Financial Inclusion in Emerging and Frontier Markets Landscape Review July 2018 This material is not to be construed as investment advice or an offer for a particular security. For important disclosure information please refer to the last page of this presentation. Table of Contents* Pages Introduction 2 The Fundamentals of Financial Inclusion 5 Private Capital & the Market Opportunity 17 Assessing Impact in Financial Inclusion 23 The Investment Landscape 32 Appendix 40 *Fiduciary Trust Company International, headquartered in New York, (and subsidiaries doing business as Fiduciary Trust International) and FTCI (Cayman) Ltd. are part of the Franklin Templeton family of companies. Such references pertain only to the body of this presentation and not to the “back page” disclosure. Please refer to the last page of this presentation for important disclosure information regarding this entire presentation. Copyright © 2020 Fiduciary Trust International. All Rights Reserved. Introduction Introduction Overview This landscape review is designed to provide a comprehensive understanding of the role client capital can play in effecting change within a given impact issue area. The reviews are structured to cover the following major topics: The Fundamentals of the Issue Area • The Landscape Review explores the underlying dynamics of the impact issue area, explaining the scope of the challenge and its importance to human or environmental welfare. The Role of Private Capital • Impact investing is not a panacea. Rather it is often most effective as a complement to traditional philanthropy. The Landscape Reviews identify what, if any, market failures are relevant to the issue area and the role private capital can play in addressing them. Outline a Framework for Impact • The Landscape Reviews are intended to serve as a frame of reference as investors assess the impact potential of a particular investment opportunity. Identify the Opportunity Set • The Landscape Reviews provide perspective on the range of investment strategies within a particular issue area. 3 Introduction Overview Landscape reviews are prepared using information collected from a variety of sources. Academic and Industry Research • We consult both publicly-available and privately-sourced research to inform its views. Opinions of Experts • We consult with its network of fund managers, investors, consultants, and other issue area specialists. Outline a Framework for Impact • The Landscape Reviews are intended to serve as a frame of reference as investors assess the impact potential of a particular investment opportunity. Investment Manager Interviews • While in-depth due diligence on a particular investment manager is beyond the scope of a Landscape Review, We interview investment managers that are actively engaged in the issue area to learn more about their strategies and benefit from their perspective. 4 The Fundamentals of Financial Inclusion The Fundamentals of Financial Inclusion Microcredit & the Origins of Financial Inclusion Financial inclusion is, today, one of the most popular investment themes among impact investors, in part because it has a long track record dating back to the emergence of the modern microfinance movement in the 1970s. At the time, developed market donors and investors were drawn to the idea that access to credit could provide a pathway out of poverty for the world’s poor. Microcredit also had appeal as a market-based alternative to aid-driven development interventions that were sometimes criticized for being paternalistic and ineffective.1 Microcredit: The Original Theory of Change The modern microcredit movement has featured a variety of models, but one of the core theories of change was that the small allotments of credit from responsible microfinance institutions would: - Offer the global poor an alternative to the onerous terms of local money-lenders; - Provide the resources the poor need to invest in income- generating activities and increase their earnings potential; and, - Ultimately generate a variety of positive impacts stemming from improved incomes and living standards.2 6 The Fundamentals of Financial Inclusion Doubts Emerge about the Impact of Microcredit The excitement over microcredit may have reached its peak in 2006 when Muhummad Yunus, the founder of Grameen Bank in Bangladesh, was awarded the Nobel Peace Prize. But just a few years later, the results of a series of randomized control trials (RCTs), designed to more precisely measure the impacts of microcredit, undermined the movement’s sometimes lofty rhetoric. Taken together, the RCTs found minimal evidence that microcredit programs systematically increase household income. Published in the mid-to-late 2000s, the studies prompted the development community to rethink the role financial services play in the lives of the poor. “The Miracle of Microfinance? Evidence from a Randomized Evaluation,” Banerjee, Duflo, Glennester, and Kinnan In 2009, economists Banerjee, Duflo, Glennester, and Kinna published what became one of the more frequently cited randomized control trials that raised doubts about the extent of microcredit’s impact on poverty alleviation. However, as Banerjee and Duflo later lamented in their book Poor Economics, the media and microfinance leaders overlooked some of the important lessons their work revealed about the way the poor use financial services.3 The Study The Results The Implications • In 2005, the authors partnered • The authors found that • Banerjee and Duflo conclude in with Spandana, a fast-growing microfinance did indeed Poor Economics that microcredit Indian MFI, to study the effects of accomplish its basic goal. works and “…has earned its introducing microfinance to a new Households that had existing rightful place as one of the key market. businesses made new instruments in the fight against investments or started additional poverty.” (emphasis in original). • Spandana was expanding into the businesses after receiving a loan. city of Hyderabad and identified • But they also believe the results 104 neighborhoods in which it was • However, their data did not reflect the natural limits on the prepared to open a branch. indicate a “radical transformation.” potential of tiny microenterprises New business creation rates only to lift families out of poverty. • The authors then randomly increased from 5% to 7%; selected 52 sites for branch • Further, the stringency of MFI business profits increased, but openings (the treatment group) lending and repayment policies only for the largest 15%; and there and 52 sites that would be left may reduce flexibility and was no effect on average untouched (the control group). The disincentivize risk-taking, rather consumption, a proxy for sites were surveyed at 15-18 than free borrowers to pursue new household welfare. months and again at roughly 36 ventures.5 months. • Further, there were so signs of any changes in education, health, or women’s empowerment.4 7 The Fundamentals of Financial Inclusion Beyond Microcredit & The Shift to Financial Inclusion Over the past 10 years, the field has shifted away from an emphasis on microcredit and towards the broader notion of financial inclusion. Whereas modern microcredit programs were conceived as tools in the fight against poverty, financial inclusion is regarded as a development objective in its own right. Enhancing access to basic financial services can yield significant quality of life improvements for low-income households, fuel the growth of promising small businesses, and enhance the quality of a country’s financial system. Financial Inclusion Defined: Financial inclusion means that individuals and businesses have access to useful and affordable financial products and services that meet their needs – transaction, payments, savings, credit and insurance – delivered in a responsible and sustainable way. 6 (emphasis added) The Primary Objectives of Financial Inclusion in Developing Countries: Meeting the financial needs of underserved and low-income individuals and households Meeting the financial needs of micro, small, and medium enterprises (MSMEs) Capturing the broader economic benefits of an inclusive financial system 8 The Fundamentals of Financial Inclusion Financial Inclusion: Individuals & Households To understand the relevance of financial services to the lives of the global poor, impact investors need only examine their own personal balance sheets. The student loans, 401(k) accounts, credit cards, and life insurance policies one might find are representative of four product categories designed to help meet a set of four fundamental needs common to all households, rich and poor alike.7 Universal Needs… …the Tools and Products to Meet Them Consumption Smoothing - Auto Loan - Small Business Loan The need to manage inconsistent - Overdraft Facility - Home Mortgage cash flow and make intertemporal Credit - Credit Card Balance - Equipment Leasing consumption trade-offs - Student Loan - Revolving Line of Credit Asset Building - Savings & Checking Acct. - Health Savings Acct. The need for financial security, to - 401(k) Retirement Acct. - Certificates of Deposit accumulate assets for use as Savings - Brokerage Account collateral, and to invest in the future. - Savings Bonds Risk Management - Life Insurance - Umbrella Insurance The need to protect against the risk of - Health Insurance - Homeowner’s Insurance devastating loss Insurance - Disability Insurance - Commercial Insurance - Auto Insurance Ability to Transact - Wire transfers - Credit Cards The need to send and