Unlocking the Microfinance Cash Box

There is idle money everywhere in Liberia, yet little of it is available to lend at scale. Liberians pride themselves on keeping their finances close and community oriented. They hide cash in the folds of their lapas — colorful, patterned batik cloths that women across West Africa tie around their waists like wraparound skirts — under mattresses and in giant metal lockboxes.

The lockboxes are where many village savings and loans associations (VSLAs) keep their cash. Susu clubs, as these groups call themselves across West Africa, function as informal community banks. In Liberia, susu clubs number more than 1,000 and represent a tight-knit financial web in which intimate connections allow for flexible terms of service. Most Liberians — urbanites and rural dwellers alike — boast membership in more than one club. They pool their savings and lend to members and non-members to meet household and business needs, big and small. Club relationships are deep and accountability is high; one club member hosts the box in his or her home, and five others hold keys to open its locks. They gather periodically to deposit new cash and deliberate on lending requests.

Many members are petty traders, traveling across Liberia, West Africa and as far as China to buy and sell wares. The International Center for Trade and Sustainable Development (ICTD) puts the proportion of African households relying at least in part on informal cross-border trade at 43 percent, with women accounting for 70 to 80 percent of traders.¹ But in Liberia, male and female traders’ investable capital, beyond what they use for commercial activity, stays locked down in their communities. Deeming their net worth too meager, and the cost and complexity of formal service providers too high, Liberians shun commercial banks and stick to susu.²

At Liberia’s nine commercial banks, the feeling is mutual. Despite the youthful population’s growing appetite for digitized services, the banks have scaled back their presence in impoverished areas.³ Most banks cater to large foreign-owned businesses — mostly Lebanese, Indian and Chinese merchants, store owners and hoteliers — some local corporations and the Liberian government. That clientele has not had the hoped-for impact on bank balance sheets, however. Following failed attempts to name and shame highly indebted customers,⁴ banks have instead heightened their reluctance to lend.⁵ Only two of the nine lend to small and medium-sized enterprises (SMEs) and low-income earners.

Microfinance institutions (MFIs) have made major strides toward filling this gap and expanding financial access for the world’s most vulnerable groups. MFIs operating in markets with the highest microloan transaction volumes have successfully attracted capital from traditional institutional investors, in a step away from the sector’s traditional dependence on philanthropy and public financing. They have done so through the securitization of microloan portfolios — a tactic adopted from the world of high finance. Though not yet employed in Liberia and its regional neighbors, securitization has the power to catalyze financial inclusion. With the right legal and institutional framework, microfinance securitization can also help develop each country’s capital markets and facilitate the more efficient allocation of resources across the continent.

NOBEL ORIGINS

MFIs stand in the space between the intimate VSLA and the well-resourced commercial bank. In 1976, Bangladeshi economist Muhammad Yunus conceptualized microcredit as a loan scheme for a group of women in the village of Jobra, India. A decade later, he founded Grameen Bank to formalize the scheme — and pioneered the microcredit industry. By 2006, the bank’s assets had grown to $6 billion in outstanding loans to micro, small and medium enterprises (MSMEs) in developing countries. Yunus and Grameen Bank were co-awarded the Nobel Peace Prize in 2006 for “their efforts to create economic and social development from below.”⁶

Microcredit has evolved into microfinance. In Liberia, and around the globe, MFIs now offer poor households and businesses an expanded array of services beyond microcredit. These include everything from mobile money and microsavings to microloans and microinsurance. The last component is not currently available in Liberia, and the country has only one deposit-taking MFI. But the sector is attracting a growing number of active borrowers looking for a simpler way to leverage their projected income to obtain small but personally significant amounts of credit. Women make up 98 percent of Liberian MFIs’ nearly 310,000 active borrowers, with more than $5.5 million in loans.

At inception, microcredit institutions depended for scale on subsidies from public investors, international development agencies and philanthropic foundations.⁸ Then came securitization, invented in the 1970s to create liquidity on the balance sheets of mortgage lenders in the U.S. by pooling housing loans and issuing securities backed by those loans. Investors in these securities received a promise of cash flows that would be channeled to them from borrowers through a special-purpose vehicle (SPV), less a servicing fee.⁹ By the late 1990s, microfinance loans had joined credit card receivables and car loans on the growing menu of assets used to back debt and equity instruments.¹⁰ For the securitization of microloans, microfinance investment vehicles (MIVs) serve as SPVs. Issuing both equity and debt instruments, MIVs provide an avenue for institutional investors with an appetite for exposure to microfinance, and they give MFIs more-affordable resources for onward lending.

MFIs have shown their poverty reduction capacities around the globe. In Bangladesh, they helped significantly increase household incomes for microborrowers, lifting 2.5 million people out of poverty between 1991 and 2011. That amounts to a 10 percent decrease in poverty over a 20-year period.¹¹ In 2006, the Bangladesh Rural Advancement Committee (BRAC) became one of the first to attempt microloan securitization. As the world’s leading MFI, with clientele from poor communities who have little or no collateral, BRAC attracted a combined $180 million in financing from Citibank’s Bangladesh arm, German Development Bank KfW, local investment firm RSA Capital and Netherlands Development Finance Co. The fund, disbursed over six years, significantly boosted BRAC’s efforts targeting the ultra-poor. By 2010, BRAC had helped about 300,000 Bangladeshi households attain food security and economic sustainability. Central and Eastern Europe and Latin America have followed suit, with ProCredit Bank in Bulgaria raising $48.7 million in 2006 and Ecuador’s Banco Solidario raising a total of $90 million between 2009 and 2011.¹²

The geographic expansion of microfinance across Asia, Latin America and Africa, and its financial expansion through securitization, have especially benefited women and rural dwellers, who now make up 80 percent and 65 percent, respectively, of global participation.¹³ For many, microloans have simply helped them meet basic needs, such as health care and education. Their impact, therefore, has leaned more toward providing some financial stability for households to subsist in poverty rather than immediately transcend it.¹⁴

CRISIS MANAGEMENT

The microfinance industry has had its share of crises. The 2010 credit crunch in the Indian state of Andhra Pradesh was the most notable among a slew of MFI failures in Latin America, South Asia and North Africa.¹⁵ The key drivers of the Andhra Pradesh crisis were a lack of microfinance regulation, credit bureaus and a unique identification system. Without adequate know-your-customer (KYC) data to assess poor households’ creditworthiness — even for loans of $500 or less — MFIs lent to clients who were already heavily indebted, according to a BBC News report.  With no regulatory protection, the borrowers accepted annual interest rates of up to 120 percent; more than 80 people took their own lives in what the BBC described as a “suicide epidemic.”¹⁶

Commercial banks fell into trouble, too. Having invested in microloan securities to meet lending targets for government’s protected sectors, they allowed MFIs to transfer principal and interest payments in monthly fixed-amount payments instead of immediate pass-through disbursements. The remaining borrower repayments stayed on the balance sheets of already failing MFIs. Rating agencies, for their part, assigned mismatched ratings to MFIs and their securitized portfolios. In one instance, an MFI with a BBB- rating issued AAA securities.1⁷

In the throes of the Great Recession, the 2010 microfinance crisis cast MFIs as little better than traditional financial institutions. Since then, the sector has done much to reverse this fall from grace, and on a global scale. Numerous initiatives now promote technology and sophisticated tools to implement self-imposed standards for corporate governance and social impact. Such improvements have ensured the sector’s continued attractiveness to institutional investors with risk appetites suited to complex structured finance.¹⁸  As of 2016, 127 MIVs globally held $13.5 billion in assets under management and served 400,000 active borrowers.

CAPITAL INFUSION

This level of professionalism has not reached Liberian MFIs, however. In addition to low liquidity on MFIs’ balance sheets, high operational costs and regulatory restrictions hinder their profitability and keep them from gaining traction. Household borrowers needing smaller amounts cannot cope with interest rates that can top 25 percent. MSMEs looking to scale up find the Central Bank of Liberia’s lending cap stifling. The absence or shallowness of capital markets in Liberia and across sub-Saharan Africa (SSA) has added to these challenges. Legal frameworks limit institutional investors’ ability to diversify risk and omit the possibility of securitizing any asset, let alone microloans. As a result, most MFIs still function on public investments or philanthropy, deprived of the resources held in pension funds, insurance companies, commercial banks and personal bank accounts, under mattresses and in lockboxes.

The securitization of microfinance can provide an infusion of capital for Liberia and sub-Saharan Africa, as it has across Asia, Eastern Europe and Latin America. Though securitization’s relative impact in those regions has been small, Bangladesh’s initial $180 million issuance amounts to 3,273 percent of Liberia’s $5.5 million MFI loan portfolio for 2019. Securitization can position MFIs to lend in higher volumes to individuals and MSMEs at lower interest rates, and can quicken the flow of resources from commercial banks and other institutional investors into real economic activity. ¹⁹ For VSLAs and the economically diverse households and businesses they serve, securitization can also provide a channel for the investment of individual and pooled resources.

Microfinance securitization may benefit from African nations’ growing appetite for greater regional cooperation. The latest such initiative was the creation of the African Continental Free Trade Area in 2019.²⁰ According to the South Africa–based Trade Law Center, 29 out of 54 signatory states have now ratified the agreement.²¹ The securitization of microloans would create an opportunity for smaller countries, like Liberia, to attract capital from institutional and retail investors beyond their borders. As others take steps in that direction, Liberian investors of all classes could diversify their portfolios by buying MFI securities in neighboring countries. This could lead to the gradual development of a sub-regional and continental capital market, which would boost trade and economic growth in the real sector as MSMEs continued to grow through greater access to capital.

Comprehensive upgrades are underway in Liberia and across Africa to promote financial inclusion, with support from the World Bank Group and other development partners.²² These contribute to a suitable environment for microfinance securitization. For instance, authorities in Liberia are working to bring all adult residents into the national identification card and credit reference systems, using biometric data such as fingerprints and facial recognition. The central bank’s National Financial Inclusion Strategy clarifies regulations to allow for mobile credit and the adoption of tiered KYC requirements for banks and non-bank financial institutions. Both measures serve to simplify and expand access to financial services for the mostly undereducated public.

Liberia, however, lacks the legal and institutional ecosystem to create a secondary market in microloans. So far, the nation’s Securities Exchange Commission and Central Securities Depository — established in 2016 — exist only on paper. Putting these entities to work and establishing a credit rating agency would be fundamental to the securitization of any asset in Liberia, including microloans. A comprehensive legal framework, including proper enforcement mechanisms, would underpin these components and aid in mitigating potential pitfalls of the system. Not surprisingly, Liberia appears nowhere in PwC’s latest Africa Capital Markets Watch, which reports periodically on trends in financial markets across the continent.²³

In a market as small as Liberia’s, the cost of some institutional arrangements within this ecosystem might outweigh the benefits, at least in the short run. These include independent agencies that would assist MFIs in the expensive and cumbersome task of securitizing their loan portfolios while mitigating risk both before they issue securities and in the event of an MFI default. The domestic and regional markets in sub-Saharan Africa would benefit from having regional bodies fulfill those functions. The Economic Community of West African States (ECOWAS), covering the mostly Anglophone bloc of West African countries, including Liberia, could agree to establish and facilitate initial funding for these entities.

INDEPENDENT AGENCY

Sharon Stieber, former vice president of structured transactions at Fannie Mae, put forward the idea of an independent guaranteeing agency in 2007. In an article for the MIT journal, Innovations: Technology, Governance, Globalization, she proposed that such an entity could play a role similar to that of Fannie Mae and Freddie Mac in the U.S. housing market.²⁴ Her proposal was not specific to any region but could be applied to sub-Saharan Africa. In Stieber’s scenario, the agency would oversee the pooling of loan portfolios from one or several MFIs operating in the region, as well as the preparation of legal documentation and all necessary disclosures pertaining to the portfolios, and the cash flow structuring, modeling and fulfillment of transactions between investors and loan servicers through the SPV. The agency would also obtain credit ratings for the MFIs and securities, structure and sell the securities, and act as trustee and custodian of all documentation pertaining to them.

The Regional MSME Investment Fund for Sub-Saharan Africa (REGMIFA) is leading the way in that direction.²⁵ The organization acts as a multilayered fund attracting public and private investment in MSMEs. Endorsed at a Group of Eight summit in 2007, the fund offers shares to development finance institutions (DFIs), international finance institutions and aid agencies, all of which share a measure of risk and underwrite the senior and subordinated debt notes offered to private investors. As of September 2019, REGMIFA partnered with 49 MFIs in 19 SSA countries, had reached 176,890 borrowers and had a total loan portfolio of about $127 million.²⁶

Africa’s sub-regional blocs could create bodies similar to REGMIFA to attract resources from homegrown DFIs, institutions and retail investors. If such an agency was established in the ECOWAS region, it could help MFIs in Liberia and neighboring countries avoid the prohibitive cost of individual securitization processes and the burden of coordinating complex tasks beyond their core function. Like REGMIFA, the agency could mitigate foreign exchange risk and employ subordination for credit enhancement.²⁷ The fund itself would need to be over-collateralized to provide added assurance for investors.²⁸

An ECOWAS guarantee agency could help MFIs meet global standards for corporate governance, financial management and social impact. The agency’s technical assistance could include mandatory, phased investments in the technology needed for loan origination and servicing, financial reporting and disclosures, and cybersecurity. The heightened professionalism of MFI operations would afford the guarantor access to credible reporting for display on its web portal, over which regional investors would feel a shared sense of ownership

Financial institutions across sub-Saharan Africa have sufficient resources to underwrite this scheme, beginning with the African Development Bank and the African Export-Import Bank, which could headline the list of equity investors. Ecobank, United Bank for Africa and other leading commercial banks could subscribe to the senior and subordinated debt notes. A plethora of insurance companies, pension funds and high-income individuals could join them, following the REGMIFA model.²⁹ VSLA apex bodies — unregulated associations that represent VSLAs in their dealings with financial sector regulators — could help pool funds from interested members to meet the minimum investments for the debt tranches. The guarantee agency could then leverage existing linkages between commercial banks and mobile money platforms to disburse cash flows to VSLA investors. The agency could further accommodate VSLAs by incorporating a tiered-investor KYC arrangement, now globally recognized as appropriate for providing financial services to clients at various income levels.

MITIGATING POTENTIAL RISKS

As securitization gains traction across sub-Saharan Africa, the potential risks will rise. Borrowers’ overindebtedness, resulting defaults and MFI failures, and institutional investors’ overexposure to weak microlenders could create a domestic and regional domino effect akin to the case of Andhra Pradesh. In a 2010 article describing the risks of microfinance securitization from the Indian state’s perspective, consultants Daniel Rozas and Vinod Kothari recommend installing mitigating systemic elements, including strong MFI regulatory oversight, credit reference and national identification systems for KYC data collection, and robust consumer protection.³⁰

Rozas and Kothari also recommend that legal frameworks for securitization treat microloans as distinct from other underlying assets because the typical MFI is the most viable servicer of its own portfolio. In their research, they found that an SPV pooling mortgages could retain a new loan servicer without default risks resulting from an originator’s terminated involvement, but hazarding such sudden changes to a portfolio of microloans could imperil the value of the issued securities. Borrowers would perceive the changes as signaling a creditor’s imminent failure. Or they could simply lose commitment to pay, in the absence of a familiar servicer, and stop paying their debts.

Sub-Saharan Africa could establish a regional receivership entity for failing MFIs as a safeguard against these pitfalls. Under receivership, an MFI would continue servicing its performing loans pending its sale or the transfer of those loans to a more profitable competitor. This would seek to protect the cash flows to investors from borrowers in good standing. SSA countries could create an environment for competing regional credit rating agencies to assess diverse financial institutions and instruments, including those in the microfinance sector.

The African Union, ECOWAS and other sub-regional economic communities have the political tools to effect such major advancements across the continent. Their convening power has already brought African leaders together to agree on regional and continental frameworks for political and economic governance. The establishment of guarantee and receivership agencies by ECOWAS seems the next logical step and could set the pace for the continent’s investment in a sophisticated, integrated capital market, providing the legal and regulatory structures to accommodate microfinance securitization and cross-border investment.

Elevating financial inclusion as a prominent feature in all aspects of this microfinance securitization effort could do much to brand it as credible and sustainable. Sub-regional and continental efforts to set consumer protection standards could complement domestic financial literacy programs to build consumer confidence and whet the appetites of borrowers and retail investors alike. Both groups include a young, mobile-first generation and the traditional, dominant MFI clientele: rural Liberian women who barely have the power to charge their simple Nokia cellphones, let alone catch a web signal.³¹ An evenhanded, seamless improvement of digital and in-person user experiences could secure MFIs the loyalty of customers who have shied-away from the complexity and expense of formal finance.

These regional policy developments could trigger more robust efforts to standardize cybersecurity infrastructure and risk management procedures to guard against fraud, system failures and data theft. For the SSA microfinance sector, which up to this point has functioned on manual, antiquated systems, this would be a major leap forward.³²

LOOKING FORWARD

In Liberia and across sub-Saharan Africa, elements already exist to build a viable ecosystem that supports securitization of microfinance. Mobile money has turned Kenya into a mostly cashless society; 83 percent of the population has access to a digital wallet with M-Pesa or Airtel app.³³ The technology has picked up steam across West Africa, with Ghana and Liberia leading the region at 38.9 percent and 20.8 percent, respectively. Pension funds, insurance companies and commercial banks with significant reserves need new avenues for investment. By subscribing to grassroots financial networks such as VSLAs, high- and low-income earners alike have expressed an appetite to invest in their local communities, not just borrow from them. MFIs, primed with a higher risk appetite than traditional banks, can serve as a conduit between Africans and their financial service providers, offering avenues to improve living standards and increase investment returns.

The end of the lockbox tradition will be bittersweet. It is hard to let go of the comfort and camaraderie of informal financial transactions with people one knows and trusts. Thus, the transition will be slow, as policy decisions on the continent take months and years, and cultural shifts longer. For now, Liberian women still snuggle their bills in the rolls of their lapas; some still hide money under their mattresses; and rural susu clubs still congregate, keys in hand, at the mud huts of their cash custodians to conduct the next round of transactions. But cash management is gradually going mobile, and with the advent of microfinance securitization, the ever-dynamic Liberians and their African neighbors will do with their susu investments what they have done with their other small-business pursuits — go regional and global.

Lilian Best is Secretary to the Board of Governors at the Central Bank of Liberia and an Intern at WorldQuant as part of the IFC–Milken Institute Capital Markets Program. She has a BA in political science from the University of California, Berkeley.