It takes too long for most GB type microfinance institutions (MFIs) to break-even financially, often 10 years or more. Essentially, this is because they are not able to attract sufficient funding to grow at anything near an optimal rate. Accumulated deficits increase, negative equity (technical bankruptcy) is experienced and further mobilization of large amounts of funds becomes impossible. So the MFIs muddle on, increasing their outreach to the poor when they can access funds, and inch toward operational self-sufficiencty.

There is an alternative. A "fast-track" approach to institutional financial break-even within 4 to 5 years, through maximizing outreach to the poor, can be taken, if adequate funding is available. Quasi-equity funding, that is soft loans repayable in local currency, with terms of 8 to 10 years and grace periods of 6 to 8 years, that enable their repayment out of profits, and that are legally subordinated to other debt, can cover the inevitable accumulated operating deficits prior to break-even. It will keep the MFIs solvent and leverage, at near-market and market rates, the increasing amounts of on lending funds that will be required.

While some Central Banks throughout Asia, including the Banko Sentral na Philippinas, have recognized the potential of new generation microfinance for widespread reduction of poverty in their countries, none have fully acknowledged the unconventional nature of microfinance for the poor i.e. unsecured loans with near-perfect repayment rates, but a shortage of conventional equity. Nor have they fully facilitated the vital role that private sector microfinance companies could play in poverty-reduction. Microfinance for the poor should not be forced into the Procrustean bed of conventional banking regulations, like for example requiring MFIs to become banks. They do not need to be banks to do microfinance with the poor; they need their own set of enabling and suitable prudential norms and regulations.

Initially these microfinance companies for the poor (MFCPs) will have difficulty in attracting private investment. Primarily this is because investors don't yet see microfinance with the poor as a potentially profitable enterprise. Indeed some still believe it to be immoral to make money in doing business with the poor. This will change when the number of companies making reasonable profits in this business increases. Meanwhile, however, the shortage of conventional equity creates two major, interrelated \problems for microfinance companies: slower than optimal rates of growth due to shortage of funds, and large operational deficits prior to institutional financial break even, which itself is delayed by the less than optimal growth rates. The resulting negative equity further frightens off potential investors and makes banks, including development banks, reluctant to lend to microfinance companies, even at market rates.

CASHPOR Financial & Technical Services Ltd (CFTS) commenced operations in Mirzapur, Uttar Pradesh, India, in Sept. 1997, to prove that with adequate financing an MFCP could break-even financially within 5 years, by providing quality financial services to about 20,000 poor households at the district level. CFTS has met its business plan targets for fiscal 00/01. Three and a half years later, with 10,613 active loan clients (97% of target), Rupees 30.1 million loans outstanding (102% of target) and only 1.284% portfolio at risk (slightly better than the 1.5% target), the company is projected to break-even financially within one year, that is, by end March 2002. At that time, four and a half years from start-up, it will be providing financial services to more than 20,000 poor households in Mirzapur District. Thereafter efforts will be made to transform CFTS Mirzapur into a community-owned financial institution for the poor, by offering shares to its clients ¹.

CFTS was not able to attract much conventional equity nor, indeed, much grant funding. However, it has been able to attract sufficient amounts of other types of funding, particularly longer-term soft loans and shorter-term near-commercial loans. Initial start-up funding for CFTS was provided by conventional equity, actually share application money from CASHPOR Technical Services Sdn Bhd, an associated company of CASHPOR Inc, based in Malaysia. A large soft loan from the Grameen Trust of Bangladesh, however, provided most of the funds for training of field staff and establishing branches as well as for initial loan capital. A small grant from a private Indian company helped with the preliminary operating expenses. Next, in Year 2, came a soft loan from the Calvert Social Investment Foundation USA which was used for operating expenses. The Small Industries Development Bank of India (SIDBI) started providing near commercial funding for on lending (at 11% pa, compared to a prime lending rate of 12%) in Year 2, and has supplied additional amounts each year, as the demand for our loan products has increased. In Year 3, Friends of Women's World Banking (FWWB) began supplying commercial funding (at 14% pa) for on lending. Currently it is considering our application for a second loan. The Grameen Foundation USA provided a soft loan of about Rupees 10 million for on lending in Year 4, and currently is considering our application for additional funding.

Re-arranging this funding conceptually by type and use, gives the following interesting picture:

Important observations on the actual funding of CFTS to-date are:

i)

the relative unimportance of conventional equity and grant funding, accounting for only 6.6% of total funding over the three and one-half year period;

ii)

the critical importance of medium to long-term soft loans, being 41.3% of total funding and covering operating deficits as quasi-equity;

iii)

the virtual equal importance of near commercial loans for on lending and

iv)

the relative unimportance of commercial loans. The accumulated deficit of CFTS as of end Sept. 2000 was Rupees 12.2 million, which is less than half of our soft loans that are designed to cover it. The projected accumulated deficit for the end of the current fiscal, which will be its highest prior to break-even, is about Rupees 17 million. Therefore, it is expected that the same funding strategy will see CFTS through to operational self-sufficiency within one more year, i.e., by end March 2002 and enable it to cover its accumulated deficits by the end of the next fiscal year. For on lending funds after institutional financial break-even, however, CFTS will have to seek an increasing proportion of funds at commercial rates from banks.

Based on its experience in India, CASHPOR is formulating a new financing strategy for its member MFIs, to operational and full financial self-sufficiency through maximizing their outreach to the poor. It identifies the funding requirements of MFIs according to their stage of development, and suggests the types and possible sources of funding that could meet the needs. It is hoped that member MFIs will build this strategy into their business plans; and that funders will play their appropriate roles, so that microfinance can achieve its great potential for significant reduction of poverty throughout Asia.

Grants from donors must be sought to cover the heavy, up-front costs of training and motorizing field staff and establishing branches, as well as the development costs of group formation. Supplying such grants to MFI start-ups is a particularly suitable role for bi-lateral donors and development foundations. However, donors may find the sum involved, around US$250,000 over three to four years, too small to process. This may point to a role for MFI wholesalers to package start-ups in a particular country, so that donors would be able to process one big loan, instead of several smaller ones² If equity and grants are not sufficient to cover on lending as well as operating expenses, then quasi-equity in the form of 7 to 9 year term soft loans, with grace periods of 5 to 7 years, at interest rates of 2 to 5%, and repayable in local currency, should be sought to cover the balance. These soft loans should be legally subordinate to current loans.

Medium to long-term, soft loans that are legally subordinated to current debt and are not callable, can be called quasi-equity, because they are designed to be repaid out of profits after institutional financial break-even. In concept, they are similar to equity provided in the form of medium to long term redeemable preferred shares. Quasi-equity is vital to the financing of MFIs working with the poor because normally they will not be able to attract enough conventional equity or grants to cover all of their development costs and operating deficits prior to break-even. If the quasi-equity can cover up to half of these essential expenditures, then the MFI may not experience negative equity, and it should be able to attract an increasing amount of on lending funds in the form of loans from domestic development banks, at near-market rates. This is important because much of the quasi-equity may have to cover essential development costs and operating deficits, and will not be available for on lending. Of course, the interest rate charged by the MFI to its clients will have to be sufficient to cover the cost of funds, as well as other essential operating costs.

Only a few organizations are supplying quasi-equity to GB-type MFIs. The Grameen Trust of Bangladesh was a pioneer of this kind of funding; but its impact has been restricted by limiting the proportion that can be spent on development costs and operating deficits to 40% of the total funding. Development banks, like SIDBI in India, have begun financing MFI capacity-building with quasi-equity. The Grameen Foundation USA is financing some MFI capacity-building with quasi-equity. Much more of such funding should be made available to well-managed MFIs that are on-track with their business plans toward operational self-sufficiency. It is most appropriate during years 3 to 5 in the development of an MFI, and also most needed then as initial equity and grants are likely to have been exhausted by development costs and deficits. Development foundations and Trusts, national and international, as well as national-level microfinance funds should give priority to such funding, as the primary goal of many of these organizations is social development. Development banks also should provide some quasi-equity, along with their semi- and near-commercial loans to MFIs.

Where savings facilities can be provided legally to microfinance clients, they can be a relatively cheap source of funds for MFIs, enabling them to bring down their average cost of funds. However, microfinance companies may not be permitted to mobilize savings until they can meet minimum capital requirements laid down by monetary authorities.

The main role for quasi-equity is to cover essential development costs, e.g., staff training and group formation costs, that cannot be covered with conventional equity or grants. Some quasi-equity may be left over for on lending, but usually it will not be much. By the third year the on lending requirements of an MFI will have become large. National-level Microfinance Funds and Development Banks can play a vital role at this time by providing on lending funds at semi- or near-market rates. Not only will this help growing MFIs to source the funds required to meet their business plan targets for loans outstanding and interest income, but also it will help the MFI to build the capacity to pay higher, more realistic, interest rates for their funds. This should enable them to borrow the increasing amounts that they will require to finance their expansion toward operational self-sufficiency.

For further expansion, and to make a significant impact on poverty in their country, MFIs ultimately will have to access on lending funds from commercial banks. Initially, banks will see microfinance with the poor as a high risk business, because they will doubt the ability of the poor to repay, and because most microfinance loans will be unsecured. Guarantee Funds can play a critical role in bringing well-performing MFIs and commercial banks together by guaranteeing to the bank a sizeable proportion of the repayment of the MFIs, thereby reducing the risks of the banks.

The main role for quasi-equity is to cover essential development costs, e.g., Funders of MFPCs will expect efficient provision of financial services to the poor, and effectiveness in poverty-reduction. Minimum standards for operational and financial performance of MFCPs need to be established; and funders should make their continued participation contingent upon reasonable adherence to these standards.

David Gibbons is the Executive Trustee of CASHPOR Inc. and Executive Chairman of CASHPOR Financial & Technical Services Ltd. (India).

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1. CASHPOR is planning to "franchise" its microfinance methodology for poverty-reduction to other poor districts throughout the Hindi heartland. Its ability to do this, and therefore, its ultimate impact on poverty in India, will depend primarily on the financial resources that it can attract. Our experience in eastern UP has shown us that human resources are not a constraint in India. Training of new field staff in microfinance is necessary of course, but it is mostly on-the-job in existing branches, and can be co-ordinated with the human resource requirements of the planned franchising. Training for senior staff in financial management will have to go hand-in-hand, but it is already available at various institutions in India and elsewhere, for the small numbers of personnel that will be involved.

2. I am grateful to Stav Zotalis of AUSAID for this point