Research Paper on feasibility of using charity funds for securitization of Microfinance receivablesPrepared for: Professor Ron Schramm FIN417E: Emerging Markets FinancePrepared by: Andrew CAI (091010) – Chase CHEN(091018) –Kenichi Iwakura(092004)- Lehana SINGH(091133) – William Li(091081)Submitted Date: 28 August 2010This is to certify that this work is entirely and exclusively my/our own, except for those cited and noted.China Europe International Business School
Executive Summary (Andrew Cai)Initially we started out to explore the various charity funds in the market which are puttingmoney in structured financial products. But during the course of our study, we found that the realhurdle was on the demand side from micro-finance industry. Hence, we focused our research onthe current scenario in micro-finance industry. We analyzed the current financial markets andevolution of structured products. We explored the cases in which microfinance receivables havebeen structured in the past. We analyzed all the key stakeholders which can be used for usingcharities for structuring of receivables. Our research shows that though there is some processrelated hurdles, charities can give a new dimension to the microfinance industry. In all, our paperis divided into 4 parts as under.A. Current structured products in Microfinance (Lehana Singh) a) Traditional Model and evolution of current system b) Mechanism behind securitization of Microfinance receivables c) Problems in the current system d) Current Examples of MFS (Main Focus on India) e) Future CourseB. Charity Funds (Kenichi Iwakura) a) Research by exploring existing securities and Charity products/derivatives being marketed especially in developed countries 1. World Bank Global Bond 2. Vaccine Bonds 3. As a product of private banking (provided by RBS Coutts) 4. Charity Notes b) How can charitable derivatives be converted / used in to Micro-Finance based securities of emerging markets? 1. Credit enhancement from Multi-Lateral Agencies 2. Involvement of MFI supporting funds 3. Introduction of DPFs. 4. BBVA CODESPA Microfinance Fund c) How can charity be leverage for increasing the scale/fund raising of micro-finance?C. Regulations (William Li) a) What are tax benefits for investors in investing into charitable funds? b) Are there some regulatory hurdles? c) What are the regulatory mechanisms required for sustainable Micro-Finance models?D. Partners (Chase Chen) a) How can NGOs be leveraged to sell microfinance based securities? b) How can existing firms be leverage to sell MF Securities?
A. Market for Micro Finance based securitiesTraditional ModelCommercial banks perform the role of financial intermediation. They lend to big corporate1. in the form of loans2. Subscribing to their debt issuancesImplications – In this process they take direct exposures on the overall credit risks of theunderlying borrowers or corporate assets.In traditional model, Credit risk consists of the following types of Risks1. Industry risk2. Business risk3. Financial risk4. Project risk5. Management riskAll these risks are faced by the big corporations and hence banks end up taking lending decisionswithout fully understanding and appreciating the nature of the multiple risks that represent theborrowing organizations.Evolution of other traditional ModelsAsset Backed Securities - To reduce the risk from external factors of the corporations, bankscame up with new ideas. They de-constructed assets into different buckets, evaluated separatelyand allocated thereafter to various lenders or investors as per their needs and risk appetites. Thisapproach intended to move the lenders from the traditional platform of lending to anundifferentiated organization to a new improved paradigm of lending against specific assets andrepresented an improvement over the traditional lending model.Receivables backed Securities included specific cash flow receivables as collateral trapped inescrow arrangements. Next, the lenders interests were strengthened by enabling them to haveexclusive first charge on the underlying designated cash flows with other bankers / lendersformally agreeing to such an arrangement.Securitization - Modern markets involve complete isolation of the borrowing entities fromdesignated cash flow and the same are transferred to the lenders.Mechanism behind securitization – Securitization is based on the mechanism of convertingcredit into securities. This involves 3 assumptions1. The security is accurately priced by the issuer2. Credit can be fully calculated for such as security3. The rating assigned by the rating agency full reflects the risk in such a security
These assumptions led to creation of Credit Derivatives, where1. Risk could be measured and traded as a commodity with the underlying financing involved but All the risks and rewards associated with underlying pool are transferred to the buyer2. Financing and the credit could be stripped as two different Products3. Risk could be undertaken by guaranteeing the total expected return from the credit transaction4. PTC Issuance - When an investor buys these debt instruments, the investor is given a PTC. However, this does not mean that the investor owns the assets. Rather, when the original lender recovers money from the original borrower (as interest or otherwise), it is then passed on to the SPV, which then disburses it to the investor in the form of a fixed income1.5. Credit Enhancement Risks – Credit Enhancement is provided to an SPV to cover the losses associated with the pool of assets and is divided into 2 parts a) First Loan Facility (as part of the process in bringing the securities issued by the SPV to investment grade). The provider of the facility bears the bulk (or all) of the risks associated with the assets held by the SPV d) Second Loan Facility in terms of Liquidity Facility is provided to assure investors of timely payments. These include smoothening of timing differences between payment of interest and principal on pool of assets and payments due to investors.6. The transaction structure should be such that the bankruptcy of seller does not affect the underlying pool but it could not be reinforced in case of massive failures such as in the financial crisis or 2007.7. There is no recourse to seller once the underlying pool is sold but the US and other leading government is enforcing new laws to hold the issuer / seller responsible for the underlying risks of the original securities.1 PTC ( Pass Through Certificates) http://www.investopedia.com/terms/p/passthroughcertificate.asp http://www.daytradingshares.com/quick_learning/pass_through_certificate_PTC.html
Problems/ Gaps in Modern Credit Derivatives (Aftermath of Financial Crisis)Banks played on the greed and more and more derivatives started to be created withoutunderlying risk considerations. The credit rating agencies joined the game. This led to thefinancial crisis of 2007-09. With the increase in the securitization of the cash flow loans, majorgaps were created between Deal (asset based) and financed amount due to1. Increase in discount of the receivables for the fear that they will not be collected as was the case with Home based mortgages.2. Banks have started to put cap on the amount of loans / exposure to individual firmsGaps Identification through Stakeholder Mapping ( Reference Banco Sol Class Case)Traditionally MFI (Microfinance Institutions have been trying to put an independent equitystructure through an SPV (Special Purpose Vehicle). There are 2 prime purpose of putting anSPV1. SPV helps in maintaining Equity / Debt ratio good enough to attract 2nd party2. SPV structure ensures the 2nd party that the SPV will have first right to the receivables in case of any default or fall back in the whole arrangement.Advantages to MFIFrom an MFI’s perspective, there’s an important difference between securitization and portfoliobuy-outs.1. While portfolio buy-outs can be conducted only by banks, securitized micro-loans can be purchased by banks as well as by other institutional investors, such as mutual funds.2. Existing lenders will also be able to take larger exposures as they now have the tools to evaluate risk of loan pools and risk-manage exposures on their balance sheets3. A high-quality MFI can also lower its cost of funding by signaling its quality via the rating that a securitization carries4. Securitization and bonds are two different financing structures. Micro-loan-backed securities represent claims on the repayment cash flows from a specific pool of loans, while bonds represent claims on the organization that issues the bonds.Modes of Involvement of Bank – Primarily there are 2 modes for a bank to enter intomicrofinance market1. The bank either enters into a partnership model with these organizations wherein funds are provided in order to generate micro finance loans for the bank’s books directly2. Securitize the micro finance portfolios already generated by the MFIs / NGOs, thus, in turn, freeing up their equity capital and contributing to enhanced generation of micro finance assetsMezzanine Level of Involvement of Bank 2 - In both the above mentioned cases, the bankprovides the organizations with financial support at a mezzanine level in order to enable themoffer credit protection on the micro finance portfolios to a reasonable extent. The bank needs touse a credit rating agency to develop a process to help the bank in securitizing these debts. Thebenefits to the MFI in this involvement of bank are2 Role of a Rating Agency ‐ http://www.icra.in/files/PDF/Pressreleases/March%2022,%202010‐GVMFL‐March‐2010.pdf http://www.microcapital.org/microcapital‐brief‐share‐microfin‐ltd‐of‐india‐raises‐11m‐through‐non‐convertible‐debentures‐ncd‐with‐assistance‐from‐standard‐chartered/
1. Parsimonious capital instead of costly capital from existing lenders (even with P2P platform)2. Unlimited capital from the Money market (with respect to the risk calculated by rating agency) MFI Collateral +3 Guarantee (X+Y) (X+Y) Credit 2nd Party SPV 1st Party Investors (Equity Partners) Investors X Credit Y Equity3 1. Course Pack – Emerging Market Finance (Case on Micro ‐ Finance) 2. IFMR (Institute of Financial Management and Research)
Current Examples of Structuring of MF receivables in India1. Equitas Deal MFI - Equitas45 Financer (Non Banking Institution) – IFMR Securitization – $ 0.96 m Rating Agency – CRISIL Transaction Partner - IFMR Underlying Assets – Receivables of Samruddhi from Loans to farmers for Crop Production Transaction Structure - Par The transaction is structured at parCapital Structure of SecuritizationPTC Yield Principal Principal % Expected Legal Rating Terms (Rs. mn) Maturity Final (Months) Maturity (Months)Series A1 Fixed 125.4 80% 14 20 AA(so)Series A2 Residual 31.3 20% 20 20 BBB(so)Cash 18.3 11.7% of n/a 20 UnratedCollateral issue size of PTCs Deal Evaluation 1. The Pass Thorough Credits (PTCs) will be issued by a special purpose vehicle, IFMR Trust Pioneer I (SPV), set up specifically for the purpose of this securitization 2. IFMR Capital, the sole structure and arranger, also provides mezzanine financing in the form of an investment in 100% of the BBB(so) rated Series A2 securities 3. The senior tranche of PTCs, rated AA and equal to 80% of the portfolio, will be purchased by an institutional investor, while the junior tranche, rated BBB and equal to 20% of the portfolio, will be held by IFMR Capital. The junior tranche is completely subordinated to the senior tranche. 4. Moreover, IFMR Capital as a mezzanine investor in the BBB-rated securities will improve the overall credit appetite for such assets. 5. Investors in Series A1 PTCs enjoy credit protection in the form of subordination of the Series A2 PTCs, the cash collateral stipulated for the transaction, and the excess interest spread (EIS) that is trapped in the structure. Credit protection available to Series A2 PTCs is in the form of cash collateral and EIS.4 http://www.equitas.in/PressRelease_9Mar09.html 5 http://dealcurry.com/2010047‐Share‐Microfin‐Raises‐Rs‐100‐Cr‐From‐SIDBI.htm http://www.dnb.co.in/Arcil2008/Securitisation%20in%20India.asp
2. Bhartiya Samruddhi Finance Limited (Samruddhi)MFI - Samruddhi, established in 1996Banks - ICICI Bank, HDFC and IFC- WashingtonSecuritization – $ 0.96 mUnderlying Assets – Receivables of Samruddhi from Loans to farmers for Crop ProductionTransaction Structure - Par6Deal Evaluation1. Excess spread collected from the receivable is used in the following activities a) Paying Collection agent for collection cost (Samrudhi in this case) b) Guarantee purchase by Bank Consortium for 15% collection2. Risk Reduction and Disciplining of MFI All the payments to MFI were kept in an account hypotheticated to one of the partners in the banking consortium (ICICI in this case). Hence, the MFI had a strong incentive for being disciplined and diligent in its operations.3. The banks consortium showed high confidence in the underlying assets as they accepted the par structure where the default or prepayment of higher interest rate loans in the pool will reduce the excess interest spread (EIS) if available in the form of credit enhancement6 1. http://www.careratings.com/Content/CreditRatings/Securitisation1.pdf
74. Share Microfin Limited (Share) DealMFI - Share (Largest MFI of India)Banks - ICICI BankSecuritization – $ 4.9 m8Underlying Assets – Receivables of Share from Loans to farmers for multiple agriculturepurposesTransaction Structure - Premium9 (Default or prepayment of higher interest rate loans in thepool will lead to premium loss)Deal Evaluation1. The bank calculated NPV of the $4.9m by using WACC based on the risk computed by the internal departments for Credit risk management. Later an agreement was reached with MFI and independent 3rd party rating agency.2. Risk Reduction and Disciplining of MFI a) Partial Credit Protection by a guarantee from Share (MFI) to ICICI for 8% of receivables b) Since, the transaction was a premium, bank (ICICI) settled for lesser guarantee than in case of Samrudhi (15% = nearly double of 8%)7 http://www.sharemicrofin.com/resouces.html 8 http://dealcurry.com/2010047‐Share‐Microfin‐Raises‐Rs‐100‐Cr‐From‐SIDBI.htm 9 1. http://www.careratings.com/Content/CreditRatings/Securitisation1.pdf
Some famous examples of structuring of MF deals outside India1. BRAC (Bangladesh Rural Advancement Committee) Deal10, 2006MFI – BRAC, the largest national Non-Government Organization (NGO)Bank - Citigroup, RSA Capital (Bangladesh),FMO (Netherlands) and Kiwi (Germany)Securitization - US$180 million (Term Period 0f 6 years)Rating Agency – CRAB (Credit Research Agency of Bangladesh) Deal Evaluation1. 150% collateralized by micro-loans, at the beginning of the transaction (approx. 400,000 loans to cover each US$15 million issue)2. AAA rated3. In the initial tranche of US$15 million in equivalent BDT, (a) FMO has directly invested US$5 million, (b) Citibank has funded US$5 million against FMO guarantee, and (c) the remaining US$5 million has been syndicated (participated by Citibank and two other local banks).4. Initial pool selection has been done using software developed by MF Analytics (U.S.), which generates a pool similar in key parameters to the total loan portfolio of BRAC. The securitized pool is a “sub-portfolio”, which reproduces characteristics of BRAC’s total loan book and hence it is diversified across product type and geography5. The transaction has no direct credit enhancements, but it is over collateralized with micro- loans to achieve a higher credit rating6. Due diligence was supported by the fact that BRAC has received “The CGAP Award for7. Financial Transparency” demonstrating high level of MIS reporting systems, Audit and Controls, and data available in various segments that facilitate analysis and decision-making11.10 http://www.alliancemagazine.org/en/content/case‐study‐brac‐launches‐worlds‐first‐microcredit‐securitization 11 http://www.themix.org/sites/default/files/MBB%2014%20‐%20Building%20Domestic%20Capital%20Markets.pdf http://www.microcapitalmonitor.com/cblog/index.php?/archives/544‐BRACs‐USD‐180mn‐Microfinance‐Securitization‐wins‐Recognition‐from‐International‐Financing‐Review‐Asia‐and‐CFO‐magazine.html
2. BOLD 2 (BlueOrchard loan for development 2))MFI – BRAC, the largest national Non-Government Organization (NGO)Bank - Morgan Stanley and BlueOrchard financeSecuritization - US$100 million CLO (Collateralized Loan Obligation for a Term Period 0f 5years)Rating Agency – Unrated (Ratings taken only for various tranches)There seems to be mismatch between the various tranches offered to rating agencies. Hence,information is not transparent.3. Banco Compartamos SA ‐ Still exploring details. Negative evaluations by rating agencies had been rejected by the MFI. Hence, there is a lack oftransparent information about the parties and deal.4. Credit Ease Fixed Income Ltd. Only results used to get general idea. Details of the same are excluded from this research paperdue to some confidentiality issues.Future Course of developments1. Consolidation12 ‐ With the increase in competition the small players will not be able to match the scale and efficiency of the big players. Also, this will limit their ability to attract capital at lower cost. Kiva has already crossed $100 m loan portfolio and some of the other big companies are also approaching massive scales. The global microfinance sector has nearly reached US$30 billion in asset size reaching 130 million clients worldwide 2. Integration of Bidding based P2P systems13 is increasing with traditional MFI’s. 3. The market for securitized micro-loans is much larger than the market for portfolio buy-outs, and this can ultimately lower MFIs cost of funding. Via rated securitizations, microfinance can now become an “asset on its own merit.” 4. Escaping from current conservatism of rating agency - The level of credit enhancement for the current securitization is relatively high. It is very premature to compare securitization with other sources of funding for MFIs as micro loans represent a new asset class and thus lack a track record.5. Due to the recent financial crisis, rating agencies are conservative. Hence the large amount of credit enhancement is evident in the current deals. As more micro loan securitizations are done, and these securities build a track record, the level of credit enhancement is expected to decrease. And as confidence in the asset class builds, demand from investors will grow, which will also lower MFIs’ cost of funding. 12 http://www.microfinancefocus.com/news/2009/11/05/kiva‐microfinance‐loans‐touches‐100‐million/ 13 http://www.micrograam.com/showUserHome.do?method=searchProjectsInGrid&status=open http://www.microfinancefocus.com/news/2010/03/12/micrograam‐e‐bay‐of‐microfinance‐launches‐online‐marketplace/
B. Charity FundsResearch by exploring existing securities and Charity products/derivatives being marketedespecially in developed countriesThere are certain instruments which provide an investor in a developing country to make aninvestment in Charity related activities. In this sector we will explore and provide an overview ofthe instruments available today.1. World Bank Global BondsThe world’s largest institutional investor in the sector of social development, the World Bank,issues global bonds through its subsidiary, the International Bank for Reconstruction andDevelopment (IBRD). The investor is aware that the proceeds will be utilized for internationaldevelopment by the investing, debt providing activities taken by the World Bank. With anexcellent AAA credit14 it is the safest and easiest form of investment for charitable causes. TheWorld Bank has issued Green Bonds which are issued to finance the activities which areenvironmentally conscious, and prevent global warming. The feature of these bonds is that theyrely on the credit worthiness of the World Bank, and are not linked to specific projects.2. Vaccine BondsAlthough very similar to the World Bank Global Bonds, there are some bonds which are tied tospecific causes or deeds. A successful instrument is the “Vaccine Bond” which was successfullymarketed in Japan by HSBC Securities, Mitsubishi UFJ Securities and Daiwa Securities. Theissuer of the bond is the International Finance Facility for Immunisation (IFFI)15. The proceedsof the bonds issued are used solely for the purpose of financing the activities of the GAVIAlliance 16 , a public-private partnership of major stakeholders in immunization, to promoteimmunization in developing countries. This bond structure enables investors to support“charitable” deeds which are visible to the investors, with the credit support of cooperatinggovernments. However, the credit is derived from the credit worthiness of the supportinggovernments, and not the profitability of the immunization activities, which is basically the samestory with the World Bank Global Bonds.3. As a product of private banking (provided by RBS Coutts)The English private bank, RBS Coutts, provides investment opportunities to its clients.14 The bonds are supported by the 187 government members, including the United States, Japan, UK, France and Germany. 15 The IFFI was launched in 2006 due to the initiative of the United Kingdom Government. IFFIm is also supported by France, Italy, Spain, Sweden, The Netherlands, Norway and South Africa who have together pledged to contribute US$ 5.3 billion to IFFIm over 20 years. This strong financial base enables IFFIm to have a triple‐A rating from the three major rating agencies. IFFIm raises finance by issuing bonds in the capital markets and so converts the long‐term government pledges into immediately available cash resources. The long‐term government pledges will be used to repay the IFFIm bonds.(From the website of IFFI: http://www.iff‐immunisation.org/01_about_iffim.html) 16 It includes developing country and donor governments, the World Health Organization, UNICEF, the World Bank, the vaccine industry in both industrialised and developing countries, research and technical agencies, civil society organisations and the Bill & Melinda Gates Foundation. Since it was launched at the World Economic Forum in 2000, GAVI has prevented more than 3.4 million future deaths and helped protect 213 million additional children with new and under‐used vaccines. (http://www.iff‐immunisation.org/supporting_gavi.html)
According to their website17, “Our experienced charity investment team works with high networth donors, trustees and charities. Taking into account your objectives, we will help to devise arobust and truly bespoke investment strategy that will enable you to grow your assets, andmaximize the impact of your charitable activities.” However, there are no structured productsprovided, which means this service is tailor-made and not a generic conventional product whichcan be marketed and traded in the securities market.4. Charity NotesCredit Suisse provides a structured derivative product with a charitable aspect added on calledCharity Notes18. According to the Credit Suisse website, “The Charity Bonus Note is a structuredderivative with capital protection. It is based on a global portfolio of 20 underlying equities thatCredit Suisse analysts expect to increase in value. In addition, an annual amount of 1% of thenominal value of the Note is paid to the charity Symphasis each year. Even if the overallperformance of the portfolio is negative, the investor receives repayment of at least 100% atmaturity.” The Symphasis Charity is a fund set-up by Credit Suisse, and is the socialdevelopment arm of the Credit Suisse group. This investment instrument utilizes a portion of theentire fund to be donated to charitable activities within Switzerland, but the payment risks are notrelated to those activities.b) How can charitable derivatives be converted / used in to Micro-Finance basedsecurities of emerging markets?As we have studied in the previous section, the risk of the charitable activity and the paymentrisk of the investment instrument are disconnected. A structure has been set-up that either (a)there is an issuer with good credit and the project risk is totally disconnected with the risk of theissuer, or (b) a certain amount is set aside from the original fund and is used to make a donationinto charitable activities. In other words, the risk of the charitable or social development aspect istotally disconnected. However, there are ways we can utilize these structures to support the fundraising activities of MFIs.Credit enhancement from Multi-Lateral AgenciesOne way to make CPs viable is to involve creditworthy Multi-Lateral Agencies (MLAs) into thestructure, relying on the MLA’s credit. MLAs are financial institutions founded for the purposeof development of certain regions. Candidate MLAs are, the Inter-American Development Bank(IDB) for Latin and South America, African Development Bank (AFDB) for Africa and theAsian Development Bank (ADB) for Asia. As described in section A. above, it is very importantfor credit support for marketable securities, but it will be very difficult for specific institutions toprovide credit for the issuance of these securities. No recourse is an important factor for financialinstitutions since the control of the balance sheet is extremely important under the Bank ofInternational Settlement (BIS) Basel II regime. Micro-Finance Receivables (MFRs) which arehighly diversified are may be sufficient in terms of risk-taking, however, a credit worthysupporter will make these products marketable in developed markets.17 http://www.coutts.com/private‐banking/charity‐services/charity‐investments/ 18 https://www.credit‐suisse.com/news/en/media_release.jsp?ns=39556
However, if MFRs are wholly guaranteed by MLAs, they will be indifferent from MLA issuedbonds, therefore, there must be a differentiator factor in order for the MLAs to accept providingcredit support. We think that the risk sharing concept will be the key. To be specific, the MLAswill provide a 90% guarantee, and the remaining 10% risk will be borne by the certificate holder.Under these terms, we believe these products will be both accepted by the investor and the MLA.Please refer to Exhibit B1 for the structure of this transaction. An important feature of thisstructure is that the MFI will sell the receivables without any recourse, and can convert thereceivables to cash for further lending.(Exhibit B)Involvement of MFI supporting fundsThere are some Debt Providing Funds (DPF) to MFIs set up by charity foundations and financialinstitutions. The main purpose for these funds is to provide loans to MFIs and indirectly lend tomicrofinance borrowers. However, we propose that these DFPs not provide loans but actuallypurchase securitized assets from MFIs. The biggest difference from the DPF’s perspective is thatthey are not taking the corporate risk of the MFI. They are actually taking the diversified risks ofthe obligors. If the DPF are already taking the risks of MFIs, then they shall take it in the formsof securitization. In the future, if the MFIs have a good track record, and the DPFs are receivingstable payments from the obligors, it will be a good sign for investors other than DPFs to enterthis sector and invest in receivable backed securities. In the world of finance, track record is veryimportant. There are many institutions which are very hesitant due to the reason of no trackrecords. Therefore, in order to develop the micro-finance based asset backed securities marketviable, DPFs are the best front-runners in this sector.Introduction of DPFs.DEXIA Micro-Credit Fund (DMCF)19According to the Blue Orchid Website, the DMCF is described as “The DMCF is a Luxembourginvestment company dedicated to direct debt financing of microfinance programs worldwide.”BBVA CODESPA Microfinance Fund2019 http://www.dexia.com/e/discover/sustainable_funds2.php 20 http://www.blueorchard.com/jahia/Jahia/pid/464
The Blue Orchid website introduces this fund as “Launched by the Spanish bank Banco BilbaoViscaya Argentaria (BBVA), this fund invests in microfinance institutions located in LatinAmerica, providing them with loans in the respective local currencies whenever possible. Theaim of the fund is to promote sustainable development across Latin America by enabling greaterprovision of basic financial services to boost the activities of micro-entrepreneurs.”c) How can charity be leverage for increasing the scale/fund raising of micro-finance?In the U.S.A. and the U.K., charity donations are tax exempted, so this is an advantage for fundraising. However for the purchase of asset backed securities of MFIs, this is a gray zone area,and regulatory authorities must make regulations clear so that “Charity related investments” aretax exempted. Other than the tax exempted aspect, I believe there is no concrete reasoning howcharity can leverage the fund raising of micro-finance. One idea is that the government imposesregulations for companies to spend a certain ratio of their costs or profits for charitable activities,and of course microfinance is one option.
C. RegulationsD. What are tax benefits for investors in investing into charitable funds?The laws regulate the tax benefits principles and intensify tax supervision. The fund can besupported and supervised by tax. Tax reduction and tax-free comprise the measurement for thefund development. Some developing countries have the laws which regulate that foundation,donors and beneficiaries have the right to enjoy tax benefits. Investments in charity fund are taxdeductible expenses. These investments can reduce donors’ taxable income and lower their taxbill.If someone itemizes deductions on his or her tax return, he or she may be able to take an incometax deduction for a gift to a qualified charitable fund. The actual cost of his or her donation istherefore reduced through his or her savings on his or her taxes. For instance, if you are in the 33%tax bracket, you would save $33 on a donation of $100. 21 However, the investment in thecharitable funds has the amount limitation. If someone donates more than 20% of his or heradjusted gross income to charity funds, he or she has to consult with the tax advisors to see theamount of tax deduction.E. Are there some regulatory hurdles?In most developing countries such as China, the laws need to be completed in investment incharitable funds because of the start of charitable funds. The tax benefits policies are scattered inmany laws or relative files. Sometimes, laws have the problems in implementation. For example,in China, the preferential policies have not been fully executed. Only 10 the state charitablefunds have the rights to conduct tax deduction, but the local funds aren’t authorized to conducttax deduction. This hinders the incentive of charity power. Some developing countries’governments push, advocate and lead the development of charitable funds’ policies and make thepublic investment in charitable funds. That leads to the unclear charitable responsibilities.In western countries, corporations belong to juridical association and charitable funds belong toconsortium as a juridical person. They are in the same level. That means that the charitable fundsare the separated operators and they cannot be administrated by governments and corporations.But in such developing countries as China, they haven’t set up the concept of the consortium as ajuridical person. Almost all of the charitable funds are managed by corporations withoutindependence. Moreover, the governments intervene the charitable funds.c) What are the regulatory mechanisms required for sustainable Micro-Finance models?Investment and running in the charitable funds play an important role in the development of thecharitable funds. The laws must define the open, transparent principles and improve supervisionmanagement mechanisms. The charitable funds must have the policies for their charity, record itclearly writing, and keep it under regular review- if they have delegated their investmentfunction to an investment manager these are legal requirements.22The regulations must address the following considerations: enough resources for the charity tocarry out its present and future activities effectively; the level of acceptable risk and how to21 http://nonprofit.about.com/od/fordonors/tp/taxdeductionsforcharity.htm 22 http://www.charity‐commission.gov.uk/Publications/cc43.aspx
manage it. The charitable funds must invest in diversification, i.e. having different types ofinvestment, and different investment within each type. This will reduce the risk of lossesresulting from concentrating on a particular investment.The laws require the charitable funds to accept the annual audit and the supervision from thetaxation department. The annual working report must be published through mass media andcharitable funds must accept the supervision and investigation from the society. The charitablefunds must make the public know the future public benefit activities and the detailed fund-usingplan. The laws should focus on the establishment of internal regulation mechanism. Thecharitable funds can set up the institutional framework. The regulation must determine thetaxation benefits and intensify the taxation supervision.
D. Partnersa) How can NGOs be leveraged to sell microfinance based securities?b) How can existing firms be leverage to sell MF Securities?Today, microfinance is developing to be a worldwide movement. As an effective weapon againstpoverty and hunger, microfinance has been changing people’s lives for better. Not throughcharity but providing loans to the poor.Today, China is the home to microfinance institutions. Major actors include NGOs andinternational organizations such as the United Nations Development Program, governmentagencies such as the Agricultural Bank of China and Rural Credit Cooperatives (RCCs). Theyall operate with different guidelines and goals.While other countries are more open to accept international services, nongovernmentalorganizations within China currently do not have any legal standing to provide small loans, yetoften operate with temporary licenses issued by the national government. For NGOs andinternational organizations such as the UN, the capital is raised through private sources andgovernmental funding. Strict restrictions on operations in China, however, often undermine the
effectiveness.State-own banks and agencies are driven by policy considerations, leading to microfinanceoperations tend to resemble welfare sponsors. In hunger of profitability, the country’s largestbanks, such as the Bank of China and China Construction Bank, have largely withdrawn fromrural operation. Currently, the Agricultural Bank of China (ABC) is the only nationalgovernment institution which has ventured into small financial services. Yet, because the banksremain controlled by the state, project sustainability is disregarded for political considerations,leading to excessive project failures.RCCs have been a fixture in rural since the 1950s. From the1970s to the mid 1990s, the RCCswere under the control of the ABC, later under the direction of the People’s Bank ofChina. Since June 2003, control of the RCCs has been transferred to provincial governments,leading to their transformation into rural commercial banks. RCCs provide most financialservices to the rural sector with 85% of China’s agricultural loans. The institutions providecredit to rural entrepreneurs remain bogged down under unclear regulatory frameworks andinadequate loan control. According to a survey, the RCCs have a non-performing loan ratio of44%.In a shift for the government, lending between citizens was legalized in March 2009. Onceunderground lenders, previously operated outside any legal framework yet provide an estimatedtwo trillion RMB in loans a year. A 2008 survey claims that about 69% of rural households ineight provinces had borrowed from private lenders, many of them are ineligible to borrow fromanywhere else. Private lenders often place very high interest rates on their loans—povertyalleviation is not their goal..The problem in China is that the demand is not yet being met, not because it is too big, butbecause the market is not open. In the rural, there are few financial options. In order to solve thisproblem, the market has to be opened and new financial institutions are needed to place loans torural areas.One popular provider of microfinance loans are Non-governmental organizations (NGOs).NGOs normally conduct value formation seminars and entrepreneurial skills training for thosepeople who are prospective borrowers of funds. Commercial banks do not offer this kind ofservices to poor borrowers. Microfinance loans are approved fast. These small loans do not oftenmeet the commercial banks requirements on borrowers’ cash flows. The poor borrowers do notneed to go to commercial banks, wait for long periods in the banks. These are psychologicalcosts that the poor borrowers do not incur if they borrow from an NGO in the countryside. Poorborrowers prefer NGOs to commercial banks. The NGO credit service is more customized, withmore intensive supervision and monitoring of the utilization of funds.There are cases where donor agency or government absorbs some of the costs of credit for thepoor, so-called subsidized interest rates. In these cases, the microfinance programs distort themarket and generally suffer, low repayment rates, limit growth and institutional dependency.