%); FMO (12%); and KfW (12.4%) e/ IMI f/ IPC g/ Andean Development Corporation (11.73%) and Swiss Development Corporation (7.31%) h/ Interchurch Organization for Development Corporation (2.85%) and ADA Foundation Roger Adams (2.22%) i/ Andean Development Corporation j/ Profund (17.8%) and ACCIÓN Gateway Fund (6.4%) k/ IMI l/ Details not available m/ Andean Development Corporation n/ IMI o/ IPC = not applicable IFC = International Finance Corporation; IMI = Internationale Micro Investitionen AG; IPC = Internationale Projekt Consult, GmbH; KfW = Kreditanstalt für Wiederaufbau Sources: Jansson (2003); Executives of Financiera Compartamos, FFP FIE;

19 of private risk capital participation but finding the most appropriate level of such capital to achieve the social mission in respect of the target group, on an increasing scale. Those who like to see significant private sector for-profit involvement in these institutions may have to wait a few more years to see such developments. Transformations in some cases have resulted in employee ownership of the financial institutions. This is the case with ACLEDA Bank and Hattha Kaksekar in Cambodia, Banco ADEMI in the Dominican Republic, K-Rep Bank in Kenya, and CARD Bank in the Philippines. In Banco ADEMI, employees own 20% of the share capital, and since 1998, the bank has paid out $1.3 million in dividends on these employee shares (White and Campion 2002, p.38). The highest employee ownership of 33.5% is reported by Hattha Kaksekar in Cambodia. In ACLEDA, employees initially owned 5.4% of the share capital collectively through the ACLEDA Bank Staff Association, established primarily for this purpose. This stake had increased to 10.9% by December The employees of XAC Bank own 20% of its equity. The employees of K-Rep Bank own 10% of its shares. It is, however, important to note that other leading transformed institutions, such as BancoSol, FFP CLA, Mibanco, FFP FIE, Financiera Compartamos, and Financiera Calpiá in Latin America; and Nirdhan Utthan Bank, OMB, and EMT in Asia, do not have any employee ownership. In two exceptional cases, namely CARD Rural Bank in the Philippines and SML in India, transformation has enabled the members of the founder NGO to own shares of the new financial institution. At the end of May 2002, member clients of CARD Rural Bank owned 29.3% of its shares. SML, however, is unique. About 99% of SML's paid-up capital of $1.2 million (as of 31 March 2003) has been contributed by 26,034 poor In most cases, transformation has brought significant improvement in governance and institutional sustainability. women clients. Although such high levels of member ownership may look remarkable from a social or equity point of view, its merits from a financial point of view are undoubtedly questionable. The members, given their economic status, are not in a position to provide additional capital in case the institution needs an urgent capital injection. Nor do they have the capacity to carry out effectively the oversight function generally expected from shareholders. Both factors suggest that such high level of member ownership in a large MFI is a risk factor rather than strength of the institution. 7 In most cases, transformation has, in line with the expectations, brought significant improvement in governance and institutional sustainability. This is a consequence of two main factors. First is the need to meet the requirements of the banking authorities to get a license to become an RFI. Second is the new ownership structure and the new board of directors. The legal and operational requirements have led to improved management and operations, particularly in portfolio classification and management, loan loss provisioning, internal control, liquidity management, risk management, and management information, in addition to, obviously, maintaining capital adequacy. In most cases, transformed institutions had to spend considerable resources for staff training and to put in place proper systems and more transparent procedures for doing business to meet the licensing requirements and to retain the license. In addition to meeting an array of "safety and soundness" tests, transformed institutions also had to meet the standard "fit and proper tests" in regard to appointment of management and board members. The transformed institutions have also brought in experienced bankers and accounting personnel for specialized functions such as asset 7 In a report submitted to the Inter-American Development Bank, a consultant identified that the lack of sufficiently deep-pocketed shareholders, both for financial support and monitoring, is a crucial factor in virtually all MFI failures seen in Peru during the 1990s (Inter-American Development Bank 2001, p.7). Have the Transformed Institutions Met the Expectations? 13