Microfinance is for the empowerment of the poor and the low income earners. They are not to serve the already served population.

WILL MY MICROFINANCE COMPANY COLLAPSE?

I encountered an “owner manager” of a microfinance company who had signed onto a one on one microfinance operational support and advice session. During the course of our discussions we spoke on the challenging facing the Ghanaian microfinance sector. I mentioned in our discussions that over 50 microfinance had collapsed as at end 2013. This particular subject led the owner manager to ask a question that I found quite revealing.

The “owner manager” made a confession and stated that “anytime I hear the news of microfinance companies collapsing I feel very uneasy and very much afraid. I always ask myself; will my microfinance company collapse”?  

In my dealing with microfinance companies I have not thought about personalizing the challenges within the sector although I have looked at the issues from the operational point of view. I am sure the fears of the owner manager was largely the point that the failure of the company would mean that he would have several liabilities to deal with. This is because the capital invested in that business was not entirely his own and that he was answerable to the depositors and other investors.

The “manager owner” was expecting an answer for his question. Something that I have not really thought off. Well I told him “the answer to your question is that your company will collapse if you do what caused the failure of those companies”.  This article will look at some of the things that might have contributed to the collapse of some of the MFIs. I am sure these pointers can provide answers to other owners of MFIs who are battling with the fear of whether their microfinance companies will collapse.

This article is not a scientist explanation of the causes of collapse of some microfinance companies but from an operational point of view to explain why your microfinance company will collapse if you do what will cause it to collapse.

 FACTORS THAT LEAD TO MICROFINANCE COLLAPSES

To start with it is important to note that business collapse can be fueled by two main factors: external or internal factors.   

External Factors

The external factors are largely the economic, political environment within which the business is operating. The external factors are economically related to the happening within a defined nation and sometimes even at the world level. A typical example is the effect of the world economic crisis which happened in 2008. This crisis affected business across certain parts of the world including Africa. The external factors may also include, high inflation rate, foreign exchange rates, regulatory policies, political decisions, economic opportunities or markets, etc. For instance, the absence of adequate economic opportunities in a particular country or region cannot guarantee the efficient loan repayments. Lack of economics opportunities will prevent loan clients within such catchment areas from finding the needed opportunity to invest the loans they secure so as to repay the loans they contract from the MFIs or banks. High occurrence of such events can therefore lead to high poor loan performance and therefore can affect the overall sustainability of the MFI.

With reference to the collapses of MFIs in Ghana, the role of external factors like the risk arising from regulatory or compliance, market and foreign exchange contributing to the collapsing MFIs cannot be compared with factors arising from the competencies of the owners, board and staff of the collapsed microfinance institutions or what can best be referred to as internal factors.

Internal Factors

Internal factors that can negatively affect the operations of the MFIs are the day to day decisions and actions of the staff and management of the MFIs. These activities have a measure of risk which when not managed adequately can affect the entire operations of the MFIs.

Risk is very central to the management of MFIs just like any other financial institution. Financial institutions including MFIs are responsible for the distribution of financial resources within any economy. They mobilize financial resources from the “haves” in the society as deposits and make them available to the “have nots” as loans or credits. These activities involve the management of risk.  The MFIs are to ensure that the money they mobilize from the “haves” can come back to them with some added value in the terms of interest. On the side of the “have nots” they are to ensure that loans or credit extended to these people can be repaid. These two events are all risk centered activities which should be managed to ensure that neither the depositor nor the borrower become a negative risk to the activities of the MFIs.the

Microfinance institutions are more prone to risk. This is because they deal with the part of the population that have been known to be highly risky. These clients are risky because they have low level of education, are involved in enterprises that are risky, live in areas that are known to have poor sanitation and therefore high incidence of diseases, have no or little access to health care facilities, do not have reliable income, etc.

Another pointer of risk is the fact that microfinance is a business of small volumes. This therefore means that there are several small element of risk associated with the various small transactions. Each small transaction comes with cost. This is one reason that explains the high operational cost associated with microfinance. MFIs are, therefore, presented with the challenge to manage both inherent risk and cost in each of the small  transactions so as to stay in business.

The situation with most MFIs in Ghana is that although it is known that microfinance has high operational cost, most MFIs rather pursue activities that increases cost instead of keeping cost under control. For instance some MFI have adopted physical branch establishment in order to expand outreach and increase their share of the market. This system has led to a situation where such capital investments now competes with available funds for on-lending purposes. It is important to note that the loans and advances are the main source of income for microfinance. Growing bad loan or not having the needed funds to grow quality loans therefore means that a microfinance company may not be generating enough income to support its operations.

Most MFI in Ghana are keen about how their companies image. This has led to investment in image enhancement through office set up, branded office buildings, cars, etc. The problem here is not the image investment but the source of financing the image enhancement. Some MFIs have funded this using depositors funds. The owners expect that the branded image will lead to client confidence and further translate into increase business activities from their clients or investors. The inability to match the terms of these investments to the terms of clients deposits have led to liquidity mismatches.  The effects of poor liquidity management adopted by some MFI companies is one main thing that have threaten the existence of the microfinance companies. 

Managing MFIs for success

As indicated earlier microfinance is already an expensive business. Therefore for microfinance to achieve the objective of being sustainable through increasing outreach and achieving impact there are two ways to go about it. One way is to increase the volumes of transactions so as to be able to finance the cost of the MFIs. The second scenario is that as much as possible MFIs must try to cut down on any activity that have cost implication through being efficient. For instance MFIs must look at their staff needs very well before they undertake to hire more staff. Getting job executed within the MFIs is not necessary about having many staff. It is about improving the capacities of the staff to enable them to handle task effectively.

 The situation with the Ghanaian microfinance is that most owners actually take on staff who rather become a source of cost. To some owners, hiring or keeping a number of staff is more to satisfy “business ego” rather than for economic or business sense.  MFIs that intends to stay for long need to insist on ensuring that they have the acceptable staff to client load that can guarantee efficiency. The simple way to manage this is to ensure that the frontline staff or credit staff have the number of loans or deposit clients whose business with the MFI can pay for the cost of hiring that particular staff.

The other source of cost that have threaten the operations of the microfinance companies is the cost at which majority of them mobilize or take on investments. The other side to the cost is the terms or tenor for the borrowings (investments) or deposits. The cost of the investment made by investors to the MFIs ranges from 5 % to 10% per month. The high cost of investment has been necessitated by the lack of adequate source of competitive funds.  MFIs are, therefore, forced to take on these high cost investments which in most cases cannot be passed on as loans to generate the needed income to repay the investors on due dates.

The other challenge with regards to the cost of investments is the issue of the tenor. It can be observed that the sources of funds for the MFIs are mostly short term. The short term nature of the funds cannot allow them to adequately invest the funds for long term purposes. The interesting thing is that some MFIs can take on investment with only one month tenor and give loans for three months. Under this circumstances most MFIs are not able to effectively utilized the funds they contract and this rather become a cost to the MFIs that is if they are able to make payment when such investments are due.

The chances of a microfinance company failing is a factor of what is being done from within by the management and staff of  the microfinance and not what is happening outside it. These include how the financial resources are being managed, the attitude and lifestyles of the owners, their personal life styles and their business management skills. The microfinance companies that have become very successful are not only owned and managed by entrepreneurs. They are managed by people who have improved their understanding and skills in microfinance. This is what owners of microfinance companies in Ghana must aim at.

To prevent more microfinance companies from collapsing, there must be sustained investment in the board, management and staff of these companies. Owners, managers and other stakeholder must put much emphasis on how to improve knowledge and skills with regards to microfinance management. MFIs must analyze their outreach objectives, capital investment   and staff recruitment and ensure that all these actions do not become a drain on the resources of the company.  MFIs must focus on the microfinance business and avoid creating other investments or business entities using short term funds from the MFIs.  So to conclude a microfinance company will collapse if you fail to know that your success as a microfinance is not how much you spend but how much you generate from what you spend.