(RiskCenter) Fitch Ratings says in a special report published yesterday that the fast growing microfinance industry, which provides financial services to low-income populations in emerging markets, could be exposed to greater risks. Separately, the agency has published its rating criteria that formalise the agency's existing approach to microfinance institutions (MFIs).
Fitch notes that high growth and transformation within the microfinance sector puts pressure on internal control systems, and places new demands on the quality of management and corporate governance. Increased access to commercial funding brings new demands in risk management, disclosure, and moves MFIs away from their traditional base of public or donor funding. Transformation to for-profit and regulated structures heightens the risk of "mission drift", leading the MFI away from its traditional social mission.
"As microfinance institutions transform and their clients become more integrated into the mainstream financial sector, convergence occurs between microfinance and mainstream banking," says Mark Young, Managing Director in Fitch's Financial Institutions group in London. "In Fitch's view, this convergence could reduce their resilience to the broader economy. The microfinance sector's success could bring some of the greatest risks it has yet to face."
The microfinance sector was estimated to have a total asset size of more than USD34bn at end-2006, and is set to experience continued fast growth rates. There are important differences in risk profiles between conventional banks and MFIs. Despite these differences, Fitch believes its current bank rating methodology and rating scales can accommodate the wide variety of MFIs, of which the agency rates 24 in Latin America (National ratings) and 10 in Eastern Europe and Asia (International ratings).
"The success and growth of microfinance in the past decade have mainly hinged on the successful management of the "double bottom line" of both financial and social performances, and on a track-record of low loan loss rates, although this has occurred during a relatively benign economic environment," says Sandra Mai Hamilton, Associate Director in Fitch's Financial Institutions group in London.
Fitch retains the same analytical framework for MFIs as for rating banks. However, certain risks are of greater significance due to the specialised nature of MFI activities, their ownership profiles, legal structures, and operating and regulatory environment. Fitch pays particular attention to operation and credit risk management, corporate governance, funding and liquidity, capitalisation and likelihood of support from stakeholders.