When investing money there will always be risks, as in financing studies point out there is risk/return tradeoff. Defined as, “the principle that potential return rises with an increase in risk. Low levels of uncertainty (low-risk) are associated with low potential returns, whereas high levels of uncertainty (high-risk) are associated with high potential returns.”(Investopedia, n.d) The diversification of risk gave birth to the phenomenon called Mutual Fund. One of the major risks in financing and accounting is mutual funds, and micro financing. Where micro financing lies is its ability to lend money to the poor in order to help them better their situation, by encouraging them to put it towards a business venture or new ideas. It is a phenomenon that is seen across the world, helping the poorest countries including India, Mexico, Nigeria, and other countries. The purpose of this paper is to answer the question of what is micro finance role in mutual roles, and why it works. While answer the central question, also investigate why the United States there is no mutual funds-microfinance. In understanding micro financing, a clear understanding of mutual funds is needed.
Mutual funds are an informal, easy, and suitable way to invest, without having to worry about choosing individual stocks. An investment tool that is a culmination of funds collected from investors for the purpose of investing in stocks, bonds, and other securities. Mutual funds can be defined as, “funds that are operated by money managers, who invest the fund’s capital and attempt to produce capital gains and income for the fund’s investors.”(Investopedia, n.d) The investment company will then manage the funds and investors will buy the shares. If they were to invest in the mutual funds that are made an owner along with other shareholders of the large investment portfolio. When shares are purchased the fund’s manager will then invests the contributions of all the shareholders. Each day, the manager over the funds adds up the value of each fundholding holding, and figures out the quantity of shares that have been purchased by individual shareholders in order to calculate the Net Asset Value (NAV) of the price of one share of each mutual fund. Depending on the amount of shares that and the NAV of each fund is dependent of the role of the fund manager. Once the NAV of the shares increases the shares of the mutual funds are worth more.
For ways, that mutual funds can make money while in the portfolio is first that mutual funds can receive dividends from stocks that are already in its portfolio. If the fund has money in the bank that earns interests or receive interest payments can be given to the fund. The end of the year, the fund can make profits by selling bonds or stocks that have risen in price. Just like in any investment, funds do not always make money, bad investments, stocks that sold for fewer, and the possibilities of capital losses. Equity Funds are the termed given to mutual funds that invest in stocks. The mutual funds that specialized in large-cap stocks can have market caps that go up to billions of dollars, they are some of the larger and profitable companies within the United States. Other mutual funds specialize in small-cap and medium-cap stocks. The medium-cap stocks fall in between, where they have the ability to purchase bonds that are issued by municipal governments, agencies within the federal government, and corporations. Mutual funds can invest in the tax-free bonds, that just buy the bonds were interest is earned, and exempt from most state, local, and federal taxes.
Where mutual funds come in internationally is through their specialization within securities that operate outside the United States that are better known as, global or international funds. These types of international funds are able to specialize in stocks, bonds, or a mixture of the two. In particular an international fund, specializes in countries and regions such as Latin America, the Pacific Rim, or parts of Europe such as, Germany. Mutual funds or equity-fund managers choose three style when they make decisions of choosing stock for their investment portfolios. The first styles are seeing where there is value, manager’s search or stocks that compared to other or similar companies are undervalued. The second style is managers that try to find stocks from well-known and established companies, which are growing at a faster rate than their competitors and within the market. The third style is actually a mixture of the first two styles that look for stock that helps build their portfolio in both value and growth.
At one, time, there were fewer than 500 mutual funds available 25 years ago. However, that number has increased to over 7,000 today and counting. In buying mutual funds, there are several advantages and disadvantages. The advantages of mutual funds are that they offer instant diversification in the stock portfolio that reduces risks of investment. Funds can be spread among large investments so that if one stock does not do as well, the impact is lower than if only one stock was available. Mutual funds also reduces the risk by investing in the different assets classes such as bonds, cash, international and U.S. stocks, and other securities. Mutual funds can lessen the expenses within the portfolio as they can be purchased at a commission free price. Mutual Funds serve as liquid investments, they could be sold instantly without worrying about searching for a buyer or a correct price to sell at.
However, there are many reasons why there are many disadvantages to mutual funds. One of the biggest reasons not to invest in mutual funds are that each year 80 percent of all mutual funds perform at an average worse than other stocks or funds. A reason why their returns are usually low is that in all funds, there is a variety of fees and expenses that affect the return on investments. In order to account for the liquidity and withdrawals of funds they have to maintain large position of cash. However, it is not a clear picture on determining if a fund is of good value at any particular point in time. In stocks, it is possible through several measurements to detect stocks that are undervalued, however in mutual funds it is at foremost difficult to determine the Net Asset Value is of good value or not. The possibility of mutual funds returning a good ROI for particular periods is of various reasons including the result of the fund’s holdings reaching peaks in which they have plateau or decreased. Mentioned earlier the value of a stock or its Net Asset Value is the result of how a well the job of the fund manager is doing if he/she is doing an admirable job then the fund will do a good job. Mutual funds are the most common publicly available fund, currently they control over $6.5 trillion in assets in the United States and over $14.5 trillion worldwide. They are generally invested in publicly traded securities, and a single asset class such as bonds, blue chip equities, and small caps. In dealing with Mutual Funds they are wrapped in numerous regulations and rules that dictate public offerings. Within the US for public offerings the daily portfolio holdings must value at least 85 percent, with 15 percentage left over to invest in non-liquid investments, i.e. MFIs. Investing in micro financing is a complicate process that many fund managers choose not to do.
Where micro financing plays into mutual funds, is that it is a driving vehicle for lending to the poorer nations. Investopedia defines micro financing as, “A type of banking service that is provided to unemployed or low-income individuals or groups who would otherwise have no other means of gaining financial services. Ultimately, the goal of microfinance is to give low income people an opportunity to become self-sufficient by providing a means of saving money, borrowing money and insurance.”(Investopedia, n.d) Microfinance is a small scale financial service provision for the poor that can take a form of credit and savings. Savings provide people with the opportunity to save excess liquidity to use in the future and obtain a return on this investment. Microfinance can help reduce the risk of poverty, increase productivity, increase the individual’s incomes, and improve the quality of their lives. Microfinance can also give the necessary access to financial services not privy to all. The financial services include the working capital that is needed in helping to boost their businesses, their credit, and meeting their everyday needs in providing a safe place to hold their savings. “Microfinance is about giving low-income people access to financial services, typically by lending tiny amounts of money to people who usually would not be able to borrow from traditional financial institutions, mostly because bank do not serve those who cannot offer traditional collateral and with no credit history.”(Diena, 2009) What microfinance provides is a service that is not available to everyone. What microfinance not only gives money, but aids in services such as helping to save, remittances, and insurance.
The history of microfinance dates back to the 1960’s and 1970’s. Micro finance services are not a panacea for poverty assuagement. The original and arguably the most famous of the Micro finance Institutes is the Grameen bank founded by Muhammad Yunus, Doctor of Economics, in 1976, who believed that making loans available to a wide population that which many were poor, could improve the widespread poverty in Bangladesh. “Muhammad Yunus, known as the “banker to the poor”, pioneered the movement of microfinance three decades ago since Grameen Bank was founded, he has served nearly 8 million people in Bangladesh, and 97 percent were women.” (Diena, 2009) The bank began as a research project to test out his new method for giving credit and banking services to the rural poor. The Grameen Bank was extremely successful, and the project, with the support of the government was presented in 1979 to the Tangail District. After the initial success in the district, it quickly spread to the other districts of Bangladesh. In 1983, the bank underwent a transformation to an independent bank courtesy of the legislature of Bangladesh. The was known for its excellent repayment rate, but a religious boycott in 1995 against the bank’s policy of improving the status of women and again in 1998 the banks repayment record was hit by the flooding in Bangladesh.
However in recent years the rate of repayment has been seen to be recovering. At present The Bank has grows across the nation and gives out micro loans to poor citizens. As of mid-2005, Grameen Bank branches number over 1,500. Its success has inspired similar projects around the world. One uncommon factor of the Grameen Bank is that it is primarily owned by the people who borrow from the bank, most of them being women. The borrowers of the bank own a total of 94%, and the remaining 6% is owned by the Government of Bangladesh.
Applicably designed financial products and services permit many poor people to increase and expand their economic activities, raise their incomes, and increase their confidence. Within the micro lending concept, the borrower is meant to have a promising business, as the issue of discouraging self-reliance as the segment is commercially apart of the market based concept in creating a relationship with people who receive the loans. Since the development of the microfinance offerings particularly in the Grameen Bank, has “disbursed USD 7,59 billion as loans and with 98.32% repayment rate, increased by 30bp in 2008 from 98.02 %, it proves that poor people are worthy of loans and when credit is given, they can repay their loans promptly and with interests.”(Diena, 2009) Within the Micro financing institutes, there is still a disadvantage in some instances to individuals at the bottom of the pyramid that tend to face unfair barriers in order to receive working capital in able to support their businesses.
“On 18 November 2004 the United Nations launched the International Year of Microcredit, as part of an effort to build support for making financial services more accessible to poor and low-income people.”(UN, 2008) Micro Finance Institution is used in referring to numerous organizations that offer similar services. These are various institutions and organizations include credit unions, commercial private banks, National Government Organizations (NGO), non-bank financial institutions, and state-owned banks. Financial Non-Government Organizations (NGO) is the common figurehead of Micro Finance Institutions. In most cases NGOs the micro credit as not able to get savings deposits from the public, yet they are fully dedicated to giving financial services for micro financing. NGOs usually employ the new techniques in lending and able to generate an efficient response that gives them the opportunity to be sustainable basis, and give aid in order to help in the development of the poorest parts of the economy. Some prime examples are that of Bangladesh and some parts of Africa. Micro finance programs are fundamentally run by National Government Organizations, most that are centered on the community organizations that aid in the social development of the region.
Many NGO’s do not regard themselves as financial institutions; however they offer micro lending, micro credits, and other financial products and services. Nonetheless, from an industry perspective, as NGO continue to be involved in giving financial services for the poor, they will be referred to as Micro Finance Institutions. This consideration is also given to the small commercial banks and other organizations that offer micro credit, and lending financial services. Throughout this paper however, the organizations will labeled collectively as Micro Finance Institutions or MFIs, no matter the capacity in which it is involved in the micro finance process. When referring to MFIs in both cases the part of the institution, which offers micro finance, is the only sector being referred to. Other institutions do play a part in the sector of Micro finance and play a part in the reshaped and deepened financial sector. These are namely community-based financial intermediaries; they range from credit unions that have the member’s cooperative housing societies to those that are managed or own by entrepreneurs and local municipalities. On the other hand, these institutions tend to have a broader client base than the financial NGOs and already consider themselves to be part of the formal financial sector.”(Prosperity Rings, n.d) Although it is dependent on the country some individuals do not always have access to the organizations, however they do not always go as far as the financial National Government Organizations.
“Microfinance institutions differ from traditional banks since they developed innovative lending techniques in order to overcome all the obstacles that low-income borrowers are facing such as lack of collateral and no credit history.”(Diena, 2009) The access to these facilities provided by MFIs also allow for those in poverty to (a) cushion themselves against economic shocks, such as the flotation in oil prices. (b) To develop their skills and through entrepreneurship achieve self-reliance. (c) Also to accomplish social empowerment, this is especially pertinent in the cases of low income and women that live in poverty. In researching MFIs and the borrowers, women were the familiar micro finance client, which were often low income and looking for ways to finance their business in order to feed their families, better their situations. The clients that MFIs typically are majority low income females. MFIs profoundly impact the individuals that borrow the loans in the capacity of the work they do, and in rural areas where farming, and activities such as petty trade, and food processing are prevalent. Whereas is areas where there are more resources there are numerous jobs that range from service providers, street vendors, shopkeepers, and artisans. Nevertheless, it is not only the poor that benefit from micro financing but also those who are considered feeble or non-poor can also apply for Micro credit and other such similar financial aid.
Microfinance programs have been applied within the United States, in programs that address social and economic welfare of the populations. During the late 80s and the 90s more programs were reform to include those individuals that are closely hovering near the poverty line. Similar programs such as micro financing were created to help give business loans and credit to low income individuals. These business credits were given to spark up the low income communities, in hopes that it would change the statuses of the individuals and the areas. Currently only a few hundred remain that operate in low income, and rural communities. These programs are nothing new as they were first implemented during the presidency of Theodore Roosevelt with the New Deal Era. Social programs such as Welfare, and other programs aim to put an end to poverty, homelessness, hunger, and unemployment.
The problems with microfinance within the United States is that many of the full time employment sector are not self-employed. Only a small percentage serve this title, and of that only an even smaller percentage are not sharing the same initiative as microfinance institutions. Unlike in most third world countries, the small business that people start up is most self-made crafts, and food processing. The problem within the United States is that usually smaller businesses sometimes struggle against competition from bigger businesses such as Wal-Mart, or Target. Consumers can already shop at low prices, and not everyone cares for self-made crafts from different countries. Not only is the problem with the lack of interest in exports but also the accessible nature to obtaining loans within the country. The United States is mired in debt from student loans, credit card loans, mortgage loans, and basic debt. Individuals can get loans for almost any entity better than individuals living in least developed countries.
However, that is not to say that there are still millions within the United States without access to banking institutions. Individuals within rural or low income communities, were banks are not available. Programs for micro financing are still in the United States, an estimated 500 programs help to serve women, small businesses, and individuals seeking credit or capital to start up an organization. Although not as major as in other countries, there are several large programs that cater to not only individuals across the world but domestically as well such as Accion, and Grameen America, started by Muhammad Yunus to help low income individuals with education, business development, and microloans. Micro financing has initially taken off online as businesses such as Kiva.org serve to lend micro finance loans, supported by regular citizens to those in other countries, with the guarantee of their money back. Microfinance within the United States has not really been a failure, however, not many American citizens are made aware of the number of microfinance programs that in the country to help in areas that eventually will alleviate poverty within the United States.
“”The only way to solve the problems of poverty and terrorism in the world today,” he said, “is through investment.”(Hurt, 2003) Investment into the poor leads to greater returns. Those who come from this sector of society are often denied access to the more known and more conventional formal financial institutions. This can be for many reasons, the main one is directly related to the level of income: the poorer you are, the less likely that you have access. Also, it is often true that the “poorer you are, the more expensive or onerous informal financial arrangements are.”(Sapovadia, n.d) However the other option of informal arrangements may not appropriately meet the assured financial services that are needed, may end up excluding the individuals who are poor. The poor that are excluded are the main clients of micro finance. Research has shown that micro credit is able to help those within the economic foundation, the capacity, and self-employment resilience in working as their own boss.
Micro Finance Invests in Mutual Funds
There is a growing trend within the market that includes the investment of micro financing in mutual funds. Microfinance is transforming into a commercialized entity, appealing to foreign investors, and financial markets attracting mainstream financial markets. “Today, MFIs are accessing more diverse and commercial sources of funding, from short-term funding as saving deposit to long-term funding as fixed-rate bond. A commercialized MFI also attracts equity investors,” (Dieana, 2010) the primary focus of Micro financing is helping the poor and the building up those financial markets. In order to do so some funds and investors are enabling local intermediation with enticements such as, promises that banks in within the countries will lend their currency to Micro Finance Institutions. Those offerings to local market building, in conjunction with solidifying the governance, and consistency make the addition of new sources of funds a positive resource in microfinance. Microfinance investment funds systematized as structured finance products and mutual funds are providing the wide range of resources of the capital markets to MFIs. They help to empower the poor or low income individuals through the aid of friendly financial services. Mutual funds and the structured products serve a great means of providing a combination of ethical, social, and financial returns for the MIFs, investors, and borrowers.
In defining microfinance investments as an asset class is a progress that is underway. To attract investors (private or commercial) new financial tools will be needed to satisfy the risk-return of the investments while still achieving the social benefits of microfinance services. “By investing in micro-loan backed securities, mutual funds and other institutional investors can own an asset that is both high in quality and low in correlation to other asset classes.”(Chakkungal, 2012) Micro financing utilizes the vehicles of investment funds in order to generate new resources for their MFI’s. Reasons why so many private and commercial bank investors are investing in microfinance investment funds (mutual funds) are because unlike traditional commercial banks, the loan repayment rate are near-perfect for MIF’s. Regulatory structures have been modified to enable MFI’s to operate in ways that seem unconventional such as tangible collateral, the lack of secure transaction in developing companies. One of the first microfinance investment funds was the Dexia Micro-Credit Fund launched by Luxembourg bank in 1998, they mostly cater to Latin American and European countries. Other notable funds include the Global Microfinance Fund, Microvest I, LP, CARE, SCDF, MEDA, which are based in the U.S, and Impulse a Belgian fund. Operating and starting a publicly available MFI mutual fund is a considerable challenge, “funds need to amass US$50 million to US$75 million in assets within three years to be an attractive business proposition.”(Mattaus-Maier, 2007) The risks associated, and the difficulty of breaking down the investment proves too much for most fund managers.
One of the main ways of investing mutual funds is by the Registered Fixed-Income Mutual Funds. These are funds that were established by the Domini Social Bond Fund(DSBFX) that are issued from corporations and governments with the intent to boost the social human impact by supporting corporations services in helping under privilege communities, giving access to bank services, improving healthcare, and education. These funds are the most common micro financing investment vehicles such as, Dexia Microcredit Fund, BlueOrchard, and responsibility Global Microfinance Fund. These two year loans are currently registered in only two countries including Holland and Luxembourg. Due to the strict regulations that US has on publicly available mutual funds, it is an attractive feature in taxes and legislation as nonlisted securities. “They are distributed through bank networks, such as Credit Suisse or Dexia and are offered to both institutional and retail investors on a private placement basis.”(CGAP, 2008) These types of funds are able to have their investments redeemed on a monthly basis, receive a 5.8% return, and are invested in senior debt of MFs. the advantages of investing in Micro finances are: the great uncorrelation with all asset classes and its resilience to the crisis; as well as the low volatility and higher return. Moreover, it is the social responsible investment with more impact, the main reasons they have to invest in MF are social responsibility, diversification, and return.
Micro Finance benefits expands as the types of service that can be offered. Which can lead to the growth of the probable market of consumers that micro finance can reach. Micro credit has a limited perspective compared to its range in diversified financial offerings, including remittance services, insurance, savings products, payment, and other various services that people benefit from. How these additional services and products could help alleviate poverty can be seen in an example of a poor farmer who may not want to borrow money yet would rather have a safe means of saving the proceeds from the farms harvest. Different research and articles suggest that micro financing can, “Help the poor to increase income by aiding the building of viable businesses, and reduce their vulnerability to external shocks.”(PH&N, n.d) Micro financing also serves a powerful tool in encouraging confidence in self-empowerment especially targeted towards women and the poor to change the dynamics of the economic system.
Having access to financial services such as micro finance is a vital part in the fight against reducing poverty. This is shown by the income generated from a business helping not only the business activity itself expand but also the contribution to the household income and its attendant benefits such as food, medicines, security and education. This is shown clearly in the many successes Micro finance has had in poor countries such as India, Mexico, Africa, and other countries.
In Mexico, since the institution of micro finance institutions it has handed out $2 Billion in loans to over 6 million borrows from 80 MFI’s, and yielded a deposit of 117 Million indicated in 2011.(MixMarket, 2011) The Mexican microfinance market has increasingly grown at a steady and profitable pace over the last years, with the support of the national government, and new legislative measures that have created an improve the regulatory environment catering to increasing clearness within the country. Emphasis from the credit services have been placed on lending to microenterprises as they have average the lowest loan balances within the region. However, some concern has arisen of the possibility of the political changes that could change for the negative or position of the support of the micro financing industry in Mexico. The people that have benefited the most from micro lending within Mexico has been the women, in the cities closer to the border where the U.S have facilities and factories, many women are left to feed their families.
There are two main forms that are authorized in the deposit-taking institutions that specialize in the credit sector, such as Popular Savins and Credit Cooperatives (SCAPs) and the Popular Financial Societies (SOFIPOs), and popular savings. Within the Mexican system, there is provident supervision for the various institutions under transition. “Whereby federations will continue to exercise auxiliary supervision over their member SOFIPOs while a new Protection Fund containing a central oversight authority (the CSA) will be created for SCAPs.” (BU, n.d) In addition, there are other niche entities including Cajas Populares, that both operate within the government’s permission given as a conditional extension to operate as credit unions or informally. “The National Bank for Savings and Financial Services (Bansefi), provides technical assistance to popular savings and credit institutions and low-level savings accounts to individual clients.”(BU, n, d) The National Banking and Securities Commission (CNBV) of the Ministry of Finance. In Mexico today they are experiencing intense regulatory process transformation with the passage of the 2009 law that sets the legal framework for the SCAPs.
Brazil, one of the nation’s wealthiest economies, yet it also serves as one of the poorest countries as the disproportion wealth gap accounts for the highest number of individuals in poverty in Latin America. However, this is a good breeding ground for micro financing as Brazil has also its successes in micro financing as there are 41 MFI’s that have handed out over $1.8 billion in loans to over 2 million borrowers, with deposits of over $118 million.(MarketMix, 2011) The main providers of micro finance services are the credit cooperative. The NGOs, commercial banks, and non-bank financial institutions provide the remaining microfinance, however, much of the population is left without access to micro finance services. Many banking correspondents established in facilities offer bank transfers, loan disbursements, and open accounts. The main body that regulates the industry is the National Monetary Council while the Central Bank of Brazil plays a secondary role of monitoring the micro financing process. However, the Central Bank of Brazil oversees the volume of credit cooperatives that are in control of their partner cooperatives.
The rule of law of micro financing in Brazil is regulated through their government, in terms of hindering the growth of the micro financing initiative within the country. Brazil served as Latin America’s birthplace for the Micro Finance Institute in the 1970’s, however, the country has maintain a slow growth and low penetration. “Financial regulations in Brazil contain substantial prudential controls and are also notorious for changing with dizzying frequency. Tax and labor laws are complex and add to the list of negative incentives or operating restrictions that MFIs face.”(Nichter, 2002)
Until currently a clear view of the information on the regulation within Brazil was not freely available. Within Brazil, there are several regulations and laws that restrict the type of products MFIs can offer. They are not allowed to offer services such as insurance, savings, and other products that other international countries can offer. Brazil’s source of funds is tightly regulated; however banks have greater flexibility in offering various products.
“The previously mentioned prohibition on offering savings products is one example—MFIs may not accept deposits, a funding source that has numerous advantages such as low financial costs, wide availability, and relative stability.” (Stichner, 2002) Currently the laws in place require a large percentage of saving deposits and demand deposits to be used in housing and rural credit programs. With the tightening of regulations, the currency restrictions, and the slow registration process can shy many foreign investors from investing in the micro finance industry within Brazil. At present, the regulations on fund sources have not negatively impacted MFIs as they are still available to the public. However, the downside to MFI dependency on funds from the public include the slow process of approval, and the stringent conditions that defined the appropriate use.
Currently Bangladesh served as one of the first countries to first mutual fund investment in micro financing in India. “A recent micro-loan securitization, completed by IFMR Capital and Equitas Micro Finance, has enabled the first ever mutual fund investment into the Indian microfinance sector.”(Chakkungal, 2012) The total of 55,000 micro loans ($10.4 million) came from Equitas Micro finance a MFI that serves over 700,000 low income individuals. This is a milestone because it is one of the first of its kind to microfinance securitization programs. It is importance is shared, “by investing in micro-loan backed securities, mutual funds and other institutional investors can own an asset that is both high in quality and low in correlation to other asset classes.”(Chakkungal, 2012) Within Bangladesh, the funding has started to slowdown as the government has decreased the lending to the MFI, and the banks within Bangladesh have not been able to pick the slack. There has been an outcry for the government to provide new sources of funding (securitization or access to capital markets) that have become to increase over the course of years.
“The framework for credit-only institutions is not tailored to microfinance but is instead regulated by the Law on Credit Institutions and the General Law on Auxiliary Credit Organizations and Activities.”(BU, n.d) The unregulated, Financial Company with Multiple Corporate Purposes (SOFOMES) is the most used form for organizations that use the credit-only concept in order to adapt for use by Micro Finance Institutions. Unregulated SOFOMES do not need permission from any government agency, and do not have as much monitor from the National Commission for the Protection and Defense of Financial Services (CONDUSEF) SOFOMES that are regulated however are supervised by CNBV. In 2009, a provision that that regulated the industry was interpreted by the Law on Credit Institutions that was able to establish m a new niche bank and institution. Commercial banks and niche banks are similar; however niche banks have a limited scope of allowed activities in exchange for lower capital requirements. These regulations are intended to encourage SOFOMES, other non-banks, and credit unions, in order to increase their markets and services for further operations.
Through various research and studies, it has exposed the extent to which individuals are that hover above or below the poverty line are susceptible to be extremely high. The attributes that contribute to and from poverty can range from illness or death of a wage earner, theft or even adverse weather. These shocks produce a prodigious assertion on the limited financial resources of the family units. The absences of financial support can lead to a family become much further entrenched in poverty, thus setting the family backwards into poverty. Another benefit of Micro finance is the development of women rights. Women, who in many contexts are excluded from the basic rights of prosperity are not given the opportunities that are afforded to them with the help of Micro finance programs to aid their move out of poverty. However, this is not always met with an open mind. “Islamic fundamentalists in this Muslim-majority country have attacked organizations for their work with girls and women. But other Bangladeshis proudly talk without prompting about how much the countrywomen women have changed in the last decade or two.”(Waldmen, 2003) It has been found that being able to perform transactions with formal institutions can also lead to the building confidence and empowerment. One of the many examples of this is the National Bank of Agriculture and Rural Development (NABARD) with over 500 banks finance and lead money and resources to the SHGs. The Self-Help Groups are made up of fewer than twenty members that are mainly women that come from the poorest parts of the region. The members of the SHG save as a group a small amount each month, this allows members of the group to be able to borrow from their group fund in times where it is needed such as illnesses, school fees, or other emergencies. When a SHG shows it is capable of managing the funds they are then allowed to take out loans from the local banks in order to invest in their small business ventures.
Self-Help Groups are comprised of over 20 million women and number over 1.4 million, making the SHG-Bank in India the largest model of the micro finance program. Due to the success of the SHG’s there is similar models that are growing in Africa and Southeast Asia, from the help of international organizations such as Catholic Relief Services, Oxfam, and the Opportunity International. These programs help to develop the usually poor countries economy by letting the population establish as sustainable income by giving them a chance to borrow money. The result of the programs is that will likely increase the amount of income within the population that leads to improvements in the communities, economic development, and increase in their level of economic status. However, In spite of these benefits of Micro finance, the industry has several criticisms such as the dependency on the loans. Although the goals of Micro finance institutions and programs aid the poor in improving their situation, they however do little to do discourage the need for basic infrastructure service such as health, water projects, education, and social change.
However, in the country of Bangladesh, “the Bangladesh Rural Advancement Committee runs a commercial bank, a dairy, a hatchery, a poultry feed factory, a plant-tissue culture laboratory, seed processing centers, an Internet service provider, a chain of clothing and craft shops, a university, and more.”(Waldmen, 2003) The committee helps to provide healthcare to the population with over 2000 prenatal clinics, and 90 basic clinics that help to gain 3.5 million women with micro financing. Another central criticism is that some believe that there are lending programs who charge excessive interest rates. “Blue Orchard typically charges two to seven percentage points more than Libor for loans to local micro credit institutions, which then charge rates to their borrowers based on assessments of risk factors. In countries like Nicaragua, local lending rates can be up to 22 percent above Libor.” (Hurt, 2003) As much as Micro Financing is essential run as a banking enterprise, there is not much money to be made in making investors rich.
Microcredit dependency is another issue raised by critics of the system of Micro Finance. Microcredit reliance is a situation whereby people begin to rely more heavily on the system to support themselves. However most of the developed world is dependent on continual access to credit so the defenders of microcredit argue that there is no reason to expect the poor in developing countries to behave any differently. The toughness of reducing poverty is questioned by most critics. Critics believed that once the government gets their money by withdrawing subsidies from the Micro Finance Institutions, that once the governments withdraw their subsidies for the MFIs the institutes will be unable to continue to help the poor and aid economic development and therefore possibly damaging the economy. While there is no actual evidence for this it has been seen in Bangladesh that micro finance cannot be a substitute for growth. The poverty rate within the country for the past 20 years has been around 53 percent slightly declining to 45 percent, and the growth has remained under 5 percent in the last decade.
However, all these criticism of Micro Finance Institution within these poorest countries fail to outweigh the obvious benefits of the work of MFIs financial offerings. These offerings then are formed to make a different bond, which are then sold to investors once they have been divvied up. Due to the cash flows and the worth of the new asset that is based around the basic bonds, which can make investments difficult to evaluate. Nevertheless, a person may select to capitalize in the securitized bonds will need a greater knowledge of the complex market that is contributory to the expansion of a vigorous and experienced investment education. In aiding the Micro Finance Institutions another financial source that is growing in the market is securitization.
“Securitization describes the process of pooling financial assets and turning them into tradable securities.”(Investopedia, n.d) “Securitization is the creation and issuance of debt securities, or bonds, whose payments of principal and interest derive from cash flows generated by separate pools of assets.”(Cowan, 2003) Among the firsts to be securitized were residential mortgages for homes, soon it was followed up by credit card debt obligations, commercial mortgages for businesses, student loans, auto loans, entertainment royalties, and even selling the debt or bond as a collateralized mortgage obligation (CMO). The Mortgage Backed Securities (MBS) were securities that backed by mortgage receivables, and Asset-Based Securities (ABS) were securities that were backed by other types of non-mortgage receivables. When looking at the different securities, there are notable differences among the numerous types of asset and mortgage-backed securities. Within the investment banking community, they are clustered into the area of structured finance, and simply referred to as securitized products.
The structure of developing a securitized bond is a direct process that involves the originator and the SPV. “An issuer or a financial institution with assets may wish to securitize sells the assets to a special-purpose vehicle (SPV). For legal purposes, the SPV is a separate entity from the financial institution, but the SPV exists only to purchase the financial institution’s assets.”(Investopedia, n.d) In order for the originator to sell the assets to the SPV, the originator must obtain more cash and eliminate the assets from its financial record, giving the issuer a greater flexibility over the assets. The SPV will issue tradable securities in order to fund the purchase of the assets. The bonds referred to as securitized products can then publicly sale, lease, or transfer to other investors within the markets. Mortgage Based Securities and Asset Based Securities each represent the interests in the underlying pools of financial assets and loans that are securitized by issuers who often also initiated the assets. The basic goals for all the securitization transactions are to divide them financial assets supporting payments on Mortgage Based Securities and Asset-Based Securities. The separation guarantees payments related with the securities are consequential solely from the separated pool of assets and not from the creator of the assets. “By contrast, interest and principal payments on unsecuritized debt are often backed by the ability of the issuing company to generate sufficient cash to make the payments.”(Cowan, 2003)
When dealing with securitized products the one of the main factors is that securitized products or individual securities are normally given in tranches. Meaning that a much larger deal will be divided down into lesser pieces that each have dissimilar investment features. The various tranches that exist make the securitized products appeal to a bigger number of investors. The various investors that choose the different tranches are best combines their want for a cash flow, safety and a yield.
According to Investopedia the many benefits of securitization are:
- “More capital for lending – Securitization provides the financial institutions with a instrument for eliminating assets from their financial statements. Which increases the pool for capital that can loaned to investors.
- Makes non-tradable assets tradable – This act is able to grow the liquidity in a numerous ways that at first illiquid financial assets.
- Spreads the ownership of risk – Pooling and allocating financial assets offers larger capacity to differentiate risk and offers investors with more options as to the quantity of risks to have in their portfolios.
- Creates an attractive asset class for investors – Investors that purchase securitized products have the advantage that securitized products are able to be interchangeable, and can provide a wide variety of yields.” (Investopedia, n.d)
One of the characteristics of securitized products is high yield. In most securitized products, they offer an attractive relatively high yield. However, the high returns do not come without a price, compared to other bonds, the technique of the cash flows for some is comparatively uncertain. These are one of the reasons investors mandate high returns because of this uncertainty. Another characteristic of securitized products is diversification. Securitized products are one of the biggest fixed-income securities, these types of fixed-income give the investor another option to the corporate, municipal, and government bonds issued. A third characteristic of securitized bond is safety. In financial intermediaries, there are various methods that are used to offer bonds that are typically securer than the assets that back them. In many securitized products, they show an investment-grade rating to show their safeness to investors.
“Internal credit enhancement refers to safeguards that are built into the structure of the securitized product itself.”(Investopedia, n.d) The distinctive types of credit enhancement are the common forms of internal credit enhancement that include relegation, in other words it is where the tranches that are highly rated will receive the priority cash flow over the tranches with ratings that are lower. In addition, it will have priority over collateralization, in which the quantity of the SPV bonds that are offered are valued lesser than the assets backing it. The effects that are proposed for the types of internal credit enhancement are that shortfalls of cash flow due to the value losses that underlie the assets, which have no effect on the securest bonds. This is able according for the low amount of losses, but the protection value is less sure if the basic assets are ample.
“External credit enhancement occurs when a third party provides an additional guarantee of payment for bondholders.”(Investopedia, n.) The distinctive types of external credit enhancement are surety bonds, guarantees from corporate, and bond insurances issued from third parties. One of the downsides to external credit enhancement are that when getting the added guarantee it does not work well if the party or issuer providing it is not a good company. In the instance that the third party that issues the guarantee is hit hard by the economy or suffers a substantial financial loss than the worth of the guarantee may be insignificant and useless, leaving the bonds safety reliant on the original rudiments.
Securitizations help provide additional financial resources for MFIs. “For regulated MFIs that have the capability to take deposits, securitization enables them to reduce reserves and free capital so they can use the surplus to leverage more credits.”(Alarcon, 2008) For MFI’s securitization has proven to be an effective tool for MFIs in helping to serve the poor. Furthermore, the securities issued are appealing to investors because of their high returns and key features. Securitization n benefits MFI by making loans safe and liquid. Low income people who acquire these securities do so in order to build capital for their small enterprise or business. They are able to save and invest for the future while gaining credit, and leverage. They appeal to investor’s because investing in short-term loans (typically two years or less) will net them a greater return than just remaining in their portfolio. They help to link the international capital markets to microfinance in addition the government rules and regulations of securitization of loans insures that they investors will maintain a lower risk of investment.
In following the process of securitization, Micro Finance Institutions are able to drive pass the slow regulation process that most banking institutions implement in deposit taking. MFI’s is then able to focus on other activities such as allocating money, time, and resources of outreach, community, and economic development. Securitization is described, MFI will share the risks of the loans with other investors while preserving and increasing their profits. The Micro Finance Institution will simply transfer the microloans or actual assets from the balance sheet to the investor. “From a risk management stance, the originator passes credit, interest rate and prepayment risks to the SPV and ultimately to the purchasing investors.”(Alarcon, 2008) More financially sophisticated firms, like hedge funds and international investment banks to pool together and securitize the MFI-issued debt. These key benefits and factors have allowed institutions such as BRAC in Bangladesh, parts of Latin America such as Brazil, Mexico, and the ProCredit Bank of Bulgaria that has thrived in areas of economic stability and market growth. “MFIs that use securitization have a more precise estimate of their liabilities. This increases the effectiveness in the use of resources, thus reducing the interest rate for micro borrowers.”(Alarcon, 2008)
A more real example is the BRAC securitization within India. BRAC serves as their largest NGO and aids in the development of not only the economy but social issues such as health care, education, and infrastructure development. “It was the world’ first securitization of micro-credit receivables and the first of a new type of investment called micro-credit backed security (MCBS).”(Sundaresan, 2008) Along with being the first triple A rated within Bangladesh, it was different than other investors such as BlueOrchard, as it directly pooled micro-credits instead of pooling loans. The transactions were in local currency that help to mitigate the risks, and linked directly to the performance of the portfolio. In helping India, BRAC relied on funds from members, donor grants, loans form foundations, and MFIs. The government put pressure on BRAC with reducing their high interest rates on loans, but BRAC couldn’t lower and sustain continuing to help borrows. The key derivative came from securitization, it was the most viable option as it reduce leverage, the ability to plan for future growth, obtaining more funds, and attracting investors. Most importantly BRAC was able to get from the MFI, alleviating the pressure on them to reduce their interests’ rates. (Sundaresan, 2008) In order to apply this innovative financial technique, securitization can be applied to microfinance in two ways. The simple way that most MFIs are taking is to securitize the MFIs donor microfinance loans in order to regenerate funding for the MFI to make additional loans called regenerative securitization. (Schwarez, 2011) The second that securitization can be used is to fund new microfinance lending without going through commercial bank intermediation but through the capital markets, referred to as transformative securitization. (Schwarez, 2011) The problem however requires the MFI to sale their loans to the SPV, in which, is delegated under the rule of law of that country. In that case, the MFI would want to ensure that investors that he loans would be protected from the creditors under the rule of law of that country that the MFIs are located.
There are currently two securitization models, the single originator securitization model, and the multi-originator securitization model. The single originator model was displayed during the India transaction, which was structured by IFMR Capital in 2009, the SPV was named IFMR Trust Pioneer-I. Equitas Micro Finance India Private Limited was the originator and the servicer, as it matured with 99.91 collection efficacy, and no shortfall from investors. The multi-originator model was placed within the capital markets by four MFIs that contributed 37,627 microloans that calculated to be $273.6 million sold to the SPV IFMR Capital MOSEC. This structure works best for MFIs because it adds value by centralizing the post-transaction reporting and monitoring effort. It also helps to introduce multiple smaller MFIs to capital markets to make them more attractive to investors. This answers many critics of securitization in microfinance, because the startup costs is usually around $25 million, which many MFIs do not have, however, if they are able to pool together than they could obtain that amount. Overall, securitizations benefits outweigh any negative aspects as they serve to better support the poor and getting people out of poverty. With the resources of obtaining money from investors, and other funds, they are able to generate more money for more individuals to borrow from, thus they obtain capital in order to help finance their businesses.
In conclusion, this paper’s goal is to answer the initial question of the succession of micro finance into mutual funds. Gathered from this paper are the definitions, history, advantages, and disadvantages of mutual funds and micro finance. Within the paper Bangladesh gave an example of how the two concepts are coming together to provide more financing to the country. Mutual funds are set up to provide funds for investment and stocks, micro financing is a way to give or lend money to poor or low income individuals looking for capital, insurance, or financial security to better their living situation, support their business, or become self-reliant on themselves. Micro financing is in the business of bringing in billions of dollars to needy individuals. What many don’t want to happen is a “commercialization” of the concept however, with the markets and stocks for investment brings more money to the table. And providing ways to end poverty will not only take goodwill but also lots of money. “While mutual fund experts see long term potential of such move impacting the industry, fund houses attribute three-pronged causes for the initiative: industry expansion, generating investment benefits for downtrodden working class and technically risk mitigation for mutual fund investments.” (Das, 2009)
The second questioned to be argued and answered in this paper is why the US does not have mutual fund-microfinance within the company. The answer is that the United States contributes to many mutual funds and Micro Finance Institutions around the world, however, the United States although has millions of people in poverty do not consider themselves a poor nation that needs international dollars to be lent to its citizens. There are other programs in place such as the welfare system that is supposed to help those in need or in poverty with ways to better situation such as food cards, affordable housing, free healthcare, cash, and other incentives that also help to get a job to be self-sufficient. So the U.S government already has a system in place meant to combat poverty, and microfinance programs. Although over the recent years, the program has been least effective, the government still relies on the system to keep poverty below what the national percentage in other countries are. However, if the United States did have a mutual fund-micro finance system in place, many people low income or middle income would be better off, helping them to become entrepreneurs, improving their communities, and helping others in other countries get off of their feet and become business owners as well. In order for this to happen there need to be change in regulation of mutual funds aiding microfinance as explained it is currently expensive in terms of taxes, and only done within institutions outside of the United States.
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