Are Small Capital Grants Worthwhile?

The MicroStart approach is to make small grants available to participating MFIs. These grants can be used to cover operating losses or to capitalize loan funds. SUM staff wanted these grants to be a way to funnel small doses of funds in a way that would not overwhelm a small and young MFI’s capacity to absorb them. Each grant has a ceiling of $150,000 and is used for either covering operating losses and/or for loan capital.

A. The Value of TA is Greater than the Value of Money In each of the country visits MicroStart participants pointed to examples of other donors who wanted to provide loan capital, but were not interested in or capable of supporting long-term technical assistance relationships. Thus, MicroStart occupies a relatively unique position on technical assistance, but on loan capital it is simply one source among several. In fact, some organizations voluntarily participate in the technical assistance component only, and MicroStart should welcome this. In the Philippines about a third of the organizations are participating without receiving any funding, and the remainder stayed in the program even after they learned that they were getting 13% loans rather than grants or recoverable grants. Their continued participation shows how valuable they consider the technical support to be.

The size of the grants is appropriate. For the smallest, newest organizations it may be the first time they have had their hands on enough money to get going seriously. For slightly larger ones, it is enough to ensure that the MFI will take the program seriously, without seriously distorting its behavior. With a larger grant, an organization’s staff may pay lip service to technical advice, considering it just another "hoop" to jump through to obtain the money. With small grants, it is easier to tell which institutions are truly committed to growth and accept advice because they believe that it will lead to success—rather than to more donor money.

Finally, given that the MicroStart philosophy is to provide an opportunity to young institutions whose potential for growth is unproven—a small grant is a less risky investment. It won’t destroy the institution or bankrupt the donor if the investment turns out to be a bust.

B. Structuring Funding Relationships MicroStart has three main actors: the UNDP country offices (with or through the advisory boards) as donors, the TSPs as service providers, and the MFIs. During the evaluation it became clear that in two of the countries visited, funding issues were undermining, or threatening to undermine, the effectiveness of technical assistance provision. As we view MicroStart's primary value added to be on the technical side, we have attempted to identify a funding framework aimed at supporting healthy technical assistance relationships.

Implicitly, MicroStart acted as though the relationships were laid out along a line: the donor contracts with the TSP, who is in turn responsible for selecting the MFIs and for the MFIs' performance. The TSP in that model is the agent of the donor. Performance-based contracts with the TSPs reinforced that idea. However, a triangle is probably a more apt description of the actual relationship (see figure below). The contract with the MFIs, although based on the workplan developed with the TSP, is approved by the advisory board (usually with strong government involvement) and is a contract between the MFI and UNDP. The TSP is not a direct party to the agreement. In a linear arrangement, the only control the TSP has to enforce performance is the threat of withdrawal of funding. However, we do not believe that it is effective for TSPs to use this threat in the MicroStart context. Its use places TSPs into the role of policeman rather than teacher or partner.

In an ideal framework, the TSP would have a mainly technical relationship to the MFIs, after its important role in MFI selection. That relationship would continue as long as both parties consented: i.e., as long as the MFI wished to receive assistance, and as long as the TSP felt that the MFI was responsive to its lessons. The funding relationship would be distinct. The MFI would be responsible to the donor/advisory board for a limited number of objective performance targets. Continued access to funding would be based on the achievement of these targets, not on whether or not the MFI implemented specific suggestions of the TSP. The only role of the TSP in determining whether access to funding should continue would be in certifying the accuracy of the information provided regarding targets. The TSP would still be judged on overall performance targets for the group of MFIs, which would give it an incentive to select MFIs well, define targets carefully, and work assiduously with the MFIs. In fact, the MFI and the TSP would have a joint interest in reaching targets, placing them on the same side, as partners. However, the main responsibility for achieving individual targets would rest where it belongs, with the MFI.

We believe that this type of a funding agreement structure would allocate responsibilities more appropriately and would provide incentives for constructive exchange between the MFIs and the TSP. In order to make it work, the UNDP offices, with the advisory boards, would have to take on a slightly more direct relationship to the MFIs. SUM would need to assist by developing formats for agreements with MFIs that improve on existing agreements in two areas:

Agreements should explicitly describe the conditions and practices under which tranched funding would be withheld.

Agreements should establish a small number of indicators as the key performance targets. It is recommended that those indicators include (a) an outreach indicator, such as number of active clients; (b) a portfolio quality indicator, such as PAR-30; and (c) a cost recovery indicator, such as the operational or financial self-sufficiency ratio. A larger number of indicators would still be reported, but continued access to funding would be based on these three.

There is a requirement for the TSP to report on operational self-sufficiency ratios twice a year, and on portfolio quality and numbers of loan clients every quarter. However, whatever spirit of promoting financial viability exists, in practice there is no required benchmark to reach so that the TSP and MFI can see if they are reaching this goal or not. To really have influence, clear targets need to be set out and negotiated during the contracting process. This will automatically sharpen focus on achieving a portfolio quality, numbers of clients and operational efficiency that will contribute to financial viability.

Although work plans for individual MFIs may have certain targets set out, their contracts have none built into them. This has led to confusion as to how well an MFI is doing. It also makes it impossible to phase out a non-performing institution based on objective criteria that makes it clear to everyone why and when participation in MicroStart should be ended. As it stands now, several organizations reported to the evaluators their complete surprise when the advisory board or the TSP informed them they would be phased out, or that their funding would be held up because of non-performance. This negatively affects the relationship between the TSP and the MFI where the value of technical assistance is lost in the process.

Ideally, targets should reflect the portfolio quality, the operational self-sufficiency and number of active loans. Requiring too many targets is confusing and can become an empty exercise for the MFIs and/or the TSP. In Morocco, Ivory Coast and the Philippines, many MFIs viewed the ratios they report quarterly and bi-annually as something more useful to UNDP than to them. Socodevi in Ivory Coast calculates the ratios on their MFIs behalf because they see it as "information that the donor, and not the MFI, requires". The accounting manager for MUCREFAB in Ivory Coast stated that she reported the information that went into the ratios and could calculate them, but she had no idea what they meant or how they could be used as financial management tools.

C. Helping MicroStart MFIs with Long Run Funding Strategies MicroStart grants are clearly not a main funding strategy for most of the organizations. They may be the main strategy for a brief period, but if successful, the organizations will need additional, larger sources of funds within a short time.

When they enter the program, most of the MFIs that MicroStart supports are not dependent on donor funding. Many have local, private sources of funds, usually in small amounts. This means that many of them have had to pay attention to the "bottom line"—keeping costs down and relying on internally generated revenue to cover them. In this environment, financial viability is not an abstract concept, it matters—a lot.

This is a good thing and should not be changed. It would be a shame if MicroStart turned out to be an initiative that merely made it possible for donors to pour huge amounts of money into young MFIs. The purpose of grants to MFIs should not be to fully fund an institution but to provide an opportunity to put the institution on the path towards developing financial viability.

The point of emphasizing financial viability for MFIs is so that they are not dependent on donor funding. MicroStart TSPs should put the spotlight on this and accelerate technical assistance efforts in this area. In addition, MicroStart TSPs should also assist the MFI to cultivate funding relationships with private sources of funding early on. For example, Zakoura in Morocco is beginning to do this with commercial banks through its founder who is an influential businessman. For now, the loans are interest free, but Zakoura is preparing for the day when it will need to pay for this money. MUCREFAB in Ivory Coast is also trying to negotiate terms with a bank, BOAD, to increase the size of its loan capital.

Long run MFI funding strategy is an area where SUM should provide guidance and information. Even the TSPs are often weak on this topic, and in-country perspectives are often limited. Without alternate strategies, the default option will probably turn out to be reliance on donors.

D. Flexibility on Funding Thus far, MicroStart is applying a generic funding level to most MFIs. Whether they need it or not, or can absorb it or not, an MFI receive the $150,000 Micro-capital grant. Some exceptions deserve mention here. In Ivory Coast, CMEC-Katiola received only $6,000 to buy some equipment and cover some operational costs to enable them to establish a solid accounting system. Any future money is contingent on its success in doing so. In the Philippines, some MFIs are not receiving any grants at all; in these cases, the MFIs get only technical assistance from the TSP. Flexibility in determining initial funding levels would be useful. The TSP could then more effectively tailor the assistance a given MFI receives.

Creating some type of mechanism whereby phased injections of additional funding is possible would also be important. MicroStart bets on institutions before their true potential is known, and it is only natural that some of the bets don’t deliver. This is in keeping with the idea in section II about making MicroStart more of a winnowing process. Similarly, since institutions are young, three years and $150,000 may not be enough. For those who have proven their potential, another phase of modest funding and technical assistance may sometimes be in order. It is important, though, that any additional attention to an MFI is directly linked to the actual progress towards financial viability, operational sustainability and expanding outreach to clients.

E. Credit Union Funding A particular issue with regard to flexible funding involves credit unions and other savings-based institutions. Within the microfinance profession there are differences of opinion about the appropriateness of providing loan capital to savings-based MFIs. One view, probably the dominant opinion among credit union analysts and microfinance experts, is based on repeated experiences across the world where credit union ability to grow through savings was destroyed by receipt of donor loan capital, which undermined incentives to raise deposits. Clients of such credit unions only saved the minimum amounts necessary to qualify for loans. In this view it is not appropriate to give grants or loans for capital or basic operational support to credit unions. The other view (held, for example, by TSP Socodevi) is that credit union growth based on savings alone is too slow, and that if credit unions are not too large and are properly managed, they can use donor funds safely to boost their ability to earn income and build equity. This evaluation is not the place for an elaboration of this debate. Rather we merely point out that MicroStart should not fund loan capital grants to credit unions until SUM has investigated this issue -- from both sides and with a look at experience -- and come to some well-founded conclusions, so that it can provide sound advice on this topic to the country offices.

F. Funding Recommendations Structure funding agreements to encourage MFI responsibility for performance and to enhance technical service relationships SUM should develop a format based on objective targets and clearly stated procedures for withholding tranches SUM should develop guidance and supportive information to help MFIs plan long run funding strategies that involve donor independence Allow flexibility in the amount and timing of MicroStart funds Refrain from providing grants to credit unions and other savings-based organizations until SUM has a considered the issue carefully and come to a policy position.

MicroStart: Finding and Feeding Breakthroughs Midterm Evaluation Prepared for UNCDF/SUM 10 December 1999 Elisabeth Rhyne and Jill Donahue To learn more about this author, visit United Nations Capital Development Fund's Website.

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