Blended finance makes banks take the plunge

Guarantee programs have existed for a very long time, but not with this structure and not on this scale, aimed at these target groups. It is the blending that makes it special.

The COVID-19 pandemic has made financial institutions more conservative, sees Marnix Monsfort, Director Financial Institutions at FMO. Which leaves the underserved even more in need of funding. But there is a solution: a blended one.

Have financial institutions been hit so hard by the pandemic, that they shy away from risk?

Actually, what we see in our portfolio, is that financial institutions have come out of the pandemic quite well, up till now at least. In some countries, governments have provided support and overall we see enough liquidity in the markets. But the risks – some real, some perceived - of certain investments, have gone up, because of increased uncertainty. Will there be another lockdown, what effect will that have on, for example, a small food supplier to a big airline company? Or a restaurant? So even if there is enough money, banks tend to play it safe and rather invest in, say, government bonds or large corporates, because it fits their risk appetite better.

With what effect?

There has been a missing middle for a long time already. A large corporate can usually get a loan quite easily, just like individuals. But that does not go for small businesses and medium enterprises, MSMEs. For two reasons. First: most of the time a loan to an MSMEs is a modest amount, with less return for a financial institution and high operating costs. And second: small entrepreneurs often can’t provide enough collateral, so the risks are higher. Because of the pandemic, the ‘missing middle’ is ballooning. An even larger group is perceived as too risky and too cumbersome to serve.

Increasing our loans to banks was not the answer, because the problem is not a lack of money.

And what does that mean to FMO?

The missing middle is a category we very much want to reach, that we have to reach. Sustainable support for small entrepreneurs helps reduce inequalities, expands financial inclusion and provides jobs: small companies are the backbone of any economy. So we asked ourselves, what can we do, so these MSMEs are included? Increasing our loans to banks was not the answer, because the problem is not a lack of money. One of the solutions is supporting fintech companies, alternative lending platforms, that specifically focus on small businesses, like Liwwa in Jordan. But the real money is with the big banks and the problem there is the perceived high risk of underserved entrepreneurs. Mind you: the perceived risk is something else then the actual risk. So to tackle that perceived risk, my two colleagues, Angelica Ortiz de Haas and Maurits Fliehe Boeschoten, came up with a quite revolutionary guarantee program we call NASIRA, constructed with blended finance.

Quite revolutionary? That is a bold statement.

Yes, bold, but true. Guarantee programs have existed for a very long time, but not with this structure and not on this scale, aimed at the target groups NASIRA has: young, women and migrant entrepreneurs and COVID-19 affected businesses, in Africa and the European neighborhood. It is the blending that makes it special. Normal guarantee programs mostly have a 50/50 split per loan. Both parties take the same loss. But because we have the EU and the Dutch government on board willing to accept more risk, we can structure it differently as a guarantee on a portfolio of SME loans. With NASIRA the local financial institution takes the first 5 percent loss. The next 15 percent is on the NASIRA fund, so basically on the EU and the Dutch Government. And only the third tranche, albeit the largest, 80 percent, is on FMO’s account. This set up lowers the perceived risk of lending to these entrepreneurs significantly for local financial institutions. It makes banks take the plunge to support these underserved groups and unlock money that is already in the market.

But does that change the system in the long run? You can’t keep on providing guarantees forever?

And that is why our higher aim is for financial institutions to better understand the real risks in lending to these ‘difficult’ groups. To get that information we have a detailed monitoring program in place. On a monthly basis the local bank and FMO can see how a NASIRA-portfolio is performing. Where are the problems and why? Borrowers from a certain city are falling behind, maybe the loan officer needs training? With the detailed monitoring banks can gain the knowledge they need to assess the real risks in lending to these underserved groups.

And that is how the NASIRA program will make itself obsolete eventually?

No, more is needed. NASIRA has a Technical Assistance program to support financial institutions to identify what women, migrant and young entrepreneurs need and how to better serve them either with financial products or non-financial services. What are the hurdles they face? How do they communicate? This information is key. In Sub-Saharan Africa, for example, half of the population is below 25 and facing massive unemployment. An unemployed young guy will not just step into a bank with a business idea under his arm and ask for a loan, he doesn’t feel welcome and has no collateral to offer. But if a local bank has taken the time to learn how to reach out to these young people, and concluded that - with the data of the NASIRA-program in their computers - a loan based on just a solid business plan is an acceptable risk, we have reached our goal.