International Debt Financing and Performance of Microfinance Institutions

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International Debt Financing and Performance of Microfinance Institutions
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in Strategic Change · February 2013
DOI: 10.1002/jsc.1919
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Strat. Change 22: 17–29 (2013)
Published online in Wiley Online Library
(wileyonlinelibrary.com) DOI: 10.1002/jsc.1919 RESEARCH ARTICLE
Copyright © 2013 John Wiley & Sons, Ltd.
Strategic Change: Briefings in Entrepreneurial Finance
Strategic Change
DOI: 10.1002/jsc.1919
International Debt Financing and Performance of
Microfinance Institutions1
Roy Mersland
University of Agder, Norway
Ludovic Urgeghe
Center for European Research in Microfinance, University of Mons, Belgium
Introduction
During recent decades, the provision of microfinance services to poor families and
micro-entrepreneurs has evolved to become a global industry. Until recently, dona-
tions and subsidies have been the main source of funding for microfinance institu-
tions (MFIs). Lately, however, the growth of the industry and the pressure by donors
toward financial sustainability has pushed MFIs to turn to international capital
markets. Moreover, international funding is regarded by many as essential to fuel
the growth of the sector, arguing that only international capital markets can handle
the estimated US$200 billion needed to reach the potential demand for microfi-
nance services worldwide (Swanson, 2008). Recent academic research (Mersland et
al., 2011) has also shown that internationalization, notably through investments,
can have an overall positive influence on the social performance of MFIs.
The development of specialized investment funds, called microfinance invest-
ment vehicles (MIVs), illustrates the emergence of this new specialized capital
market. MFIs typically have both financial and social objectives (Armendariz and
Morduch, 2010) and attract funding from actors with varying degrees of profit
motivation, from purely development-oriented to maximum profit-oriented
(Goodman, 2004). In 2010, the 95 MIVs in operation managed US$8 billion
coming from public and private institutional investors (42%), individuals (34%),
development institutions (21%), and others (3%), mostly invested in the form of
loans to MFIs2 (MicroRate, 2011; Reille et al., 2011).
The international financing of
microfinance has become a new
specialized market which attracts
investors with varying degrees of
profit motivation.
Investors lending at commercial
rates target MFIs with relatively
better financial performance,
while those lending at subsidized
rates target financially weaker
MFIs that focus on female
customers.
Commercial funding to microfinance institutions (MFIs) seems to follow the
negative screening approach, being driven mainly by financial performance and
professionalization of the MFIs while subsidized funding seems to follow a positive
approach, being driven mainly by targeting poverty alleviation and social inclusion.
1 JEL classification codes: G11, G23, L2, O16, O17.
2 The repartition of microfinance assets invested by MIVs in 2010 was 82% loans and
18% equity (MicroRate, 2011).

18 Roy Mersland and Ludovic Urgeghe
Copyright © 2013 John Wiley & Sons, Ltd. Strategic Change
DOI: 10.1002/jsc
Th is article examines the profiles of the MFIs receiv-
ing loans from MIVs. More specifically, using data from
319 MFIs in 68 developing countries, we study whether
there is a relationship between an MFI’s access to inter-
national debt and its financial and social performance. We
find that access to commercial debt is related to strong
financial performance, a high level of professionalization,
and a low average loan size indicating outreach to poor
customers. The targeting of women is not a priority for
MFIs accessing international commercial debt. As for
MFIs accessing subsidized international debt, they target
female customers to a greater extent than other MFIs.
Th e rest of this article is organized as follows. The next
section discusses how the financial and social perfor-
mances of MFIs influence the type of funding received,
and outlines the hypotheses to be tested. The third section
explains the model, the methodology, and the dataset used
for estimations, while the fourth section presents and
discusses the findings. The fifth section concludes.
International funding and the performance
of MFIs
In this section we develop hypotheses on how interna-
tional funding is associated with the social and financial
performances of MFIs.
The relationship between international funding and
MFI social performance
First, we investigate the link between the MFI’s social
performance and its access to international funding. As all
MIVs claim to offer social returns to investors, they belong
to the field of socially responsible investments (SRIs).
Indeed, an SRI is “an investment process that integrates
social, environmental and ethical considerations into invest-
ment decision making” (Renneboog et al., 2008, p. 1). In
other words, we label “socially responsible” any invest-
ment that is linked to the corporate social responsibility
(CSR) of the target firm. In its modern understanding,
CSR not only involves the ethical obligations of firms
toward their stakeholders, but also requires investing in
projects that yield social and economic benefits (Carrol,
1979; Porter and Kramer, 2002). In the microfi nance
world, CSR would then mean that MFIs fulfill their social
mission in an economically sustainable way.
There are two approaches for responsible investment
selection: negative screening and positive screening (Bollen,
2007; Juravle and Lewis, 2008). Negative screening (also
called avoidance, or exclusion) involves a two-step process.
First, the investment manager excludes specific fields or
activities that investors consider undesirable (for instance,
firms involved in weapons, alcohol, or tobacco). Then,
investments are selected by a classical risk/return analysis.
In contrast, with positive screening, nothing is excluded
beforehand but investments are selected primarily with
non-fi nancial criteria (e.g., high environmental or social
performance).
We will test two hypotheses. In the first one, MIVs
use a positive screening approach and we expect to find a
positive relationship between the social performance of an
MFI and its access to international funding. In the second
one, they use a negative screening approach and we expect
to find a positive relationship with financial performance
and none with social performance. The hypothesis of a
negative screening in microfinance is based on the idea
that MIVs consider microfinance a social investment per
se, as if they avoid or exclude any other activity which is
not microfinance, and then apply a typical financial analy-
sis to the remaining potential investment projects.
Based on the above, we propose the following
hypotheses.
In the case of positive screening
H1a: The presence of international funding in an MFI
is positively related to its social performance
In the case of negative screening
H1b: There is no relationship between the presence of
international funding in an MFI and its social
performance, but a positive relationship with financial
performance

Debt Financing and Performance 19
Copyright © 2013 John Wiley & Sons, Ltd. Strategic Change
DOI: 10.1002/jsc
The relationship between international funding and
MFI financial performance
To propose hypotheses on the influence of an MFI’s finan-
cial performance on its access to international funding,
we make the assumption that the microfinance invest-
ment landscape is as described by Goodman (2004): on
the one hand, development-oriented investors finance not
financially sustainable MFIs with grants, subsidized loans,
or donated equity while on the other hand, commercial
investors fund financially well-performing MFIs with
loans and equity at market prices. Therefore, and as we
focus on debt investments, the distinction should be made
between commercial and subsidized loans. Loans are
labeled “commercial” when the MFI has to pay interest at
the market rate, and “subsidized” if the interest rate is
below the market conditions.
Commercial funding and MFI performance
At its best, microfinance has proven that it can generate
profi t and growth while being low risk (Swanson, 2008).
According to a study of MIV portfolios by Oehri and
Fausch (2008), microfinance investments show low vola-
tility and low correlation to other asset classes, which
potentially makes microfinance an interesting asset to
include in a portfolio for commercial investors.
Building on business lifecycle theory, which states that
the development of organizations depends on their capac-
ity to access adapted funding sources (Little, 1974;
Channon, 2006), several authors (Kooi, 2001; de Sousa-
Shields and Frankiewicz, 2004; Van Maanen, 2005;
Bogan, 2008) argue that MFIs should be funded as
follows. In the youth phase, MFIs need highly risk-tolerant
subsidized capital in the form of grants and donated
equity to support the early years of operation as MFIs are
not sustainable enough to attract commercial funding. In
the growth phase, MFIs must increase their scale and gain
market shares with retained earnings and subsidized loans
as the main sources of funding. This stage is also when,
by complying with stricter banking regulations and trans-
parency standards, MFIs can make the transition from
non-profit organizations to regulated institutions so that
they can mobilize deposits and have easier access to com-
mercial funding. Regarding this specific issue, Bogan
(2008) notes that this transition to a regulated entity is
an expensive and difficult process that also requires sub-
sidized funding. Consequently, many large and estab-
lished MFIs continue to receive support to finance the
transition in the form of grants and subsidized loans along
with risk capital provided primarily by socially oriented
investors. The last stage of the lifecycle is maturity, a stage
when the MFIs are formal regulated banks with capital
structures similar to those of commercial banks (Bogan,
2008). Thus, mature MFIs should be funded mostly by
deposits, local capital markets, and commercial debt
coming from international funds.
Taken together, commercial international funding
should be positively related to the financial performance
of the MFI, as outlined in this second hypothesis
H2: Th e presence of international commercial funding
in an MFI is positively related to its financial
performance
Subsidized funding and MFI performance
As for subsidized funding, the lifecycle theory predicts
that MFIs in their early stages need subsidized funding to
compensate for their lack of profitability. We could, there-
fore, expect that international subsidized funding is nega-
tively related to the MFI’s financial performance. However,
the relationship might not be that clear cut. The SRI lit-
erature provides insight into what type of MFIs the socially
oriented investors would typically target. As previously
outlined, social investors put their money into projects
that yield social benefits. However, socially oriented inves-
tors also intend to ensure good economic performance
from their investments (Porter and Kramer, 2002). There-
fore, MIVs claim to have “double bottom line” objectives,
and thus they invest in socially and financially sound
MFIs. Moreover, De Schrevel et al. (2009) indicate that
the rapid growth of MIVs between 2004 and 2008 is