The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

In 2003, the Council of Microfinance Equity Funds (CMEF) was formed by a handful of equity investors in microfinance with the goal of sharing, developing, and disseminating industry best practices in equity investing.

I recently had the pleasure of catching up with Jim Kaddaras, who was Vice President of Special Projects at Accion from 2001-2003. He was instrumental in launching the CMEF in 2003, and also led the charge on the creation of Accion Investments. Jim is now a Partner at Developing World Markets, and is still a Council member.

Q: What did the landscape of microfinance equity investing look like in 2003?  

Jim Kaddaras: It wasn’t much of a landscape – it was more of a scatter shot.

Accion owned stakes in some of their Latin American affiliates and Accion Investments was just launching in 2003. Procredit was a player (they were called IPC back then and their banks had separate names). FINCA had some equity investments and ShoreBank had a smattering of equity holdings.

ProFund had been around since 1995 as the first investment company focused on microfinance equity but it was winding up when the Council started. Africap was just starting, based on the ProFund model. Various other Council members, plus the development finance institutions (DFIs) and several non-profit networks, held a handful of equity investments.

Q: What was the goal of the Council when it was formed?

JK: We felt that by gathering people who had been making equity investments in a one-off way, we could help to develop and disseminate best practices in the field.

Q: Who were the Council members in the early days?  

JK: I believe the founding members were Accion, Oikocredit, Doen Foundation, ProFund, ShoreBank, and Triodos. Other early members were Africap, Andromeda Fund, Calvert Foundation, Citigroup, DID, Deutsche Bank, Open Society Institute, Opportunity, SARONA, SIDI.

Calmeadow in Toronto was also present at the creation. Its founder, Martin Connell, was a Canadian businessman who wanted to do something social and funded a lot of early studies and research.

Q: Where was the first Council meeting? What topics were discussed?

JK: An early meeting was hosted by Oikocredit at their office in Amersfoort, in the Netherlands. The first couple of meetings were focused on getting organized as a Council, discussing who else should be invited to join the Council, and building consensus around the idea of having members pay dues, which was a very controversial topic at the time.

In those early meetings we also focused on setting out the lay of the land as it currently stood so everyone was starting from the same vantage point. And we discussed what type of research and writing the Council should focus on.

Council members represented much smaller organizations back then and we faced issues of how, given our limited capacity, we would cover the world and provide help to MFIs far away. We discussed ways to provide more effective governance in an efficient manner and debated the use of head office staff vs. trusted local directors to serve on boards. We explored the potential for sharing directors among investors in joint investments, and discussed how best to execute this concept of “piggy-backing” off of like-minded investors.

Q: What were some of the early CMEF publications?

JK: The first Council publication was the Characteristics of Equity Investments in Microfinance, which I co-authored with Beth Rhyne. This report looked at where equity investments were in microfinance by region and country, and so tried to quantify and describe the investment landscape in microfinance. The report also examined the role investors were playing at the time – were they active on boards or passive?

The report also focused on effective corporate governance. It focused on how boards should be organized, which committees were important and why, and how to strike the proper balance in terms of a relationship between governance and management—that is, how to ensure that the power wasn’t tilted too much in one direction or the other so the board was in charge of overall strategy and direction, and management was in charge of executing that strategy and managing day-to-day operations.

Q: What were some of the controversial topics when the Council started?

JK: The Council was made up of pretty like-minded investors so there weren’t too many controversial topics among members. But one of the big issues we discussed was what to do when you didn’t have like-minded investors on the board.

All of the Council members at the time were convinced that there should be a double-bottom line and everyone investing was trying to build the field, so making money was not the leading concern. Over time, it was recognized that to build the field, we had to draw other investors in, and to do that, we had to be able to offer a reasonable return. It seems now that some investors feel the social mission can be subordinated to financial returns, but that didn’t exist back then.

We, as equity investors, were also concerned about the role of NGOs in institutions that had transformed from an NGO into a for-profit entity. Often, the non-profit entity would get most of the shares of the for-profit entity in exchange for the microfinance operations it had previously housed, and we struggled with the issue of an NGO keeping up with the capital needs of a growing MFI. Sometimes the original NGO can act as a brake on the growth of the institution, and this is especially true when a strong founder is involved. It can be hard for the founder to let go of his or her “child.” It isn’t always easy from an investor perspective for the founders to be involved. Sometimes the NGO ends up with diluted shares as a minority stakeholder but there can still be complications (i.e. the NGO requires special rights associated with its shares). An NGO refusing to let go can drag the MFI down.

Now, much more diverse shareholdings make it more challenging to have like-minded investors on the board. It used to be like a family sitting at the table and now, sometimes there are strangers.

Q: Looking forward, what do you think will be important issues for the Council to tackle in the future?

JK: The Council has done the industry a great service in terms of supporting pioneer investors and drawing new investors into the field. Now, the Council’s most valuable contribution will be in continuing to promote the best practices in corporate governance, and in striking the optimal balance between the social mission and financial returns.

It will be important for the Council to help shape where MFIs end up at the end of the day. Is the future of MFIs to become part of the mainstream banking system, or will they continue to operate separately as specialized institutions?

The Council should also focus on keeping the social mission of the MFI. How can we ensure this social mission remains – or is our job as social equity investors in microfinance essentially now done and we should move on to other things?

Have you read?

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The Investing in Inclusive Finance program at the Center for Financial Inclusion at Accion explores the practices of investors in inclusive finance. Across areas including risk, governance, stakeholder alignment, and fund management, this blog series highlights what’s being done to help the industry better utilize private capital to develop financial institutions that incorporate social aims.

When you hear the word “democracy,” you probably think of equality, elected representatives, voting rights, and so on. You probably also think of specific contexts. In the United States, for example, many of its citizens pride themselves on living in a democratic country. But what about democracy in business? Or more specifically, democracy in microfinance institutions (MFIs)? Should democracy extend to the decision-making in their governing boardrooms?

Although good governance has become a top priority for microfinance investors, donors, and regulators worldwide (CGAP’s Microfinance Gateway lists it as a Hot Topic), the structures of boardrooms and views on governance vary from institution to institution, country to country, and continent to continent. None of these structures, however, seem to be “democratic” in the way we define the word – representative of all parties involved. For example, as we covered in a previous blog post, the Anglo-American model of governance empowers CEOs to also serve as chair of their corporate board, which can result in management dominance of decision-making.

At the CMEF’s most recent meeting in April in Lima, Peru, a portion of the discussion was dedicated to asking why the client voice is not heard in the boardroom. Although it was generally agreed that financial institutions should strive to incorporate clients at the governance level in some way, the response on “how” varied greatly.

FINCA, for example, advocated for and currently uses market research through client surveys, focus groups, and social audit committees that ensure that the client voice is being considered in decision-making. Another suggestion was establishing mechanisms for receiving and integrating client feedback. Not all CMEF members agreed with these suggestions, however, and asserted that the methods for incorporating the client voice should be determined by each organization.

Financial Inclusion 2020’s Addressing Customer Needs Working Group’s suggestions of conducting quarterly client panels or including client representatives on boards were also considered. One concern expressed was that if a client did serve on a board, it would be difficult to choose one client that would best represent a large and diverse group of clients. Note that this discussion was framed with the assumption that MFI boards would be the ones selecting the client representatives.

But what if client representatives were selected, not by the board or the management, but by other clients? Wouldn’t it be more representative of the client voice if the clients could elect their own representative? Clients are major stakeholders of their MFIs, so shouldn’t they have the right to vote for someone who best represents their voice at the governance level? In the same way that union leadership is elected democratically, clients should be afforded the same due process. As the United Service Workers Union (USWU) explains, unions give individual workers a voice in decisions and events that directly affect their work, and give the individuals a say in changing and negotiating workplace conditions and solving workplace problems.

Clients are integral stakeholders in MFIs, and whether it is done through an elected representative, a market research function, quarterly client panels, or a social audit committee, their views should be represented in the boardroom. As is expected, the “how” will likely vary from institution to institution, but in order to reach a greater level of democracy in boardrooms, a way to include the client voice in every MFI must be found.

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> Posted by Center Staff

The Council of Microfinance Equity Funds (CMEF) is proud to issue its latest paper, “Growth in Commercial Microfinance: 2005-2008.”

This work by Preetesh Kantak illustrates the significant changes in the commercial microfinance industry over the past four years. Traditionally, growth studies, such as MicroRate’s annual microfinance investment vehicles (MIVs) survey, have focused on growth in the assets of MIVs. This growth has been phenomenal, and of course strongly influences the MFIs in which they invest. The “Growth in Commercial Microfinance” series, of which this is the third publication, dissects and clarifies growth in the MFIs themselves – the actual investment opportunity-set. With this study, CMEF gauges the opportunities available to investors in MFIs.

The first study of this series, published in 2004, focused on the transformation process of NGOs and start-up MFIs into regulated, for-profit entities. A large part of this effort was the enumeration of guiding corporate governance principles and the impact that this new business model had on the sustainability of the institutions and industry. The second study, published in 2006, examined industry growth in the preceding two years, and explored the distribution of MFIs, borrowers and depositors by region.

In this latest installment, the author first analyzes the internal, “organic” growth of MFIs presented in the 2006 study. The report explores the increasing and more pervasive efforts at financial intermediation and how the growth of saving products have matched, if not exceeded, the growth of loan products.

By analyzing changes in the distribution of loan sizes on a regional and aggregate basis, Kantak also looks into an interesting phenomenon occurring in the distribution of loan sizes within larger and smaller MFIs. He then constructs his own risk management metric to better visualize the tradeoff between high losses on loans and proper risk management provisions. Overall, even with the explosive growth that characterized the sector through 2008, it seems as though MFIs improved their commitment to low-income borrowers and their investors.

Through a breakdown of the Dupont Formula, the author further illustrates the rapid maturing of the industry. MFIs have shown improvement in return on equity, profit margin, and the use of leverage between 2005 and 2008. This increased maturity, however, has also led to some increased concentration, as evidenced by the paper’s Herfindahl analysis.

Finally, the report presents an updated composition of ownership of characteristic commercial MFIs. The composition of ownership is an important determinant of an MFI’s mission and direction, as well as the effectiveness of corporate governance.

You can learn more about CMEF by clicking here.