The fast growing microfinance industry could be exposed to more significant risks as it becomes more closely aligned with the traditional financial industry, says Fitch Ratings In a special report published today.

Fitch notes that high growth and transformation within the microfinance sector puts pressure on internal control systems, and places new demands on the quality of management and corporate governance. Increased access to commercial funding brings new demands in risk management, disclosure, and moves microfinance institutions (MFIs) away from their traditional base of public or donor funding. Transformation to for-profit and regulated structures heightens the risk of “mission drift”, leading the MFI away from its traditional social mission, it adds.

“As microfinance institutions transform and their clients become more integrated into the mainstream financial sector, convergence occurs between microfinance and mainstream banking,” says Mark Young, managing director in Fitch’s Financial Institutions group in London. “In Fitch’s view, this convergence could reduce their resilience to the broader economy. The microfinance sector’s success could bring some of the greatest risks it has yet to face.”

“The success and growth of microfinance in the past decade have mainly hinged on the successful management of the “double bottom line” of both financial and social performances, and on a track-record of low loan loss rates, although this has occurred during a relatively benign economic environment,” says Sandra Mai Hamilton, associate director in Fitch’s Financial Institutions group in London.

Separately, the agency has published its rating criteria that formalize its existing approach to MFIs. It retains the same analytical framework for MFIs as for rating banks. However, certain risks are of greater significance due to the specialized nature of MFI activities, their ownership profiles, legal structures, and operating and regulatory environment, it says. Fitch pays particular attention to operation and credit risk management, corporate governance, funding and liquidity, capitalization and likelihood of support from stakeholders.