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> Posted by Julie Shea

The microfinance rating agency MicroRate recently published “Role Reversal Revisited,” which charges that government-funded Development Finance Institutions (DFIs) continue to crowd-out private funding for microfinance.

The premise of “Role Reversal Revisited” is that DFIs should invest where private sources of funding don’t yet dare go because the risk is too high and the process too time-consuming; they should pave the way for private resources rather than competing with them. DFIs have historically been a major source of funding for global microfinance, but as the industry matures and proves itself as an investable asset, private lenders have displayed an increased willingness to channel funding into microfinance institutions (MFIs). The development community widely acknowledges that if microfinance is to continue to grow, there is no alternate to private funding, because public funding from DFIs is limited.  DFIs’ main task should be to create conditions that will attract private funding to MFIs, for example by seeding the next generation of MFIs and promoting microfinance infrastructure.

“Role Reversal Revisited” is a follow-up to the controversial “Role Reversal” (MicroRate, 2007), which uncovered a pronounced tendency for DFIs to lend to the most creditworthy MFIs, forcing private microfinance investment vehicles (MIVs) to invest in smaller and riskier institutions. These claims caused considerable controversy and a consequent pledge from DFIs to change their behavior. “Role Reversal Revisited” finds that DFIs have in fact done the opposite of what they promised – they’ve increased their share of foreign loan financing to the largest MFIs and become even more risk averse than they were in 2007. DFIs are not crowding out potential investment dollars; rather they are pushing aside actual investment dollars, as evidenced by high levels of over-liquidity among MIVs during this period. Two notable patterns of behavior emerged in the study – subsidized pricing is being used to compete with private funders (i.e. DFIs offer loans at below-market prices which private funds can’t match) and there continue to be signs of “trophy lending” (lending motivated by a desire to show a microfinance portfolio on the balance sheet rather than by borrower need for funding). Read the rest of this entry »