next billion, 14 April 2020
The COVID-19 pandemic has generated a real sense of crisis in inclusive finance, surpassing even the reaction to the 2008 financial crash a decade ago. And particularly among investors, the topic of highest concern is the looming crisis in liquidity for financial institutions.
For microfinance institutions (MFIs) in many countries, the combined effects of the pandemic and its economic impact will lead to high levels of non-performing loans (NPLs), as clients struggle to make their scheduled payments. During past crises, the typical impact on MFIs has been a period of retrenchment. Much of this is likely to be repeated: With slowing trade and economic activity, fewer loans will be made and portfolios will shrink. The combined effect of credit losses from the NPLs and a shrinking portfolio will put serious pressure on equity capital, quite possibly threatening MFIs with outright insolvency, and ultimately, losses to investors.
But a financial institution can simultaneously be insolvent and still liquid, and in a crisis, preserving MFIs’ liquidity must take precedence over maintaining their solvency. To understand why, it’s important to explore the two concepts, and how they’re likely to impact MFIs and their investors as the current crisis progresses.
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