The area of micro-finance is of keen importance to our nation’s development. Considering it benefits to the national economy, it has become of great importance to understudy the unique challenges it confronts and the possible options required to address it. This will help salvage ailing industry and set the grounds for the establishment of a formidable Micro-finance industry.
Last month I published an article on the reasons why I believe our microfinance companies are fading out and promised to give a recommendation on how these problems can be resolve. This article sort to do exactly that, however, it will purposely focus on how we can use the nation’s capital markets to balance the Asset and Liability Mismatches saddling the entire Micro-Finance Industry whiles reducing their cost of capital or interest on deposit.
I reckoned in my previous article that the main problems bedeviling the industry, herein Ghana, can be attributed to Asset Liability Mismatches, Huge Cost of Deposit, Weak Credit Standards and Unsustainable leverage positions. Even though, all these factors collectively interplays to create the unexpected Ponzi Schemes the industry is battling. Its however obvious, from the analysis of numerous financial statements, that the problem of Asset Liability Mismatches and Huge Deposit Cost, contribute significantly to the industry’s problems than the other stated factor.
Fortunately, these two challenges can effectively be resolve with a mixture of capital and financial market tools, interlaced with strong regulatory oversight. By utilizing these capital market instruments, Micro-finance companies can effectively balance their long-term assets with equivalent tenured liabilities and at the same time enjoy lower debt financing. This will improve their liquidity positions and effectively support their expansion plans.
To balance their books effectively, Micro-Finance Companies (MFC’s) can raise a substantial amount of equity capital from the Ghana Alternative Market, which is purposely designed to provide long-term capital support for SME’s. Equity capital raised through this medium will help these micro-finance companies gain access to long term equity capital, which can perfectly fuel their long-term loans without distress. Equity capital raised through this medium does not carry with it interest obligations and panic withdrawals associated with deposit financing.
In addition, companies can also list the debt instruments or raise debt capital from the Ghana Alternative Exchange (GAX). Currently, a number of finance houses and Savings/loans institutions in the likes of AFB, Izwe and Bayport financial services have taken advantage of this opportunity. However, no micro-finance institution in the country has raised debt instrument on the GAX, making them loose out on the wonderful opportunity it affords.
Using the GAX to raise debt comes with several advantages, with the noticeable ones being, flexible interest payment terms, relatively lower cost for funds, possibility of refinancing principal during maturity date without taking big hit on company’s cashflow and the lack of principal amortization. All these outcomes are critical to the success of every micro-finance company.
Firstly, debts raised on the GAX will be required to make only semiannual interest payments and absolutely no principal payments in-between. This condition gives companies a more flexible payment term than conventional bank loan which requires monthly settlement of both interest and principal amount.
Also, the cost of debt for companies that raise capital from the GAX has consistently proven to be lower than the interest required to raise deposit capital for micro-finance operations or interest on commercial banking loans. Currently, interest on bank loans hovers around 33% for firms, however the interest on debt raised from the alternative market amounts to 28.4-29.5%. Table below indicates the sources of funding for Micro-finance companies and their corresponding interest rates or cost of funds.
|Sources of Capital||Average Interest Rate|
|Debt based raised on GAX||28.5%|
|Micro-finance Deposit Cost||36.0%|
Data from Annual report Ghana, GSE website and Field Survey
From the table it can easily be realize that debt raised through the capital market, GAX, offered the lowest cost however micro-finance companies have failed to capitalize on this opportunity to reduce their huge exposure to deposit funding which is undoubtedly the most expensive source.
With commercial banks been skeptical to loan funds to Micro-finance companies and deposit cost been unsustainable and excessively riskier currently, it is advised that our Micro-finance companies take advantage of the opportunities that exist, in order to remain competitive. By raising capital on the GAX, the can seize several opportunities that will make them formidable and well resource to face the vicissitudes that will confront them in the future.
|Debts from GAX||Commercial Loan||Deposit Financing|
|Principal Payments||Only at Maturity||Spread Across loan Tenor||Every three months|
|Maturity Period (Avg.)||2-3 years||1-2 years||3-6 months|
|Cost of fund (Avg)||28%||33%||36.0%|
I believe we can solve the problems our micro-finance companies’ face using financial tools available to us and the Ghana Alternative Exchange (GAX) is on that worth taking a second look at.
Author: Emmanuel Ogyem is a corporate finance analyst with Cornerstone Capital Advisors, an investment banking firm in Ghana. The Opinions expressed herein represent his own independent thoughts, based on his personal research, and should not be misconstrued for that of his firm. The firm, is therefore not liable for any material misrepresentation or factual inaccuracies found herein.