Roadmap to funding for microfinance institutions

Understanding the technical, financial, social and operational requirements you must meet to secure financing for your business

Access to capital: a key challenge for fast-growing MFIs

As a microfinance institution (MFI) operating in a frontier market, your business plays an essential role in helping financially excluded people to access the funds they need to build a brighter future for their families as well as protect them from risk. Yet – like many MFIs – you may lack access to the capital that you need to grow to the next level.

You might be able to access the funds you need to expand your reach into new territories or to grow your loan book through a relationship with a microfinance investment vehicle (MIV), such as a development finance institution, or an international creditor. Many such vehicles are interested in making debt, or perhaps even equity investments in businesses such as yours.

However, there is a great deal of competition for a limited pool of capital, and the process of applying for funding from an MIV can be complex. In this white paper, we aim to help you understand which legal, technical, financial and social aspects of your business a funder will evaluate when it considers whether to provide you with capital.

The search for funding: where to start

For an MFI, the challenge of accessing capital starts with identifying a partner that would be interested in providing funding to its business. MIVs range from commercial investors seeking a market-rate return on investment to development finance institutions and non-profits who emphasise social impact.

Your first challenge will be to attract the attention of a lender or funder that will be a good fit for your institution and your business model. A good place to begin is to make sure that your institution has created a profile on MixMarket and that you have submitted the most up-to-date financial information for your institution. MixMarket is often the first place that a funder will go to learn about the microfinance market in a new country, and you want to make sure that you are visible when funders are looking.

A proactive approach to finding funding is to attend regional microfinance conferences. Representatives from MIVs often attend such events to find investment opportunities.

Organisations that host microfinance conferences and events include:

Most countries will have industry umbrella organisations such as trade associations and practitioner networks. Maintaining membership with these umbrella organisations is key because MIVs will often approach the networks when first considering investment in a new market. Networks will often have knowledge of which funders are working in the market and may connect MFIs and funders if there is a potential fit. Membership will allow you to access these opportunities in addition to other services these associations provide, such as software vetting and industry best practices.

Members of your business network – for example, your contacts in the public, commercial banking or non-government sectors – might also be able to introduce you to MIVs that focus on your territory or market segment.

Due diligence: what funders want

Once an MIV decides that it might be interested in funding your business, it will begin a comprehensive due diligence assessment. Its aim will be to understand your business and assess whether it is a good investment. Depending on the MIV, it will evaluate your business from a range of perspectives, including:

  • financial health and sustainability
  • the quality of your management team and corporate governance
  • business model
  • your social mission and impact
  • business processes and system
  • regulatory compliance

Passing due diligence is all about winning your potential funder’s trust and confidence. Truthfulness and transparency are as important to lenders and investors as the numbers you show them. Since they are lending and investing money on behalf of other institutions, MIVs are by nature cautious and will check your facts and figures carefully.

Financial checklist

Funders or investors will usually ask you to produce:

  • annual audited financial statements for at least the previous three financial years
  • your latest monthly or quarterly management accounts
  • operational and profitability costs and ratios
  • prudential ratios benchmarked against the limits set by your local regulator
  • details on loans outstanding from other lenders including collateral pledges
  • detailed data on key performance indicators such as:
  • Gross Loan Portfolio (GLP)
  • average loan size
  • outstanding and disbursed loans
  • average maturity of loans
  • market share by assets, by GLP, by number of clients
  • PAR levels – PAR30, PAR60, PAR90, PAR180
  • Risk Coverage Ratio (loan loss reserve / PAR30)
  • number of rescheduled loans and reasons for the rescheduling
  • monthly productivity of loan officers
  • interest rate – based on outstanding portfolio and disbursements
  • details of funding

Your reports and statements should follow the international accounting standard for your country – usually Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). You should also adhere to international definitions and standards when calculating PAR and other core metrics.

Mission, model and management

In addition to the financial health of the business, funders and investors are usually interested in its purpose, culture, business model and operations. Before you seek funding, you should capture key corporate information in a convenient format, such as PowerPoint presentation or a Microsoft Word document.

Some examples of information a funder might find interesting include:

  • Your mission: Why does your MFI exist? Who are its customers and how do you try to help them?
  • Your history: Outline the major milestones in your business’s lifespan, from the day it was founded.
  • People and culture: Who are the founders of the company, what is their vision and what have they done in the past? Who works for the company and what sort of culture does it have? Is Key Person Risk adequately addressed?
  • Your customers: Who do you target with your products and services? For example, what is the split between men and women in your customer base, and between rural and urban customers? For what purpose are they borrowing money?
  • Products and services: Describe the financial products and services you offer.
  • Your operations: How many branches and credit officers do you have? What is the cost of running each branch?
  • Your business plan: What are your growth ambitions? Where do you see your business in a year and in five years in terms of the size of your loan book, workforce, product range and number of branches?

Processes and systems

Funders gravitate towards MFIs that have robust business processes and systems in place. This gives them confidence in the financial information you provide to them, as well as in the way that you run your business. Automating business processes by putting in place the right financial software can give you an edge when you are seeking external funding. Here are some areas to consider:

1. Transparency

Do you have a real-time view of your portfolio across your branches and can you produce this data at a click without needing to manipulate it in a spreadsheet? Many MFIs still follow multi-step processes to consolidate portfolio data across multiple branches and loan officers, and rely on historical reports that are three to four weeks behind the latest events in the business. Today’s cloud-based business solutions allow you to view and consolidate transactions in real time.

2. Managing fraud and human error

Do you have systems, policies (such as segregation of duties) and processes in place to reduce the impact of fraud and human error? Software can help you to strengthen your business process by removing manual processes where human error can creep in or where data can be tampered with. It can also enable you to set up approval processes and audit trails, so that employees can be made accountable for their actions.

3. Operational efficiency

Have you streamlined your business processes to keep costs down? Are you using automated systems to boost productivity, reduce the need to store and manage paper, and simplify data capture? Such tools enable to you record transactions in an electronic database, impose tighter financial controls and give access to systems and information to your workforces and field agents.

4. Resilience and scalability

Funders will want to know the business is future-proof. That means demonstrating that your operations and processes can cater for growth and absorb shocks. An important component of this is showing that you can grow revenues and profits, while keeping costs under control. Technology plays a vital role in growing your business without adding proportional overhead. Analysing your data, meanwhile, can help you to keep ahead of changes in the market so that you can adapt faster than your competitors.

Social impact

The weighting that a potential funder will give to your social impact metrics varies between different institutions, depending on their mandates and investors. Some funders and investors may be interested in working with MFIs that address a social problem or opportunity, for example, helping entrepreneurs to access capital for growth or supporting rural women with loans.

Most will require you to, at least, comply with international ethical, environment and social standards. You should be able to produce certificates demonstrating compliance with these standards during the due diligence process. Some of the social impact metrics in which funders may be interested include:

  • how many end-customers you are reaching
  • direct and indirect jobs your business creates
  • your impact on strategically important issues such as financing small-scale farmers, supporting female entrepreneurs, funding education or serving refugees

A Poverty Measurement Tool

Tools such as the Poverty Probability Index (PPI) can enable your organisation to measure and demonstrate its impact in helping to address poverty and financial inclusion. The tool—which integrates into Oradian’s cloud-based MFI business software—uses 10 questions about a household’s characteristics and asset ownership to compute the likelihood that the household is living below the poverty line.  With the PPI, you can identify the clients who are most likely to be poor or vulnerable to poverty and share that information with your potential funder.

Compliance, certification and corporate governance

Funders will expect your organisation to be in full compliance with local regulations as well as to follow best practices in corporate governance. For example, having a strong leadership team, overseen by a board with independent, non-executive directors can help boost your attractiveness to an external investor. So can having separate risk and independent audit departments.

Compliance checklist

Potential funders may ask you to produce copies of the following contracts and certificates:

  • certificate of incorporation
  • share certificates
  • proof of registration with your regulatory body
  • shareholder agreements
  • outstanding loan agreements
  • supplier agreements
  • quarterly reports you are required to submit to your regulatory authority
  • environmental and social compliance certificates
  • audited financial statements including certified balance sheet and profit and loss accounts
  • an auditor’s report indicating that you comply with the prudential ratios set out by the regulator
  • an auditor’s report commenting on the adequacy of your procedures, policies and controls for anti-money laundering and combating of financing of terrorism
  • copies of statutory reports you file with your regulator

Digital transformation: an important step on the roadmap to funding

If your organisation plans to apply for external funding, you can start preparing by shifting from manual processes and legacy technology to a modern, cloud-based platform, which will allow you to plug into digital fintech and take advantage of industry trends. The Oradian toolset enables you to grow and gain business benefits by becoming more efficient, making informed decisions and reaching more clients.

In addition to helping you craft a technology strategy to address your business, goals, challenges and opportunities, the Oradian team can help you review your business’ processes and operations. Then we identify which areas of your business and which processes can be improved and how, using global best practices.

With the right platform in place, you can make informed decisions with accurate real-time reporting. In just a few clicks, you can consolidate data from all your branches and create reports that follow best practice. No more end-of-the-month processes, waiting for reports to be done manually. You have accurate on-time reports all the time, which will impress a potential funder.