Lesson 3.

2:
Donor / MFI Relations

In this Lesson
When donors and MFIs work together as partners they can achieve
common objectives embodied in their individual missions. This
philosophy emphasizes the importance of investing in building
institutional capacity to reach its own goals, not projects to disburse
credit. A funding process can be designed to support the selection of
MFIs with like-minded objectives, and those that can meet minimal
eligibility criteria of portfolio quality, outreach and viability. A
funding agreement based on performance measures that track with the
MFI’s business plan form the basis for the accountability and
objectivity that guide a healthy relationship throughout the life of the
grant.

In Depth
Partnerships

MFIs often choose to partner with a variety of organizations—commercial banks, international NGOs,
bilateral and multilateral donor agencies or government agencies. Some of these organizations provide direct
services to MFI clients, while many provide support services to bolster an MFI’s institutional capacity. In
meeting the simultaneous objectives of outreach and financial sustainability, capacity-building partnerships
are an important tool. Effective partnerships require solidarity of vision and a contribution valued by both
parties. For the most effective partnership, the MFI and its donor partner’s missions should coincide in
purpose and vision. Through this complementarity of mission, the MFI helps fulfill its partner’s mission on a
local level, while the donor or technical assistance organization helps strengthen the capacity of the MFI to
carry out its mission.

Project accounting vs. Institutional accounting systems

When designed as projects, investments in MFIs bring with them project-centered reporting criteria. This is
not only an added burden on the MFI’s systems and human resources, it also deters from the proper tracking
of the financial health of the institution as a whole. Project budgets require monitoring via expenses. Over the
life of the project, the institution draws down on a pool of funds. In this manner purchases such as fixed
assets are seen as one-time purchases, not investments in institutional assets. Hence they are expensed and
not depreciated over time. If the MFI takes on the accounting systems of the donor, it does not build a locally
acceptable accounting system, which hinders long-term institutional viability. If the MFI is a start-up
financed by a donor who puts budget monitoring at the heart of financial reporting requirements, the
microfinance operation risks producing meaningless financial reports, not the financial statements and
portfolio reports that are needed to properly manage, measure performance, and lay the foundation for
growth.

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 Institutional appraisal, factors behind the numbers

An on-site institutional appraisal allows a funding agency the opportunity to understand the institutional
factors underpinning the MFI’s operations and business plan. Understanding these factors is an important
step in deciding whether or not to fund the MFI and whether the MFI is capable of reaching performance
targets. There are a number of institutional factors that are examined on-site. Some of these, among others
are:

Human resources: How the MFI recruits and whether or not it offers adequate training to its employees
Existing partnerships: How the MFI leverages partnerships for its current operations, and how it is
perceived by partners, other MFI’s and knowledgeable people in the country
The market, the level of development of microfinance in the country, and the performance of other
microfinance operations in the market
Leadership: Whether any institutional risk exists from potential loss of a leader and how the institution
builds its future leaders
MIS: How the information produced is understood and used by staff and whether they have adequate
skills to access it

Current Discussions
Sustainable access to financial services is important to a development process that enables poor people to
build assets and produce income. Donors invest in microfinance for a variety of purposes; however, key
among them is expanding and deepening the reach of financial services to those populations who do not have
access to them. There are two prevalent, but very different strategies used by donors to support microfinance.
Some donors choose a project-oriented approach to microfinance. Other donors use an institutional
investment or business-like approach to support sustainable access to financial services for poor and
low-income populations.

What approach promotes sustainable microfinance?

Which approach enables more people to access financial services?
Should a donor fund a microfinance operation that will never become sustainable?

Donors have traditionally carried out development efforts using a project-oriented approach. In the case of
microfinance, this approach is challenged. Some donors argue that a project approach is necessary as there
are certain populations that need access to financial services, but that these services will never be extended
on a sustainable basis. Factors such as the isolation of the area or the characteristics of the population play a
role here. In such cases, a donor may be willing to fund a project to ensure a specific target population,
deemed unreachable by sustainable institutions, receives credit. The donor will have to recognize that this
choice guarantees that a limited group of people will benefit from the resources over a limited period of time.
The choice requires the donor to support the effort well into the future, and perhaps indefinitely.

The shift from a project-oriented approach to institutional investments represents a major change in the
mindset and outlook for donors to achieve development objectives. Donors that choose an institutional
investment approach, use their funding to support an MFI’s move towards sustainability. They note that only
sustainable microfinance operations will provide significant increases in scale and outreach well into the
future. Using this approach, the donor’s investment matches the MFI’s business plan. What before was
defined by the donor under the project-oriented approach, now comes from institutional targets based on the
MFIs own business plan. For donors, this means supporting an institution’s own development to help it reach
more people and become a permanent part of the country’s financial landscape.

Many donors finance microfinance operations that will never become sustainable. A variety of reasons are

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 offered in support of this approach. Some of the most common ones are based on the priority of the location,
client group, institutional partner or activity, such as agriculture. Many of the activities are supported for
political reasons. Donors often support microfinance as a means to support a larger social objective, such as
empowerment or access to health services or in response to civil strife, a political crisis or natural disaster.
Critics of this approach often argue that a donor may be better advised to support these efforts with grant
funds rather than starting unsustainable credit projects that are not what is really needed by the affected
population or what is likely to help them. Microfinance is not the solution to every problem. Supporting
vulnerable populations with grant funding and social services is appropriate, valuable and worthy.

Recommended Reading
CGAP.
2. “Anatomy of a Microfinance Deal,” Focus Note No. 9, August 1997.

CGAP. “Format for Appraisal of Microfinance Institutions,” Technical Tool Series No. 4, July 1999.

Additional Reading
Funding application of CGAP’s investment fund available at:
http://www.cgap.org/html/mfis_funding_app01.html

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 3.

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