The European Fund for Southeast Europe (EFSE) pioneers a sustainable local currency SME financing window.

Competition Finalist

This entry has been selected as a finalist in the
The G-20 SME Finance Challenge competition.

EFSE envisages establishing a specialized local currency SME financing window. The range of financial services for SMEs includes long-term loans and (quasi)-equity instruments via local financial institutions or companies. Furthermore, technical assistance will be provided to local partner financial institutions for developing appropriate financial products for SMEs.

About You

Organization: European Fund for Southeast Europe S.A., SICAV-SIF Visit websitemore ↓↑ hide↑ hide

About You

First Name

Sylvia

Last Name

Wisniwski

Your Organization

Finance in Motion GmbH

Country

Germany, HE

About Your Organization

Organization Name

European Fund for Southeast Europe S.A., SICAV-SIF

Organization Website

Organization Phone

0049-69-977876-50-0

Organization Address

c/o Citi, 31.z.a. Bourmicht, L-8070 Bertrange

Organization Country

Luxembourg

Organization Type

Private Institution

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Your solution

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Name Your solution

The European Fund for Southeast Europe (EFSE) pioneers a sustainable local currency SME financing window.

Describe Your Solution

EFSE envisages establishing a specialized local currency SME financing window. The range of financial services for SMEs includes long-term loans and (quasi)-equity instruments via local financial institutions or companies. Furthermore, technical assistance will be provided to local partner financial institutions for developing appropriate financial products for SMEs.

Country your work focuses on

n/a

If multiple countries, please list them here. If your solution targets an entire region, please select it below

Albania, Armenia, Azerbaijan, Belarus, BiH, Bulg., Georgia, Kosovo, FYR Macedonia, Montenegro, Moldova, Rom., Serbia, Ukraine

Region(s) your solution focuses on:

Europe and Central Asia.

Range of turnover in your target firms, in USD

Less than $1 Million, $1-5 Million.

Average turnover in USD of your target firm

Number of employees in your target firms

Fewer than 5, 5-24, 25-49, 50-74, 75-99, 100-150, More than 150.

Average number of employees of your target firm

5

Specify the size, average and range of expected loans or investments in each target firm

Currently EFSE has a focus on microfinance but also serves the lower end of the SME segment. EFSE intends to further scale up to cover the full range of SME financing. Under the current EFSE structure, micro and SME beneficiaries can obtain an individual subloan size of up to EUR 100,000. EFSE does not define any minimum investment size per firm (average outstanding loan size is about EUR 5,000).

This rather low average loan size is a reflection of the post-conflict focus of the early investment activities. However, due to the rapidly evolving local markets, many micro and small enterprises are scaling up and graduating towards SMEs. Under the envisaged SME financing window larger investment sizes with longer maturities, primarily in local currency, shall be offered.

What stage is your solution in?

Operating for 1‐5 years

Innovation

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What makes your innovative solution unique?

Unique tiered funding structure leveraging private capital: The Fund has different layers of capital bearing different risks. Donors provide funding for the most risky tranche that absorbs losses on investments until its depletion. Given this risk buffer, the structure leverages funding from private investors. In addition, donor funds are used on a revolving basis and, hence, are used efficiently and effectively to maximize development impact.

This combination of public and private capital ensures a sustainable and crisis-resilient funding mix. As all investors provide long-term funding and accept to hold their shares until maturity, the funding base shows little to no volatility.

Scalable and flexible structure that adapts to market needs: The structure of the EFSE allows for broad social impact: inclusion of various investors to grow the capital base, expansion of operations to new countries, strong portfolio growth and product development in line with market demand, capacity building in line with respective needs in the partner institutions and overall fast decision making, i.e. quick disbursement to partner institutions.

Non-financial support through the EFSE Development Facility: This Facility addresses capacity gaps in the financial institutions to enhance MSME finance. In general, cost-sharing is applied. While the initial funding for the Facility came from donor agencies a major share of the current budget is now financed out of the Fund’s profits.

The Fund is structured as a true PPP both on investor and management level that allows the effective and efficient use of scarce public funds. As a regional initiative it serves as a coordination platform promoting sector dialogue and contributes to harmonising standards throughout the whole region.

How does your proposed innovation leverage public intervention in catalyzing private SME finance?

The Fund envisages establishing a local currency SME financing window with seed capital of EUR 50 million. These donor funds will allow leveraging additional private capital of up to four times (EUR 200 million). The seed capital for establishing this new financing window under the well-tested and proven EFSE Fund of Fund structure would allow promoting local currency financing as well as financial instruments that are considered more risky (e.g. long-term loans, subscription of SME corporate bonds etc.).

Furthermore, the EFSE Development Facility would initially be funded by another EUR 5 million donated funds in order to finance technical assistance and capacity-building in partner financial institutions for promoting appropriate SME financing products.
The Fund is structured as an umbrella fund and, hence, allows for incorporating specific fund windows as the proposed SME financing facility. Against this background, each fund window can have its development purpose and be individually designed in terms of capital structure and offered services.

EFSE issues various classes of Shares and Notes (A Shares & Notes, B Shares and C Shares), each reflecting a different risk level. C Shares are exclusively reserved for donors. The C Shares bear the first loss. The B Shares will only suffer a net loss to the extent that the C Shares are depleted, being followed by the A Shares and Notes. This waterfall structure allows private capital to invest in emerging markets in Southeast Europe – and potentially new countries - while yielding attractive financial as well as social returns. While funds mobilized from the international capital markets by international finance institutions is mostly found in the mezzanine tranche (B-Shares), private investors are generally invested in the most senior capital tranches, i.e. A-Shares and Notes.

In the current EFSE structure, the leverage factor is seven, i.e. out of each EUR of public funding a total amount of EUR seven can be mobilized for development purposes. Regarding the proposed SME financing window, we suggest adjusting the leverage factor to four in order to cater for the considerably higher risks of local currency financing together with the innovative financial instruments to be offered (long-term loans, equity, quasi-equity etc.). However, the Fund strives hard to largely mitigate the currency risks by using hedging instruments provided by TCX and other innovative structures.

Due to this innovative approach, EFSE has been able to attract a significant number of reputable private investors. Out of the close to 30 investors, the majority are private investors. Against this success of the existing Fund, we expect that also the new SME financing window within the Fund will attract private capital.

The Advisory Group, comprised of 13 governors/representatives of central banks in the target region, is an informal consultative body of the Fund. It provides the fund management team with strategic guidance and strong linkages to local markets, which is particularly relevant for the proposed solution of local currency lending to SMEs.

In 2009, the Albanian government became the first public shareholder from the EFSE target region. This is particularly critical for promoting local currency lending as the donated capital from local governments should ideally be provided in local currency. Promising discussions in this perspective are under way with another local government, with the objective to attract private capital from the diaspora communities in a second stage.

What barriers does your proposed solution address?

Asymmetry of information, Informality, Lack of collateral, Lack of financial capacity, Lack of SME access to skills / knowledge / markets, Unavailability of financial products tailored to SME needs, Lack of institutional capacity of financial intermediaries, Underdeveloped local capital markets (term local currency funding, exit options for SME equity), General barriers to SME development related to investment climate, Lack of financing to women entrepreneurs, Specific barriers to fragile and weak states.

If you checked any of these barriers, describe how your solution addresses them

The EFSE improves the access of micro and SMEs to financing. Still, much of the MSE sector’s potential to promote growth, employment, and poverty reduction in Southeast Europe has yet to be realized. Although financial intermediation has improved in recent years, businesses in the region continue to list accessing credit as a principle obstacle to investment and growth. Banking intermediation in the EFSE target region is less than a quarter of the rates in the Euro area. Small companies often lack the required collateral (average collateral in the region represents 124 percent of the loan value) and therefore face particular problems. In the absence of fully developed financial sectors in the EFSE target region, MSEs are still forced to rely on internal financing for funding purposes hampering successful businesses to expand (see “Doing Business Statistics”).

EFSE provides very scarce long-term funding of up to 10 years, exceptionally also up to 15 years. Local financial markets are characterized by short-term deposits and lack long-term funding. Furthermore, Central Banks in the EFSE target region are closely monitoring maturity gaps and do only allow limited maturity transformation. In case banks are able provide long-term loans they generally benefit larger corporate. As a consequence, SMEs that require long-term credit for financing fixed assets or other larger investments find it particular difficult to find appropriate funding sources. EFSE particularly addresses this shortcoming by providing funding quality otherwise not available in local markets.

EFSE promotes local currency lending. Many borrowers in the EFSE target region take loans in foreign currency since interest rates look more favourable compared to loans denominated in local currency. However, this exposes the final borrower directly to the negative consequences of a devaluation of the local currency. By directly offering local currency credit lines to partner financial institutions the Fund seeks to stimulate local currency lending. However, in addition to stimulating long-term local currency lending, EFSE also wishes to promote innovative financial services. In addition to providing medium- to long-term loans to SMEs, EFSE also wishes to stimulate the development of equity (surrogates) for SMEs.

EFSE also improves the institutional capacity of our partner institutions through focused technical assistance financed by EFSE’s Development Facility. The objective is to support financial institutions to better serve SMEs with appropriate, innovative financial products. At the level of the final beneficiary, EFSE’s Development Facility strives towards increasing the level of financial education and literacy in the region. Understanding and being able to negotiate the terms under which borrowers enter loan agreements is a critical component of economic empowerment of SMEs. In this context, the Fund is an active supporter of the CGAP Smart Campaign promoting responsible finance practices and customer protection.

Impact

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Provide empirical evidence of your proposed solution's success/impact at present. If your project is in the idea phase, please provide evidence that speaks to its potential impact

Since inception, EFSE is one of the fastest growing development finance investment funds world-wide. Having started with an initial investment portfolio of EUR 65 million, EFSE has shown an average annual growth rate of close to 70% over the last four years. This clearly demonstrates that EFSE has addressed a significant gap of long-term business financing in the local markets.

At the same time, private capital continuously increased its share in the overall funding base. In December 2005, donor funds contributed a large share to the total funding base. Today this has changed and the share of private capital represents 68% of the total capital commitments with more than 20 institutions and individuals . Within this group, particularly the number of private institutional investors has significantly grown to more than a dozen today, with the first investor entering the capital base at the end of 2006.

Given this early success, donor agencies have provided further capital to boost the first loss piece, allowing for further expansion in quantitative terms and for extending the risk frontier in qualitative terms. On the one side, this allowed a geographic expansion from an initial number of four countries with investments to now 14 target countries. On the other side, additional donor funding also allowed to expand the risk frontier in terms of entering into more risky albeit very rewarding financial transactions from a development impact perspective such as the first equity investment, a significant increase of subordinated debt investments and also investments into very innovative financing structures such as Trust Preferred Securities. This went hand in hand with incorporating also new types of partner financial institutions such as leasing companies and investment companies.

Regarding the risk-return profile of the EFSE, the Fund has not only paid target dividends to all shareholders at all times but also distributed complementary dividends in all business years. Equally important is also that the Fund has only registered unrealized capital losses in the form of impairment provisions that currently represent well below 1% of the total net asset value of the Fund.

The Luxembourg Fund Labeling Agency - LuxFLAG, an independent, non-profit making, association aiming to promote the raising of capital for microfinance, has recognized these achievements by awarding its label to EFSE for four consecutive years.

The proposed solution will benefit from the proven capital structure and reputation that EFSE has established among a diverse group of investors. Furthermore, EFSE has gained first experience in local currency investments already, which will be leveraged for the new financing window. By the same token, EFSE can build on its extended network of more than 60 partner finance institutions.

How many firms do you expect to reach?

Until 2014, the Fund plans to reach a total number of 400,000 firms in 14 countries. With the new local currency SME financing window, another 10,000 SMEs can be reached, considering a total investment portfolio of EUR 200 million (average size of disbursed investment EUR 40,000, average maturity of 5 years).

What is the volume of private SME finance you aim to catalyze?

By 2014, a total funding base of EUR 200 million will be mobilized for the new SME window. Roughly 75% of this amount – EUR 150 million - will represent private capital, committed by private institutional investors and international/development finance institutions, which are expected to contribute each half of this amount.

What time frame will be required to reach these targets?

Against the background of the past growth dynamics, the aim of placing an investment portfolio of another EUR 200 million and a 75% participation of private capital can be realistically achieved within one to two years.

The more ambitious target is to increase the share of private institutional investors in this portion. The Fund continuously works towards optimizing the capital structure with the objective to provide additional risk comfort to private investors. With the planned extension of SME financing instruments and a broadening of SME categories served, the Fund will also further increase in attractiveness for private investors.

Does your solution seek to have an impact on public policy?

Yes

What would prevent your solution from being a success?

The opening of a local currency SME financing window fully depends on the timely provision of public funds for constituting the first-loss capital tranche. This is an essential requirement for leveraging additional private capital. By the same token, once the first-loss capital piece is made available, we consider the provision of mezzanine funding by international/development finance institutions as equally critical to scale up the solution quickly enough given the enormous SME financing demand in the EFSE target markets.

Furthermore, the proposed SME financing window may face currency swings and volatility, which could lead to a temporary and/or partial erosion of the first-loss capital tranche. This is, however, precisely the risk-taking function that the local currency SME financing window has to take. Given the experience of the EFSE with hedging solutions this risk could be mitigated to a wide extend through direct cash flow hedges, balance sheet hedges or guarantee schemes.

Describe the social impact of your innovation. Please include both numbers and stories as evidence of this impact

Having served over 200,000 sub-borrowers with a total amount of EUR 1.2 billion, creating 214,000 new jobs, EFSE has shown remarkable social impact. Regarding the support to enhance capital formation in micro and SMEs, roughly one third - EUR 390 million - were provided for financing fixed assets. The 2008 Impact Study also confirmed that 82% of the EFSE sub-borrowers note a very significant or significant turnover increase as a result of the loans received from EFSE financing.

With the proposed solution of local currency SME financing, we expect to further reach out to 10,000 SMEs over the next five years, helping to create an additional 50,000 jobs and sustain hundreds of thousands of additional jobs. This is in addition to the 300,000 target firm to be served by EFSE between 2010 and 2014, providing EUR 2 billion funding with the aim to generate another 400,000 jobs.

Below please find two SME clients benefiting from EFSE funding (please see also www.efse.lu):

After being unemployed for 2 years, Gennadiy Lysikov from Izum, Ukraine, decided to become an entrepreneur, at first trading at the local market with foodstuffs and then - after inheriting a 6 hectare piece of land - moving into agricultural production. With a UAH 198,000 (EUR 19,500) loan provided by Megabank from EFSE funding, Gennadiy doubled his agricultural area and considerably expanded his business volume.

KIM DOOEL was founded in 1999 in Negotino, Macedonia as a small family business producing tomato ketchup and mayonnaise. Since 2002 KIM DOOEL cooperates with EFSE’s partner lending institution EC Bank and has received 3 loans of EUR 105,000 from EFSE funding. These loans were used for further developing the business, purchase of raw materials and machines. Now the company has 31 employees and is a well known, successful food brand on the market.

Sustainability

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List all the funding sources that are required for the sustainability of this solution

Given the particular risk profile of this new Facility, donor grants at the amount of EUR 50 million are required to constitute the first loss capital, covering partly the risks of local currency investments and innovative SME financing products. This first loss piece will then help leveraging an additional EUR 150 million of private capital.

Furthermore, additional TA funds of EUR 5 million are required to enhance the institutional capacities in the partner financial institutions to develop and scale up a sustainable local currency SME investment portfolio. The TA funds could be filled up again through directing profits of the fund to the TA Facility as already practiced under EFSE. Given that partner financial institutions have little to no experience with long-term financial products in local currency, particular emphasis needs to be placed to develop the necessary skills and expertise in these institutions to incorporate local currency SME financial services into their product offerings on a sustainable basis.

Demonstrate how your proposed solution has the capacity to graduate from dependence on public finance. What is the time frame?

The Fund’s capital structure requires public finance to leverage private capital with the objective to significantly increase the volume of funding available for SMEs. As a mandatory ingredient to produce such leverage effect the public seed funds must remain as a first loss risk cushion and cannot be substituted. However, it should be emphasized that the constitution of this risk cushion requires a one-time grant contribution. This seed funding is then continuously revolved and the respective capitalized dividends lead to a growing junior tranche which in turn can further leverage private capital.

Additional public funding is only required if we wish to extend the local currency SME portfolio beyond the target of EUR 200 million, i.e. the maximum leverage of four is reached.

The Fund strives to make maximum use out of these public funds by increasing the absolute and relative amount of private capital contributions over time and within the private capital contributions the share of private institutional investors. Currently, the Fund relies on a total amount of EUR 482 million of private capital out of which 44% was from private institutional investors, clearly demonstrating the success of EFSE’s financing solution and the effectiveness of the leverage mechanism.

Next to leveraging more funding for maximizing social impact among SMEs, public finance provided in the form of first loss capital allows the Fund to extend the risk frontier by adding new countries, innovative financial instruments and untested financial solutions for enterprise financing. Hence, public finance allows tapping very fragile and weak markets or business segments and through this serve as market enabler for MSME finance.

This illustrates that the structural link of public funds with private capital will never become obsolete as we believe there will always be untapped SME business segments in EFSE’s target region which risk-averse private investors would not invest in without the risk protection that EFSE offers. In case markets become more mature and stable and do no longer need EFSE’s “risk protection-based funding mechanism” as commercial funding becomes directly available, EFSE will move on to tap less mature markets and business segments.

Consequently, EFSE will always move to those markets where it adds most value, making optimal use of its public funds and encourage risk-taking in immature but high impact markets, where private investors would not get engaged in on a stand-alone basis.

Demonstrate how your proposed solution will survive a potential loss of its largest private funding source

A well-diversified funding base of around 30 investors at present is one of the cornerstones of our solution. Furthermore, EFSE’s investors invest in the Fund with a long-term capital commitment of minimum 3 years with no possibility for an early redemption prior to maturity. Consequently, the Fund is not threatened by any liquidity swings as open investment funds generally do. Based on a comprehensive maturity gap analysis, EFSE’s management takes measures to prolong capital investments coming close to maturity as early as possible. In practice, investors have actually increased their capital commitments during all times and new investors were attracted even during the financial crisis, proving the stress-resilience and attractiveness of the Fund. The potential loss of EFSE’s largest private funding source is therefore not a major concern for the Fund given the elasticity of the funding base, long-standing relationships with current investors and the strong interest of new investors to invest.

With regards to its funding structure, EFSE is able to take advantage from a flexible approach taken by the international/development finance institutions represented in the investors group. This means that these institutions will lower their capital subscriptions if interest from private institutional investors in the Fund soars significantly. In contrast in times of decreasing private demand international/development finance institutions increase their funding volume so that demand for MSME refinancing can be met at all times. This “buffer role” is mainly taken over by international finance institutions that also in times of crisis have access to refinancing from capital markets and can hence provide flexible financing to EFSE. This arrangement allows EFSE to weather times of crisis successfully without being dependent on any single investor.

Please tell us what kind of partnerships, if any, could be critical to the greater success and sustainability of your innovation

EFSE has established a client network of more than trusted 60 financial institutions, with which it is doing business for many years. Leveraging these business relations will ensure the rapid implementation and scaling up of the proposed solution as well as its long-term sustainability.

The Fund also closely communicates with the Central Banks and Supervisory Agencies as well as with credit bureaus, deposit insurance agencies and others in its target countries. These relationships are helpful in conceptualizing and implementing the proposed solution.

In order to mitigate the risks that stem from currency fluctuations stable partnerships with strong hedging partners that provide sustainable and flexible solutions are important. Innovative structures such as TCX and Cygma have proven their hedging capacity for less liquid currencies and could act complementary to hedges offered by international banks. Since EFSE is an investor in TCX it has privileged access to its products.

Are there non-financial issues that could threaten the sustainability of your proposed solution?

Almost 10 years later, political tensions between various countries in our partner region are still ongoing and could cause a potential threat to the Fund. However, even in the very unlikely event of a complete default of investment portfolios of one or more countries, EFSE’s risk cushion would be able to sustain major losses given the multiple layers of national and regional first loss capital. A liquidation scenario is therefore highly unlikely given the robust capital structure.

Please tell us if your proposed solution aims to scale up through a high growth sector, expand immediately to multiple sectors, and/or scale up geographically

In terms of geographic outreach, EFSE started with four countries at the time of the Fund’s inception in late 2005 (Bosnia and Herzegovina, Kosovo, Montenegro and Serbia). In 2006, it expanded to five additional countries (Albania, FYR Macedonia, Moldova, Bulgaria and Romania). In 2008, Ukraine was approved as a new target country, followed by the Caucasus region and Belarus in December 2009. There is further potential for geographic expansion in the neighboring regions in case respective first loss capital is made available.
This geographic expansion strategy does not only allow for a broader risk diversification across countries and better possibilities to tap also very weak and instable markets, but also allows serving a greater diversity of financial institutions and, hence, MSMEs.

Regarding targeting economic sectors, the Fund has always taken an inclusive approach. Except for harmful or illegal economic activities defined in an exclusion list, firms from all economic sectors including the agricultural sector are eligible to benefit from EFSE financing. It is up to the partner finance institutions to identify the economic sectors and firms that they can best serve. Through the appropriate selection and mix of partner finance institutions, the Fund aims at maximizing the social impact for MSMEs and to particularly tap those market segments where the Fund could add strong value. However, all growth scenarios are built on the principles of responsible lending, i.e. fair, transparent and based on a sound assessment of the repayment capacity of the firms served.

By the same token, EFSE also takes an inclusive approach towards eligible enterprise categories. EFSE wishes to serve all legal forms and the full scale of companies, from micro to medium enterprises to allow and facilitate the graduation and scaling up of enterprises. Given the diversity of MSMEs as well as a non-uniform MSME definition used in the target countries and by the partner finance institutions, the Fund has refrained from applying a specific MSME definition. The Fund rather indirectly defines the types of businesses eligible for financing by defining the purpose of eligible subloans and its maximum amount.

However, EFSE acknowledges that businesses are graduating over time and that this is particularly true in such dynamically evolving markets as the EFSE target region. Against this background, EFSE’s partner financial institutions indicate a very high demand for SME finance. Several markets show strong signs of recovery after the financial crisis and also benefit from major economic and political reforms, creating new business momentum particularly for enterprises to grow into the SME category or to grow within the SME category. Therefore, EFSE has identified a very strong demand for the proposed local currency SME financing window.

205 weeks ago Matt Guttentag said: On October 27, 2010, the judges reviewed entries for the Changemakers G-20 SME Finance Challenge competition and would like to pass on ... about this Competition Entry. - read more >
206 weeks ago Radovan Jelasic said: The stability of the financial sector remains the key pillar of a functioning market economy a precondition of general stability. The ... about this Competition Entry. - read more >
206 weeks ago said: It is very good that EFSE has contributed in the sustainable development of the SEE countries, other institutions must to learn from ... about this Competition Entry. - read more >
206 weeks ago said: I am proud to say that I, as well as my other colleagues from the Central Banks of the EFSE partner countries, are all members of the ... about this Competition Entry. - read more >
206 weeks ago said: EFSE has been one of the key players in small business finance in the Western Balkans. Long term credit lines provided by EFSE have ... about this Competition Entry. - read more >
207 weeks ago said: I am pleased to see EFSE achieving a very significant growth in its portfolio and products in its fifth year of operation. This growth ... about this Competition Entry. - read more >
207 weeks ago said: The use of the funds – namely for the provision of first-loss capital – is an illustrative example of innovative public development ... about this Competition Entry. - read more >
207 weeks ago The European Fund for Southeast Europe (EFSE) pioneers a sustainable local currency SME financing window. has been chosen as a finalist in The G-20 SME Finance Challenge.
215 weeks ago updated this Competition Entry.
215 weeks ago submitted this idea.