1. What is microfinance?
2. The microfinance market
3. Micro-entrepreneurs
4. Microfinance institutions
5. Capital markets
6. Microfinance investors

Microfinance can be defined as the provision of comprehensive financial services to micro-entrepreneurs

The vast majority of the population in emerging economies works in the informal sector of urban and rural areas. These micro-entrepreneurs, traders, artisans or farmers are excluded from mainstream economic growth and must rely on themselves to survive. Their income often depends exclusively on the success of a small business in which they invest their frequently impressive skills, creativity and energy. Unfortunately, their ventures rarely extend far beyond the subsistence level, mostly because of lack of capital or exploitation by loan sharks.

Microfinance combines the profit-seeking motive with the priorities of social development

Over the past 30 years, specialised financial intermediaries have successfully targeted this market and developed products and methodologies that are perfectly adapted to its needs and characteristics. They have proved that microfinance is a risk-manageable and profitable business: micro-entrepreneurs borrow at market rate and boast a repayment track record that beats that of most commercial banks (97% on average). Experience has also shown that microfinance is not only a business per se, but also a powerful development tool: even very modest loans generate huge business productivity gains and contribute to both job creation and better family living standards (adequate nutrition, better health and housing, more education).

Microfinance is becoming a new asset class and an integral part of mainstream finance

It is no wonder that microfinance is now quickly gaining momentum: about 10,000 institutions are engaged in it today throughout the world. They are still a varied lot, in terms of size, legal structure and vision. However, three widespread and promising trends accompany the success of this new industry, reinforcing it structurally.

1. Microfinance institutions are now engaging into commercial funding as a way of reinforcing their long-term sustainability. Commercialization has indeed proven to be one of the essential conditions of stability, growth and independence for all leading microfinance institutions.

2. The microfinance industry increasingly requires financial expertise and specialised know-how. A growing number of talented business professionals have successfully achieved economies of scale, product diversification and profitable growth in this increasingly competitive market.

3. Microfinance is maturing into a transparent and regulated industry. Regulators, well-known business auditors and rating agencies pay significantly closer attention to leading microfinance institutions, given their growing importance in national capital markets. Their involvement provides a solid legal, financial and political framework to sustain the growth of the industry.

This evolution does not mean that microfinance is shifting away from its focus on poverty alleviation, on the contrary: commercialisation, expertise and regulation are the means to improving the scale and quality of impact on the socio-economic situation of the micro-entrepreneurs and their families. Sustainability is the key to this long-term effort, and this in turn is based on the economic longevity of the microfinance institutions themselves.

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Growing demand

The microfinance industry is developing fast, both in size and quality. First and foremost, demand is growing exponentially, driven by the millions of micro-entrepreneurs who still long for such basic financial services as working-capital loans. For micro-bankers to meet the projected demand, it is estimated that in the next five years alone, they will need between USD 10 to 20 billion. Secondly, new and increasingly sophisticated products (credit and debit cards, leasing, housing and education finance, insurance and transfer payments, to name a few) are being introduced as the industry matures and the needs of existing clients evolve with the growth of their businesses, further increasing the industry's funding requirements.

Commercial supply

Neither clients' savings nor assistance from the international community will provide the volume of funding that microfinance institutions (MFIs) require. Today, these sources barely cover 5% of the existing needs. MFIs thus realise that access to the capital markets is essential in order to maintain their growth and expand the reach of their services to the poorest, but economically very active, members of the population.

  Demand                                       BlueOrchard                                        Supply

BlueOrchard Finance is dedicated to bridging the gap between capital markets and micro-enterprises

The integration of microfinance into the sphere of international capital markets holds the promise of a long-lasting virtuous cycle of investment and growth for millions of micro-entrepreneurs in emerging markets. Such integration requires the development of innovative and reliable financial products that can channel savings from industrialised countries toward microfinance investment opportunities in emerging markets. BlueOrchard Finance has been created to do just that.

Micro-enterprises are small businesses employing up to ten people, located in urban or rural areas and generally family-owned and operated. Their total assets rarely surpass USD 10,000. They are active in the trade, production or services sectors of the so-called "informal economy" which can be seen as the most important place of value creation and the seedbed of entrepreneurship in emerging countries.

Industry specialists estimate that there are about 500 million micro-enterprises in the world. Each one needs an average micro-credit of USD 500 per year to finance its activities. This small loan allows the micro-enterprise to pre-finance staff and materials as well as to cope with specific and systematic shocks; this shifts the enterprise's focus away from survival and emergency towards stability and sustainability.

Estimates indicate that today only 5% of the demand for micro-credit is fulfilled. Thus, although leading micro-banks enjoy significant growth rates - BlueOrchard clients have grown 40% per year on average since 2003 - the gap between supply and demand is still very large.

In terms of development and social impact, this change of focus allows significant improvements for the micro-entrepreneur. He or she can finance growth adequately and hire new staff if required, and above all stabiliSe cash flow, bringing security to the enterprise. This stabiliSed cash flow allows entrepreneurs to better manage spending, start saving, and thus provide better standards of living to their dependents in terms of housing, nutrition, health and education. Finally, access to banking and increased security promotes a sense of entrepreneurship, and enhances self-esteem and social reputation. The initial small loan can eventually reintegrate entrepreneurs into the formal networks of the economy and foster the structural and sustainable development of local communities.

Microfinance Institutions (MFIs) are specialised providers of financial services to micro-enterprises. Contrary to traditional money lenders, the MFIs tend to offer a large number of clients the opportunity to enter into a virtuous cycle of growth and capital accumulation thanks to their scale of operations and cost efficiency.

Although there is still considerable variety in this sector, there is an international trend towards MFIs becoming for-profit, regulated, audited, evaluated and rated, full-scale financial intermediaries. Microfinance institutions are not confined the sphere of social development, but rather represent the latest expression of the ongoing globalisation of the world financial system, of which they form an integral part. They offer access to capital to a portion of the world population that was formerly excluded.

MFIs have developed competencies that allow them to be efficient financial intermediaries. Years of experience and an intimate knowledge of the socio-cultural environment of their target market have taught them to :

• Develop an original credit distribution methodology based on proximity, through intensive presence of loan officers in the field.
• Adapt credit risk analysis techniques by incorporating their knowledge of the micro-enterprise environment and particular risk factors linked to this sector.
• Create and update products and services to meet the needs of their clients and design adequate collateral or guarantee requirements.
• Integrate and adapt commercial banking technologies: good Management Information System (MIS), credit scoring techniques, debit cards and ATM networks, etc.

The main characteristics of MFIs  are their excellent credit repayment rates and hence their high solvability. Worldwide, mature microfinance institutions will have portfolio at risk rates under 3% (Africa 2%, Asia 2%, Eastern Europe 1%, Latin America 3%), which largely beats the non-performing loans levels of mainstream finance and commercial credit banks.

Today, industry specialists estimate that there are about 10,000 microfinance programmes worldwide. About 300 of these are commercially sustainable and offer excellent prospects for fixed-income or equity investment. They are expected to grow to 500 within the next few years.

Investments in microfinance represent a new asset class that generates both financial and social returns, and offers capital markets attractive risk/return profiles. BlueOrchard is dedicated to  bridging the gap with capital markets.

1. Financial return: microfinance investment has an attractive risk-return profile 

Competitive returns: microfinance debt offers a better return than monetary instruments (an estimated additional 100 to 150 basis points) with only a slightly higher level of risk: it is an excellent alternative to fiduciary deposits or certificates of deposit. Microfinance equity also represents an attractive longer-term opportunity.

Low systematic risk: Microfinance offers lower volatility than traditional emerging market equities or bonds. It is invested in instruments that are not yet quoted on stock exchanges and whose value is not influenced by unpredictable fluctuations in interest rates and credit spreads. Microfinance shows weak correlation to political, economic or even climatic events. The informal sector is by its very nature a thriving source of new businesses, which are somewhat independent of the fate of the formal economy. Similarly, it is weakly correlated with global financial movements in major markets.

Low specific risk: The leading MFIs are highly solvent and have a low risk profile. Their main assets are loan portfolios of very high quality, as demonstrated by their exemplary default rate (3% on average),  lower than that of many commercial banks.  Microfinance institutions have well-diversified portfolios. Credit risk is spread over thousands of micro-borrowers, active in markets with good growth prospects.

2. Social return: microfinance adds a new dimension to your money

By investing in microfinance, you contribute to growth and poverty alleviation in emerging economies. You push back the frontiers of international finance and encourage a virtuous development cycle of capital accumulation, investment and job creation. Better housing, nutrition, health and education are among the most immediate  beneficial effects of microfinance on the welfare of micro-entrepreneurs and their families.

Investors today have various ways of interpreting the effects of the current integration and volatility in the global financial system.

Some investors find it harder to diversify the risk of their portfolio adequately. With globalisation, a shock on one side of the system soon affects the entire system. This has created a demand for hedge funds and investment vehicles that focus on non-correlated products which can contribute adequately to the beta of their portfolio.

Other investors find it harder to satisfactorily control the underlying activities of their investments. Lack of transparency, constantly confirmed by the increasing number of governance scandals and bankruptcies, has triggered a sense of resentment. To these investors, financial markets seem to not be fulfilling their socio-economic function and appear unconcerned with ethics. This has created a demand for socially responsible funds.

Yet another class of investors find it harder to reconcile their investments with the objectives of long-term human and environmental sustainability. The challenge of aligning economic growth and human needs with environmental conservation has created an awareness of sustainable development among leading actors worldwide. Those investors have created a demand for "triple bottom-line" investments (people, planet, profit).

Most investors find it harder to invest in new niche markets and promising high-growth industries. The burst of the technology bubble and the inability of new high-tech and life-sciences funds to offer returns that compensate for their high risk and volatility means that their are few "hidden gems" left for investors to discover.

Microfinance meets all of these investors' needs:

• They are less correlated
• They are socially responsible
• They promote sustainable development
• They represent a niche opportunity in a promising growth industry