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Marguerite Berger Lara Goldmark Tomás Miller-Sanabria Editors
Inter-American Development Bank
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An Inside View of Latin American Microfinance
Copyright © by the Inter-American Development Bank. All rights reserved. No part of this book may be reproduced or utilized in any form or by any means, electronic or mechanical, including photocopying, recording, or by information storage or retrieval system, without permission from the IDB. Produced by the IDB Office of External Relations To order this book, contact: IDB Bookstore Tel: (202) 623-1753 Fax: (202) 623-1709 E-mail:
[email protected] www.iadb.org/pub The views and opinions expressed in this publication are those of the authors and do not necessarily reflect the official position of the InterAmerican Development Bank. Cataloging-in-Publication data provided by the Inter-American Development Bank Felipe Herrera Library An inside view of Latin American microfinance / Marguerite Berger, Lara Goldmark, Tomás Miller Sanabria, editors. p. cm. Includes bibliographical references. ISBN: 1597820393 1. Microfinance—Latin America. 2. Financial services industry—Latin America. 3. Banks and banking—State supervision. 4. Inter-American Development Bank. I. Berger, Marguerite. II. Goldmark, Lara. III. Miller Sanabria, Tomás. IV. Inter-American Development Bank. HG178.3 I68 2006 332.742 I68--dc22
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And to the pioneers of microfinance who are partners in their quest.
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To sixty million entrepreneurs who strive daily to succeed.
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A CKNOWLEDGMENTS .............................................................................vii F OREWORD ............................................................................................. ix Luis Alberto Moreno C HAPTER 1 The Latin American Model of Microfinance .............................1 Marguerite Berger C HAPTER 2 Pioneers in the Commercialization of Microfinance: The Significance and Future of Upgraded Microfinance Institutions .................................................................................37 Marguerite Berger, Maria Otero, and Gabriel Schor C HAPTER 3 Downscaling: Moving Latin American Banks into Microfinance .......................................................................79 Beatriz Marulanda C HAPTER 4 Regulation and Supervision of Microcredit in Latin America ...........................................................................109 Ramón Rosales C HAPTER 5 Microfinance Institutions in Times of Crisis: Impact, Actions, and Lessons Learned ...................................145 Armando Muriel, Victoria Muriel, Giulissa Franco, and Elsa Martín
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CONTENTS
CONTENTS
C HAPTER 6 The Right Technology for Microfinance ................................167 Sergio Castello and Carlos Danel C HAPTER 7 Beyond Finance: Microfinance and Business Development Services .............................................................193 Lara Goldmark C HAPTER 8 Future Challenges in Latin American Microfinance .............235 Robert Peck Christen and Jared Miller C HAPTER 9 The Future of Microfinance in Latin America .......................269 Tomás Miller-Sanabria A BOUT
THE
C ONTRIBUTORS ..................................................................291
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This volume attempts to capture more than a decade of experience gained by the Inter-American Development Bank (IDB) and the Multilateral Investment Fund (MIF) in the promotion of microfinance in Latin America and the Caribbean. The book describes the evolving Latin American microfinance model, as related by the very practitioners who have helped develop and apply this model with such extraordinary financial results and developmental impact. We greatly appreciate their willingness to share their insights and experiences in the field of microfinance in Latin America and the Caribbean. Special thanks to Sergio Castello, Robert Peck Christen, Carlos Danel, Giulissa Franco, Elsa Martín, Beatriz Marulanda, Jared Miller, Armando Muriel, Victoria Muriel, María Otero, Ramón Rosales, and Gabriel Schor, whose work in the region has benefited millions of lives. Thanks is also owed to Carlos Alberto dos Santos for sharing his ideas and experience. The continued support and insights provided by Sandra Darville of the Multilateral Investment Fund proved crucial to this effort. Her patience is deeply appreciated. Donald Terry, Manager of the Multilateral Investment Fund, launched the idea for this book, and we particularly appreciate his support and encouragement to carry through with this project. Lyle Prescott translated several chapters from Spanish to English, while providing patient editorial guidance and help with proofreading. Her invaluable help is gratefully acknowledged. Nancy Morrison’s skillful editorial advice was always valuable and is highly appreciated. Thanks are also owed to the staff of the IDB’s Office of External Relations for their timely advice. Tetsuro Narita researched sources and verified data and information. His interest and professional curiosity will undoubtedly lead him to continue in the field of development finance. Nicole Rohrmann’s helpful assistance in proofreading the manuscript is also much appreciated.
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ACKNOWLEDGMENTS
ACKNOWLEDGMENTS
A deep obligation is owed to Dr. Steven Wilson of the MIF for his careful reading and revision of the manuscript. Without his comprehensive suggestions and improvements, this book would not have been published.
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Rooted in ancient traditions of collective self-help, microfinance has become the most rapidly growing segment of the financial systems of Latin America and the Caribbean, and one of the most profitable. The consistent double-digit growth of microfinance in recent years reflects a market which is becoming widely recognized as having tremendous growth potential and excellent credit quality, while also being countercyclical. But for the majority of people living and working at the base of the economic pyramid, the full potential of this instrument has yet to be realized. The fundamental value of microfinance lies in its ability to unleash entrepreneurial spirit and to generate the possibility of better lives for millions of hardworking individuals who currently lack access to the formal financial system. Microfinance transcends income standards and balance sheets: it turns hope into profit, profit into opportunity, and opportunity into sustainable economic growth for families and the communities where they live. For the past three decades, and since the introduction of the Small Projects Program, the Inter-American Development Bank (IDB) has directly supported microfinance. During that time, the IDB has extended loans to governments to support legal frameworks and regulatory reform, to create credit bureaus, and for on-lending to banks and microfinance institutions. Grants and low interest loans have helped many pioneering NGOs to develop and expand micro credit lending, and have provided the basis for seed capital and sustainable growth. Over the past 10 years, the Bank’s Multilateral Investment Fund (MIF), in particular, has become an important source of innovation and capital for the sector in the region, providing equity and institutional capacity building for new microfinance institutions and related investment funds. Microfinance in Latin America and the Caribbean is now at a crossroads. Based on several successful models developed in smaller
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FOREWORD
FOREWORD
countries, microfinance needs to be brought to full scale across the entire region. Over the next five years, an important focus for the IDB Group will be to mobilize all of its instruments to develop new products, improve regulatory environments, and promote programs with a range of partners, from small NGOs to large commercial banks. The ultimate goal is to spur private markets to triple microfinance in the region from its current portfolio level of $5 billion to $15 billion by 2011. The hard reality is that the LAC financial system is today irrelevant to the daily lives of the vast majority of the population. Now is the time to change this reality in order to create financial democracy for the region, providing the poor with more options to use their resources, energies, and talents. They will do the rest. . . .
Luis Alberto Moreno President Inter-American Development Bank
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The Latin American Model of Microfinance Marguerite Berger
I
n a region of great inequality and economic instability, microfinance is a capitalist paradox. In the past 20 years, microfinance has gone from an obscure development experiment to a multibillion dollar enterprise bringing banking to millions of people. Although the industry has grown globally and there are star performers in every region, institutions in Latin America stand out for their integration into the formal financial system and their impressive growth, outreach, and profitability indicators. At the end of 2004, 80 of the top microfinance institutions in Latin America—both NGOs and formal financial institutions—were serving more than 4 million clients with a combined outstanding loan portfolio of $4 billion (Miller and Martínez 2005).1 With hundreds of institutions operating in the region, including a number of large commercial banks that have recently entered the microfinance market in countries such as Brazil,Mexico,Peru, and Venezuela, the actual amount of microcredit is much larger. Getting to this point has not been easy, and microfinance has by no means reached its zenith in the region. Latin American microfinance faces continuing challenges, especially those related to reaching unserved populations, maintaining profitability in the face of increasing competition, and attracting more private investment.
1
The figure used is for outstanding portfolio, a stock measure, which means that over $10 billion in loans were disbursed by the 80 reporting institutions in 2004.
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Nevertheless, the experience to date in Latin America clearly illustrates the story of how a visionary approach to enterprise lending developed into an industry in its own right. In most countries of the region, policymakers, donors, and the public view microfinance institutions (MFIs) as important contributors to financial and socioeconomic development. What’s more, the financiers to Latin America’s microenterprises have a lot to teach the banking world about how to work with a new client segment and how to manage the risks entailed. Microfinance in Latin America has some defining characteristics that distinguish it from microfinance in Asia, Africa, or the transition economies of Eastern Europe. Most of Latin America’s pioneers began as private, nonprofit institutions, working in urban markets. MFIs have focused on credit as the primary service offered, only recently beginning to develop savings programs and expand their product lines in such areas as housing and remittances. Although most of the pioneers did target the poor, and low income people still form the majority of microfinance customers, an exclusive focus on the poor is not the defining characteristic of Latin American microfinance, as it is for many Asian and African institutions. In Latin America, the emphasis has been on providing services to enterprises with insufficient access to financial services, and to the unbanked in general. This book offers an inside view of Latin American microfinance, as seen by those who have worked over the decades to make it grow. The lessons are relevant not only for the global microfinance community, but to the field of development writ large. In a region of great inequality and economic instability, microfinance is a capitalist paradox. It has been able to create viable services for those at the base of the economic and social pyramid, survive and grow in adverse economic conditions, and become a profitable and rapidly growing part of the regulated financial sector.
Characteristics of the Latin American Model Many would argue that no single Latin American model of microfinance exists. In reality there is a multitude of models, approaches, and ways in which institutions respond to demand for financial services on a small
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scale. The various operational forms take into account the circumstances of each country or market, such as the degree of development of local financial markets, macroeconomic conditions, the regulatory framework, and available human capital.
Defining Microfinance In keeping with its focus on Latin America, this book defines microfinance as financial services primarily for microenterprises: their owner/ operators and their workers. It is important to understand that the term “microenterprise” has a broad definition; it includes independent economic activities ranging from individual vendors selling oranges on the street to small workshops with employees—and anything in between.2 Some policymakers and scholars do not consider the smallest activities of the poor as enterprises, but even these activities have a claim to that title by virtue of the risks their owner/operators take with their own assets, no matter how small they may be. And for microfinance institutions, these enterprises and those who work in them are valued customers. In defining microfinance, the characteristics of the customers are as important as the volume of money involved in the transactions. Because they are informal and typically family-based operations, microenterprises and their owners and workers lack the papers, property, and documented salaries generally required by banks, especially when granting loans. The key to microfinance is the development of products and technologies to provide financial services to these customers on a sustainable basis. The distinction between microfinance and microcredit can be confusing, but it is an important one. Both terms refer to small transactions, but microcredit relates only to the lending side of financial operations. Microfinance, on the other hand, refers to a whole range of financial services including microcredit, but also microsavings, transfer of remittances, microinsurance, and more. Microfinance has been depicted in the press and the development literature in a number of ways. At one end of the extreme is the view 2
For further discussion of this point, see Berger (2000).
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that microfinance is a type of poverty reduction program, while at the other, microfinance is touted as the latest way for banks to make money. Important to understanding this complex debate, again, are the customers of microfinance. Microenterprises are the dominant employers of the poor, whether as owner/operators or employees. Microentrepreneurs share some characteristics with the poor: they possess limited documentation of income and credit history; they generally did not have access to formal financial institutions before microfinance; and they tend to live in the same areas. Some define microcredit exclusively with respect to the size of the loan, typically using $300, $500 or $1,000 as the threshold below which a loan can be considered “micro” and assuming that those with loans below this amount are poor. The first problem with this definition is that it is useless for comparisons across countries with different levels of development, incomes, and prices. The second problem is that the breakthrough of microcredit is not only to be able to undertake ever smaller scale transactions effectively, but to make such loans and to get repaid. That means managing risks that existing financial institutions have been unwilling or unable to undertake. If the customer lacks documentation and guarantees, how do lenders assess the risks involved in this type of financing and manage those risks effectively? The experience of Latin American microfinance institutions provides some basic principles. First, MFIs must evaluate the applicant as well as his or her business. It would be accurate to say that the smaller the loan size involved, the more important the character of the borrower becomes. In microcredit, a borrower’s willingness and ability to pay are at the heart of the transaction.
Some Key Features of Latin American Microfinance No generalization can account for every case, but it is still possible to identify some key trends and features that serve to contrast Latin American microfinance with microfinance in other regions, particularly Asia. The microfinance model associated with the Grameen Bank in Bangladesh is well known, but the Latin American model has received
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much less attention. This book not only reviews the history of development of Latin American microfinance, but also focuses on what makes it unique. Perhaps the most important defining characteristic of Latin American microfinance is the commercial orientation of its leading institutions with respect to operations, financial performance, financing, and ownership, an orientation now catching on in Asia as well. Other key features that define microfinance in Latin America are its adaptability and responsiveness to customer demand, its greater urban concentration, and the diversity of its customers. The microfinance industry has been growing at an estimated annual rate of 30 to 40 percent over the past three to five years, and at even higher rates in such countries as Brazil, Mexico, and Peru. Latin American microfinance institutions are larger than their counterparts in Africa, Eastern Europe, and the Middle East, but they have still not achieved the same massive scale found in some well-known Asian institutions. Some of the difference between microfinance outreach in Asia and Latin America can be explained by the huge variation in population between the two regions. But while Latin America’s population is 14 percent the size of Asia’s, it has only 6 percent of the number of microenterprise borrowers as Asia. The average number of borrowers per microfinance institution (MFI) is 31,000 in Latin America, compared to 130,000 in Asia.3 Nevertheless, Latin American microfinance is on a steep curve and gaining fast. Client demand for financial services has been one of the key drivers of Latin American microfinance since its beginnings. To some extent, specialized microfinance institutions the world over share this characteristic, in the sense that their underlying mission is one of improving the well-being of their target customers. Responding to customer demand and their own capabilities, most microfinance institutions in Latin America began by offering credit, and expanded their services once their credit technology had been perfected. Latin American microfinance institutions now offer a range of credit products for micro 3
MicroBanking Bulletin (2005), 11 (August), tables.
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THE LATIN AMERICAN MODEL
MARGUERITE BERGER
as well as small enterprises: individual and group credit, investment loans, housing and consumer loans, and lines of credit. Their deposit operations include several kinds of accounts: passbook savings, fixed term deposits in different currencies, and checking accounts. Some institutions offer other types of services as well, such as national and international wire transfers and remittances, currency exchange, public utilities collections (for water, electricity, and telephone, whether to public or private sector providers), local tax collections, and even “discounted mortgage” paper, such as promissory notes and other debt instruments. One of the secrets of microfinance in Latin America and other parts of the world is customer loyalty. MFIs realize that for financial institutions, face time plus good service equals trust, and that translates into loyalty. They know their customers well and do their homework so that the products they offer will respond to customer needs and make their customers feel valued. Although this is changing, Latin American institutions still tend to be long on credit and shorter on deposits. Some of the leaders, such as Women’s World Banking in Cali, Colombia, still maintain the unregulated nonprofit status they began with, and therefore cannot accept deposits. Savings play a bigger part in Asian microfinance than in the Latin American variety. In some cases, savings are forced; borrowers are required to make savings deposits as they repay their loans. In others, savings are voluntary, with accessible and convenient savings accounts offered to borrowers and others in the community. Latin American microfinance is known for its reliance on private sources of funding to fuel growth and continued operations. As compared to their counterparts in Asia and Africa, for example, Latin American MFIs depend more on borrowing than on deposits and equity for their funding (Barrès 2005). More importantly, a greater proportion of the equity and borrowing comes from commercial sources and/or at market rates.4 Commercial financing certainly means less donor dependence, but
4
See for example, Miles (2005); Heinen (2005); Portocarrero Maisch, Tarazonia Sonia, and Westley (2005); Jansson (2003).
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it also implies new risks. However, as microfinance institutions began to grow to a certain size, they realized there are risks in donor dependence as well, particularly the slow response of donors to crises in the institutions and the inability to meet their customers’ growing demand for services without integration into local financial and capital markets. The rapid expansion of Latin American MFIs is enabling them to reach ever more customers from their traditional target sectors and expand into other sectors. This allows them to attract funding from sources that previously dealt only with the traditional banking sector; this in turn allows them to expand their outreach further. By 2005, some 20 Latin American microfinance institutions had already built up their assets to levels in excess of $50 million each. The largest microfinance institutions are able to put together and issue instruments large enough to attract private investment, giving them an advantage in funding. New investors include pension funds, investment banks, and international investment and capital development funds. Sustainability and profitability of Latin American microfinance are as high or higher than that of other regions, despite the smaller size of operations in Latin America. Although economies of scale are important, the minimum size that a microfinance portfolio requires to attain sustainability—and even profitability—is much lower than had been originally thought by observers of the region’s banking sector. The top performing Latin American MFIs in terms of profitability have shown that good rates of return can be achieved at the portfolio size of $1 million. Furthermore, while large size can help, it is not a guarantee of greater sustainability or profitability. Despite having the greatest concentration of commercial, privately funded microfinance, Latin American microfinance is a case of innovation from below. It got its start from tiny nonprofits in a few low-income countries that evolved into major banking institutions and paved the way for a new wave of commercial banking entrants into the sector. While nonprofit roots are common to MFIs in other regions, the State tends to be more directly involved in microfinance outside Latin America. This is especially the case in Asia, where government ownership has played a role in some of the leading institutions, including BRI in Indonesia,
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a State-owned agricultural bank, and Grameen Bank in Bangladesh, which was partly owned by the government in the 1980s. However, there are some signs of convergence between the two regions in this area, as State-owned banks expand their role in Latin American microfinance and commercial approaches grow in Asia.
Understanding the Latin American Model in Historical Context The development of microfinance is part of the long history of financial services. Scholars point to the banking operation of the religious order of knights known as the Templars as the first banking institution (Weatherford 1997). In response to the needs of wealthy individuals and important institutional clients (the Church and European monarchies), the Templars offered an array of financial services including insurance, transfers, currency exchange, loans, savings, and mortgages, laying the foundation for modern banking. The Italian bankers who followed in the Templars’ footsteps expanded these services to the middle of the market, catering as much to the needs of small landlords, merchants, and vendors as to those of the aristocrats and high officials of Church and State. To avoid confronting the Church’s policies against money lending, loans were disguised as transfers, advances, or exchange transactions. Of course, money changing and money lending are age-old activities. But for centuries, informal financial services such as those provided by individual moneylenders or rotating savings and credit associations (ROSCAs) were the only alternative available to the poor. Only with the Industrial Revolution in Europe did non-elites begin to participate fully in the cash economy, and issues of access to markets and financial services began to surface. Indeed, the origin of the term “malicious moneylender” is associated with an exploitative relationship in which small farmers contracted debt at exorbitant rates from individuals who served as middlemen between their farms and faraway markets (see Von Pischke 1991). In the 1700s in Ireland and in the 1800s in England, Germany, and Italy, institutional models to serve the low end of the market began to
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emerge. The Irish loan funds provided credit and savings services to owners of microenterprises for 150 years; and the cooperative movement was created to meet the needs of urban wage earners and small farmers. The cooperative movement was “exported” to Latin America with varying success, in some places leading to the formation of solid financial institutions serving lower-income segments. In the mid-1900s, developing country governments and international development agencies around the world began to support large-scale initiatives to provide credit to the low-income population in rural areas. These supply-side schemes, mostly run through public agricultural development banks, failed for a number of reasons, such as inefficiency and corruption and highly subsidized interest rates that resulted in credit rationing. Ironically, the cheap credit aimed at reducing inequality ended up making it more severe. New thinking in the 1970s questioned the established wisdom of “bigger is better” for business, acknowledging the useful role that informal enterprise played (and still plays) in generating income and employment for the poor (see Schumacher 1973; ILO 1972). It is against this backdrop that the pioneers of microfinance launched their innovative programs in the 1970s and 1980s. Perhaps the world’s best-known microfinance institution, the Grameen Bank in Bangladesh, was started around the same time as a series of experiments that were taking place in Latin America. Beginning in 1972, Projeto Uno in Recife, Brazil began to offer working capital loans to microenterprises based on the principle that agility in approving and disbursing loans was more important to these clients than the interest rate.5 Projeto Uno also introduced the concept of young, proactive loan officers who developed personal relationships with the clients and were responsible for all aspects of the loan cycle, from origination to recovery. Other precursors to the Latin American microfinance industry included a loan fund that targeted the tricicleros in the Dominican Republic (men who pedal huge tricycles that hold baskets laden with goods for sale), which led to the creation of Banco Ademi in that country; and Fedecrédito 5
Projeto Uno operated from 1972 to 1979.
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in El Salvador, a cooperative that offered loans to its members using group guarantees and that offered financial incentives to its staff based on loan recovery. The women’s movement also helped spur the development of microfinance, particularly in Asia and Latin America. In 1974, 100 women met in Ghana to talk about their concerns in preparation for the International Year for Women in 1975. Arguing that with access to credit they could improve their earnings and satisfy other needs, they insisted that access to credit was their foremost concern—not education, housing, or health care. At the 1975 United Nations Women’s Conference in Mexico City, a group of 10 women started planning Women’s World Banking, which subsequently launched affiliates worldwide, including those in the Dominican Republic and Colombia. The Grameen Bank and many Latin American MFIs, especially in the NGO sector, still target women as their primary clients. In the 1980s, microfinance developed beyond the experimentation stage. By this time, Grameen had entered its expansionary phase and became the first development project to transform itself into a microfinance institution. Grameen made a number of important methodological contributions to the field, such as using peer groups as mechanisms for borrower selection and guarantees, adapting loan amounts and terms to seasonal and other needs of borrowers; advancing the vision of a proactive bank that “goes to the people”; and using savings and insurance as an important part of the product mix, providing the client with protection in times of shocks or crises. The lesser known State-owned agricultural bank of Indonesia, Bank Rakyat Indonesia (BRI) was one of the first to show that microfinance could not only reach scale, but could be profitable. In the mid-1980s, the Bank underwent a major restructuring and began providing small-scale savings and loan services to millions of individuals. Today, the Bank has over 2 million customers with micro and small accounts. The BRI case has provided a convincing example over the decades that microfinance can and should be delivered in an efficient manner through the formal financial system. BRI’s contributions to the field include lessons on offering convenient savings services; a model incentive system for Bank
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staff; and a world-class management information system without computers. A model of simplicity, BRI used index cards to track and record loan payments until the early 1990s. This low-tech solution shows that technological advances in microfinance facilitate improvements in efficiency and outreach, but do not guarantee these outcomes. In Latin America, the early ad hoc experiments in Brazil and elsewhere were followed by a period of concerted efforts and learning in Colombia and the Dominican Republic. In Colombia, advocates of a credit-plus-training model like Fundacion Carvajal debated internally and with partner institutions. ACCION International, which was associated with Carvajal in its early days, moved away from the credit-plus model and toward a minimalist approach. Around the same time, the Fundacion para la Educacion Superior (FES) supported the work of a number of nonprofit institutions, including those linked to the Women’s World Banking (WWB) network. The WWB affiliates adopted the credit-only, or minimalist, model early on. Today, WWB-Cali is known as one of the most efficient microfinance institutions in the world, and has been able to access local capital markets despite its NGO status. Another important lesson out of Colombia, although later, came with the near-failure of Finansol, since renamed Finamerica. This institution, affiliated with the ACCION network, expanded its activities beyond its areas of core competence, at the same time as it loosened controls on the credit methodology, masking rapid deterioration of the loan portfolio. When the institution’s true situation was made public in 1997, a group of socially oriented investors and donors came forward with new capital. This first widely documented “microfinance bailout” was undertaken in large part because of the belief that if Finansol failed, donors and investors might lose confidence in the rest of the Latin American microfinance industry (Lee 2002). Finally, in the late 1980s, Colombia became the pioneer of the second-tier model for financing credit to microenterprises. Under this approach, the public sector entered the microfinance sector again—not as a credit retailer, as in the 1960s, but as a credit wholesaler. With support from the Inter-American Development Bank (IDB), Colombia and another 14 countries, including El Salvador, Paraguay, and Peru, created
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programs to channel funds and technical assistance to commercial banks and specialized MFIs to help them expand access to credit for micro and small enterprises. The IDB-financed program contributed to rapidly expanding microcredit in the countries where it operated, but was not always successful in creating a sustainable commercial microfinance industry, especially in countries like Colombia and Argentina that were characterized by heavier State intervention.6 Following this experience and others by the IDB, the Multilateral Investment Fund (MIF), a private sector window of the Bank, became one of the first development agencies to make equity investments in Latin American MFIs. MIF was the lead investor in one of the first specialized funds for equity investments in microfinance, Profund.
The Results of Latin American Microfinance Today, microfinance is a going business concern in Latin America. As a business proposition and as a vocation, microfinance seeks to serve people who were not considered to be creditworthy by traditional banking. It has accomplished this by developing systems to assess and manage the risk of lending to people who have only limited assets, no formal documentation of income, and no formal credit history. Microfinance entails creating viable distribution channels and reducing the transaction costs of small transactions. In this way, it can overcome the high unit lending costs associated with very small loans that have served as barriers to entry into this market niche. Compared to other regions of the world, the availability of bank credit to the private sector is very limited in Latin America, reflecting the underdevelopment of markets and institutions, including property rights, as well as the large share of credit to the public sector. Credit to the private sector averaged only 31 percent of GDP in 2004, which is actually lower than the 37 percent average for 1995–2002. In contrast, credit to the private sector averaged 77 percent of GDP for emerging Asian markets as a whole (23 percent for South Asia) and 141 percent for Western 6
For a full review of this IDB program, see Berger, Beck Yonas, and Lloreda (2003).
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Europe in 2004.7 In addition, overhead costs, interest margins, and credit volatility are among the highest of any region in the world, approaching those of Africa and Eastern Europe. This context poses both a challenge and an opportunity for MFIs and banks interested in microfinance, as the potential for growth is high, but so are costs and risks. It is difficult to provide precise figures on the number and amount of microloans and savings as well as the potential clientele for these services. The best data available indicate that in relation to the 60 to 80 million microenterprises in the region, microfinance accounts (deposits and loans) cover less than 10 percent of the total. This does not include microenterprise workers or others who may demand microfinance services. Studies relying on data from the past five to six years indicate that the coverage of microfinance in Latin America is less than in Asia, but greater than other developing regions of the world.8 At the same time, huge differences in microfinance coverage exist among countries of the region, between urban and rural areas, and in the range of financial services offered. The microfinance market does not present homogeneous characteristics across the region, and there is still a need and the opportunity for greater coverage. As regards the providers of microfinance, Latin America is characterized by the coexistence of a broad range of institutional types, especially in comparison with other developing regions. The institutional models include nonprofit specialized microfinance institutions, sometimes delivering nonfinancial services to their customers; regulated special-purpose finance companies dedicated to microfinance; specialized commercial banks with a microfinance orientation; and credit unions, finance companies, and commercial banks that offer different microcredit instruments as part of their product line. While development of Latin American microfinance centered on the development of institutions, today it is moving from being about specialized institutions toward being about specialized products that can be offered by many types of financial institutions. This is a big lesson for other regions. 7
Business News Americas (2005); IDB (2004).
8
See Westley (2001) and Christen (2001).
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Microfinance Customers Latin American microfinance serves a broad range of customers on the credit side, and even more so on the savings side. Particular methodologies that rely on the homogeneity of borrowers, such as village banking, are not as prevalent in Latin America as in some other regions, although they are important in rural areas and successful models exist, such as Compartamos in Mexico and the Finca network regionwide. Of the 4 to 5 million microfinance customers in Latin America, only 10 percent are served by village banking, and about half of these are customers of Mexico’s Compartamos.9 As noted, Latin American microfinance is not exclusively focused on the poor, although most of the pioneer MFIs in the region began with this orientation. Its focus is more on enterprises with insufficient access to financial services and the unbanked in general, including both the poor and customers above the poverty line. Part of its strategy is to provide services to a broad base of clients. Nevertheless, there are some institutions that target the poor, including Compartamos in Mexico (see chapter 2). Associated with the broader range of clients in terms of poverty status is the more urban and less female character of Latin American microfinance. Three-quarters of the people in Latin America live in urban areas. Latin American microfinance has made greater headway in rural areas in the past few years, but it still remains heavily urban. In Asia, particularly in countries with a dense rural population such as Bangladesh and Indonesia, microfinance began as a rural phenomenon; that outlook continues to dominate, although this is also changing. There are important examples of women-targeted microfinance institutions in Latin America, including the regulated finance company Compartamos, a number of Women’s World Banking affiliates, and the network Pro-Mujer. Still, the percentage of women among microfinance customers is lower in Latin America than in other regions, including the 9
For further information on village banking in the region, see Westley (2004).
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Middle East and Northern Africa. Cross-regional comparisons show that women are only 38 percent of the borrowers of Latin American MFIs, while they are over 60 percent in Asia and Africa.10 This may be due in part to the larger size of Latin American institutions that do not target women primarily, relative to those that do. Latin America is relatively better-off than other regions, on average, and thus the average loan size in Latin America is higher. However, when taken as a ratio of per capita GDP, loan sizes in Latin America are similar to those in Asia.11 In Latin America, average loan size is often used as a proxy for client characteristics, and the focus of lenders is typically on sustainability versus poverty alleviation. Not surprisingly, little is known about the socioeconomic characteristics of microfinance customers in Latin America. While some individual microfinance institutions conduct market research to identify customer needs and develop new products, most such research is proprietary. Recent quantitative research shows that microfinance outreach to the poor and low-income groups varies greatly by country and type of financial institution.12 The nongovernmental organizations still concentrate their portfolios on the lowest end of the microenterprise spectrum, at least as measured by the relationship between their average outstanding loan and GDP per capita. All three types of microfinance institutions in the region—banks, finance companies and NGOs—hold the bulk of their loans in the $1 to $800 range (Marulanda and Otero 2005). But NGOs show a more even distribution of loans by size, with a greater than average proportion of loans in the $1 to $500 range (50 percent) and much lower than average proportion of loans in the over $1,600 range. Nevertheless, looking beyond percentages to the number of clients served, one can see that banks and specialized finance companies are responsible for a much greater share of microcredit than are NGOs. They are also responsible for larger numbers of credits of the smallest
10
MicroBanking Bulletin 2005 11(August), tables.
11
MicroBanking Bulletin 2005, 11(August), tables.
12
See summary of research in Marulanda and Otero (2005).
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size, indicating that they play an important role in the low end of the microfinance market today.13 Some observers have taken Latin American microfinance institutions to task for their relative lack of outreach to the poor.14 They argue that Latin American microfinance lags behind its counterparts in Asia and Africa in terms of bringing low-income populations into the banking sector. Part of the problem may be the choice of poverty line and changes from year to year, given that microfinance clients tend to be clustered around (both above and below) the poverty line. Recent studies carried out in Bolivia, Haiti, and Peru with ACCION clients from Bancosol, Sogesol, and MiBanco show that a large percentage of the borrowers of these institutions are below the national poverty line: 49 percent in the case of Bancosol, 37 percent in the case of Sogesol, and 27 percent in the case of MiBanco. Looking at the distribution of clients above and below the poverty line, it is also clear that these institutions also have a significant percentage of borrowers who are above the poverty line. Some 42 percent of Bancosol’s customers have household incomes greater than 120 percent of the national poverty line; this figure is 47 percent in the case of Sogesol and 38 percent in the case of MiBanco. The classification of borrowers above and below the poverty line is very sensitive to changes in the poverty line itself, indicating that they are concentrated near the poverty line.
Sustainability and Profitability The performance of Latin American MFIs has been hotly debated over the past few years (see Conger and Berger 2004). Latin America is home to many of the world’s most sustainable and profitable MFIs. Latin America ranks well in terms of the sustainability of its institutions,
13
Chapter 2 explores this issue of loan size distribution in greater detail, with an analysis of institutions that upgraded from NGOs to formal financial institutions, and illustrates some of the pitfalls of using average loan size as a proxy for depth of outreach by MFIs in the region.
14
See arguments by Christen and Miller in chapter 8.
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with 87 percent of MFI borrowers served by sustainable institutions. On average, the profitability of Latin American institutions tends to be higher when measured by return on equity, even adjusting for implicit subsidies, and lower when measured by return on assets. This indicates that on average Latin American institutions enjoy thinner margins, but make up for this by being more highly leveraged than their counterparts in other regions. For the most successful MFIs in the region, profitability is already on par with major international banks operating there, allowing them to attract more external financing and expand their outreach further. Some 21 of the top specialized MFIs worldwide—most of them located in Latin America—outperform the top 5 global banking institutions in the world, and 45 MFIs outperform the top 10, according to research by Julie Abrams (2005). Other studies and indicators of profitability tend to support this finding. The Boston Consulting Group’s annual report on the banking industry, for example, found that return on equity (ROE) after tax averaged 13 percent in the industry worldwide. During the same year, Latin American financial institutions reporting to the MicroBanking Bulletin averaged 15.6 percent ROE, while Asian institutions averaged 12.4 percent (Sinn and others 2004). Sustainability as well as profitability is improving in Latin American microfinance. Recent research by The Microfinance Information eXchange (the MIX) and the MicroBanking Bulletin found that MFIs take five to seven years to become sustainable, although a substantial proportion of those studied took longer. More recently founded MFIs tended to reach sustainability sooner than MFIs did in the past, with those founded between 1999 and 2003 becoming sustainable in as little as two years (Stephens 2005). This picture is relatively similar across regions. However, analysts such as Robert Peck Christen and Jared Miller also argue that profits of Latin American MFIs are being squeezed, calling into question the prospects these MFIs have for future growth and highlighting the need for improved efficiency. The many roads to sustainability and profitability can be grouped in three main categories: upgrading (the creation of a regulated financial
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institution by and from an NGO), downscaling (commercial banks and other financial institutions reaching down to micro clients), and de novo or greenfields (creation of brand new institutions, often with support from international networks). So far, the first road has been the most common way to reach commercial viability, although the other two are growing (see chapters 2 and 3). Still other institutions have reached sustainability comparable to the regulated providers of microfinance while retaining the legal structure of nonprofit NGOs. These nonprofit institutions receive less attention in this book, as their access to finance, growth, and, more importantly, the range of services they can provide their customers tend to be more limited.
Lessons from the Latin American Experience Many factors help explain the success of microfinance in Latin America. As box 1.1 shows, most of them are internal to the institutions that provide microfinance services. Thus one of the main lessons is that the internal capacity of microfinance institutions goes a long way toward assuring their success and the development of microfinance as a whole. (The exceptions are few, mainly consisting of institutions confronted with a multitude of unfavorable external conditions.) Well-managed microfinance institutions can overcome some—but not all—of the challenges of an unfavorable regulatory environment, poor economic conditions, and even unfair competition. Moreover, successful microfinance institutions deploy innovation, flexibility, and customer service to overcome the barriers in the low-income microenterprise sector that often limit the penetration of standard banking products. The specifics behind these very general lessons, shared in this book, are what really explain the success of Latin American microfinance.
“Upgrading”: Latin America’s Key Legacy To a large degree, the development of Latin American microfinance in the past two decades has been fueled by the process of “upgrading”: transforming microcredit NGOs operating under the radar of bank
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Box 1.1 Microfinance Success Factors Internal Factors • • •
• • • •
•
•
•
Mission that emphasizes outreach to target group and strong financial performance Knowledge of the market (both demand and competition) Products (both deposit and credit products) that are well-tailored to the needs of the target market Credit technology that is efficient and controls risk Strong management information systems and sound internal controls Strong, visionary leadership Motivated staff with specific microfinance expertise and personnel systems that reward performance Good corporate governance, characterized by transparency, accountability, and adherence to the mission, as well as clearly defined and appropriate roles for management and the board Ownership mix that includes private sector patient investors, not dependent on donors Funding from a variety of sources (including equity, deposits, and loans, not only donations).
External Factors • •
•
•
•
Size and concentration of the microenterprise and unbanked sectors Macroeconomic conditions (especially stable prices or predictable inflation levels, which enable microfinance institutions and their customers to withstand economic cycles more easily) Favorable regulatory environment (including overall sound prudential regulation/supervision, norms that permit microfinance to be profitable, and limited government involvement in retail lending) Reasonable levels of competition (which provide incentives for better service and lower cost, but are not predatory) Political connections (can be helpful, but not required).
Sources: Adapted from Otero and Rhyne (1994) and Berger, Beck Yonas, and Lloreda (2003).
supervisors into regulated financial institutions. Chapter 2 explores the different paths to upgrading, presenting the cases of Calpía (El Salvador), Banco ProCredit Los Andes (Bolivia), Chispa (Nicaragua), BancoSol (Bolivia), Finamerica (Colombia), Compartamos (Mexico), and MiBanco (Peru), along with insights from the leaders of the networks to which they belong. Although some notable upgraders are not covered, the focus on these cases permits an in-depth perspective on the
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upgrading phenomenon. The pioneering, innovative quality of many of these institutions is evident from the ways they faced various challenges on the road to upgrading. Why would nonprofit organizations want to get into microcredit in the first place, and then why would they go to all the trouble of obtaining banking licenses and complying with costly regulations and reporting requirements? The answer to the two questions is linked. It has to do with providing sorely needed financial services to increasing numbers of microenterprises and low-income people: the target constituency. Upgrading has also been a response to the quest for funding, along the way increasing efficiency, promoting sustainability, strengthening corporate governance structures, and offering a wider range of services to the people they were set up to help. The cases of upgraded MFIs presented in chapter 2 show not only the positive side, but also some of the pitfalls of creating for-profit regulated institutions out of microfinance NGOs. For example, early upgraders faced governance issues that their parent NGOs had not anticipated. Concerns about the costs of the upgrading model echo a continuing debate in many lines of business on whether to fix, buy, or start up:15 to expand or modernize existing capacity in an already owned or controlled institution, such as an NGO; buy capacity through acquisition of a financial institution or microfinance portfolio; or build a microfinance institution from scratch with a greenfield option. The cost of upgrading, by strengthening a nonprofit institution and then creating a new for-profit institution, is now considered to be much higher than working with existing commercial banks or even creating brand new institutions to expand the range and depth of microfinance. While cases of NGO upgrading are still underway in the region, the use of this early approach will probably decrease. Today, a second generation of upgrading has arisen in some countries. Led by the international firm IPC and its affiliated investment company, ProCredit Holding, MFIs that operated as finance companies 15 This is a twist on the typical business conundrum: fix, close, or sell? See, for example, Slater (2004).
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in Bolivia, Ecuador, El Salvador, and Nicaragua have upgraded to become universal banking institutions. The ACCION affiliate in Mexico, Compartamos, is also in the process of upgrading to universal banking status. This trend follows the original logic of upgrading, especially in terms of providing a broader range of services to microenterprises and low-income people. Their new status will allow these institutions to continue to expand services. Certain preconditions make for successful upgrading, or make it a lot easier. Among the most important are visionary leadership within the NGO seeking to upgrade and an unfailing focus on achieving sustainability and commercial viability. As the cases of microfinance institutions in Bolivia and Peru show, a good regulatory environment is also important to permitting microfinance institutions and microfinance products to be sustainable (see chapter 4). The proper credit technology, good IT systems, risk management systems, and sound corporate governance are also important. Another key factor is human capital, including banking, management, and business-financial skills. Observers from outside Latin America often assert that upgrading means moving up-market to increase profitability. Since it is more efficient to administer larger loans and their portfolios grow faster, there might be an incentive for “mission drift”: abandoning the original mission and clients. Although regulated MFIs are certainly seeking to generate more profits, the target market of MFIs varies considerably from that of traditional banking institutions. Upgrading is not necessarily upgrading the clientele; it is upgrading the institution to better serve the same type of clients—and in some cases, new ones. The first generation of upgraded MFIs now serves a wide spectrum of clients, ranging from those whose clients have not changed, like Compartamos in Mexico, to those that have incorporated small businesses in a significant way, like Banco Los Andes ProCredit in Bolivia. While it is true that their average loan sizes have risen, the range of products they offer and the different terms of their loans have also expanded. At the same time, the number of customers they reach with very small loans has stayed steady or even increased. Chapter 2 contains an extensive discussion of this issue.
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The impact of these institutions on the markets for financial services in the countries where they developed is huge, as they bring large numbers of unbanked customers into the formal financial sector and create impetus and models for existing financial institutions to follow. Of the 40 to 50 cases of upgrading that have taken place in the past 15 years around the world—especially in Latin America—nearly all are still in operation and several are leaders in the financial services industry. However, in places like Chile and Peru, banks are catching up or even passing the most well-known MFIs as lenders to microenterprises and the poor. Only in Colombia and Honduras does the nonprofit model continue to be the driving force in microfinance, followed by a few existing banking institutions, most notably Banco Caja Social and Bancolombia in Colombia. In part this is due to a highly unfavorable regulatory environment in Colombia, where interest rate ceilings limit the ability to charge cost-covering rates. In Honduras, very low levels of required capitalization and the ability of nonprofit institutions not regulated by the banking authorities to capture deposits has made it easier for NGO microfinance institutions to remain as such.
Downscaling: Commercial Banks and Microfinance Downscaling is the term of choice applied to the process of commercial banks and other existing financial institutions deepening the reach of their financial services—particularly credit—to smaller-scale businesses and lower-income individuals. With competition increasing in the financial services industry in Latin America, formal banking institutions have become much more interested in downscaling. In chapter 3, Beatriz Marulanda argues that formal financial institutions and banks enter the microfinance sector for three main reasons: market-niche profitability, product and market diversification, and fulfillment of a social function. The interest of the Latin American banking industry in microfinance is evidenced by the importance being given to the subject by the region’s bank federation, FELABAN (Business News Americas 2005). As Marulanda notes, returns from microcredit are a necessary but insufficient reason for downscaling. Banks entering
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this market tend to possess a social commitment from shareholders and directors to bring their operations closer to the poor. However, a study by Valenzuela (2002) also found that the banks’ motives are linked to shrinking financial spreads and the search for more profitable niche markets. Downscaling banks tend to target larger microenterprise clients initially, expanding deeper into the sector as they gain experience in the field. Banks have the access to the funding and infrastructure necessary to handle large volume and large markets, and they have extensive networks of branches to deal with deposit products. Some downscaling banks already provide savings products and services to microenterprises and the low-income population, facilitating their expansion into microcredit. The broad geographic range of their existing savings customers also allows them to use the savings history of clients to assess credit risk, a technique pioneered by the Colombian bank, Caja Social. Some bank involvement in microcredit grew out of consumer credit operations that made use of credit scoring models. Chile was the first Latin American country where large-scale consumer credit was introduced, following major structural reforms in the financial sector in the 1980s. Consumer credit provided Chilean banks with a platform for expanding into other countries of Latin America, including Argentina, Bolivia, Ecuador, Paraguay, and Peru (Marulanda 2000). Microcredit tends to occupy a market niche similar to that of consumer credit for lower-income people; both involve small-sized loans and high operating costs. However, they differ markedly in the source of loan repayment, and thus in the risks that characterize them. With microcredit, repayment is made from the cash flow of productive activities, typically in the informal sector, while consumer credit is normally repaid out of the wages and salaries of formal sector employees. As a number of financial institutions have found out, moving “down-market” and shifting to “downscaling”are not the same. The Bolivian experience is illustrative. Early attempts by consumer finance companies to sell their products down-market, without differentiating them, to microentrepreneurs (with no fixed salaries, and limited assets and documentation) led to over-indebtedness of these customers, and
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consequent setbacks for existing MFIs. Important lessons were learned by MFIs, which were able to downscale commercial loans and other products using microfinance technology to better serve the needs of microentrepreneurs. Major differences exist between downscaled and upgraded institutions in terms of their ownership, management, culture, and relationship to the microenterprise sector (although the differences are narrowing somewhat between the pioneering upgraders and the most prominent downscaling institutions). Microfinance is labor-intensive, with higher transactions costs and interest rates. Furthermore, microfinance best practices include very different salary structures, portfolio management, and loan collection mechanisms. As a result, commercial banks are developing new organizational models to reach the microenterprise market and overcome the problems inherent in introducing a new credit culture into an existing organizational structure. While only a few banks have so far been able to make the changes necessary to integrate microfinance into their operations, others have created new divisions, financial subsidiaries, or service companies that source, originate, or collect microloans and microsavings. Partnerships with NGOs have provided a learning laboratory in some cases, as they did for Banco Wiese (now Wiese Sudameris) and Banco de Credito, which worked with the NGO Accion Comunitaria and its offshoot, MiBanco, in Peru. In chapter 3, Marulanda sums up the most important factors determining the success of traditional banking institutions in downscaling: proper regulation and supervision, specialized and adapted microcredit technology; a lack of government involvement in retail microfinance operations; and the full long-term commitment and participation of the banks, their partners, and their shareholders. Without these requirements in place, downscaling in microfinance is necessarily limited.
New Sources of Financing Specialized investment funds have played a key role in the upgrading and startup of MFIs and in expanding the microcredit portfolios of
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smaller traditional financial institutions that want to offer microfinance products. More than 40 microfinance investment funds worldwide now provide much of the capital invested in the leading private microfinance institutions, both debt and equity. Over the last ten years, the investments of these funds have grown from almost nothing to more than $600 million (Goodman 2005). The first investment fund established with a financial return objective, Profund, was created to invest in Latin American microfinance institutions. Its ownership was heavily concentrated in international development agencies, including the Multilateral Investment Fund (MIF) of the Inter-American Development Bank. Profund has been successful in helping to create and expand Latin America’s leading microfinance institutions, while earning a favorable return for its investors. Although these funds are private, much of their capital still comes from international financial institutions such as MIF and the International Finance Corporation (IFC) and from national investment funds or banks in the European countries. However, private sector participation is steadily increasing.
An Enabling Environment Latin America’s sweeping financial sector reforms during the 1980s and 1990s created new opportunities for microfinance by increasing the scope of competition and removing some of the barriers to entry for new financial institutions. In most countries, microfinance was not explicitly a part of the reform programs, but these reforms created space for microfinance and incentives for financial institutions to look for new clients. As chapter 4 argues, it is difficult for a microfinance industry to grow without a sound regulatory environment and appropriate supervision practices that balance protection of depositors and the financial system with access to credit for the smallest businesses and those without formal sources of income. The development of microfinance has not been uniform across Latin America, as Ramón Rosales highlights in chapter 4, looking at the experiences of Bolivia, in particular, as well as other countries. The countries in the forefront of microfinance in
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the region are those in which the regulatory framework was adapted to facilitate microcredit operations, allowing MFIs to become regulated institutions without changing their client focus, and permitting already regulated financial institutions to offer credit to a new clientele. These legal structures acknowledge that microcredit operations merit a different, but not preferential, treatment consistent with the intrinsic characteristics of credit operations based on character, cash flow, informal documentation and incomplete information, but little or no hard collateral. The case of Women’s World Banking in Colombia shows that microfinance can be successful in a mediocre regulatory climate. However, such a regulatory environment can often prevent microcredit customers from benefiting from deposit services at the same institution, thereby limiting the ability of MFIs to use deposits to fund their lending operations. Sound regulation and supervision also benefits consumers of financial services. It is particularly important for depositors; indeed, protecting depositors’ interests is considered by many to be the main rationale for regulation of financial institutions. Most experts would agree that microfinance institutions that do not accept deposits should not be regulated and supervised by the banking authorities. When financial crisis hit Bolivia in the late 1990s, the top FFPs (a type of finance company mainly specializing in microfinance) found their deposit base increasing due to their good reputations. However, had they been unregulated or held to lesser standards by bank supervisors, this would not have been possible. An appropriate regulatory environment also gives borrowers access to permanent, stable, and growing sources of financing and provides them with information to make informed choices. From the standpoint of MFIs, regulation and supervision are extremely important, allowing them to establish their own financing base by borrowing from depositors and commercial investors. In return, regulated MFIs must accept permanent public supervision and comply with prudential standards, accounting rules, information disclosure, and other banking norms. Subjecting MFIs to the same rules and measurements as other financial institutions offering a similar range of services (such as net worth, credit limits, loan loss provisions, and accounting)
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enables them to compete fairly. Finally, the possibility of insuring MFI deposits boosts the confidence of their depositors. The focus of regulators and supervisors should be that of the public at large, although pressures from different constituencies may at times interfere. Regulators and supervisors are interested in reducing the cost of financial services, while ensuring the solvency of financial intermediaries. Their job is to establish and enforce the rules that promote secure operations and the good performance of all segments of the banking sector. In that capacity, promoting particular credit instruments or models would not be appropriate. An important element in the context of an evolving regulatory approach that emphasizes the development of microfinance services by all financial institutions—as opposed to trying to build the retail capacity of specific institutional form, the specialized MFI—is the development of industry infrastructure, including central credit registries and credit bureaus. Access to information about potential borrowers through a credit bureau or registry helps financial institutions better select their clients and manage the risks of lending to microenterprises. It also strengthens the links between microfinance and traditional finance, as credit bureaus and central registries track transactions by both types of institutions. Bank regulators throughout Latin America and the rest of the world are under pressure to act to integrate microfinance into the regulatory framework for the financial sector. In some countries, this trend is the result of many years of work by nonprofit institutions that—with the support of donors and international agencies—have developed lending technologies for microenterprises and have subsequently had a hand in establishing MFIs. It may also come from traditional financial intermediaries that want to enter a new market niche as they face increasingly stiffer competition. Microentrepreneurs themselves are also gradually pressuring governments to cap interest rates, as has happened in Colombia, Ecuador, Honduras, and Nicaragua. Unfortunately, as Ramón Rosales points out, the pressure for regulatory reform often appears in the political arena, sometimes leading to political solutions, which may not always be positive for microfinance.
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Weathering Crises Until the financial crises of the mid- to late 1990s, many argued that Latin American microfinance had not been put to the test. That claim can hardly be made today. Not only have the region’s MFIs been put to the test, but in many cases they have proved to be even stronger than their more traditional counterparts in the region’s financial services industry. The financial crises of the 1990s systematically affected all financial intermediaries in Latin America, including microfinance institutions. But as Armando Muriel, Victoria Muriel, Giulissa Franco, and Elsa Martín note in chapter 5, microfinance institutions rode out these crises and many emerged in even stronger positions. Furthermore, since their loan portfolios were much less cyclical than those of traditional commercial banks, their presence reduced volatility in the financial system as a whole. The case studies of Bolivia and Ecuador presented in the chapter show how these institutions successfully met management challenges during a systemic crisis. Close customer contact, personal rapport with the entrepreneurs, mutual trust, a culture fostering prompt and full repayment, proper prior selection, and appropriate financial technologies used by the microfinance institutions put them in an advantageous position vis-à-vis traditional financial institutions. Nevertheless, the results were not uniform. Different microfinance institutions handled crisis situations in different ways, with varying degrees of success. And these differences provide key lessons for MFIs in other countries and regions.
Technological Advances Technology has helped make atomized financial services dealing with very small amounts of money practically and financially feasible. Technology helps improve the efficiency of microfinance institutions, but it is not a guarantee. As one part of a package of managerial and financial changes, and when combined with client focus, information and communications technologies can contribute to sustainable microfinance.
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In chapter 6, Sergio Castello and Carlos Danel examine how technology is providing microfinance institutions in Latin America with new ways to expand outreach and provide improved services to microentrepreneurs in both urban and rural areas. Information and communications technology has been playing a growing role in the financial services in general over the past several decades. It took MFIs a while to feel comfortable making major investments in new technology. At times technological change in microfinance has followed advances in other parts of the financial services industry, but there are times when microfinance has jumped ahead. The use of new electronic gadgets such as Palm Pilots for microfinance applications in the field has attracted a lot of attention, but other changes, particularly automation of back-office functions, have yielded a greater return in terms of efficiency and improvements in the bottom line. Risk assessment for micro and small business credit differs markedly from the analysis typically performed by commercial banks in Latin America, which is based on value of business assets and personal wealth. Character assessment is still central to the microcredit product, and it can be aided by looking at information on past behavior of borrowers to ascertain their ability and willingness to pay. Microfinance institutions in Latin America have found that their large base of clients and transaction histories for these clients provide an attractive database to develop models to predict repayment performance. Technological changes in mainstream banking have dramatically changed the original relationship-based nature of the business and new processes have made small business loans relatively less attractive to traditional banks. Microfinance can be considered a form of relationship-based lending applied to small business because it relies heavily on a close relationship with the business owner. New technology is actually helping institutions increase microfinance outreach and efficiency while enhancing the loan officer–customer relationship. Technologies such as the personal digital assistant (PDAs) enable MFIs to efficiently access and process real-time information, so that client needs can be met immediately during loan officer visits. Chapter 6 illustrates how MFIs have combined innovative technologies such as PDAs, automatic
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teller machines (ATMs), smart cards, interactive voice technologies, credit scoring, and biometrics into effective packages, drawing from the experiences of leading MFIs throughout the region.16 However, there are no shortcuts, as Castello and Danel warn. Without organizational innovations to complement the new technologies in boosting productivity, technology investments are unlikely to show positive returns. Many microfinance institutions are still struggling to master the basic information management processes used by formal financial institutions, in some cases to acquire a new status as regulated entities. Nevertheless, for those that are ahead of the curve or that dare to experiment with alternative organizational configurations, new technologies represent huge opportunities to access new delivery channels that will enable them to expand outreach, reduce transaction costs, and introduce new products.
Microfinance and Business Development Services Despite the fact that the Latin model has evolved as a microfinance-only model, not bundled with business development services (BDS), there is a clear sense that microfinance is not a panacea. Policy and regulatory reform has been on the agenda from the beginning in the region, and lots of interesting experiments are going on with complementary but institutionally separate business development services. As Lara Goldmark points out in chapter 7, many microcredit institutions operated a credit-plus model in the 1970s, not the “minimalist” model (financial services only) that is most prevalent today. Even in contrasting these two approaches, one must distinguish among the different types of “plus” services traditionally offered along with microcredit: from basic educational initiatives in health and literacy (directed at entrepreneurs and their families), to financial education and business planning (linked to management of the loan), to management or skills
16
These MFIs include Prodem in Bolivia, Finamerica in Colombia, ADOPEM and ADEMI in the Dominican Republic, Banco Solidario in Ecuador, Compartamos and FinComun in Mexico, Financiera Vision in Paraguay, MiBanco in Peru, and Bangente in Venezuela.
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training (related to the business activity). Traditionally, institutions offered these additional services for reasons related to their social mission; some also claimed that training contributed to better repayment rates. The credit-only model is by no means hegemonic. While there has been a shift away from providing nonfinancial services, the change is not as dramatic as the rhetoric implies. The field of small enterprise development has evolved since its birth in the 1950s through the “market development” and “value chain” approaches of the new millennium. The twin fields of microfinance and enterprise development have informed and influenced each other along the way. One thing is clear: for Latin American microfinance, the days of affirming that microcredit linked to business development services improves portfolio performance and impact are gone. On the other hand, a wave of promising sectoral projects is exploring ways to increase the availability of finance through supply chain mechanisms. In sophisticated markets, there may be commercial incentives to offer value-added business services in areas other than nonfinancial areas.
Unanswered Questions The experience of microfinance in Latin America has much to teach to other regions, but this does not mean that microfinance in Latin America has reached a pinnacle of perfection. In chapter 8, Robert Peck Christen and Jared Miller are not so sanguine about Latin American microfinance as other observers in this book. While acknowledging its achievements, they argue that there is still a long way to go to fulfill the promise of microfinance in the region. They focus more on some of the problematic aspects of Latin American microfinance that must be addressed if the industry is to continue to develop and to fulfill the mission of most microfinance institutions. The main challenges are: continuing to improve performance, especially efficiency in credit service provision; reaching unserved populations, especially in large countries; and facing competition. Christen and Miller argue that Latin American microfinance is more narrowly concentrated on enterprise credit, as opposed to other parts
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THE LATIN AMERICAN MODEL
MARGUERITE BERGER
of the world where it tends to be broader, including savings, insurance, and other financial services, along with microcredit not only for microenterprises but also explicitly for consumers, whether in the informal sector or not. Although some experts disagree, these authors find that profit margins are not as robust as in the past because competition has intensified in key markets. Nevertheless, all can agree that Latin American MFIs will have to achieve ever-greater efficiencies to compete. Microfinance is developing in large countries in different ways than in Bolivia and El Salvador, two of the countries receiving a lot of attention in this book. Except for Mexico, the big countries are not following the path blazed by upgraded MFIs; few nonprofits there are interested in becoming regulated institutions, and even greenfield microfinance is limited. In Brazil, for example, nonprofits are weak, State banks are strong, and a number of recent downscaling efforts were based on consumer credit technologies rather than the proven principles of microenterprise lending. However, the extensive network of points of service for bill payment and disbursement of social assistance used by low-income people in Brazil offers an important base for the establishment of banking relationships that are not present in many other countries. As in Chile, State-owned banks in Brazil are likely to play a larger role in microfinance. Another challenge is the need to continue attracting funding sources for microfinance from the private sector, including equity. Despite the expansion of deposits and other private financing to MFIs in Latin America, commercial microfinance has not fully graduated from donor dependence. Many of the leading institutions still receive subsidized financing from development agencies or count these agencies among their ultimate owners, through special investment funds. Prospects are good for the continued migration toward private sources, including retained earnings and deposits as well as innovative financing mechanisms such as bond issues and securitization. In addition, the numbers of borrowers and amounts of money already involved in the sector show that the size of this phenomenon has gone way beyond what donors and subsidized multilateral lenders could support, as the cases presented in this book demonstrate.
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Although less common than in the past, some NGOs are still seeking to become regulated microfinance institutions. More banks are entering the microfinance market. The framework for regulation of microcredit as a financial service swings from control of interest rates to liberalization and back again (Silva 2005). The question of how poor people with limited resources can afford to repay high interest loans is constantly asked anew. Adopting and adapting new technology in this field continues to hold promise and present challenges. Institutions and policymakers continue to grapple with how best to provide sustainable financial and nonfinancial services to microenterprises, whether bundled or unbundled. Those who do not constantly review the lessons of the leading microfinance institutions may be doomed to repeat their errors. The insights of this volume are offered in the hope that they will help shorten the path that institutions, policymakers, and investors, and the public that supports them, take in developing sustainable financial services for microenterprises and others that have long been excluded from formal markets. In chapter 9, Tomás Miller-Sanabria, an investment officer at the Multilateral Investment Fund, looks ahead to the challenges facing Latin American microfinance and some of the still-emerging trends in this emerging market. Among the forces that will shape the development of Latin American microfinance are increased competition; further technological advances; economies of scale and greater efficiency; the demands on human capital, management, and corporate governance structures; product innovation and the globalization of services; and the changing investment climate. Latin American microfinance has made incredible strides in the past twenty years, especially in the last ten. But this book is not about microfinance history in the region, (although it does contain some history); it is about the achievements and challenges of today and tomorrow. This book tries to strike a balance between an accurate and penetrating analysis of the microfinance phenomenon in the region and the exploration of its future. Both aspects can be useful to readers in other regions, as well as in Latin America itself.
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References Abrams, Julie. 2005. Microfinance Profitability Index. MicroBanking Bulletin 11 (August): 19–21. Barrès, Isabelle. 2005. Supply of Funding. MicroBanking Bulletin 11 (August): 47–58. Berger, Marguerite. 2000. Microfinance: An Emerging Market within the Emerging Markets. In Emerging Financial Markets in the Global Economy, eds. Larry Sawyers, Daniel M. Schydlowsky, and David Nickerson. River Edge, New Jersey: World Scientific. Berger, Marguerite, Allison Beck Yonas, and María Lucía Lloreda. 2003. The Second Story: Wholesale Microfinance in Latin America. Washington, D.C.: Inter-American Development Bank, Micro, Small and Medium Enterprise Division. Business News Americas. 2005. Banking in Latin America: Poised for Growth. FELABAN’s 40th Anniversary Commemorative Report. Santiago, Chile. Christen, Robert. 2001. Commercialization and Mission Drift: The Transformation of Microfinance in Latin America. CGAP Occasional Paper No. 5. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. Christen, Robert, and Richard Rosenberg. 2000. The Rush to Regulate: Legal Frameworks for Microfinance. CGAP Occasional Paper No. 4. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. Conger, Lucy, and Marguerite Berger. 2004. Latin American Microfinance: The Debate Heats Up. MicroEnterprise Americas Edition 2004: 22–29. Goodman, Patrick. 2005. Microfinance Investment Funds: Key Features. Luxembourg: Appui au Développement Autonome (ADA). Heinen, Erik. 2005. The MFI as a Borrower: Institutional Characteristics and MFI Performance. MicroBanking Bulletin 11 (August): 33–41.
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Inter-American Development Bank (IDB). 2004. Unlocking Credit: The Quest for Deep and Stable Bank Lending. Economic and Social Progress in Latin America. 2005 Report. Washington, D.C. International Labour Organization (ILO). 1972. Employment, Incomes and Equality: A Strategy for Increasing Productive Employment in Kenya. Geneva. Jansson, Tor. 2003. Financing Microfinance. Washington, D.C.: InterAmerican Development Bank, Micro, Small and Medium Enterprise Division. Lee, Patricia. 2002. Corposol and Finansol: Institutional Crisis and Survival. In The Commercialization of Microfinance: Balancing Business and Development, eds. Deborah Drake and Elizabeth Rhyne. West Hartford, Conn.: Kumarian Press. Marulanda, Beatriz. 2000. Here Come the Commercial Banks. In Glenn D. Westley and Brian Branch, eds. Safe Money: Building Effective Credit Unions in Latin America. Washington, D.C.: Inter-American Development Bank. Marulanda, Beatriz, and María Otero. 2005. Perfil de las microfinanzas en Latinoamérica en 10 años: Visión y características. Boston, Mass.: ACCION International. Miles, Ann. 2005. Financial Intermediation and Integration of Regulated MFIs. MicroBanking Bulletin 11 (August): 9–12. Miller, Jared, and Renso Martínez. 2005. Banking: Championship League. MicroEnterprise Americas Edition 2005: 5–11. Otero, María, and Elisabeth Rhyne. 1994. The New World of Microenterprise Finance: Building Healthy Financial Institutions for the Poor. West Hartford, Conn.: Kumarian Press. Portocarrero Maisch, Felipe, Álvaro Tarazona Soria, and Glenn D. Westley. 2005. ¿Cómo deberían financiarse las instituciones de microfinanzas? Washington, D.C.: Inter-American Development Bank, Micro, Small and Medium Enterprise Division. Schumacher, E. F. 1973. Small is Beautiful: A Study of Economics As If People Mattered. Blond and Briggs: London. Silva, Samuel. 2005. Back from the Shadows. MicroEnterprise Americas Edition 2005: 32–35.
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Sinn, Walter, Ranu Dayal, David Pitman, Gerold Grasshoff, and Thomas Herbeck. 2004. Winners in the Age of Titans: Creating Value in Banking 2004. Frankfurt, Germany: Boston Consulting Group. Slater, Robert. 2004. Jack Welch on Leadership. New York: McGraw Hill. Stephens, Blaine. 2005. Sustainability in Sight: An Analysis of MFIs that Become Sustainable. MicroBanking Bulletin 10 (March): 23–29. Valenzuela, Liza. 2002. Getting the Recipe Right: The Experience and Challenges of Commercial Bank Downscalers. In The Commercialization of Microfinance: Balancing Business and Development, eds. Deborah Drake and Elizabeth Rhyne. West Hartford, Conn.: Kumarian Press. Von Pischke, J. D. 1991. Finance at the Frontier: Debt Capacity and the Role of Credit in the Private Economy. Washington, D.C.: The World Bank. Weatherford, J. Mclver. 1997. The History of Money: From Sandstone to Cyberspace. New York: Three River Press. Westley, Glenn D. 2001. Can Financial Market Policies Reduce Income Inequality? Washington, D.C.: Inter-American Development Bank, Micro, Small and Medium Enterprise Division. ————. 2004. A Tale of Four Village Banking Programs: Best Practices in Latin America. Washington, D.C.: Inter-American Development Bank, Micro, Small and Medium Enterprise Division. Westley, Glenn D., and Brian Branch, eds. 2000. Safe Money: Building Effective Credit Unions in Latin America. Washington, D.C.: Inter-American Development Bank.
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Pioneers in the Commercialization of Microfinance: The Significance and Future of Upgraded Microfinance Institutions Marguerite Berger, Maria Otero, and Gabriel Schor
U
pgrading has been a challenging but ultimately successful process of institution building—and as such, a powerful case study in effective development. Upgrading—the transformation of nongovernmental microfinance organizations into formal financial institutions that are supervised by banking authorities—has allowed them to provide financial services to microentrepreneurs, small and medium enterprises (SMEs), and low-income households. A key remaining challenge for these institutions will be to manage diversification and competition without distorting their basic microcredit product. Fifteen years ago the process of upgrading was front page news, as these institutions led the development of sustainable microfinance and helped to strengthen the financial sectors of their countries significantly. Upgrading is not the main way that microfinance is expanding in Latin America today, but the lessons learned from the history of upgrading provide valuable insights for the development of financial sectors that can better serve microentrepreneurs, small businesses, and low-income families. Upgraded microfinance institutions (MFIs) continue to play a key role in microfinance and in the financial sectors of their countries, despite the increasing importance of “downscaling,” or outreach by existing formal financial institutions to smaller-scale clients and the creation of new specialized institutions from scratch (greenfields). Up-
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CHAPTER 2
MARGUERITE BERGER, MARIA OTERO,
AND
GABRIEL SCHOR
graded MFIs reach more clients than commercial banks or greenfield institutions (Marulanda and Otero 2005). In the smaller countries of Latin America, upgraded MFIs continue to account for the largest share of microfinance, notably in Bolivia and El Salvador. In Bolivia, led by Banco Los Andes ProCredit, BancoSol, and two other fondos financieros privados (private finance funds, or FFPs), microfinance has added over 450,000 clients to a banking system that had only 142,000 clients in 1997; the share of microcredit in total banking assets has grown from 5 percent in 1999 to 11 percent today. More importantly, the current average size of loans from MFIs is only $1,000, while the traditional banking system currently concentrates 55 percent of its portfolio in 4,144 loans larger than $200,000.1 The original motivation for institutions to “upgrade” was the quest for commercial sustainability, combined with scale outreach. Nongovernmental organizations had limited access to finance for on-lending; becoming regulated institutions meant they could gather deposits and access commercial sources of refinancing. The challenge for the upgrading institutions was to manage a more complex business model with the diversification of products and clients that came as a result, without neglecting their original low-income clients. At the same time, they needed to maintain high loan portfolio quality and highly efficient operations to keep financial performance strong. This chapter explores the extent to which the institutions have been successful in meeting these challenges. This chapter also identifies key factors that help make upgrading successful and considers the implications of these factors for the development of microfinance and the financial sector more broadly. It reflects on ownership structures and the role that investors and consultants have played in ensuring the success of the upgrading process. In concluding, the chapter looks ahead to the challenges that both upgraded institutions and those wishing to upgrade will face in the future.
1
Data are derived from the monthly bulletin on the banking system, December 31, 2005, published by the Bolivian Office of Banking and Financial Institution Supervision (Boletín Informativo Mensual Sistema Bancario, Superintendencia de Bancos y Entitades Financieras).
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The Beginning of the Upgrading Process In the world of microfinance, the term upgrading refers to the process whereby an informal or semi-formal microfinance institution creates or is transformed into a formal financial institution, to be regulated and supervised by the banking authorities of its country and made part of the formal financial system. The term refers to the upgrading of the institution, not its market niche. In most cases, an existing microfinance NGO creates a new financial institution that is subject to banking regulation and supervision, and then becomes a major owner of the new entity. Two global microfinance organizations, ACCION International and International Projekt Consult (IPC), were early champions of the commercialization of microfinance, working at first to help nonprofit organizations upgrade into regulated financial institutions. These organizations were able to benefit from and implement the learning from their worldwide operations, and ultimately were able to raise the resources necessary to become owners of the formal financial institutions they helped create (figure 2.1). Although there are other well-known upgraded MFIs in Latin America affiliated with Women’s World Banking and FINCA, or independents such as FIE in Bolivia, this chapter focuses on the experience of the MFIs associated with these two pioneering organizations to provide in-depth comparable views of MFI upgrading. The first commercial bank specializing in microfinance, BancoSol, was created in 1992 in Bolivia by the NGO Prodem, which was formed in 1987 from a partnership between ACCION International and local business people. Financiera Calpiá, created by the Salvadoran NGO AMPES in 1996 with the support of IPC, was the pioneer in Central America.2 After BancoSol, other MFIs were upgraded in Bolivia, most notably Caja Los Andes in 1995, FIE in1996, and Prodem FFP in 1998. These became FFPs, or fondos financieros privados (private financial funds), a specialized regulated entity created for microfinance under the Bolivian regulatory framework. Caja Los Andes was upgraded once
2 Financiera Calpiá was upgraded again in June 2004, becoming a full-fledged commercial bank: Banco ProCredit.
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GABRIEL SCHOR
Figure 2.1 Overview of the Upgrading Process NGO
Regulated finance company without deposits
Regulated finance company with deposits
Full-fledged commercial bank
Upgrading process supported by ACCION Bolivia
Prodem
Colombia
Actuar/Bogota (Corposol)
Mexico
Compartamos
Peru
Accion Comunitaria
BancoSol (1992) Finansol/Finamerica (1994) SOFOL Compartamos (1999)
To be completed in 2006 MiBanco (1998)
Upgrading process supported by IPC Bolivia
Caja Los Andes (1995)
Banco Los Andes ProCredit (2004)
El Salvador AMPES
Calpía (1996)
Banco ProCredit (2004)
Nicaragua
Confia/ProCredit (2000)
Banco ProCredit (2005)
ProCredito/Caja Los Andes
Chispa
Source: Compiled by authors from company data.
again to become the commercial bank Banco Los Andes ProCredit in 2004. Finally, Compartamos in Mexico will become a full commercial bank in 2006. Based on their experience in Bolivia and other countries, ACCION and IPC focused strongly on upgrading NGOs to regulated finance companies and banks: ACCION in Bolivia, Colombia, Mexico, and Peru; and IPC in El Salvador and Nicaragua.
Why Upgrading Happened There were many reasons why upgrading began in Latin America and was, on balance, ultimately successful. As development finance thinking moved from an orientation from government to the private sector, nonprofit organizations that had developed microcredit products were increasingly looking toward commercializing their operations to obtain more funding and ensure sustainability. Changes in the regulatory
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environment opened up new opportunities in the financial services industry, and the spread of international and regional expertise helped these organizations bring themselves or their subsidiaries under the regulatory umbrella.
The Evolution of Development Finance Thinking Twenty years ago the prevailing wisdom held that microfinance could not be provided on a commercial and sustainable basis. Against the background of manifold but mostly rather frustrating public interventions, and a general trend toward allowing private sector approaches to play a much more prominent role in development, NGOs mushroomed all over Latin America. NGOs became the preferred model, particularly for the international donor community, for the delivery of microfinance, since many were offering credit services in some form. Although most credit-granting NGOs originally saw credit primarily as an adjunct to educational and training services for the poor, which were at the core of their activities, some focused on credit and geared their lending operations to sustainability. The so-called “minimalist” approach, championed by organizations such as ACCION International and IPC, went further than merely advocating that NGOs focus on credit. The intention was to demonstrate that microcredit could be granted under cost-covering conditions, allowing financial institutions to operate on a sustainable basis and ultimately to form part of the regular financial system. The early stages of upgrading were also a time of transition for the international development agencies, which made funds available for microfinance projects but were not ready to move to a fully commercial model, preferring to support MFIs owned by nonprofits. Without banking models, commercial bank owners were wary of microfinance, and its champions did not yet have the resources to create their own commercially oriented microfinance institutions. It was necessary to first demonstrate the financial viability of microfinance before appropriate stakeholders could be persuaded to invest in larger, formal financial institutions. However, in the NGO owners with whom they worked,
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GABRIEL SCHOR
IPC and ACCION found partners who shared a deep commitment to the microenterprise target group as well as to creating a sustainable model of microfinance. An important realization was that rapid access to finance was more important to microentrepreneurs than low interest rates. This made possible a paradigm shift from subsidized interest rates to costcovering rates. These rates, coupled with innovative credit technologies, guaranteed that microfinance would become a viable business model. It was shown that credit risk could be controlled and that the relatively high administrative costs of microfinance institutions (in comparison to those of commercial banks making consumer or corporate loans) could be covered by market interest rates.
The Quest for Funding In the beginning, the primary reason MFIs chose to upgrade their institutional and regulatory status was their need to access funds to grow. Funding is still one of the primary bottlenecks in microfinance that limits an institution’s capacity to increase its outreach and reach significant scale. In the face of this constraint, in the late 1980s, the more developed microfinance NGOs realized that both donor funds and the capacity of local banks to extend them loans—generally no larger than the NGO’s equity base—were completely inadequate sources of long-term funding. When these incipient MFIs became formal regulated institutions they could leverage their capital up to 12 times, as permitted under the Basle Convention adhered to by most monetary authorities of the region. In addition, by becoming financial institutions they could access capital markets and create a funding structure that would include capturing customer deposits, interbank loans, borrowing from international sources, and more sophisticated means such as issuing paper in local markets or even securitizing their portfolios. It was principally accessing customer deposits and the capital markets that persuaded MFIs to upgrade. Depending on the country and regulatory framework, they used a variety of institutional structures to do so, from commercial banks to finance companies to special purpose financial institutions.
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There were additional reasons for their approach. Achieving national scale in client outreach brought greater social impact and raised the institutions’ visibility and credibility, both locally and internationally. Launching new credit and savings products for a population excluded by formal banking institutions signaled a new type of banking that could potentially change the financial system in each country, especially in the smaller ones with less developed banking systems. Building a customer deposit base meant independence from often erratic donor partners and meant that institutions could even more firmly root themselves in their target group community.
Regulatory Reform in the Finance Sector Changes in the regulatory environment for financial institutions that came about in Latin America in the 1990s also created opportunities and pressures for upgrading, as regulatory authorities sought greater control over nonbank financial institutions and adapted minimum capital requirements, collateral requirements, and supervisory norms in ways that allowed regulated financial institutions to lend to microenterprises legally and profitably (see chapter 4). Thus the upgrading process both benefited from and strongly influenced the modernization of laws, regulations, and supervision practices in Latin America. The fact that well-run MFIs had loan portfolios characterized by large numbers of very small loans of very good quality despite the lack of formal guarantees and paperwork led governments to develop new means of regulation and supervision. In Bolivia, the government even created a special department inside the Superintendency of Banks to monitor microfinance institutions and portfolios.
Technical Assistance Outside expertise from institutions like IPC and ACCION with broad experience in a range of microfinance institutions provided the connections and know-how that many of the original microfinance
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GABRIEL SCHOR
NGOs needed to upgrade their systems, management, products, and staffing, and to define reporting protocols and success benchmarks. The vision of key people within IPC and ACCION had always been to see widespread commercial microfinance and they have been driving forces behind the transformation of microfinance over the 1990s. Both companies provided knowledge, management expertise, and then access to financing: at first mainly by channeling or identifying donor resources, but later by forming their own investment companies. Investors like ProCredit Holding3 (partly owned by IPC and its staff), ACCION’s Gateway Fund, and more recently ACCION’s Investments in Microfinance SPC, bring financing and international owners and board members. Their global expertise contributes to keeping an MFI’s board and management well informed and up-to-date on the latest developments in the field and measuring the institution against international standards. Upgrading did not come easily or cheaply. It has been a tremendous institution building challenge. The regulatory and supervisory requirements of upgrading meant additional costs in systems and staff. MFIs also had to raise significant amounts of capital and make timeconsuming and costly internal adjustments, including hiring and training staff. The process was long, cumbersome, expensive, and subject to many uncontrollable delays. During the years (as many as three) that upgrading required, some MFIs became discouraged and questioned the wisdom of their decision. However, once the newly minted banking licenses were in their hands, it heralded a new life for the microfinance institutions, and none of them looked back.
Upgraded Microfinance Institutions Today Today, a sizable group of MFIs has been operating as formal financial institutions for five or more years in different country environments (table 2.1). The experience of these institutions provides enough data
3
In January 2005, IMI-International Micro Investitionen AG became ProCredit Holding Group AG.
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Name
57.8
6.6
13.9
Commercial bank Commercial bank 5
12
16
16
64
15 10
55
66
79
129
402
82 27
Sept. 30, 2005
21.0
66.3
94.6
139.4
—
98.3 26.6
12.4
17.4
17.1
37.1
59.4
18.6 7.0
Sept. 30, 2005
A+
AA
A+
A–
AA
A+ A+
Most recent
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23,852
72,891
65,804
46,452
—
77,032 2,230
Volume Number ($ millions) of accounts
Local rating by international agency
MICROFINANCE
Sources: ACCION and ProCredit Holding. Data for Bolivian institutions from Asofin, September 30, 2005, Superintendency of Banks. Note: Dashes indicate unavailability of data.
98.7
6.0
Commercial bank
138.0
180.5
144.4
121.7 35.8
At transformation
Net worth ($ millions)
OF
Banco Los Andes ProCredit El Salvador Banco ProCredit Nicaragua Banco ProCredit
10.0
8.8
15.0 11.0
Sept. 30, 2005
Deposit base (Sept. 30, 2005)
COMMERCIALIZATION
Bolivia
IPC-supported institutions
Peru
Commercial bank Finansol/ Finance Finamerica company SOFOL Finance Compartamos company MiBanco Commercial bank
BancoSol
At transformation
Number of loan clients (thousands)
IN THE
Mexico
Colombia
Bolivia
Sept. 30, 2005
Legal form
ACCIONsupported institutions
Country
Outstanding portfolio ($ millions)
Table 2.1. Overview of Upgraded MFIs
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to draw conclusions about their performance over time. Among the IPC institutions, three fit into the category: Banco Los Andes ProCredit (formerly Caja Los Andes) in Bolivia; Banco ProCredit (formerly Financiera Calpiá) in El Salvador; and ProCredit (formerly Confia) in Nicaragua. For ACCION International, four institutions fit into the category: BancoSol in Bolivia; Finamerica in Colombia; Compartamos in Mexico; and MiBanco in Peru. This cluster of seven institutions, considered among the first generation of MFIs to transform, illustrates interesting similarities as well as several pointed differences in the evolution of upgraded MFIs. When microfinance institutions become part of the financial system, with strong management and clear owners, they can access capital markets to fund their lending portfolios, allowing them to rapidly increase the number of clients they reach. Most have also been able to mobilize savings, providing another important financial service to the poor, as well as another important source of funds. By inserting themselves into the financial systems of their countries, microfinance institutions have deepened the reach of financial systems to populations previously excluded from banks and other financial institutions. Despite their significant achievement in outreach, their small average loan size means that MFIs still constitute a relatively small percentage of the assets of most banking system in their countries. (Bolivia and Peru are exceptions. In the case of Bolivia, 11 percent of the assets in financial markets are in microfinance. See chapter 4.) Today the pioneering MFIs that created formal financial institutions in the 1990s are sophisticated financial institutions (table 2.2). These institutions have gone from specialized, single-product entities to financial institutions that offer a wider range of loan products, deposit products, and a significant number of services. The upgrading of credit-granting NGOs led to very strong quantitative and qualitative growth, which has allowed these institutions to position themselves as financial service providers not just for microentrepreneurs but also for low-income households and for SMEs. For nearly all upgraded MFIs, the market concept has evolved from poor microentrepreneurs needing working capital to low-income households that need a variety of
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1999 1994 2001 1998 1995
1995
2000
1992 1994 1993 1998 No
No
No
2004
1999
2000 1998 No 1998 1999
2002
2001
2001 2003 No 1999 2002
Individual small Housing loans loans
2000
1995
1993 2006 No 1998 1995
Savings accounts
2000
1995
1992 1994 No 1998 1995
2005
2005
No No No 2001 No
Certificate Demand of deposits deposit (checking)
No
No
2005 2006 No 1998 No
2004
2004
1997 1994 No 1998 2003
Bill Insurance payment
2004
2003
2003 No No 2000 2004
2005
2003
2001 No No 2000 2004
International Domestic money money transfer transfer
COMMERCIALIZATION OF
MICROFINANCE
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2004
2004
2001 No No 2000 2004
Consumer loans
IN THE
Source: Authors’ compilations, based on company data and interviews. Note: No = not offered.
BancoSol Finamerica Compartamos MiBanco Banco Los Andes ProCredit, Bolivia Banco ProCredit, El Salvador Banco ProCredit, Nicaragua
Institution
Group Individual loans microloans
Table 2.2. Financial Products Offered by Upgraded MFIs, by Year of First Offering
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MARGUERITE BERGER, MARIA OTERO,
AND
GABRIEL SCHOR
financial products and still do not have access to them. Broadly speaking, the working poor, including salaried low-income workers, have become part of the market for these institutions. Furthermore, the loan products that these institutions offer have broadened to include not only very short-term microloans for working capital, but also larger, longer-term loans for small businesses. They are no longer restricted to loan products. Supervision by the national banking authorities allows them in most cases to offer savings products too, which substantially increases the impact they can have on development.
The Institution-Building Process Over time, upgrading institutions have faced increasingly complex institutional challenges: developing a savings base, expanding the products and services they offer, and diversifying their client base.
Developing a Savings Base: A Breakthrough for Financial Intermediation and Independence The most significant development for most upgraded MFIs has been the development of a savings base. This has shown that it is possible to issue loans to small-scale borrowers, and to fund those loans with local resources obtained through financial intermediation rather than relying on the continued provision of grants, on-lending funds by international donor organizations, or expensive loans from local and international commercial banks. The volume of funding available from local savings is ultimately far greater than can be provided by commercial providers. The sustainability of large-scale banks oriented to particular target groups can be ensured over the long term only if local savings are mobilized to finance the growth in their loan portfolio. Mobilizing local currency savings and deposits is also the ultimate hedging mechanism to protect against foreign exchange risk. All the MFIs studied here—with the exception of Compartamos, which by law cannot capture deposits—have developed savings products, both as additional financial products for existing customers and as a way
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to capture deposits from higher-income individuals and institutions. Savings passbooks, with a variety of features that enable easy access and a low or no minimum balance have been among the most popular savings products among low-income customers. Automatic Teller Machines (ATMs) and credit and debit cards are also now widely used by MiBanco, BancoSol, and the ProCredit institutions. By the end of 2004, both MiBanco and BancoSol had more than 50,000 deposit accounts, with averages ranging from $300 to $500. Similarly, by September 2005, ProCredit institutions in El Salvador and Bolivia had 73,000 and 66,000 deposit accounts, respectively, with an average balance of about $1,000 and a much lower median balance (since the total deposit volume includes institutional and corporate depositors). As of September 2005, MiBanco’s deposits of $139.4 million represented 77.2 percent of its lending portfolio; BancoSol’s $98.3 million in deposits represented 80.7 percent of its lending portfolio; and Finamerica’s $26.6 million in deposits represented 74 percent of its loan portfolio. ProCredit institutions in Bolivia, El Salvador, and Nicaragua have $94.6 million (70 percent of the loan portfolio), $66.2 million (70 percent), and $21 million (40 percent) in deposits respectively, even though a focus on building a broad-scale retail deposit base really began only in 2004 (before then only a restricted range of savings products had been available). Clearly, these microfinance institutions enjoy a high level of credibility as financial institutions—enough to attract growing deposits. Customer loyalty is high even in times of crisis. An example is Bolivia, where BancoSol and Banco Los Andes ProCredit have fared significantly better than other banks during economic and political crises over the past decade or more. The development of the deposit base has been and continues to be a challenge for the institutions. It has meant considerable investment in more staff, technology, and branches. Often branches are opened in new locations with a new, more formal look and feel. It has been a challenge to move the institutional culture toward managing a savings deposit base and related retail products. MiBanco and Finamerica, for example, have opened branches in upscale neighborhoods designed to capture savings from wealthier income groups. They have also sought
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PIONEERS
MARGUERITE BERGER, MARIA OTERO,
AND
GABRIEL SCHOR
deposits from institutions and designed a variety of products to attract larger depositors, such as certificates of deposit. Saving products have advanced considerably in institutions originally rooted in credit-led financial services. Nevertheless, savings products for lower-income groups continue to be costly. In especially competitive environments, there is a risk they could be left behind as loan products continue to proliferate. Lowering the cost of savings products for the poor continues to be an important challenge for these institutions.
Diversifying Products and Services: The Move toward Full-Fledged Banks As the positioning of many upgraded MFIs has moved toward target group–oriented retail banks, other retail banking products have been introduced, including domestic and international money transfers, debit and credit cards, currency exchange services, and bill paying services (table 2.2). Institutions are also exploring the provision of insurance products. On the lending side, the range of products has expanded to include small business loans (reaching as high as $100,000) and housing loans. Because of their commitment to low-income groups, the upgraded MFIs have been innovative in identifying the products needed by their target group and trying to provide them affordably. An area that is receiving particular attention is the provision of more efficient and lower cost remittance services. The remittance business is huge in Latin America and the Caribbean: valued at more than $50 billion in 2005.4 It provides a vital source of income for low-income families across the region. Most leading MFIs—most of which are the upgraded MFIs—are exploring ways to enable the efficient transfer of these funds to recipient households and to give recipients enhanced access to loans and interest-earning savings accounts.
4
Preliminary estimates for 2005 by the Multilateral Investment Fund of the Inter-American Development Bank.
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Strategic positioning is key to implementing a product mix that will allow an MFI to achieve a competitive advantage with regard to cost efficiency and customer loyalty. In mature markets, clients demand more choice in terms of financial products and prices. Confronted with evolving consumer demand, upgraded MFIs will need to define their paths to becoming full-fledged retail banks. Although there cannot be one “optimal path,” it is quite clear that ultimately the typical regulated MFI will be drawn to the product range of classic retail banking. The sequencing and time frame for this to happen will depend on market conditions, management capacity, and the regulatory environment.
Diversifying the Client Base: Mission Drift? In their initial work as NGOs, most MFIs deployed all their lending in working capital loans using a variety of lending technologies, especially through individual loans and solidarity group lending. The exception was Compartamos in Mexico, which primarily offered a village banking–based product from the outset. All these institutions had the same focus: lending to poor and low-income households and microbusinesses with one microloan product. However, by upgrading, most institutions broadened their product and client base. One of the more controversial developments has been the move to serve larger and better-off small and medium-sized enterprises (SMEs). With this shift has often come the criticism that upgraded MFIs have experienced “mission drift” and are now less dedicated to the lower-income groups. Linked to this have been discussions on how best to measure whether MFIs are really reaching the unbanked and underbanked. For NGOs, the generally accepted method for assessing the market they served was their average loan size. It was assumed that the smaller the average loan, the poorer and more excluded the client base would be. Typically NGOs maintained average size loans hovering between $300 and $400 and deployed one product: a four- to six-month working capital loan. The average loan size of upgraded MFIs grew after their transformation; in some cases (such as Finamerica), the growth was dramatic, as shown in table 2.3. But even though most MFIs had
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PIONEERS
MARGUERITE BERGER, MARIA OTERO,
AND
GABRIEL SCHOR
average loan sizes below $500 in the mid-1990s, they exhibit a much wider range on this measure today. While the range of clients they serve and loan sizes they offer may be wider, their outreach to low-income clients remains strong. Today, many observers continue to turn to average loan size to characterize the market of regulated MFIs, ignoring the fundamental changes that make average loan size an increasingly flawed tool for understanding the market characteristics of MFIs. The most important changes involve the definition of the market and the range of loan sizes and terms offered. In fact, there is likely to be a need for new measures for financial institutions that have become full service banks and reach a much wider segment of clients than their NGO counterparts. Looking at the loan products of upgraded MFIs today and their different loan amounts and terms, it is striking how little average loan size reveals about the market being served, especially when the upgraded MFIs are compared to NGOs serving the same market with one loan product. A more detailed examination of three regulated institutions illustrates this point. MiBanco in Peru, for example, offers seven major credit products, including small consumer loans, working capital loans, mortgage financing, home improvement loans, and small business loans. The terms for these loans range from 10 months to 18 months, with mortgage loans at 18 months, which is considerably longer than the original 4- to 6-month term of earlier products, particularly solidarity group loans. MiBanco first-time loans begin at $347 for small consumer loans, $615 for home improvement loans, $770 to $970 for lines of credit and individual working capital loans, or $16,000 for home purchase. Nearly all of MiBanco’s active clients (over 90 percent) are concentrated in these three or four products, which have an average term of about 11 months. A recent study of MiBanco’s clients sought to locate MiBanco clients in relation to the country’s poverty line, and to determine the percentage of MiBanco clients who were below the poverty line at the time of their first loan (Welch and Delaney 2003). Nearly half (49 percent) of MiBanco clients were below the poverty line in Lima, where MiBanco concentrates
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82,118 26,800 425,747 128,782 77,663
66,193
54,990
121,914 125,489 402,007 113,242 115,451
84,095
57,989
1,051
1,491
2,039 1,338 359 1,129 1,739
Average loan balance ($)
121
62
185 54 5 48 158
Average loan balance as % of GDP per capita
—
—
42,969 10,319 248,634 68,134 32,333
Outstanding Loans <$500
OF
MICROFINANCE
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42,682
50,050
53,429 17,088 353,952 94,709 51,235
Outstanding Loans <$1,000
COMMERCIALIZATION
863
1,203
611 279 n.a. 4,000 a 1,803
SME clients (number)
IN THE
Source: Data for Bolivian institutions from Asofin, September 30, 2005, and Boletín Informativo, December 31, 2205, Superintendencia de Bancos y Entidades Financieras, Bolivia. Note: All data are as of September 30, 2005. Dashes indicate unavailability of data. n.a. = not applicable. a Estimated.
BancoSol Finamerica Compartamos MiBanco Banco Los Andes ProCredit, Bolivia Banco ProCredit, El Salvador Banco ProCredit, Nicaragua
Institution
Clients (number)
Loan clients (number)
Table 2.3. Characteristics of Loan Clients of Upgraded MFIs
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MARGUERITE BERGER, MARIA OTERO,
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GABRIEL SCHOR
its activity, compared to 40 percent of the overall Lima population that lives below the poverty line. The study also concluded that Latin American MFIs may be less likely to reach the poorest of the poor because they live in rural areas; microfinance is generally concentrated in urban areas (where over three-quarters of the region’s population lives). BancoSol’s portfolio characteristics are similar to MiBanco’s, although they display greater variation and longer terms. Individual loans for working capital start at $200, with an average 18-month term. Solidarity group working capital loans begin at $150, with a 16-month term. BancoSol’s smallest loans (under $500) begin at $50, with average term of 12 months and average loan amounts of $360. Its largest loans are for SME businesses, averaging $28,500, with terms of about 77 months. Only 611 of its more than 82,000 loan clients carry such loans. Interestingly, BancoSol’s home improvement loans, averaging about $4,500 with a 39-month term, represent the fastest growing part of its portfolio, but the large majority of active clients are concentrated in working capital loans. None of this variation is reflected in the average loan size, which at more than $2,000 would appear to suggest that BancoSol is serving a very different market than its NGO precursor, Prodem. By contrast, Compartamos offers only two products but reaches over 95 percent of its active clients (most of whom are rural women) with a revised village banking model named Generadoras de Ingresos (income generator). With 4-month terms, these rural working capital loans start at $170 and average $359. As Compartamos expands into other products, particularly individual loans, the average loan size may also become less useful as a way to identify the market the institution serves because its client base will remain largely the same. Similar trends can be observed in the ProCredit institutions. The product range of Banco Los Andes ProCredit (Bolivia), Banco ProCredit (El Salvador), and ProCredit (Nicaragua) includes business loans exceeding $100,000 and terms of up to 7 years and housing loans with typical amounts of $5,000 to $6,000 (for new houses) and terms up to 10 years. However, disbursing a large number of microloans remains their core business. Some 80 percent of all loans disbursed by these three institutions are for less than $1,000. The number of loans
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disbursed with a value of less than $1,000 has steadily increased since transformation (see table 2.4). These data suggest that far from succumbing to “mission drift,” these institutions with somewhat larger average loan size reach a much wider market segment than their NGO precursors, and provide much longer terms for their loans, yet they continue to focus a major share of their lending on small loans geared to people below the country’s poverty line. Because their formalization has allowed them to grow much faster than NGOs, the fact that they are also reaching other markets does not detract from the fact that they have become the largest institutions reaching the poor with financial services in their countries. They have evolved to manage a combined portfolio in which 15 to 20 percent is in small business loans to about 3 to 4 percent of the total active clients, and the rest remains in a wide variety of products that reach low-income populations. It is often asserted that greater efficiency in administering larger loans is an incentive for MFIs to move up market—thereby leading to “mission drift.” Although regulated MFIs are certainly seeking to generate more profits, the market definition for these regulated MFIs varies considerably and is dictated more by the strategic decisions each MFI makes than by a natural, irreversible course toward a different, better-off market. The first generation of upgraded MFIs serves a wide range of markets, from those whose clients have not changed, such as Compartamos, to those that have incorporated small business in a significant way, such as Banco Los Andes ProCredit.
Table 2.4. Number of Loans Less Than $1,000 Disbursed by Upgraded MFIs Institution/Country BancoSol, Bolivia Finamerica, Colombia Compartamos, Mexico Banco Los Andes ProCredit, Bolivia Banco ProCredit, El Salvador Banco ProCredit, Nicaragua Source: Authors’ compilations. Note: Dashes indicate unavailability of data.
2002
2003
2004
— 14,173 351,157 54,350 58,020 29,979
— 15,750 516,639 55,371 69,206 36,980
49,443 16,731 759,788 55,408 82,414 47,077
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AND
GABRIEL SCHOR
Lending to SMEs can be a key part of a business strategy where reputation and providing access to low-income wage workers—that is, SME employees—are also important in building a deposit base, and in markets where the existing formal financial sector does not serve this market adequately. This is a market opportunity that upgraded MFIs can take advantage of since they have access to a much wider funding base. Some of their microclients grow significantly and demand the kind of services normally required by small and medium enterprises (SMEs). All this permits the upgraders to establish a more efficient cost structure that ultimately also allows them to offer services on better terms, benefiting both microenterprises and SMEs. However, the argument that the better off the market and the larger the loans, the greater the level of profitability of the MFI does not hold with this first generation cluster. Larger size loans have significantly lower margins, since competition from commercial banks is greater. Furthermore, they concentrate risk and may lead to deterioration in portfolio quality. The case of Compartamos, which consistently displays the highest return on equity while continuing to reach the same rural, very low-income market, shows MFIs can be highly profitable in their core markets. In the more competitive urban environments, where microfinance penetration is strong, MFIs will often seek clients across a wider spectrum than in less saturated markets, but this has more to do with competition than with the regulated nature of the upgraded institutions. This is not to say that managing a more diverse client and product base is not a challenge for MFIs. It would be naïve to suppose that institutions geared to low-income groups can readily integrate better-off SMEs and deposit clients; a different style is required for the different target groups. However, management and owners of the upgraded MFIs are typically well aware of this tension and manage it carefully.
Financial Performance Upgraded institutions have successfully managed their financial performance: maintaining loan portfolio quality, increasing efficiency and profitability levels, and accessing commercial funding sources. Today,
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upgraded MFIs are performing on par with, or better than, the leading financial institutions in their countries, while providing services to poor and low-income customers, many of whom have never had access to a bank before. Their financial performance has generally improved after upgrading. Despite setbacks in the face of recession in Bolivia and some other countries, their performance remains strong on a series of measures, including portfolio at risk, efficiency, and profitability (table 2.5).
High Loan Portfolio Quality A key aspect to maintaining profitability and the overall financial performance of any MFI is the quality of its loan portfolio. The specific indicator most often used to measure MFI performance is PaR30, which measures portfolio at risk for more than 30 days.5 The seven MFIs studied
Table 2.5. Performance of Upgraded MFIs, Compared to Country Averages (percent) Country Bolivia
Institution
PAR 30a
ROA
ROE
Banco Los Andes ProCredit, Bolivia 1.95 0.60 8.00 BancoSol 5.40 1.30 11.00 Financial sector average, Bolivia 13.68 0.42 4.21 Colombia Finamerica 4.20 1.90 11.30 Financial sector average, Colombia 3.15 2.66 24.50 El Salvador Banco ProCredit, El Salvador 2.07 1.30 10.00 Financial sector average, El Salvador 2.16 1.05 9.64 Mexico Compartamos 0.60 20.00 54.00 Financial sector average, Mexico 1.99 1.91 15.69 Nicaragua Banco ProCredit, Nicaragua 1.89 4.00 25.10 Financial sector average, Nicaragua 2.38 2.17 26.80 Peru MiBanco 2.90 5.80 33.90 Financial sector average, Peru 2.68 1.53 21.28
Op. expense/ Avg. portfolio 12.50 12.60 6.85 16.30 9.35 12.50 4.62 35.60 5.08 15.90 9.55 18.80 6.81
Source: Mexico: CNBV (2005); Nicaragua: FELABAN (2005, October); other countries: FELABAN (2005, September). Note: All data are as of September 30, 2005. a Portfolio at risk for more than 30 days. For the financial sector, this ratio is estimated by adding the past due loan portfolio and loans in legal recovery and calculating them as a percentage of the total portfolio.
5
Portfolio at risk (PaR) measures the outstanding value of loans with payments past due as a percentage of the total portfolio.
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in this chapter have generally defined late payments as one of the key indicators of financial strength, and have invested significant resources for effective portfolio monitoring and management. Among them, PaR30 falls between 0.6 percent and 5.4 percent, which compares favorably with the banking sector as a whole in the countries where they operate. Over the last several years, PaR30 has followed different patterns across the upgraded MFIs, but overall asset quality has been strong. Several of the MFIs have experienced periods of high arrears at one time or another. The presence of consumer lenders whose tolerance for weak repayment was much greater than that of MFIs led to systemic increases in client over-indebtedness in some countries. This situation played itself out in Bolivia in the late 1990s, deteriorating the portfolios of all the MFIs and eventually leading to the collapse of most of the consumer lenders. Some MFIs, such as BancoSol, were more severely affected, but all experienced a decline in the quality of their portfolios. All of the upgraded MFIs studied here have been affected by crises of one kind or another, but they tend to perform better than banking institutions and recover more quickly (see chapter 5). The microfinance market is generally not as seriously affected by financial crises because of the resilience of microenterprises and their concentration in production and services for the domestic market. However, it can be decimated by a natural disaster, as was the case in Central America during Hurricane Mitch. Upgrading and the accompanying regulatory supervision have led to stronger management in all key business areas, and have been particularly important in maintaining loan portfolio quality. But some MFIs have run into problems because of weak management and poor controls that either ignored portfolio at risk problems or attempted to resolve them by restructuring loans. Portfolio mismanagement was most apparent in Finamerica’s precursor, Finansol, which nearly collapsed in 1996. In this case, collusion between one board member and management, and their irresponsible decision to use the parent NGO to hide a poorly performing portfolio, led to the losses suffered by that institution. The experience highlighted the importance of active governance by all shareholders, as well as close oversight of management.
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To improve the quality of their portfolios, MFIs with problems have made tough changes in management, credit policies and methodologies, growth targets, and write-off and reserve policies. A majority of the seven MFIs highlighted have brought in new management either to address performance issues or to move to new levels of growth. They also strengthened portfolio monitoring to allow for quick response once portfolio at risk rose above healthy levels, usually at PaR30 of 4 percent. They improved credit methodologies by focusing on a closer relationship with their customers, more accurate loan assessments, more rigorous procedures, staff training, and staff incentives based on quality of portfolio. MFIs have consolidated their portfolios and lowered their growth targets, particularly in Bolivia. Furthermore, in the first decade of upgrading, MFIs standardized their write-off policies and increased their levels of reserves; both steps contributed to their health and stability as financial institutions. Overall, the portfolio performance of the upgraded MFIs has remained strong. Those MFIs that are commercial banks almost always outperform other financial institutions in their countries, in terms of the quality of their loan portfolios and overall financial performance, ranking in first or second place. This has been the case with BancoSol, Banco Los Andes ProCredit, and MiBanco. In many cases, MFI policies for bad debt provisions are stricter than those established by the supervisory authorities. This factor contributes significantly to the strength they demonstrate as financial institutions, and is an essential element in helping MFIs cope with crises—although it can put downward pressure on short-term profits. Over time, write-offs have also been more than acceptable in size, and significantly lower than banking sector norms. BancoSol, although hit hard by the effects of the consumer lending crisis in Bolivia and high arrears for two years, has written off only about $11 million of the more than $1.1 billion it has lent over its lifetime. Banco Los Andes ProCredit has written off some $ 4 million, representing less than 2 percent of the outstanding loan portfolio at the end of each year. During the same period, Banco ProCredit (El Salvador), operating in much a less troubled environment, has written off loans representing only about 0.5 percent
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of the outstanding loan volume at the end of each year. Indications are that these transformed MFIs will sustain high repayment rates, will effectively address arrears when these exceed desired levels, and will continue cautious bad debt provision policies.
Increasing Efficiency Surprisingly, efficiency as an operational concept is a relative newcomer to microfinance. It became a factor when competition among MFIs emerged in the latter half of the 1990s, making lower operating costs an essential consideration. Increasing efficiency lowers MFI operating costs as a percentage of portfolio, thereby increasing net income and improving the bottom line. It also allows MFIs to lower the interest rates they charge, benefiting their customers and making the MFIs more competitive. Upgraded MFIs have used a variety of measures to lower their costs. The most important include: • •
• • •
•
The use of experienced loan officers and the development of a loyal customer base, both of which increase productivity Improved product development, including significantly reducing collateral and documentary requirements to speed disbursement of micro loans Reengineering operations, both at the branch level and at headquarters Introducing new technologies, including credit scoring and PDAs, which increase the productivity of loan officers Taking advantage of technology, such as smart cards and ATMs, to design loan products that improve the quality and lower the cost of their lending products Using market intelligence to segment their markets and better understand how to serve customers efficiently and effectively
Innovation is a big part of the success of upgraded MFIs, especially today, as efficiency takes on even greater importance in increasingly
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competitive microfinance markets. In addition to the competitive pressure on interest rates, the urgency among MFIs to cut costs has been increased by their desire to extend their reach to more low-income and unbanked clients. As in the traditional banking business, upgraded MFIs and their peers continually confront the challenge of applying the right technology to automate, integrate, and redesign business processes to improve efficiency, customer service, and product quality. The upgraded MFIs have introduced experimental technologies, including using Palm Pilots to create “paperless” microloan processing systems and credit scoring to partially automate decisionmaking processes. These technologies have become common practice in some MFIs today (see chapter 6). And the importance of the “soft” factors in improved human resources management that have come with greater experience, stronger management, clearer ownership, and the success of upgrading should not be underestimated in explaining increasing efficiency. Efficiency levels vary among the upgraded institutions, but all have managed to increase their efficiency since upgrading. Competition is a factor that correlates with a high level of efficiency. Bolivia provides an interesting example. When the first NGO transformed into BancoSol in 1992, its operating costs were well above 60 percent of its loan portfolio. As competition increased in the late 1990s, efficient operations became a must for upgraded MFIs if they wanted to retain their markets and grow. Today, Bolivia is perhaps the most competitive market in Latin America and is home to four of the region’s most efficient MFIs. Operating costs as a percentage of loan portfolio for the four leading MFIs, which include BancoSol and Banco Los Andes ProCredit, hover between 10 and 13 percent, demonstrating levels of efficiency once considered impossible. In less competitive markets, efficiency has not yet proven to be as indispensable to the growth and sustainability for upgraded institutions. However, as they prepare for competition, MFIs must dedicate considerable effort to improving their efficiency. Financiera Calpiá (now Banco ProCredit) in El Salvador led the way in the late 1990s, lowering its interest rates dramatically to make its products more competitive. Its cut in rates would not have been possible if the institution had kept
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MARGUERITE BERGER, MARIA OTERO,
AND
GABRIEL SCHOR
its old cost structure. MiBanco also had few incentives to lower its costs when it began operations as a regulated MFI in a large market with no competition. It sought to increase its efficiency in anticipation of competition. From 2000 to 2005, it cut costs by more than half, to 18.8 percent of its portfolio: still above the levels attained in Bolivia. Meanwhile, overall interest rates are also decreasing in Peru as more commercial banks enter the microfinance market. For the upgraded MFIs, changes in operating costs have been reflected in a drop in the interest rates charged to their clients, with the most dramatic changes occurring in competitive environments. Bolivia has the lowest effective interest rates in the region; rates fell nearly threefold in less than three years. It is striking that despite increasing price pressure in all microfinance markets today, created by competition from efficient MFIs and commercial banks that provide consumer finance, and despite the considerable investment required to build the deposit base and wider product range, levels of profitability have remained consistently strong. This reflects the fact that upgraded MFIs and their customers are surprisingly robust.
Profitability Before the upgrading phenomenon was born, profitability was almost a dirty word for many working in microfinance. But it is, in fact, the key to microfinance sustainability, forcing microlenders to cover their costs, allowing them to obtain financing and technical expertise needed for expansion and keeping them focused on providing efficient services to their customers. Nevertheless, there is a wide variation in the level of profitability registered by upgraded institutions, with some maintaining very high levels and others performing less well (table 2.5). Finamerica in Colombia, for example, is forced to operate with a government-imposed interest rate ceiling that makes it extremely hard to break even. On the other end of the spectrum, Compartamos in Mexico (in 2004 and 2005) and ProCredit in Nicaragua (in 2004) display very high returns. Compartamos’ high earnings have allowed it to grow, which it has
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done dramatically, exceeding 400,000 active clients by September 2005. Most of the ProCredit institutions have also maintained high earnings, despite heavy investment, during their transformation into full-fledged banks in 2004 and 2005. As competition has increased in some of the markets where upgraded MFIs operate, the return on assets (ROA) has been squeezed because interest rates have declined (although this varies considerably from year to year). Return on equity (ROE) is generally considered a better indicator of profitability. ROE has remained high, in the low 20 percent range in competitive markets. In other cases, such as Compartamos, it has been more than twice that range because of the high level of interest rates charged. While the heavy investments of the ProCredit institutions in 2004 and 2005 had a temporary negative effect on ROE, the high overall profitability of the seven MFIs studied here is being achieved despite high growth rates and continuous investment in outreach and product diversification. Relatively high profitability is required to provide the retained earnings to support the capital base of rapidly growing institutions. While the upgraded MFIs have performed exceptionally well in their countries, they have nevertheless been affected by political instability, financial crises, and natural disasters at one time or another and with varying degrees of severity in nearly all the countries included here. Their ability to withstand economic shocks has proven to be considerably better than most financial institutions. The fact that BancoSol and Banco Los Andes ProCredit have continued to grow strongly and maintain comfortable levels of profitability in Bolivia, during a period of far-reaching political and economic instability, is a strong testament to the resilience of the core micro client group. Nevertheless, in assessing the long-term performance of MFIs, country risk must be considered a risk that these institutions face. It is partly due to this risk that upgraded MFIs must keep their ROE and ROA high to continue to attract the investments they need to grow. As the upgraded MFIs further solidify themselves as financial institutions, they will most likely display returns on equity and assets that are not as widely varied as they are today. A more limited range of around 20 to 25 percent return on equity is likely. Such a return has
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AND
GABRIEL SCHOR
been registered by the best performing institutions in the last several years, including those in highly competitive environments like Bolivia. These MFIs provide the best estimate of what level of profit well-run MFIs can attain over time. The relatively high levels of profitability of the MFIs have been and will largely remain a function of maintaining high loan portfolio quality, maintaining market interest rates, reducing transactions costs, and increasing efficiency in the face of growing margin pressure on interest rates.
Diversification of Commercial Funding Sources A primary motivation for upgrading was to access larger volumes of funding at lower cost, and this has certainly occurred. The seven upgraded MFIs have ample sources of funding for their operations, and seek to develop the liability side of their balance sheets so as to avoid concentrating or becoming dependant on any one source of funding. These MFIs work hard to obtain effective funding sources for their operations, even though in some countries the capital markets in which they operate are replete with debt capital and there are growing options for debt financing internationally. As mentioned, savings deposits represent an increasingly important source of funding for these organizations. Key to successfully raising affordable commercial sources of funding has been the stronger financial performance of the institutions, and the stronger management and ownership structures, which in turn has lead to strong ratings from international ratings agencies. The upgraded MFIs share three major concerns as they build the liability side of their organizations. First, these MFIs strive for diversification in the liability structure to avoid concentration that could endanger their liquidity or adversely affect the match between assets and liabilities. Second, because of their potential for volatility, MFIs tend to leverage their equity conservatively (some as low as six to seven times)—although they must balance this against profitability goals, especially in highly competitive markets. Third, these MFIs seek to manage their currency
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risk, especially in countries that are not dollarized and where hard currency accounts are offered. Commercial loans. Upgraded MFIs borrow from a wide range of sources, both local and international. In this regard, the MFIs’ major concerns focus on negotiating the best interest rates to keep their financial costs down. MFIs are constrained in the degree to which they can depend on international, hard currency commercial loans because of exposure to currency risk. When the euro rapidly appreciated against the dollar, Banco Ademi in the Dominican Republic learned that euro-denominated debt presents substantial risk for an institution that lends in local currency. Few MFIs now rely to any great extent on subsidized loans, since there are fewer available with the volumes necessary, such loans distort their balance sheets and reduce their control, and in the long run may not serve them well. Bonds/commercial paper. In the last few years, two institutions—Compartamos and MiBanco—have floated paper in their local markets as a way of funding their operations. Compartamos, using its Standard & Poor’s A+ rating, floated two $17 million bonds denominated in Mexican pesos. Following on this success Compartamos established plans for a $46 million bond issuance program. MiBanco has used guarantees from the U.S. Agency for International Development (USAID) and the Corporación Andina de Fomento (CAF) to float $10 million in the Peruvian market. BancoSol has external credit lines of $55 million, or approximately one-third of its assets. MFIs in the ProCredit group of banks have been able to benefit from the fact that the parent company (ProCredit Holding) is able to raise funds in the international capital markets for on-lending to its subsidiaries. Banco ProCredit, Ecuador is piloting local bond issues in the region.
Clearer Ownership Structures One key factor in maintaining the performance of these institutions has been the strong shareholder and management structures that have
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emerged during the upgrading process. These have also formalized the key role of IPC and ACCION in building the institutions (see table 2.6). A fast-moving, commercially oriented MFI operating in increasingly competitive markets requires very different strategies and processes, including new forms of governance and a board that is capable of playing an informed role in a regulated financial institution. Upgraded MFIs require that owners be aligned with the dual goals of profit and development. Where the NGO is carefully structured and the board is committed to good business policies and the mission of an MFI, the results have been positive. This has been the case with Fundasal in El Salvador, the NGO Pro Credito Bolivia, and ACCION Comunitaria in Peru. Of the seven MFIs reviewed in this chapter, only MiBanco is majority owned (60 percent) by an NGO. To overcome the problem of lack of financial expertise among the NGO officers, MiBanco is trying to reduce the NGO’s share of operations, and diversify sources of funding. This represents a great advance over those unregulated NGOs with no professional majority shareholder. NGOs have no real owners, and if a board is weak, power passes to management. NGO ownership of MFIs has caused difficulties in a few well-known cases. In the case of Financiera Calpiá in El Salvador, different groups within the parent NGO, AMPES, fought one another for control of the NGO’s stake, complicating the management of the finance company. At the time, AMPES held almost half (50 percent) of Calpiá, but eventually sold its shares to ProCredit Holding. After upgrading, the continuing relationship between the remaining NGO and the new MFI can also be problematic if the NGO continues as an operating entity. This is what happened to Finansol/Finamerica in Colombia. The MFI transferred bad loans to the NGO and paid its extension staff on the basis of the number of clients brought to the financial institution. The Finansol crisis taught ACCION International that it needed to be more active in the governance of the institution, and now ACCION has a much stronger presence on the board of each MFI affiliate and monitors affiliate activities and performance more closely.
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20 0 39 63.9 14.6 1 17.7
BancoSol Finamericaa Compartamos MiBanco Banco Los Andes ProCredit Banco ProCredit, El Salvadorb Banco ProCredit, Nicaragua
0 0 10 3.8 0b 0b 0
21.9 0 0 8.9 83.6b 98.6b 81.6
Accion investments or ProCredit holding 23.9 9 18 6.3 0 0 0
Accion Gateway 0 0 0 11.4 0 0 0
Other specialized funds
19.2 0.65 33 0.7 1.8 0.4 0.7
Individual investors
15 90.35a 0 5 0 0 0
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IN THE
Source: Compiled by authors from company data. Note: All data are as of September 30, 2005. a The “other” investor in Finamerica refers to four cajas de compensacion, a type of public-private pension fund in Colombia. b ProCredit Holding is in the process of buying out the International Financial Institution investor (BIO) in Banco Los Andes ProCredit. This will be completed in 2006. It completed the purchase of all other shareholders in Banco ProCredit El Salvador at the end of 2005.
NGO
Institution
International donor/FI
Table 2.6. Ownership of Upgraded MFIs (percent)
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The delicate equilibrium between development-oriented and profitoriented forces at the level of ownership and boards of directors plays a key role in assuring that microfinance institutions respond adequately to their double bottom line of social and financial returns. Having owners that have a genuine commitment to the target group and development goals is likely to keep the institutions specialized. Banks specialized in financial services for the microenterprise and low-income target groups (whether founded through upgrading or built from scratch by these owners) will remain important players in the financial sectors of developing countries and transition economies for the foreseeable future, even as commercial banks enter the field of microfinance. So far, the evidence suggests that the specialized banks are more committed to outreach and innovation in developing products for the target group.
The Emergence of Dedicated Funds and International Microfinance Groups The emergence of funds that specialize in investing in MFIs has strengthened the upgrading process. Even after it had been demonstrated that microfinance could be profitable, commercial investors were still reluctant to enter this market segment, and access to longterm finance from specialized funds was essential. Today, these funds, including those driven by ACCION and IPC, continue to play a key role, not only in upgrading NGOs into regulated financial institutions and supporting their growth, but also in building institutions from scratch. Set up in most cases as private-public partnerships, specialized investment funds have proven to be more suitable shareholders of an MFI than NGOs, both in terms of incentive structure and governance. They can also build on a broad experience gained from different investments and markets. Fund managers can make decisions quickly, responding to capital calls that require a quick response, for example. The specialized capability to identify MFIs in which to invest, the ability to exercise the governance role more effectively, and the structure that allows timely response matched to particular circumstances make specialized funds
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an ideal vehicle through which international development agencies, such as the Multilateral Investment Fund (MIF) and the International Finance Corporation (IFC), have been able to support the growth of the microfinance industry in recent years. The first specialized microfinance investment fund was Profund, founded by ACCION International (United States), Fundes (Switzerland), Sidi (France), Calmeadow Foundation (Canada), and an individual investor (Bolivia). Key to the success of Profund’s funding drive were early commitments of IDB/MIF, SECO, Argidius, and Calvert (Silva 2005). Other investment vehicles such as LACIF, Blue Orchard Finance, Sarona, and Africap have followed. A recent survey identified 38 investment funds specialized in microfinance and at least 5 additional funds expected to be constituted in 2005 (Goodman 2005). The main objective of these funds is to preserve capital and obtain a return on investment. They strive to achieve a balanced portfolio in terms of country risk and in the breakdown between microenterprise and small business investments, in accordance with the criteria outlined in the funds’ respective charters. But these owners also have a long-term interest in the success of microfinance. Most of the funds play an active role in the governance of the MFIs in which they invest, providing input through their participation on an MFI’s board of directors and bringing to the table a wealth of accumulated expertise garnered from equity and debt participation in other MFIs. The establishment by IPC and ACCION International of their own investment companies—ProCredit Holding AG and ACCION Investments in Microfinance, SPC—has been a particularly important development for the institutions studied in this chapter (table 2.7). In their capacity as owners, IPC and ACCION have demonstrated the importance of the combination of technical expertise, experience, and financial resources in influencing the development of upgrading institutions. Using all three of these elements, they have helped MFIs become commercially viable and provided a good return on investment. Moreover, this experience has generated numerous lessons that have benefited affiliates and other MFIs around the world. In contrast, many other microfinance investment funds are geared more toward debt than
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GABRIEL SCHOR
Table 2.7. Specialized Investment Companies Formed by ACCION and IPC Accion Investments in Microfinance, SPC Total equity, June 2005 ROE, 2004 Founding shareholder Other private shareholders
IFI shareholders Number of investments in MFIs worldwide Investee companies in the region
ProCredit Holding AG
$19.5 million €90 million ($109 million) 6.37% (first year of operation) 12.6% ACCION International IPC GmbH, IPC Invest (staff of IPC) Gray Ghost, Andromeda, DOEN Foundation, and other private individual ResponsAbility, Andromeda investors Fund, Fundasal IDB/MIF, IFC, KfW, FMO, KfW Group (including DEG), BIO, Finnfund IFC, FMO, BIO 6 19
•
BancoSol, Bolivia Banco Solidario, Ecuador MiBanco, Peru
•
Apoyo Integral, El Salvador
•
Visión, Paraguay
• •
Banco Los Andes ProCredit, Bolivia • Banco ProCredit, El Salvador • Banco ProCredit, Nicaragua • Banco ProCredit, Ecuador • MCN, Haiti •
Source: Compiled by the authors from company data.
equity financing in order to offset the risks associated with investing in young MFIs that have limited management experience. Accion Investments6 and ProCredit Holding have different ways of operating. Accion Investments has all of its capital committed and is preparing a second capitalization that will take it to $40 million. The investments Accion has made in microfinance, beginning in 1992, have been driven primarily by its desire to ensure that the mission of the investee institutions would not be abandoned. Accion has chosen to maintain a minority shareholding position in every institution in which it has an investment. Accion joins forces with other like-minded investors to form blocks that ensure continuity in the MFI’s strategic direction. It holds a seat on the board of each institution, maintaining a strong governance voice in these institutions. 6
Accion Investments in Microfinance, SPC and ACCION are different organizations.
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On the other hand, ProCredit Holding holds, or soon will hold, a majority stake in all but one of the 19 financial institutions in the ProCredit group. In these terms it is not an investment fund; it is the long-term parent company of all the institutions in the group. It does not intend to sell its shares and actively controls the institutions in the group, all of which share a common “ProCredit” corporate identity. All but one (Haiti) are fully consolidated into the group’s financial statements. ProCredit Holding, working closely in association with IPC, the main shareholder in ProCredit Holding, plays a defining role across the group. It guides management, supports the development of a strong corporate culture across the group, and ensures that best practice is rapidly disseminated across the group to ever improve efficiency. It has a strong role in internal audit, controlling, and risk management. It provides central support in the areas of lending, retail banking, marketing, and human resource management. It also provides long-term debt, which it is able to raise in Western capital markets on the basis of its BBB- (investment grade) international rating from Fitch. ProCredit Holding has direct control over management since the top one or two senior managers in all ProCredit institutions are IPC experts. ProCredit Holding’s business model is based on their experience that with majority control, unambiguous strategic direction can be provided, efficient decisions can be made, and synergies can be captured across the group. In an increasingly competitive microfinance landscape, the efficiencies and staff motivation that being part of a global group affords are a significant strategic advantage for ProCredit institutions.
Assessment of the Upgrading Approach Upgrading has been a dominant force in shaping microfinance in Latin America over the last 15 years. The upgrading experience has been successful because it: •
Helps solve one of the most difficult problems NGO microfinance institutions face—access to funds to grow
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•
•
•
•
•
AND
GABRIEL SCHOR
Gives MFIs access to the domestic savings base, and local and international capital markets, the only places where the resources needed to grow microfinance to a large scale are available Provides a demonstration effect that encourages other MFIs to upgrade and prompts commercial banks to integrate microentrepreneurs and low-income groups as clients Initiates a process of redefining the financial system of each country by bringing institutions whose clients were previously considered unbankable under formal bank supervision Improves financial management and performance as microfinance begins to be supervised by an outside regulatory body, which raises standards for all microfinance institutions Shows that financial institutions can have a double bottom line; upgraded MFIs seek a financial return while retaining the objective of providing access to the large majority of lowincome and poor self-employed people
The original aim of microfinance was not to focus exclusively on lending to microenterprises. One of the important advantages of supervised financial institutions is that they can offer savings products, which are considered just as important to the target clients as loans. This means that upgraders can fulfill part of their original mission much better than their predecessors. Moreover, outreach and efficiency of financial services are an integral part of the mission. When it comes to outreach and efficiency, the evidence is overwhelming: upgraded MFIs are the key drivers behind the growth of microfinance markets and the improvement of cost efficiency. Ultimately, they can offer their clients much more favorable interest rates than their NGO competitors could, if those competitors were to operate on a cost-covering basis. They can do this while maintaining very strong financial performance, suggesting sustainability over the long-term. Upgrading has allowed both MFI shareholders and regulatory bodies to make very substantial progress along the learning curve of microfinance. This in turn has made it possible to attempt more direct
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approaches. On the one hand have been the long-awaited downscaling initiatives, where existing commercial institutions embrace microfinance and enter these market segments (see chapter 3). On the other hand has been the building of supervised MFIs from scratch, as greenfield initiatives. Both approaches hold the promise of being able to outperform the upgrading process. Results can be achieved in a much shorter time period. Ownership structures can be defined from the very beginning in an appropriate way. Because of both these factors, the process can be more efficient from an economic point of view. Upgrading has been an expensive process. It is surely inefficient to invest first in an NGO and build up all its necessary internal capacities, only to end up finding that many of those capabilities are no longer needed when the NGO transforms into a regulated entity. Given the advances in microfinance today, the value of upgrading as a model for developing microfinance may be limited to situations in which a new market is to be tested or where barriers to entry are significant. In recent years, the pace of upgrading has slowed, despite a few important instances—notably ADOPEM, a Women’s World Banking affiliate in the Dominican Republic, and Finca-Ecuador. International networks such as ACCION, IPC, WWB, and Finca have a decided advantage in terms of their ability to raise capital for upgrading and the technical, business, and technological resources and experience that they can bring to bear on behalf of their affiliates. All the IPC-related ProCredit institutions in the region have already upgraded or were started from scratch as formal financial institutions, and the majority of ACCION’s affiliates are upgraded institutions or downscaling commercial banks. When the upgrading phenomenon began, the pioneer MFIs enjoyed the advantages of being first movers and operating in market environments that were not yet very competitive. In recent years the profits these institutions generated have attracted competition. Their management must be very sophisticated in the face of potentially shrinking profit margins (see chapter 8). In countries like Bolivia and Peru, where barriers to entry were low and the regulatory environment attractive, competition arose earlier than elsewhere. But new players
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have entered the market in many Latin American countries and are dramatically changing the landscape. In addition, clients have become more discriminating now that they have choices, permitting them to desert institutions that do not respond to their needs. The resulting downward pressure on prices and the scramble to enhance products has put severe pressure on institutions that were born in donor-driven, monopoly-like environments. This means much tougher going for any new upgraders entering today’s market. They will not have the grace period afforded to them by the limited competition for financial services to low-end markets that characterized most of Latin America in the past. NGOs remain relevant in certain contexts, either because their boards of directors prefer to maintain the nonprofit status—often to target the most poor—or because the regulatory system is not suitable for MFI regulation. Women’s World Banking in Cali, Colombia, for example, has over 100,000 borrowers and outstanding financial performance. It was recently able to raise capital from a $52 million bond offering, denominated in local currency, despite its NGO status. Today, Latin American microfinance includes among its key players not only the transformed NGOs that have followed the path of the pioneers, but more importantly, other regulated institutions, including the following: • •
Small commercial banks that have shifted their market to microfinance, such as Banco Solidario in Ecuador. A growing number of large banks that have reached “down market” into microfinance. These include ABN/AMRO in Brazil; Caja Social and BanColombia in Colombia; CrediFe/Banco de Pichincha in Ecuador; Sogebank (via Sogesol) and Unibank (via MCN) in Haiti; and Banco de Credito in Peru.7 Another
7 Banco de Crédito presents an interesting case, as one of MiBanco’s original shareholders, with 5 percent of total shares. In the first two years of MiBanco’s operation, Banco de Crédito sat on the MiBanco board and developed an interest in microfinance. After two years, Banco de Crédito sold its MiBanco shares. Today, it is one of MiBanco’s important competitors in the microenterprise market in Lima.
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•
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downscaling bank, the Banco de Pichincha, adds an interesting twist, integrating an NGO model into a large commercial bank. Some 250 branches of Banco de Pichincha now offer microfinance products, but with only two loan officers per branch. Commercial start-ups, such as finance companies, which from the outset operate as regulated financial institutions, including Banco ProCredit (formerly Financiera Ecuatorial) in Ecuador. Such institutions exist in a growing number of countries, especially in the Andean region. State-owned development banks using a commercial approach, which incorporate microfinance into their portfolio after creating a subsidiary service company. Banco do Nordeste, with World Bank and IDB financing and technical assistance from ACCION, follows this model. Today, it is by far the largest microfinance institution in Brazil.
The last 15 years have seen a transformation of the microfinance landscape in Latin America. In most markets there is growing competition between relatively strong financial institutions to serve microbusinesses and low-income groups. However, challenges remain for the further development of these financial sectors: in terms of continuing to expand outreach, being innovative in reducing costs to bring marginalized groups into the formal banking sector, and maintaining standards of customer service and transparency in the industry. Perhaps the most important challenge for upgraded institutions and new upgraders moving ahead is to continually redefine who they are and the role they play in their markets without abandoning the wisdom of their past experiences. Change is a given in Latin American financial markets today, and MFIs must be able to adapt or leave their microenterprise and poor clients behind. However, this challenge carries a risk. There is considerable movement toward transforming the original microcredit product through consumer lending, use of credit scoring, and tolerating higher arrears, particularly from existing commercial banks that are entering the field. A key question and challenge
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is how to diversify and compete without distorting the basic microcredit product. Straying too far from its approach and essential technology, as finance companies in Bolivia did, can lead to ruin for an MFI and problems for the industry as a whole. The lessons that were learned by the participating institutions through the upgrading process have been great. Furthermore, the institutions are now more firmly rooted in regional groupings (led by ACCION and IPC/ProCredit), which gives them genuine economies of scale. As a result, the upgraded institutions are in a stronger position to sustain their competitive advantage in their respective markets while remaining true to their mission and credit technology. They are also better situated to continue to be innovative and more efficient in providing financial services for their lower-income target groups. The strong regional and global players that have emerged from upgrading can rely on a long tradition in the philosophy and technology of sustainable microfinance, as well as the financial strength and technical expertise needed to compete. As such, they have an important role to play in continuing to improve the provision of sustainable financial services to microentrepreneurs, small business, and low-income families.
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References Comisión Nacional Bancaria y de Valores (CNBV), Mexico. 2005. Boletín Estadístico: Banca Múltiple, Septiembre. Federación Latinoamericana de Bancos (FELABAN). 2005. Boletín Financiero Mensual: Indicadores Financieros 2005, Septiembre y Octubre. (http://www.felaban.com/boletin_financiero.php). Goodman, Patrick. 2005. Microfinance Investment Funds: Key Features. Paper originally presented at the Financial Sector Development Symposium organized by KfW, 11–12 November, 2004, Berlin. Appui au Développemente Autonome, Luxembourg. Marulanda, Beatriz, and Maria Otero. 2005. Perfil de las Microfinanzas en Latinoamérica en 10 Años: Visión y Características. ACCION International, Boston. Unpublished document (April). ProCredit Holding. 2004. Annual Report. Frankfurt am Main, Germany. Silva, Alex. 2005. Investment in Microfinance: Profund’s Story. Small Enterprise Development 16 (1): 17–29. Superintendencia de Bancos y Entidades Financieras Bolivianos. 2005. Boletín Informativo Mensual Mensual Sistema Bancario, December. La Paz. Welch, Karen Horn, and Patricia Lee Devaney. 2003. Poverty Outreach Findings: MiBanco, Peru. Insight No. 5. ACCION International, Boston.
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Downscaling: Moving Latin American Banks into Microfinance Beatriz Marulanda
T
he development and consolidation of microfinance institutions have shown that microenterprise credit is a profitable and large potential market in which credit risk can be controlled. While downscaling efforts by traditional banks can increase product offerings and reduce intermediation costs, persuading formal financial institutions to become involved is undoubtedly the main challenge for the microfinance industry in the coming years. Formal financial institutions in Latin America and the Caribbean have been slow to downscale into providing credit to microenterprises, especially when compared to the proliferation of nonformal microcredit institutions. These nonregulated institutions have grown rapidly, “upscaling” into formal financial intermediaries (see chapter 2). There are now several successful cases of upscaled, sustainable microfinance institutions in Latin America and the Caribbean. By contrast, traditional financial institutions have been discouraged from moving down-market because of systemic and macroeconomic factors that have limited the potential for exploring new markets such as microfinance. Overall, the formal financial systems in the region evolved within legal frameworks that assigned deposit and lending functions to specialized intermediaries, creating artificial segmentation of the market. Such
I would like to thank all the financial institutions that provided the information presented here, as well as Mariana Paredes, without whose comments and suggestions it would have been impossible to write this chapter.
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CHAPTER 3
BEATRIZ MARULANDA
a specialized structure gave financial institutions a protected market, within which they did not have to compete aggressively for market share. As a result, a series of limited entities emerged, which were capable of surviving only under artificial circumstances and conditions. Commercial banks evolved as the institutions with broader deposit and lending operations. They therefore developed the physical, institutional, and technological infrastructure necessary for handling a high volume of operations of varying complexity. Other, more specialized financial institutions developed the appropriate infrastructure for operations serving a smaller number of users in market niches. These institutions were often not authorized to take deposits; they had a small network of offices and their knowledge of banking transactions was limited to the operations that they were allowed to perform. All these financial institutions grew in a protected environment, without the need to expand their customer base to higher risk activities or new population groups, or both. As a result, they did not need to design more complex and sophisticated products to attract new clients or create new demand. Under these circumstances, formal banking institutions did not seek out microentrepreneurs or the poor, as they were not forced by competition to engage in new risk or incur additional transactions costs. The financial reforms undertaken throughout most of the region in the 1990s sought to promote greater efficiency and competition within the sector. This objective was based on the assumption that increased competition would lead to greater financial diversification and expansion of financial services toward activities and groups that until then had lacked access to formal financial services. The reforms, carried out by most countries of the region, focused on liberalization and deregulation of the financial sectors as a means of stimulating greater competition. Government ownership in the sector was reduced and the sector was opened to foreign investment. The system of specialized banks was dismantled and State intervention through interest rate controls, excessive reserve requirements, and directed credit channeling was minimized. Even though the financial reforms introduced in various countries led to increased competition in many Latin American and Caribbean nations, this process was not immediate, and in some countries the
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process was delayed by the macroeconomic and financial crises at the end of the 1990s. Some institutions were left ill-prepared to deal with the macroeconomic crises, as the implementation of regulatory reforms often did not go hand-in-hand with supervisory reforms. Additionally, the liberalization policies that were implemented in the mid-1990s exposed some countries in the region to financial shocks from other nations, resulting in a ripple effect, adversely affecting their financial sectors. The slowdown in the region’s economic growth aggravated these circumstances, leading to greater unemployment and inflation and shrinking bank credit in some countries. Authorities were driven in many places to adopt and enforce bail-out measures and regulations to protect the public’s savings. This was the case in the banking industry crises in Bolivia, Colombia, and Peru in the mid-1990s. In the late 1990s, most countries took steps to change their regulatory and supervisory financial frameworks, including increasing minimum capital requirements, establishing new portfolio classification rules and methods for valuing assets, and adjusting regulations for risk management. The Latin American and Caribbean financial crisis led to a reduction in the number of banking institutions in the sector.1 Additionally, since many banks had to clean up their balance sheets, any search for new lending markets was postponed, such as experimentation with microcredit. Some notable success stories in downscaling, like Bolivia’s Banco Económico and Panama’s Multicredit Bank (see USAID 1998), cut back on efforts to offer services to microentrepreneurs and the poor. The result was that banking expansion into the informal sector did not materialize. The only increase in financial outreach resulted from the efforts of certain microfinance institutions that pursued mechanisms and procedures for serving that market. Credit unions also contributed significantly to the ability of microentrepreneurs to gain access to formal financial services.
1
For more on the financial crises in Ecuador and Bolivia, see chapter 5.
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Nonetheless, credit remained tight. Although the ratio of M22 to GDP rose from 21 to 29 percent from the 1960s to the 1970s in Latin America and the Caribbean, and to 38 percent in 1993–96, it remained well below the ratio in the East Asian countries and other industrialized nations in the late 1990s (see Westley 2001). Today, in the middle of the first decade of the 21st century, few major players—with some important exceptions—are performing the function of intermediating public savings toward microentrepreneurs. While a growing number of microcredit institutions provide comprehensive microfinance services, most of these are not allowed to mobilize public savings because they are not supervised or regulated. For that reason, and because of their corporate governance and limited capacity to grow, these institutions have not been able to significantly help microenterprises gain access to new and more sophisticated financial services—although they have demonstrated that this market niche is profitable. The challenge for microfinance in the coming years is to channel more public savings through the formal financial sector. The next section of this chapter describes the kinds of institutions that entered the microfinance sector and the circumstances under which they began. It follows with an explanation of the organizational model of these financial institutions. The chapter then considers the credit technology and risk measures they have used, and ends with some conclusions and recommendations.
Microfinance and Its New Participants During the region’s economic and banking crises in the 1990s, some individual banks began to make incursions into the microenterprise market. They were motivated by a number of factors and had various degrees of success. Given the success of microlending, some commercial banks began to explore the market with the help of multilateral or bilateral agencies. In Paraguay, banks made such decisions as a reaction 2
M2 is a measure of total money supply and refers to all checkable demand deposits, savings, and other time deposits.
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to intense competition, while in El Salvador, Banco Agrícola entered to diversify market niches, deposits, and loan services. As a result of these crises, some banks had to concentrate on improving their financial conditions and surviving in the market, rather than exploring new opportunities. Banks such as Banco Económico in Bolivia withdrew from the microfinance sector after a wave of over-indebtedness hit the microenterprise sector. This was caused by the entry of several consumer credit institutions into the Bolivian market that utilized inappropriate lending and credit methodologies (Rhyne 2001). Other banks, such as Banco Solidario in Ecuador, survived the crisis precisely by concentrating in the sector. Banco Solidario had lower arrears ratios than the overall system, greater stability in its deposits, and supported by a syndicated loan arranged by the investment fund, ProFund,3 during the most difficult period of the country’s exchange rate crisis. At the beginning of the 21st century, traditional banks are renewing their interest in entering the microenterprise sector. Typically, these are large banks that serve market segments with an array of deposits and loan products.4 The microenterprise sector offers them an opportunity to broaden savings and loan outreach. These large traditional banks have the infrastructure necessary to handle large volumes and large markets, and they have extensive networks of branches to deal with deposit products. Indeed, some of these banks—and even banks that have not demonstrated an explicit interest in the microenterprise market—already service this sector through their savings products and services. Many meaningful examples of downscaling can now be found throughout the region, although they remain isolated. In Haiti, for example, Sogebank is the nation’s largest bank, with 28 percent of market share, 30 branches, and assets of $340 million. In Ecuador, Banco del Pichincha is a multi-service bank that entered the sector thanks in part to its branch network in working-class neighborhoods. Previously, many
3
ProFund is a for-profit investment fund that seeks a high return on investment and targets the region’s small businesses and microenterprises, while also promoting the growth of regulated and efficient financial intermediaries.
4
The exceptions are the smaller finance institutions in Paraguay.
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Pichincha offices were not profitable because they were not tapping the market potential for deposits and loan products. The bank then made a conscious decision to better understand the needs of microentrepreneurs, and established a subsidiary, Credife, to administer new services to the microenterprise sector. This required a change in management approach and the creation of a microcredit sales team trained in a set of skills different than those required to sell more traditional bank services. Credife began operations in June 1999, and within two years it had a portfolio of $3.5 million and over 9,000 clients. By June 2005 it had almost 38,000 active clients and a portfolio of over $53 million. Loans averaged $1,409 in 2005, evidence that the bank is reaching its target population of microentrepreneurs. Impressively, the bank achieved its monthly break-even point after just 18 months of operations—during the worst economic crisis in Ecuador in a century. This experience has influenced other banks in the region, such as Banco Agrícola in El Salvador, which has started a microcredit program as a way to extend its services to underserved population sectors (López and Rhyne 2003). Many recent bank experiences in microcredit grew out of largescale consumer credit operations. The growth of consumer lending was one of the first results of the initial increase in competition in the financial sector in the mid-1990s, when consumer credit technologies based on credit scoring were first introduced by specialized agencies and international banks. Chile was the first Latin-American country where large-scale consumer credit was introduced and consolidated, enabled in large part by earlier structural reforms in the 1980s. This provided a platform for Chilean financial companies to enter other countries in Latin America such as Argentina, Bolivia, Ecuador, Paraguay, and Peru (see Marulanda 2000). Large-scale consumer credit is appropriate for the salaried population regardless of income level, but particularly suitable for medium- and low-income earners with wages of $150 to $200 per month. Consumer credit offers financing for a broad range of uses and is repaid through fixed monthly payments covering capital and interest, with credit cards available for clients with satisfactory credit histories. In general, loans range from $500 to $1,000, with repayment
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periods of 18 to 36 months and interest rates set by market forces and competition. This product does not normally require guarantees or cosigners. It is marketed through aggressive promotional practices by sales people who are paid a low fixed salary and commissions based on the amount of loans disbursed. One weakness is that incentives are not linked to recoveries and default rates because sales representatives do not maintain contact with customers. Credit officers perform an initial check of minimum eligibility criteria, but all information is subsequently analyzed by credit-scoring methodologies to determine whether the person is a qualified borrower and what the size of the loan should be. This process also includes checking credit histories through a credit bureau. Modern consumer credit techniques make it possible to respond to loan applications in two to three days. Collection and recovery of the nonperforming portfolio is addressed by a different team, even using outside collection companies, which are paid by the commissions they charge on the amounts recovered. There is greater tolerance of arrears than in the best microcredit practices because of the nature of the targeted population. Because of this, consumer loans have higher rates of nonperformance than microloans and commercial loans. Consumer credit and microcredit often occupy the same market niche, both having high operating costs, small loans, and catering to low-income families in the formal and informal sectors. They differ in the origin of the funds used to repay the loans. In microcredit, productive activities generate the cash flow necessary to repay the loan, while in consumer credit, the most common repayment source are wages. Moreover, microcredit normally finances the informal sector of the local economy, while consumer credit targets the formal sector. Both types clearly permit greater outreach by providing credit to low-income and poor people, thus increasing and reinforcing the financial system. Despite some apparent similarities, microcredit operations need to be designed differently from consumer credit, as it is these very differences that determine the risk profile of the loans. The region has experienced several situations where these separate characteristics were not adequately assessed and where massive consumer credit programs
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were put into place. The previously mentioned case of Bolivia is a case in point in which large-scale consumer credit led to over-indebtedness among microentrepreneurs.5 But there are also successful examples of microfinance evolving from a consumer credit model. In Chile, Banco Santander’s acquisition of Financiera Banefe, a consumer credit provider, resulted in development of a successful microfinance program (see USAID 1998). In Paraguay, microfinance operations developed out of consumer credit offered by finance companies that incorporated appropriate microcredit technologies.6 In Peru, two major banking institutions entered the microcredit field, having adapted and learned from the consumer credit crisis how to develop a solid microlending operation. In 1997–98, the consumer credit system collapsed, after suffering from extreme competition, overleveraging of clients, and a macroeconomic crisis. Banco del Trabajo and Financiera Solución/Banco de Crédito were survivors. These institutions now have large and growing microlending institutions. Banco del Trabajo belongs to the Atlas Cumbres Group and has investments in financial institutions in Costa Rica, the Dominican Republic, Ecuador, and Guatemala. Since its inception in 1994, Banco del Trabajo has targeted consumer loans at salaried medium-low and low-income individuals. Today it defines its mission as one of providing financial services and solutions for employed and self-employed individuals in middle- and low-income groups in Peru. Banco de Crédito began its work with microentrepreneurs through Financiera Solución, which was affected by the aftermath of the Peruvian crisis in the consumer loan industry and the over-indebtedness of the country. Financiera Solución decided to focus on the microenterprise sector, starting out by buying a loan portfolio from two failed consumer credit institutions. After absorbing Financiera Solución in 2004, Banco de Crédito participated in this market directly, and has garnered 35 percent of the nation’s outstanding loans (box 3.1).
5 6
Chilean finance companies introduced consumer credit in Bolivia.
IDB’s micro-global program trained these institutions in microcredit technologies and have influenced their move into the microcredit business.
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Box 3.1 Consumers and Microcredit: The Case of Banco de Crédito in Peru Banco de Crédito (BCP) is the leading bank in Peru, with 35 percent of the country’s loans and 37 percent of deposits, 209 network offices countrywide, and 115 offices in Lima. In 1996, BCP founded a subsidiary to provide consumer credit, Financiera Solución. After the 1997–98 financial crisis, the subsidiary changed its consumer focus to independent microentrepreneurs supported by the bank’s network. It combined consumer credit procedures with new and specialized microfinance methodology; thus using a hybrid approach. Financiera Solución’s microenterprise portfolio jumped from $33 million to $62 million from March 2001 to December 2002, matching the portfolio of its main competitor and Peru’s microfinance leader, MiBanco (see chapter 2). Moreover, in the same period, that portion of BCP’s portfolio focused on larger microenterprises increased from $17 million to $41 million. In 2004 Financiera Solución merged with Banco de Crédito. Today, BCP is designing new products and systems to expand its presence in the microenterprise sector and to reduce costs. It is developing specialized credit scoring for microcredit using the bank’s database of more than 10,000 customers. The scorecard includes a combination of demographic factors and business variables. The information allows the bank to visit only those clients who score above a certain threshold, to perform a detailed evaluation of the applicant while pricing the loan according to the customer’s credit risk. This methodology can be applied only to loans with a minimum value of $2,000 because of the cost structure of the product. BCP and Financiera Solución have demonstrated the ability to control arrears, while using technologies that differ from other microfinance institutions that use only microcredit technology.
In Paraguay, Financiera Visión, El Comercio, and Interfisa also redirected their consumer-focused lending into microcredit programs, thanks in part to an Inter-American Development Bank technical cooperation project linked to micro-global lending. Banco Solidario in Ecuador is representative of a different trend. It was specifically established by a group of private Ecuadorian entrepreneurs in 1995 to serve markets neglected by traditional banks. Later, international agencies with a social mission joined the bank as shareholders. Banco Solidario is viewed as a reliable financial intermediary for channeling funds to population sectors that lack access to the formal financial system (see Banco Solidario 2002). The bank first
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focused on small- and medium-sized enterprises (SMEs) to generate sufficient earnings to operate the microcredit portfolio until it reached a self-sustaining level. Several years later, in 2001, Sociedad Financiera Ecuatorial (SFE) was established by Internationale Projekt Consult GmbH (IPC), replicating its Eastern-European microfinance model and technology in Ecuador through its investment company Internationale Micro Investitionen (IMI).7 In December 2004, SFE became a full-fledged commercial bank, Banco ProCredit, a greenfield microfinance institution whose market niche is the microenterprise and SME sector. Other international donors and development agencies also invested in SFE. As of year-end 2002, SFE had a portfolio of more than 5.5 million euros and more than 4,300 clients, despite intense competition from Banco Solidario and other financial institutions (see Mommartz 2002). By year-end 2004, the credit portfolio had grown to $43 million among more than 20,000 clients. In Colombia, Banco Caja Social has followed its own unique path (see box 3.2). Over its 94 years as a financial institution, it has offered financial services to the poorest borrowers in the country. It has serviced the microenterprise sector with savings and loan products since its inception. The bank has always catered to microentrepreneurs by strategically locating its branches close to its customers and designing its savings and loan products to meet their demand. Three main drivers have encouraged the entrance of formal financial institutions and banks to the microenterprise sector. The most important has been market-niche profitability, followed by product and market diversification, and to a lesser extent, fulfillment of a social function. The three drivers work together, each reinforcing the other. Before banks attain profitability in microfinance, and as they are perfecting their methodologies, it is important that they have strong leadership from shareholders and directors with some degree of social commitment, and a strategic interest in expanding services to lower-income clients. The profit motive
7
In January 2005, IMI-Internationale Micro Investitionen AG changed its name to ProCredit Holding AG.
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Box 3.2 A Century-Old Commitment to Lower-Income Clients in Colombia: Caja Sociedad de Ahorros Caja Sociedad de Ahorros was founded in 1911 by Father José María Campoamor as part of the Jesuit community’s efforts to help solve the problem of poverty in Colombia. It operated as a nonprofit savings institution until 1991, when it became a commercial bank. In 1996, the bank changed its name to Banco Caja Social. The institution continues to carry out its original social function as a bank owned by Fundacion Social, a nonprofit agency. Banco Caja Social is one of the largest and oldest microfinance institutions in the region, operating for 94 years by channeling public savings to microenterprises and lowincome people in rural areas, and higher-income individuals in urban areas. It currently has a network of 122 branches in 42 cities. In 2003, it had more than 1 million savings accounts, 226,000 lending clients (40 percent loaned to microentrepreneurs), and a $159 million portfolio for the self-employed sector, where almost half of the borrowers earn less than 2.5 times the minimum monthly wage. Banco Caja Social has an excellent financial structure based on savings accounts. These accounts, together with a loan portfolio targeting different-sized companies, allow the institution to service the microenterprise sector at a reasonable cost. Nevertheless, its lack of specialized microfinance technology prevented the institution from increasing its support for the segment of microentrepreneurs without access to the financial sector, which has resulted in an average loan size of $1,770. As of July 2003, 5 percent of its loans were given to microentrepreneurs with no previous credit history. Just 2.3 percent of the overall portfolio is more than 30 days in arrears. The bank has developed a loan product to finance the purchase of a lot, site preparation, expansion of construction on previously owned lots, and/or remodeling for productive purposes. The experience has been very successful commercially. This product is generally offered to clients with a good track record at the bank, since in 80 percent of the cases there is no guarantee provided. This portfolio has climbed to $52 million (figures are not available on the amount going exclusively to microentrepreneurs). Source: Tissot (2003).
is a necessary but not sufficient reason to introduce and consolidate these operations within commercial banks. A 2001 survey appeared to confirm that banks’ motives are linked to shrinking financial spreads and the need to seek more profitable niche markets (Valenzuela 2002).8
8
The survey found that large banks see an opportunity for market diversification in this sector, but smaller banks and public banks see it as a need to fulfill a social responsibility.
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Some banks are motivated by competition to seek new markets to maintain profitability. That is the case with multiple service banks. They reach out to new clients by providing savings accounts and other financial products, thus moving from a single-product approach to a multi-product approach for client services. This shift has happened initially with larger microenterprise clients, as banks expand deeper into the sector as they gain experience in the field. One example of how a full-service oriented bank expanded into microcredit by following the needs of their clients is Sogesol in Haiti, a subsidiary of Sogebank. Forty percent of the bank’s funding was from passbook savings account holders, of whom 40 percent were self-employed individuals. Demand from these clients created the stimulus to open a line of microcredit products. At that time, there was strong competition for other market segments because of the financial liberalization in Haiti and reforms introduced in the mid-1990s, such as the removal of the cap on interest rates. Offering large-scale microcredit operations helped strengthen the reputation of Sogebank as a socially committed business leader, accountable to its community and clients (see Boisson 2002). Bancolombia, Colombia’s largest bank, followed a similar path, evolving from services for small- and medium-sized businesses into microfinance in 2001. The microenterprise portfolio had such good financial results that the directors decided to adapt the bank’s products and processes to the needs of microcredit to better serve that market. State-owned banks also began incursions into microfinance, but they were driven by government policies designed to fill a void perceived to be left by private banks. Examples include Banco Estado in Chile and Banco do Nordeste in Brazil. These institutions shared five salient features, according to Valenzuela (2002): stable and strong leadership, business orientation, protection against political interference, strong community presence, and good reputation. Banco Estado was also driven by its substantial outreach, extending to 12 million savings accounts: some 78 percent of the Chilean market. Such a strong client base made the transition quite easy (Banco Estado 2002, 2003a, 2003b, and 2003c). Under the leadership of its president, Banco do Nordeste entered new
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markets, allowing the bank to consolidate in the northeast region. It was supported by the World Bank, which sought to identify an opportunity to promote microfinance in Brazil, where the industry had not been successful and where few NGOs had even operated.9
Various Models of Microfinance Organization Most banks entering the microcredit sector quickly realize that traditional banking technologies are not appropriate for this market. In most cases, they completely separate the microenterprise portfolio from the rest of the operations. This can solve some problems but create others. It is difficult to integrate the best practices of microcredit operations for controlling credit risk and reducing operating costs into traditional commercial bank operations. Microfinance institutions have a salary structure, remuneration system, portfolio management, and recovery mechanism that differ widely from traditional banking. Loan administration and collection efforts are also extremely labor-intensive and costly, resulting in the need to charge high interest rates, a practice that could give the bank an image of being very expensive. Perhaps the most difficult adaptation of the two methods is the combination of marketing and credit functions into a single account manager, a best practice in microfinance, but not typical for commercial banking. As a result of these differences, commercial banks have designed different organizational models to reach the microcredit market while overcoming the internal impediments that can arise when a new credit culture is introduced into the same institutional structure. These models vary, depending on the size of the bank and its social commitment to the poor. Some banks have created new divisions within their institutional structure. Others have established a financial subsidiary or a service subsidiary that acts as a contact channel with microentrepreneurs. Some have integrated the operations within the bank itself. Others have formed partnerships with NGOs. 9
In Brazil, microfinance has not taken hold as a significant participant in the financial sector, even through NGOs.
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The larger the bank, the more difficult it is to integrate microcredit into the bank’s formal structure. Traditional banks have rigid guidelines, so it is difficult to introduce a new business model, particularly one as radical as those used in the microfinance sector, where many small loans must be managed efficiently and profitably. In a large bank, the importance of microcredit operations is overshadowed by the large volume of traditional operations where the bank’s administrative and recovery capacities are concentrated. Small banks tend to be more flexible than larger ones and thus can integrate microcredit operations more easily. Smaller banks have a larger percentage of their portfolio in microcredit, and therefore have a larger incentive to assimilate microcredit technologies into their traditional banking operations. It is also easier to integrate microlending into a structure designed for consumer credit since the institution’s information and commercial systems are designed to support many small operations. The introduction and evaluation of microlending operations into a bank requires pilot tests before they can be fully launched and integrated on a larger scale.
Integrating Microcredit into Banking Operations Banks that have developed microcredit operations inside the bank’s structure benefit in several ways: the operations are less costly; the new team can interact easily with other bank employees; and risk management control is easier. In most cases, the program is first implemented in a pilot branch and later extended regionally or nationally in all branches. The rest of this section includes examples of this structure in different countries throughout Latin America. Banco Solidario in Ecuador is a successful example of integrating microfinance into a bank. The bank initially focused on SMEs, with its long-term mission to service the microenterprise sector, particularly lowerincome and poor people. In late 1999, the bank’s microenterprise portfolio accounted for 18 percent of the total loan portfolio of the bank. By June 2005 this share had increased to 62 percent. By late 2002, the situation had
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reversed; the microenterprise portfolio accounted for 46 percent of the total, while the SME portfolio accounted for 20 percent (see box 3.3). Banco do Nordeste, a public bank in Brazil, started its microfinance program as an independent department within the bank called Crediamigo. It was not structured as a subsidiary, partly because the bank was a government-controlled public institution. The Crediamigo program was developed within the bank’s structure but with considerable autonomy, including subcontracting of loan officers to reduce salary costs. The program started in 1998 with great success, and the bank quickly expanded its microfinance pilot program from five to fifty branches. However, shortly thereafter arrears soared because of poor incentive systems. Initially, the banks officers’ salaries depended only on the number of loans made, ignoring repayment performance. In response, the bank curbed its explosive growth and implemented a more modest program of slow and steady growth, placing it on the path to become one of the largest microlending programs in Latin America.
Box 3.3 Banco Solidario of Ecuador: Commitment to Microenterprise Banco Solidario was founded in 1995 as a finance company (Enlace), the first private financial institution in Ecuador established to service the microenterprise sector. It became Banco Solidario in 1996. The initiative came from Fundacion Alternativa, a social organization that promoted the bank, and three private investors. Foreign investors later joined as shareholders, including ACCION International (a technical advisor since 1996), the Andean Development Corporation (CAF), Care-Ecuador, ProFund International, and Seed Capital. The market niche defined by the bank comprises more than 60 percent of the economically active population in Ecuador, who work in urban and rural socioeconomic sectors with little access to the country’s traditional banking system. The array of lending products designed for companies of different sizes permits the bank to offer financing for microentrepreneurs throughout their development and growth process. The bank has 12 points of sale in low-income urban locations, and a strong portfolio of microhousing loans, as part of a housing promotion program undertaken by the Ecuadorian government. Banco Solidario was able to mobilize savings from 14,000 clients in the first stage of this program. The bank has also designed a model that allows it to offer lower-cost housing products, thus enabling families to combine a government subsidy with a direct private loan. As of December 2005, the bank had 148,712 clients and a portfolio of $183 million, with an average loan of $909.
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Banco del Trabajo in Peru expanded its coverage to the microenterprise sector as an extension of its consumer credit program. It introduced major changes in its risk evaluation model, in particular adding visits to clients to obtain necessary information to estimate their ability to pay. In December 2005, it had a portfolio of $124.4 million in loans to microenterprises with 78,000 clients and 40 percent of the bank’s total portfolio (Banco del Trabajo 2005). The bank’s shift to microcredit was carefully planned through new methodologies for client contact, a new technology platform designed for a large array of products, a strategy of establishing branches in working class areas in Peru’s largest cities, and an incentive-based system for loan officers. The bank maintained a total separation between loan origination and risk analysis, with loan collections performed by people who did not belong to the sales force, unlike the typical microcredit technology. The development of microfinance in the bank has improved traditional bank business by lowering its arrears from 8 percent to 5 percent. This strategy has also been adopted by finance companies that try to diversify beyond their consumer credit business. That is the case for Interfisa and Financiera El Comercio in Paraguay. These two institutions entered this market niche after receiving an IDB loan and technical assistance directed at mitigating the deep financial crisis in Paraguay. That crisis forced finance companies to seek different market sectors to diversify their portfolios and reduce risk. Banco Agrícola in El Salvador is another example of a bank that has developed a strategy for serving microentrepreneurs through a structural division. However, it has been a slow process. As of June 2003, the bank’s portfolio was $11.6 million, serving 3,224 clients while still receiving funding from USAID and technical assistance from Development Alternatives, Inc. (DAI).
Creating Subsidiaries Some banks have decided to develop microlending operations through a legally and institutionally separate entity such as a subsidiary. The creation of a subsidiary to explore the microcredit market is an enormous
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undertaking, so banks tend first to develop a pilot product within their organizational structure and later decide whether or not to set one up. In this type of initiative, the services of technical advisors specialized in microcredit are important for the viability and sustainability of the project, both in teaching the bankers and creating new products and services together to meet client needs. There are two types of subsidiaries: financial and service subsidiaries. Financial subsidiaries. A financial subsidiary takes its microcredit operations outside the parent company, but the parent company participates in the decisionmaking process and provides total or partial funding for the new venture. This model allows financial services to develop independently from the bank. This was the case of Financiera Solucion, a subsidiary of Banco de Credito of Peru, which was converted from a consumer credit institution to one offering microcredit. This is a viable and perhaps required institutional arrangement for financial groups that decide to specialize in this market sector. However, no commercial bank has opted to create a new financial intermediary to enter the microenterprise sector, according to available information. Service subsidiaries. A service subsidiary is a legally and institutionally separate institution that provides the bank with the services of establishing and managing a microcredit portfolio in exchange for a commission. In this case, loans are booked on the bank’s financial statements. The main advantage of this arrangement is that all personnel managing micro-lending operations are hired and paid by the service company and not the bank, thus allowing it to sidestep the difficulty of adapting the labor and remuneration plan to the rigid structure of the traditional bank. It also does not require authorization by the financial supervising authority, which means that the capital necessary to create this type of subsidiary is less than that needed for a supervised financial institution. This model uses the bank’s infrastructure and receives operational support, but has a separate identity vis-à-vis its clients—although it benefits from links to the bank’s name and reputation.
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Banco Estado in Chile is a State-owned bank that structured its microlending operations as a service subsidiary because of the inflexibility inherent in a public bank’s labor structure (box 3.4). The bank developed its technology in-house but also introduced radical changes in the processes and systems department and in the human resources area. The subsidiary operates out of the bank’s offices, but with an independent staff. Its systems are fully integrated with the bank’s, and it
Box 3.4 A Case of Downscaling: Banco Estado in Chile Banco Estado was founded in Chile in 1953 with the mission of promoting access for small businesses and microenterprises to the financial system. In 2005, the bank had 312 branches, 75 remote service points, 12 auxiliary banks, two mobile banks with an automated service network including 813 automatic teller machines (ATMs), and 289 safety deposit boxes. The bank started its downscaling program as it sought new market opportunities that could tap the advantages of its close relations with microentrepreneurs. The bank opted to establish a special unit to consider the profile of microentrepreneurs and their needs, which differ from traditional clients. The bank hired personnel with the appropriate professional profile to develop microfinance products and services and work in the field, introducing technological changes to adjust to economies of scale and reduce transaction costs. Banco Estado of Chile Microenterprise Results, 2005 Client portfolio
168,829
Disbursed loans since inception
462,549
Disbursements
$ 676 million
Outstanding loans
$ 250 million
Arrears
1 percent
Source: Banco Estado.
The bank provides technical and physical infrastructure to the subsidiary managing the microcredit business. Today, the subsidiary has 70 branches, 36 percent in urban areas and 64 percent in rural locations. The subsidiary provides traditional loans and also services the microenterprise sector with loans to farmers and inshore fishermen. It also provides credit cards, electronic accounts, and insurance.
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relies periodically on the bank’s improvements in technological implementation and risk evaluation. Multicredit Bank in Panama, a pioneer in downscaling, has not succeeded in establishing a subsidiary. It created Acción Empresarial, but soon after ceded portfolio management back to the bank in 1999. As of December 2002, the portfolio of loans under $3,000 amounted to just $600,000, with only 709 active clients and an arrears ratio of 59 percent. Sogesol, a subsidiary of Haiti’s largest bank Sogebank, is a special case. The bank already had subsidiaries to carry out consumer credit operations but decided to launch a microcredit program with a new subsidiary. Its experience with other subsidiaries showed the plan was justified, as it allowed the possibility of motivating staff more directly, maintaining a radically different business culture, and attracting new investors. Sogesol was established as a joint venture with Sogebank (35 percent), ACCION International (19.5 percent), ProFund Internacional S.A. (20.5 percent), and a group of local investors (25 percent). This subsidiary initiates and manages the portfolio, but loans are booked on the bank’s balance sheet. It does not share the bank’s branch network, but its offices are located near the bank’s branches. Its information systems are independent and adapted to microcredit requirements, but it is interconnected with the bank’s system. Sogesol receives a variable commission based on the operating and financial costs of managing the portfolio. Sogesol is planning to offer savings products, money transfers, and other financial services to its clients. Currently, it operates in six of the bank’s thirty branches, with a portfolio of $5 million and almost 7,000 clients. It broke even with its start-up costs after only 20 months in operations (López and Rhyne 2003). Banco del Pichincha in Ecuador confronted a highly competitive microfinance environment, with many players such as Banco Solidario, Sociedad Financiera Ecuatorial (Banco ProCredit S.A.), and a handful of NGOs. The bank decided to enter the microfinance sector by establishing a specialized subsidiary in association with ACCION International as technical advisor and investing partner, while taking advantage of its own extensive network of branches and position as the country’s lead-
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ing bank. The subsidiary, called Credife, has made some of the bank’s branches profitable. In Brazil, Realmicrocredito Assesoria Financiera S.A. was established as a services company for Banco ABN AMRO REAL S.A. in 2002. The bank holds 80 percent of the shares and ACCION International holds the remaining 20 percent. The bank appoints the company’s general manager, while ACCION appoints the commercial manager. This subsidiary has faced major competition from finance companies, supermarket chains, and other large stores offering similar products. As of June 2005, the institution had 5,945 clients, a portfolio of $3.1 million and an average loan of $519. The services subsidiaries have not developed clear strategies to supply other financial services because it is unclear how they would be compensated and because the parent company already has a number of these new microcredit clients as depositors. A key element for the success of subsidiaries is the interface between the bank and the subsidiary and its acceptance at the branch level, particularly when the two finance institutions share the same infrastructure. This is the most recent model and will have to demonstrate profitability and good results in the coming years. Ultimately, the objective will be for the subsidiaries to be absorbed by the parent bank once the methodology proves profitable.
Forging Strategic Alliances Strategic alliances have been an alternative used by banks exploring the microfinance sector to reduce development and transactions costs. Some banks have entered the sector supported by or in partnership with NGOs, taking advantage of their knowledge while offering the bank’s leverage capacity. In pure partnerships, the NGO simply introduces microentrepreneurs to a bank and the bank grants them credit. The NGO offers support once the loan is disbursed and receives a commission from the bank. In other instances, the NGO assumes part of the credit risk through a lower commission as risk increases, or through a contractual
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agreement with the obligation to buy back the nonperforming portfolio if it exceeds a certain level. Another type of partnership exists where banks grant lines of credit to NGOs, which they then lend, assuming the portfolio risk for their own account. This case has worked successfully in Colombia, where serious institutions such as the five affiliates of Women’s World Banking (WWB) have received funding from commercial banks that enabled them to grow at a faster rate than similar institutions located in other parts of the region. Through this mechanism, banks are able to expand and diversify into new markets without acquiring the know-how necessary to enter the market directly. This option is mainly used by banks that want first to increase their business volume and second to learn about the sustainability and profitability of the microfinance sector perhaps to enter the market directly at a later time. Bangente in Venezuela followed a different approach. Three NGOs (Fundación Eugenio Mendoza, Grupo Social CESAP, and Fundación Vivienda Popular) formed a partnership with Banco del Caribe and several other international investors (ACCION International, CAF, the Multilateral Investment Fund, and ProFund). By December 2001, the partnership had a portfolio of $7.4 million and 5,221 clients, but had not turned a profit. Since then, the performance has improved and Bangente has achieved a satisfactory outreach (18,706 active clients as of June 2005), high asset quality, and profitability—despite the complex regulatory framework in which it operates. The founding NGOs were not able to transfer any loans to Bangente. As Bangente evolves, Banco del Caribe has become the major shareholder. This type of business model has not been particularly successful, suggesting that if banks want to partner with NGOs, they should do so only with solid and sustainable NGOs. This can be a first stage to explore microfinance.
Microcredit: Special Technology Needed Throughout the evolution of microfinance, financial sustainability has been attained only when institutions have applied special tools and procedures
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for controlling credit risk. One of the main barriers to the provision of bank resources to the microenterprise sector is the fact that companies in the sector tend to be informal. This informality makes it difficult to obtain timely, sufficient, and reliable information on their financial conditions and credit histories, thus raising the perceived risk profile. The sector does have greater access to other formal financial services such as savings and remittance transfers, since the risk in taking savings is lower than the risk in making loans. History illustrates the difficulties of using traditional credit techniques and procedures when attempting to serve the microfinance market. A significant drawback is that traditional approaches assume a minimum degree of formality and the availability of information through traditional mechanisms. Information on formal activities is available through financial statements and income tax returns. This is not the case with informal activities, so financial institutions need to use their sales forces to compile reliable and timely information about prospective clients. Credit history in the informal sector relies simply on the last transaction or evidence of payments received from clients. This is why financial institutions begin by loaning small amounts of money, increasing the loan size as the clients build credit and track record. The biggest failures in the sector have occurred when bankers relied on traditional banking procedures, particularly those used in the consumer loan market. Since consumer loans have similarities with microcredit (both are products with large numbers of very small transactions), people tend to believe consumer loan procedures will work as effectively with microloans. However, the two products are very different, as are the type of markets being served. A typical consumer loan granted by a bank goes to the salaried population in the formal sector, while microcredit is for microentrepreneurs operating in the informal sector. The main difference is the origin of the sources that will be used to repay the loan—and not the purpose for which the loan was granted.10 10
The differentiation made for the purpose of portfolio rating and classification should be between “loans to salaried workers” and “loans to microentrepreneurs” and not the distinction between “consumer credit” and “microcredit,” because the latter may include loans to microentrepreneurs that finance consumer products.
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Banco Económico and Financiera Fassil in Bolivia illustrate the problems that arise when traditional risk assessment systems are not readjusted to the reality of microfinance (Poyo and Young 1999). Both institutions were successful in the traditional banking industry, but both failed in their attempts to service the informal microenterprise sector. Other institutions that opted to establish services subsidiaries did so with the conviction that they needed to adapt their procedures for risk assessment, client contact, and portfolio management and recovery. For example, Sogesol in Haiti applied standard microcredit technology provided by ACCION International and first funded by the Multilateral Investment Fund to cover the cost of assistance and start-up business development. Banco del Pichincha and its subsidiary Credife also implemented a typical microcredit technology program. Banco do Nordeste is one of several financial institutions that applied solidarity group technology, based on advice from ACCION International, and funding and support from CGAP and the World Bank. Results of the bank’s microfinance program show the growth rates possible in a banking institution with a large network of branches (figure 3.1). In late 2004, Banco Nordeste had 163,000 clients, a portfolio of $40.2 million, and an arrears ratio of only 1.88 percent, with an average loan of $250. Banco Estado of Chile, through a subsidiary, applied several of the basic principles of microcredit technology for individual loans. It also took advantage of the bank’s knowledge of risk assessment to refine its methodology to increase efficiency and reduce transactions costs. More recently, it has been planning its access to clients through geo-referencing programs, thus improving the analysts’ efficiency in their fieldwork. It is also exploring different remuneration programs, including performance bonuses—not based on individual performance but instead on team performance across branches. It is also using mobile phone communications technology to improve efficiency in rural markets. Banco Solidario and Sociedad Financiera Ecuatorial (Banco ProCredit S.A.), both established to serve the microfinance sector in several countries of the region have implemented microcredit technologies
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Figure 3.1 Growth of a Multi-branch Bank: Banco Nordeste-Crediamigo 60
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since their inception, assisted by ACCION International and IPC, respectively. For instance, experience has taught microlending operations the importance of obtaining and validating the client’s information through site visits. Financiera Solución in Peru maintained a division of functions between those with risk assessment and evaluation responsibilities and those with commercial responsibilities. This system is more expensive to operate, requiring a high initial volume of clients to reap economies of scale, but it enforces the bank’s risk control and assessment techniques and prevents fraud. Site visits to clients were introduced to evaluate the client’s ability to pay based on total income and expenditures. Loans are structured with shorter tenors, enabling clients to build credit history through successive loans as they are fully repaid. The results have yielded a dramatic decrease in the arrears ratio as the number of loans continues to increase (see box 3.1). Banco del Trabajo of Peru and Banco Caja Social in Colombia are examples of institutions that have made few adaptations in their
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microfinance programs. Banco del Trabajo uses its consumer loan technology with few adaptations. However, it had problems predicting client performance from its standard credit-scoring models. The bank also chose to collect information through site visits to clients, unlike the process used for their loans to salaried workers, which involves only the compilation and validation of information and the use of creditscoring results. The bank increased its loan portfolio from $30 million in June 2001 to $72 million in December of 2002, increasing its client base from 25,000 to 78,600. With an average loan of $1,200 and an arrears ratio of 5.7 percent, it has become a major microfinance player in the country. Banco Caja Social in Colombia serves the microfinance sector with the same product it uses for all its clients, although it has somewhat higher-than-average loans for microfinance. Normally, it provides a threeyear loan at a fixed rate with set monthly installments and a cosigner as the only guarantee. Credit capacity is assessed through a credit-scoring methodology, but the information is compiled through site visits. The bank is developing a new credit score system for self-employed customers that is expected to increase efficiency and portfolio quality while reducing transactions costs, credit risk, and arrears. The bank requires all borrowers to open a savings account, so that loan installments can be automatically debited from the account. In most cases, credit-scoring systems are adapted to include relevant variables for microenterprises. The advantage of microfinance credit scoring is that visits are not paid to clients who fall within an acceptable risk rating, thus reducing time and resources in the client-selection process. Banks continue to stress the importance of standardizing methodology to facilitate implementation of new technologies while reducing the subjectivity of loan officers in approving loans.
Conclusion Commercial banks have shown a renewed interest in providing financial services to the microenterprise sector, including credit. There are many players with different business objectives, organizational models,
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and credit technologies used by financial institutions, subsidiaries, and banks—some more successfully than others. But there is no one single solution, model, or credit technology that can be successfully used throughout Latin America. Countries across the region have experienced different financial crises during the last decade; they have different regulatory systems, different banks with different missions and objectives, and different customers with different needs. The success of sustainable and profitable microfinance institutions has drawn the attention of formal banks to this sector. The development and consolidation of these institutions have shown that microenterprise credit is indeed a profitable and large potential market, where credit risk can be controlled. Institutions such as the Multilateral Investment Fund and Inter-American Development Bank have helped actively disseminate information on country and company case studies, as well as developing and implementing innovative technologies and effective delivery channels. There is some risk that financial players may leave this market, given the challenges to attaining profitability. But there are banks and financial institutions that have been very successful in this field. These include Banco do Nordeste (in Brazil); Banco Estado (in Chile); Banco Caja Social (in Colombia); Banco Solidario, Sociedad Financiera Ecuatorial (Banco ProCredit), and Banco del Pichincha (in Ecuador); and Banco de Crédito (in Peru). Microcredit operations have reached a significant level of development and sophistication, thanks in part to the experience of informal financial institutions. However the possible contribution of commercial and traditional banks is important to help sustain the sector by providing a full range of products and services on a large scale while reducing transaction and financing costs. The examples above illustrate how the outreach and deepening of this sector can increase more rapidly if banks continue to participate in microfinance development. Multilateral agencies and local governments should continue to promote viable microfinance organizational models and help facilitate the downscaling efforts of traditional banks, which can increase product offerings and reduce intermediation costs. First, when introducing new products and services, banks have the capacity to break even more
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quickly; they have more readily available funds for faster growth; and they have a wide network of branches to capture savings and new clients. Traditional banks can also dilute the cost of entering new niche markets by using existing infrastructure and in-house loan officers and management. All these could translate into lower interest rates for microfinance clients, depending on the degree of market competition in each country and area. Second, even though the upgrading model followed by informal microfinance institutions enables them to provide a full range of products and financial services, banks can provide these products and services more efficiently. Commercial banks, with their experience in large-scale attraction of resources, have the know-how and physical and technological infrastructure necessary to channel lending products to existing savings clients. Most banks have broad geographic coverage with many savings customers, which gives them the advantage of being able to use the savings history of clients to assess credit risk. The most important factors determining the downscaling success of traditional banking institutions are positive government involvement with no interference; specialized and adapted microcredit technology; comprehensive, long-term commitment; and participation by banks, their partners, and shareholders. The government must focus on correcting the nonprofit mentality of many financial institutions that provide microcredit. In some nonprofits, a culture of nonpayment can exist, making it difficult for new players to attract new investors and clients. This situation can also negatively affect the formalization process of NGOs, which serve the same clientele and must be accountable for savings mobilized from the public. Thus the government should abstain from offering financial subsidies to failing institutions and relaxing rules for credit risk control. An inadequate regulatory and supervisory framework makes it difficult to introduce microcredit operations into the structure of traditional banks and often leads to the withdrawal of banks from the microfinance sector. A number of bankers are still apprehensive about the politicization that could occur in this sector, which could entail financial subsidies and/or the relaxation of rules for credit risk control, as is occurring in several countries in the region.
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Certain aspects of the regulatory framework governing the formal financial sector are key factors for determining access to the microfinance sector, such as the deregulation of lending and borrowing rates (which allows the market system and competitive forces to dictate prices reflecting various risks). Also, a basic understanding of microcredit operations is required to develop an appropriate system for portfolio rating and classification to determine reserve requirements. Governments as well as banks need to understand that many people have no access to the formal financial sector primarily because of lack of recorded information needed to evaluate credit risk, rather than a lack of guarantees. Governments should promote the creation of credit bureaus that can obtain information from sources other than formal financial institutions. Financial institutions should also be made aware that microcredit can be sustainable even without guarantees. Even more important, microcredit needs appropriate technologies to evaluate repayment, and products that encourage and reward repayment, thus increasing client accountability to financial institutions. Bankers and other formal financial institutions must adapt traditional banking practices, products, and services to meet the needs of microentrepreneurs; failure to apply appropriate microcredit technology has weakened the efforts of many institutions. Although microcredit programs may achieve large-scale operations (they have no problem with funding), the portfolios of many banks have deteriorated rapidly and banks have had to halt and reengineer their microcredit programs. It is important to continue promoting the dissemination of success stories among bankers, emphasizing best practices. The focus should be on supplying a full range of financial services. The efforts made to date to promote the linkage of regional financial institutions in international remittance transfers provide an example of the expanded supply of products that these institutions can use to improve the standard of living of the region’s microentrepreneurs and their families. Persuading formal financial institutions to become involved is undoubtedly the main challenge for the microfinance industry in the coming years.
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References Banco del Trabajo. 2005. Memoria. Lima. Banco Estado. 2002. Desarrollo de un programa de microfinanzas. La experiencia del Banco Estado. Santiago (December). ———. 2003a. Bancos comerciales que implementaron el microcrédito y operan bajo subsidiarias. Seminar on Successful World Practices in Microfinance. Cartagena de Indias (March). ———. 2003b.Pasantía agrocapital Bolivia. Santiago (April). ———. 2003c. Desarrollo de un programa de microfinanzas. La experiencia del Banco Estado. Santiago (June). Banco Solidario. 2002. General Report to Shareholders. La Paz (December). Boisson, Pierre-Marie. 2002. Presentation to the panel discussion on microfinance commercialization at the Fifth Inter-American Forum on Microenterprise, 9–11 September, Rio de Janeiro. López, Cesar, and Elisabeth Rhyne. 2003. El modelo de compañía de servicio: Una nueva estrategia para los bancos comerciales en microfinanzas. Insight Núm.6 (August). ACCION International. Marulanda, Beatriz. 2000. Aquí viene la banca comercial. In Dinero seguro: Desarrollo de cooperativas de ahorro y crédito eficaces en América Latina, eds. Glenn D. Westley and Brian Branch. Washington D.C.: Inter-American Development Bank. Mommartz, Rochus. 2002. Criteria and Proceedings of an Investor: The Experience of IMI AG. Presentation to the Savings and Credit Forum, 22 November, Bern, Switzerland. (http://www.intercooperation.ch/finance/download/) Poyo, Jeffrey, and Robin Young. 1999. Commercialization of Microfinance: The Cases of Banco Económico and Fondo Financiero Privado FA$$IL, Bolivia. Washington, D.C.: Development Alternatives. Rhyne, Elisabeth. 2001. Mainstreaming Microfinance: How Lending to the Poor Began, Grew and Came of Age in Bolivia. Bloomfield, Conn.: Kumarian Press. Tissot, Patrick. 2003. Microfinanzas: Presentación Banco Caja Social. Presentation to the I Jornada de Sensibilización en Microfinan-
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zas, 9–10 October, Bogota. (http://www.asobancaria.com/index. jsp) USAID. 1998. Report of the Conference on Banking Institutions that Provide Microfinance Services. Santiago. Valenzuela, Liza. 2002. Getting the Recipe Right: The Experience and Challenges of Commercial Bank Downscalers. In The Commercialization of Microfinance: Balancing Business and Development, eds. Deborah Drake and Elizabeth Rhyne. West Hartford, Conn.: Kumarian Press. Westley, Glenn D. 2001. Can Financial Market Policies Reduce Income Inequality? Sustainable Development Department Technical Papers Series. Inter-American Development Bank, Washington, D.C. (October).
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Regulation and Supervision of Microcredit in Latin America Ramón Rosales
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ifteen years ago, vendors in the street markets of Lima, La Paz, and San Salvador had only one convenient financing option: shortterm credit at high interest rates from informal lenders. Today, several regulated financial institutions serve these markets with credit on much better terms. Recently established institutions that grew up as a result of changes in the financial regulatory system now make most of these loans. Today, a microentrepreneur in the Uyustus Market in La Paz pays an average annual interest rate of less than 21 percent for a dollar-denominated loan. In the Central Market of Arequipa, the rate is close to 50 percent for a loan in domestic currency (soles), although rates have been declining and will likely continue to do so. Before the development of regulated microfinance, rates averaged more than ten times these levels. Nearly 38 percent of all microentrepreneurs in Bolivia now have access to credit; the percentage is also high in Peru. Bolivia’s microfinance industry has developed into a sizeable and sophisticated market, unquestionably the region’s leader. Starting from nothing in the mid-1980s, microcredit had acquired significant weight by the end of 2004, with the presence of 21 lenders in that market segment, accounting for some 11 percent of the financial system’s total portfolio. In both Bolivia and Peru, however, there is still a gap in microfinance coverage, as evidenced by the scant supply of financial services available to the low-income rural population. At the same time, many
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clients in the largest urban centers are overindebted, as a result of the strong competition among microfinance institutions (MFIs), banks, and consumer lenders. In Bolivia, competition led to the relaxation of accepted microcredit technologies, and for a time a large number of loans were granted that outstripped prudent loan-to-asset levels and borrowers’ ability to pay. Indiscriminate growth in consumer loans for self-employed persons, accompanied by a quest on the part of leading MFIs to maintain and/or increase market share, meant that risks were not properly weighed. It is not surprising, then, that levels of arrears have risen over time. Bolivia and Peru were pioneers in establishing suitable regulatory frameworks for microcredit and have made the greatest progress in this area to date. This chapter will focus mainly on the relationship between the development of microfinance and financial reform in those two countries. In the rest of Latin America, developments in microfinance are also clearly linked to changes in regulation and supervision of the financial system. While microfinance was virtually nonexistent in Latin America in the 1980s, today many countries have financial institutions that specialize in small loans, including Brazil, El Salvador, Honduras, Mexico, Panama, and Venezuela. Microcredit has been regulated as a lending activity in its own right in Colombia, Ecuador, Honduras, Nicaragua, and Panama. Draft legislation to establish specialized entities is currently under study in Guatemala and Nicaragua. This chapter will examine recent changes in the regulatory framework and supervisory practices for microcredit and the effect on development of the Latin American microfinance industry. The discussion will highlight the requirements for a financial market that offers broad access to financial services for microenterprises, as well as a healthy and secure market for everyone. The concluding section reflects on future challenges for the regulation and supervision of microcredit. Although microfinance (which includes both savings and credit) is the subject of this book, from a regulatory standpoint, the emphasis is on the lending side of financial services to microentrepreneurs. Thus this chapter focuses on microcredit.
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Microcredit: Definition and Risk Profile There are no uniform definitions for microcredit, microenterprise, and small business in the region. A microenterprise can be defined in terms of the number of employees, the size of its assets, and/or the size of its annual sales, with large differences in magnitude from country to country and even within the same country. Thus statistics are difficult to compare. This book defines microcredit as a small loan (generally less than $10,000) that is not guaranteed (with real collateral), made to self-employed persons (also called microentrepreneurs) who do not keep formal accounts or operating records of their activities (and normally work in the informal sector of the economy). A microfinance institution (MFI) provides specialized financial services—including credit—to microentrepreneurs, although it may serve other types of customers as well. The risk profile of microcredit is substantially different from a corporate or consumer loan, since the two key elements that support a traditional credit decision—formal information regarding the ability to pay and real guarantees—are not available for a self-employed person or a microentrepreneur. The risk profile is also affected by the fact that microentrepreneurs perform activities with limited productivity that do not require many assets, which may make them more vulnerable to market changes and business cycles. In some cases, however, microenterprises can actually be more flexible than larger firms in adapting to changes in the business climate, such as changes in their line of work. The experience of microfinance institutions in Latin America since the 1980s shows that lending to microentrepreneurs is very profitable when a suitable credit technology is used. Otherwise, it can be a risky business, and many unspecialized commercial banks have suffered significant losses when they tried to penetrate this market. There are four key aspects of a suitable technology for microenterprise lending. First, evaluation of a client’s ability to pay hinges on the construction of simplified financial statements that capture information about the interconnected family-business unit and the net worth
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(especially the largest assets) of the business, based on information that is gathered at the place of business by loan officers using standardized data collection and processing procedures. A client’s character is also evaluated by examining his or her credit history and checking references with neighbors and suppliers. Loans are processed quickly. There is systematic follow-up, which reinforces the client’s motivation to repay. This methodology differs fundamentally from the procedures used for traditional credit, in which lending decisions are made based on formal financial information and assets that can be registered and, in the case of consumer or housing loans, on verifying the income of salaried workers. Second, microcredit is often based on a principle of scaling-up to grant new clients small loans, initially, that are within their ability to pay, thus testing their willingness to repay, and then gradually increasing loan sizes for clients with reliable performance. This method leads to the establishment of a long-term relationship between lenders and clients who, if they build up a good record, can access faster loans in larger amounts, facilitating economies of scale for the lending institution. Motivation to honor obligations is reinforced through a firm—even aggressive—attitude toward arrears. It is not unusual for a lender to drop a client who falls more than 30 days overdue in any payment of capital or interest. The institution writes off the loan and the person ceases to be a qualified borrower. Most successful MFIs clearly inform their new clients about their low-tolerance policy regarding late payments and the positive consequences of timely compliance. Third, MFI operations are decentralized. The vast majority of decisions are made by credit committees composed of loan officers and branch managers.1 Successful institutions (with proven credit methodologies and internal controls) manage portfolios composed of thousands of small, uncollateralized loans made to clients in the informal sector, and achieve high recovery rates. Decentralization also extends to the loan
1
This discussion refers only to individual microcredit and not to credit for organized groups, where each member of the group guarantees the loan jointly with the others, and the financial institutions rely on group pressure to ensure repayment.
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portfolio, including daily updates given directly to loan officers on the payment performance of their clients. The timeliness and reliability of information systems thus becomes key to effective MFI management. Information systems are coupled with the application of several layers of internal controls established by branch managers, area managers, head office executives, and finally, the board of directors. Microfinance institutions also need to have effective systems for monitoring credit. If reports on noncompliance and restructuring of loans are late or unclear, the directors and even the managers may be working in the dark, and arrears can spin out of control. Thus it is essential to check the operation of the internal control system periodically and conduct both routine and surprise audits, given that MFI employees have been known to collude and organize frauds that lead to significant losses. Fourth, it is important to promote healthy competition among MFIs, so that they do not relax their credit policies to increase their market share, become embroiled in fights to steal one another’s clients, or succumb to widespread delinquency. There is also the risk that delinquent borrowers may organize pressure groups, seeking large-scale loan rescheduling, lower interest rates, or even debt forgiveness, as occurred in Bolivia.
The Importance of Microcredit Regulation Banking regulations establish minimum conditions for lending activities, with the goal of promoting risk diversification. To protect depositors and creditors, regulations stipulate the maximum amounts that can be lent to a single client, when guarantees are required, the minimum information to be kept on borrowers, and guidelines for charging off loan losses. These requirements are based on the good practices of prudent banks and are fully applicable to corporate or business loans and, to a lesser extent, to consumer and housing loans for employed persons, where verification of job stability is the best guarantee of loan recovery. Regulations throughout the world require banks to analyze proven sources of income that will be used for repayment, and also to require guarantees to back each loan to protect depositors’ money. In the last 20 years in the field of microfinance, regulators have tried to make it legal
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to lend to people who have no real guarantees that can be registered and no source of income certified by a third party. As could be expected, this change in policy has been accompanied by prudential norms for risk management. Recommended requirements for MFIs specializing in microcredit are summarized in box 4.1, and general best practices for credit and risk assessment are summarized in box 4.2. From the standpoint of the general public, an MFI is successful if it expands its coverage, incorporating a growing number of small bor-
Box 4.1 Requirements for MFIs Specializing in Microcredit The following requirements should be considered for MFIs specializing in microcredit: 1. Minimum capital of about $1 million, given the magnitude of losses that the owners could suffer if they neglect the business. This capital base also makes it possible to reach a sustainable scale of operations. 2. Prohibited or strictly limited related-party lending, which concentrates risk and can lead to relaxation of procedures for evaluation and recovery. Operations of this kind also increase the risk of institutional governance problems. 3. Operations at the national or regional level to achieve efficiency and offer competitive rates to clients. An MFI that concentrates its operations in a municipality or small region not only has difficulty achieving high levels of efficiency, but also engages in a dangerous concentration of geographic and sector risk.
Box 4.2 General Best Practices for Credit and Risk Assessment The following practices are recommended for MFIs and other intermediaries when making the decision to extend microcredit. They should be applied to specialized MFIs as well as other intermediaries that wish to enter this market segment: 1. Require clients to have experience as a microentrepreneur, in order to verify the economic viability of their activities. 2. Require provision for a bad debt, beginning on the first day any payment is past due. 3. Prohibit the use of collateral as part of the loan loss provisions, except for duly registered real collateral. 4. Require lenders to book rescheduled loans as past due loans. 5. Require that documentation in client files reflect the information generated through credit analysis, although not all documents required of large borrowers need be included.
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rowers at progressively lower prices; in other words, when more clients are served at lower interest rates, while granting larger loans with longer repayment periods. When undertaking financial reforms, the goal is to make it possible for every enterprise or person with a viable business activity or the ability to pay based on regular income to qualify for credit from formal sources. This goal can be reached if the supply of funds is sufficient to meet demand under market conditions: that is, without subsidies or a biased system that promotes credit irresponsibly to the detriment of the depositor or taxpayer. From the standpoint of MFIs, regulation and supervision are extremely important, since they can be qualified to borrow from depositors and commercial investors, allowing them to establish their own financing base. As a result, they acquire financial autonomy and are free from the fickleness of donors or social investors. In other words, they acquire permanence in the market. Of course, in return, MFIs are required to accept permanent public supervision and comply with prudential standards and rules governing information on their performance. Once they are subject to the same rules and measurements as other financial institutions (net worth, credit limits, loan loss provisions, accounting, rate spreads), MFIs can compete on a fair basis. Access to information about potential borrowers through a credit bureau also ensures that they will better select their clients. Last, the possibility of insuring their deposits bolsters the confidence of depositors, who may even have large accounts. From the standpoint of borrowers, an appropriate regulatory environment gives them, first of all, access to permanent, stable, and growing sources of financing. Competition helps to lower interest rates (through transparent information on current market rates), which allows borrowers to make informed decisions about the institution that best serves their credit requirements. In the end, borrowers do not care much about the type of institution that lends them money; they want to obtain the best financing conditions: that is, amount, rates, terms, guarantees, and timeliness.
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RAMÓN ROSALES
Today it is recognized that a healthy, well-organized, and efficient financial system is necessary for economic development. Since financial intermediaries carry out their lending operations with financing from the public, it is essential to have a regulatory and supervisory system that ensures adequate risk management, evaluates the solvency of financial system institutions, and permits market forces to balance supply and demand. Bank supervision is facilitated by an appropriate legal and regulatory framework that supports the development of a low-risk financial system, a good accounting system in the country, and respect for contracts. On the other hand, the supervisor’s work becomes more difficult when banking legislation permits large loans to be granted to banks with limited capital or whose owners are able to withdraw the minimum capital that the bank uses to operate. Supervision is also complicated when generally accepted accounting principles are not used in reporting bank assets and when the judicial system is inefficient. The supervisor is interested in reducing the cost of financial services, while ensuring the solvency of financial intermediaries. The supervisor does not act as a market promoter, but rather establishes and enforces rules that promote secure operations and the good performance of all segments of the banking sector. Supervision focuses on evaluating how the management of institutions identifies, measures, controls and monitors the risk of its numerous clients each day. In the case of microcredit, the supervisor should be capable of giving opinions on microlending technologies, both when granting licenses to NGOs that wish to become formal financial institutions, and during on-site inspections of institutions with microcredit portfolios. The supervisor will pay special attention to preventing predatory lending, the sale of loans, or abuse of contractual position by financial institutions. Supervisors should also undertake special monitoring of institutions that simultaneously offer consumer loans, microcredit, and small commercial loans. One important tool for the supervisor’s work is a credit bureau to track payment compliance of large numbers of clients and promote fair competition in the market. In many countries, a central credit registry or risk monitoring
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institution (called Central de Riesgos, in Spanish) is operated by the superintendency or central bank, and credit history information is provided directly to financial institutions and private credit bureaus. In other countries, these functions are carried out entirely by the private sector.
Trends in the Regulation and Supervision of Microcredit Financial Sector Reforms The financial sector reforms of the 1980s and 1990s were intended to deepen financial intermediation, improve allocation of credit, and promote healthy competition. They included the liberalization of interest rates and exchange transactions, reduction of legal reserves, elimination of credit controls, authorization for institutions to operate as full-service banks, and the closing of public banks, which put an end to the policy of indiscriminate subsidies in the form of loans common in many Latin American countries. In parallel, the reforms sought to strengthen the prudential and supervisory framework of the financial system to mitigate moral hazard, the adverse selection of clients, and other risks that exist in less well-regulated financial systems. The regulatory frameworks established by the reforms stressed the minimum conditions of security for bank lending activities, with the goal of diversifying risk and reducing expenditures and costs. These conditions include an increase in minimum capitalization and equity, a reduction in the maximum amount that could be lent to one client, more precise definition of cases in which real guarantees would be required, simplification of the minimum information to be kept on borrowers, and the form of loan-loss recognition. All these measures were intended to protect depositors and creditors alike. Although the financial reforms did not specifically include microcredit, they did create a suitable framework for the development of MFIs by removing controls on interest rates. MFIs could then serve smaller, riskier clients, charging them higher rates in order to cover costs and ensure financial sustainability.
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Developments in Microcredit Regulation, 1980–2000 Although credit for self-employed persons has always existed in banks and cooperatives, a new type of institution specializing in this niche was approved in Peru and Bolivia between 1980 and 1995. Under the authority of the superintendent of banks, for–profit microfinance institutions grant small loans and take deposits. However, their establishing laws did not mention that they were supposed to serve microentrepreneurs or act as instruments to combat poverty. In the mid-1990s, the superintendents in both countries included microcredit in the regulatory framework as a credit operation aimed at unsalaried workers, and specified that this product could be offered by specialized entities as well as by banks and other financial institutions. No limitations were put on interest rates. Since 1990, banks and financial institutions have entered the microcredit business in a number of Latin American countries. The most notable cases are commercial banks specializing in small loans in Bolivia, Chile, Ecuador, and Peru; finance companies in El Salvador, Nicaragua, and Paraguay; State-owned banks in Brazil; and, more recently, commercial finance companies in Colombia (for a more detailed description of this process, see chapter 3). Microcredit has been regulated as a lending activity in its own right in Colombia, Ecuador, and Nicaragua. Legislation is currently under study that would establish specialized entities in Nicaragua and Guatemala. In parallel, microcredit NGOs with varying degrees of national coverage have been operating in the region for a number of years. Some are independent; others are members of international networks, such as ACCION, Women’s World Banking, and Finca. Specialized and multipurpose credit unions also offer loans to the self-employed. Since 1999, financial institutions specializing in small loans have been established in Brazil, El Salvador, Honduras, Mexico, Panama, and Venezuela. Except for Guatemala, Honduras, and Nicaragua, where MFIs can be established as nonprofit associations, the other countries require these financial institutions to organize as commercial com-
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panies. In Brazil, Honduras, and Mexico, the minimum capital is under $100,000; in Guatemala and Nicaragua, it is under $300,000. The institutions are able to take deposits from the public in all the countries, except Brazil. In all cases, related-party lending is permitted to a limited extent. It is only in Bolivia that legislation on microcredit and specialized institutions does not refer to “microentrepreneurs” or “microenterprises,” precisely to avoid channeling credit by determining the subjects of credit in advance. In the other countries, a tendency exists to link the definition of microcredit in prudential regulations to the definitions of microentrepreneur or microenterprise contained in the legislation that promotes them.
Pressure for Change and Sources of Resistance Throughout the region and the world, bank supervisors are experiencing increased pressure to integrate microfinance into the regulatory framework. In some countries, this trend is the result of many years of work by nonprofit institutions that, with the support of donors and international agencies, have developed lending technologies for microenterprises and have subsequently had a hand in establishing MFIs. In other countries, the pressure comes from purely commercial sources: traditional financial intermediaries interested in gaining entry into the microfinance market. These intermediaries are facing stiff competition in their traditional markets and/or they are attracted by the higher profits and growth demonstrated by microfinance institutions. Given these two trends, bank supervisors are likely to have to address the issue of microfinance sooner or later. Mature and profitable nonprofit foundations are applying for licenses to operate as supervised intermediaries, as a way of obtaining funds on financial markets and attracting public deposits. At the same time, established financial intermediaries often encounter obstacles and regulatory problems when they try to serve this market segment. This situation creates two different pressures for adjusting the regulatory framework: first, to facilitate the
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REGULATION
activity of microlending; and second, to adequately regulate the institutions involved or specializing in this activity. The pressure for regulatory reform often appears in the political arena. In particular, nonprofit microcredit organizations have played an increasingly active role in promoting legal reforms to facilitate microfinance. In some countries, the pressure has led to the creation of new types of financial institutions, precisely for the purpose of permitting nonprofit foundations to become intermediaries that can obtain funds in the financial markets and take public deposits. Microentrepreneurs are also gradually pressuring governments to set caps on interest rates, since they consider current levels to be too high, as has happened in Colombia, Ecuador, Honduras, and Nicaragua. Unfortunately, not all proposed regulatory changes are positive for microfinance. At times, a high-profile response may be offered to a problem that could be better solved with a more modest regulatory approach. Obstacles to the regulation of microfinance include a mixture of inexperienced regulators who are naïve and lacking independent judgment; specialized nonprofit financial entities whose business plans do not include large-scale outreach and lower interest rates once they achieve greater efficiency; irresponsible international donors who sometimes react to the circumstances of the moment or the changing mandates of their governments; and politicians who (in good or bad faith) forget that the financial system is only a means to permit efficient enterprises and individuals to seize business opportunities and build up wealth. To create a competitive market for microfinance in which interest rates decline over time, adequate policies and appropriate regulatory frameworks must be in place. Experience in recent years has demonstrated that an appropriate regulatory climate for microcredit requires: • • •
Professional, independent, and credible regulators Managers of MFIs (even those that originally were NGOs) who aspire to obtain legitimate returns on their investments International donors and politicians who operate with a longterm vision.
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Future Convergence Two main points of view in microfinance regulation can be identified. The first camp, concerned primarily with combating poverty, aspires to create a financial system that specializes in assisting the poor, with soft prudential standards, directly or indirectly supervised by the superintendents of banks. In this scenario, microcredit NGOs with no owners accountable for corporate governance and credit unions with a small equity base could mobilize massive amounts of funds from small depositors to replace increasingly scarce grants and soft loans. The second approach is concerned with prudential regulation and supervision of financial intermediaries, where supervisors must protect the interests of savers and creditors, requiring MFIs to adequately manage their assets and risks. In this context, supervisors may be faced with a dichotomy between prioritizing social objectives on the one hand and financial solvency on the other. In countries such as Honduras and Nicaragua, the absence of regulations has produced a market with scant competition and high interest rates. On the other hand, countries such as Bolivia have decided to define microcredit as a lending activity that can be carried out by any financial institution, based on the principle that domestic savings can and should be used for any profitable economic activity, regardless of size.2 In some cases, the regulatory framework has been further developed to allow financial entities to be established as corporations specializing in small loans, with reasonable minimum levels of capitalization.3 The challenge for regulators is how to promote transparent and competitive conditions so that the interest rate can be reduced when the institution has a better understanding of the client’s capacity and willingness to pay or when a mortgage guarantee is offered to back a loan. 2
In general, countries have not necessarily defined suitable parameters for microlending risk. In some cases, it is linked to the definition of microenterprise, but it differs greatly from country to country.
3
There are credit limits and permission is needed to make related-party loans, which would place these entities in a category of financial entities that specialize in micro- and small loans.
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Countries that have still not regulated microlending will probably join one of the two camps described above. However, there is a danger that the increase in unemployment and underemployment in Latin America may lead countries to authorize nonprofit financial entities to channel government resources, take public deposits, and be supervised by the bank superintendent, in a scenario where controls are established on interest rates. This shift would produce a new kind of public bank, a type of financial institution that has been discredited in the past. It is clear that poor regulation and low standards can harm the financial system more than the absence of a suitable regulatory framework, as is demonstrated by the case of Mexico, where three different classes of institutions have been allowed to provide microcredit services, each with different levels of loan loss provisioning for the same category of debtor risk.
Creation of Financial Institutions Specializing in Microfinance Microcredit as a Financial Operation The best way to promote microcredit is to allow it to be carried out by any financial institution. This approach effectively opens the entire financial system to anyone who can repay a small loan. From the standpoint of banking techniques, microcredit is a loan that will be recovered from the product of the sale of goods or services by a person who is self-employed in an informal environment (without licenses and accounting records), but who has proven business experience and success and is willing to allow the financial institution to evaluate and systematically record his/her assets and activities. Normally, microcredit operations can be authorized using the powers of the office of the superintendent of banks, without requiring new legislation. To do this, the superintendent can accept a portfolio report from the lending institution that lists microcredit operations, without requiring that client files contain financial statements or real
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guarantees. As a counterbalance, a short time frame is required for declaring loan losses from arrears and rescheduling. These portfolio rules do not normally establish prices for services, since interest rates are subject to the forces of supply and demand, although they must respect the regulations in effect on usury where such regulations exist.
Creation of New Institutions: Why and When The creation of an MFI authorized to take deposits from the public is justified when the establishment of a bank or other formal financial institution requires extremely high minimum capitalization (over $2 million), when maximum credit exposure as a percentage of the capital base is high (5 percent or more), and when nonprofit entities are prohibited from holding shares in financial institutions. The creation of a new type of specialized entity normally requires legislation, and the process of building consensus and enacting a law can take years. In some countries, specialized institutions have been useful—even indispensable —in promoting microfinance. In other cases, the creation of this new type of financial entity seems to have been premature or imperfectly designed. In such cases, it is likely that reforms will have a weaker impact on the financing available for microenterprises. There are two scenarios where it could be advisable to create a new type of institution to facilitate the transformation of nonprofit entities into authorized and supervised financial intermediaries. First, if the minimum capital requirement for existing institutions (that is, banks and finance companies) is high, it could impede mature, well-managed foundations from making the change and joining the formal financial system. Second, if the type of institution with a lower minimum capital requirement (finance company) is limited in the operations it is allowed to carry out (particularly with respect to mobilizing savings), it is not an attractive structure for nonprofit entities wishing to enter the formal financial system. In such cases, there are two alternatives: change the regulations governing existing institutions, or create a new type of institution that allows nonprofit organizations to become specialized
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entities. If no large, mature nonprofit organizations are interested in becoming financial intermediaries, it is obviously premature to create a new type of institution for that purpose. In some Latin American countries, the operating options of finance companies are so limited that it is impossible for them to provide microfinance services. In Guatemala, for example, finance companies cannot mobilize savings deposits and are only permitted to grant medium- to long-term loans. Since the capacity to attract savings is one of the main reasons why NGOs become financial institutions, and since microloans are usually granted with terms between 3 and 12 months, the finance company is not an attractive legal form for entities wishing to provide microfinance services. The poor reputation of finance companies in some Latin American countries has at times been mentioned as a reason for creating a new institutional form for nonprofit organizations that wish to become regulated financial intermediaries. If the reputation of the finance companies is seriously tarnished, it might be better to propose replacing them with a new type of institution that would be sufficiently flexible to include the traditional activities of finance companies, as well as microfinance. If the minimum capital requirement for finance companies is reasonable (under $2 million) and if they are permitted to mobilize savings as well as term deposits, then there really is no reason to create a new type of institution to promote microcredit. If finance companies are prohibited from mobilizing savings, then the first alternative would be to consider the possibility of removing that restriction rather than creating a completely new type of institution. An unnecessary proliferation of institutions is undesirable, since it makes the task of the supervisors more difficult. Nonprofit credit-only organizations should not be subject to government supervision, since they work with donations and not with deposits from the public. For these entities, it is preferable to apply a self-regulatory system, intended to strengthen governance mechanisms,4 4 The typical problems of corporate governance in foundations include: excessive concentration of power, including day-to-day administrative and managerial power in the
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to concentrate their operations on credit activities, and to promote external control by creditors and donors. This self-regulatory system should be based on reliable and comparable information, conforming to accounting principles applicable to financial institutions, with the participation of experienced, independent external auditors. The incorporation of these elements into the routine operation of nonprofit microcredit organizations could be accomplished through the voluntary modification of their charters and statutes, accounting standards, and procedural manuals.
The Variety of Specialized Institutions in Latin America To date, 11 different types of financial institutions have been created in Latin America, with the whole or partial aim of facilitating microfinance (table 4.1). They are in Bolivia, Brazil, El Salvador, Honduras, Mexico, Panama, Peru, and Venezuela. Except for Bolivia and Peru, which are recognized as having the most advanced regulatory frameworks for microfinance in the region, these institutions are too new to have sufficient experience or a solid track record. In general, Bolivia’s regulatory framework is considered to be somewhat more successful than Peru’s. These two cases will be examined in greater detail below. Most of the 11 types of institutions described are structured as corporations, which is consistent with the general practice of allowing only cooperatives and corporations to operate as intermediaries that accept deposits. However, there are some exceptions. In Peru, for example, the municipal credit unions are fully owned by the municipalities, although many of them are exploring privatization. Honduras is another interesting exception to the rule. A 2001 law permits nonprofit organizations to obtain licenses and operate as financial intermediaries while maintaining their original legal structure. This hands of the board of directors; the absence of a framework that delimits the functions of other areas of the institution; the absence of formal mechanisms for control; the absence of a clear set of responsibilities corresponding to the board of directors and management; the absence of mechanisms for managerial accountability; and the absence of prudential standards and rules for managing risk.
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Peru
Peru Peru
Bolivia
Brazil
El Salvador
Honduras
Mexico
Mexico
Panama
Venezuela
1980
1992 1994
1995
2000
2000
2001
2001
2001
2001
2001
Banco de Desarrollo Especializado en Microcrédito (BEM, Microcredit Development Bank)
Banco de Microfinanzas (BMF,a Microfinance Bank)
Sociedad Financiera Popular (SOFIPO, People’s Finance Corporation) Sociedad Cooperativa de Ahorro y Préstamo (SOCAP, Credit Union)
Organización Privada de Desarrollo Financiero (OPDF, Private Financial Development Organization)
Sociedad de Ahorro y Crédito (SAC, Savings and Loan Corporation)
Sociedade de crédito ao microempreendedor (SCM, Microenterprise Credit Corporation)
Fondo Financiero Privado (FFP, Private Financial Fund)
Caja Municipal de Ahorro y Crédito (CMAC, Municipal Credit Union) Caja Rural de Ahorro y Crédito (CRAC, Rural Credit Union) Entidad de Desarrollo a la Pequeña y Microempresa (EDPYME, Small Business and Microenterprise Development Entity)
Name
Corporation
Corporation
Cooperative
Corporation
Private nonprofit entity
Corporation
Corporation
Corporation
Corporation Corporation
Municipal company
Legal form
Individual and legal persons, municipalities, banks, the government
Anyone eligible to be a shareholder in a bank
Individual and legal persons. Maximum 10 percent each Legal persons. Maximum 3 percent each
No owners, only founding members
Individual and legal persons
Individual and legal persons
Individual and legal persons
Individual and legal persons Individual and legal persons
Municipalities
Owners
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Source: Jansson, Rosales, and Westley (2004). a Not less than 75 percent of the portfolio of these banks should be composed of small loans, each of which is less than 3 percent of net worth; the remaining 25 percent can be granted in loans subject to the credit limits of commercial banks (each loan up to 50 percent of net worth).
Country
Year
Table 4.1. Financial Institutions Created to Facilitate Microcredit
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highly unusual arrangement is unique among all Latin American and Caribbean countries.
The Cases of Bolivia and Peru A wide variety of institutions offer microfinance services in Bolivia and Peru (table 4.2). Table 4.3 compares the regulatory requirements facing microfinance institutions in both countries. In Bolivia, the private financial funds (called Fondos Financieros Privados, or FFPs in Spanish) operate as corporations on the national level. Their shareholders can be individuals or profitable NGOs. All (100 percent) of their microcredit portfolio is included as risk-weighted assets. Like other Bolivian financial entities, a loan loss provision of 1 percent is established after five days of arrears if the operation does not generate income; after 90 days, the loan is totally provisioned. The requirements consist of reasonable minimum capital, national coverage, a low credit limit, a
Table 4.2. Supply of Microcredit in Bolivia and Peru Country
Financial institutions providing microcredit
Bolivia
• •
• • •
Peru
• • •
• • • • •
Specialized banks (one offering solidarity credit and individual loans) Private financial funds (similar to finance companies; successful in urban microcredit but some problems with consumer loans) Downscaling commercial banks (have withdrawn from the segment) Credit unions (in the process of adjusting to new regulatory reforms) Unregulated NGOs offering credit (major presence in channeling government funds) Municipal credit unions (owned by municipalities, awaiting privatization) One specialized bank (expanding to national coverage) Commercial banks, especially those with large consumer finance portfolios Private finance companies (that also make consumer and commercial loans) Rural credit unions (some with institutional feasibility problems) EDPYMEs (with institution-building requirements) Credit unions (with a relatively small presence) Unregulated credit NGOs (with a small presence; a recent decree permits them to establish a system of self-regulation to gain access to government funds)
Source: Author’s compilations.
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Table 4.3. Regulated Risk Matrix of Microfinance Institutions, Bolivia and Peru Characteristics
Bolivia
Peru
Geographic coverage Minimum capital Individual credit limit
National $900,000 1 percent of net worth
Related-party lending Loan-loss recognition Capital adequacy
No 90 days 10 percent
Provincial $283,000 10 percent of net worth Yes 120 days 9 percent
Source: Author’s compilations.
ban on related-party lending, and timely loan loss recognition. These rules, combined with “patient” investors and capable and accountable boards of directors and managers, explain why the industry has been able to sustain itself despite the financial crises and political attacks it has suffered in recent years. In Peru, the largest specialized entities are municipal savings banks (called Cajas Municipales de Ahorro y Crédito, or CMACs in Spanish),5 operate as municipal enterprises and are therefore restricted to a given geographic area. Like the rest of the financial entities, a loan loss provision of 1 percent is established after eight days of arrears and 100 percent after 120 days. If the loan does not generate income after 30 days, the value of real guarantees can be deducted.
Characteristics of Specialized Microfinance Institutions Out of the 11 types of institutions that have been created in Latin America (see table 4.4), those established in Bolivia and El Salvador seem to be the most balanced and best justified. They play the role of finance company and microfinance entity, avoiding the proliferation of institutions (as has happened in Peru). They are permitted to mobilize public
5 For an analysis of the municipal credit unions, see Portocarrero (1999, chapter II, pages 47–68).
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FFP
SCM
SAC
OPDF
SOFIPO SOCAP BMF
CMAC
CRAC EDPYME BEM
Bolivia
Brazil
El Salvador
Honduras
Mexico
Panama
Peru
Venezuela
Demand Savings Term Savings Term Savings Term Nod Demand Savings Term
Savings Term Savings Term Termb
Savings Term No
Deposits
2,370,000
12%, same as banks
Banks: 19,800,000
Banks: 5,200,000 Finance companies: 2,600,000
Banks: 10,000,000 Finance companies: nonec
Banks: 7,500,000 Finance companies: none Banks: 6,500,000 Finance companies: 2,600,000 Banks: 11,400,000 Finance companies: none Banks: 6,000,000 Finance companies: 1,200,000 Banks: 19,000,000
Minimum capital Banks/ finance companies ($)
MICROCREDIT IN
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OF
9%, same as banks
16.6%, higher than banks and finance companies (10%) 8–11% (more capital, lower ratio), higher than banks (8%) 8%, same as banks
16.6%, higher than banks and finance companies (11%) 12%, same as banks
10%, same as banks
Solvency ratio
SUPERVISION
283,000
3,000,000
45,000
2,850,000 1,140,000a 60,000
53,000
900,000
Minimum capital ($)
AND
Source: Jansson, Rosales, and Westley (2004). a This lower requirement is applied if the entity lends only to microentrepreneurs and small business entrepreneurs and takes savings only from its borrowers. Microenterprise is defined as a business with fewer than 10 employees or with less than $5,700 in monthly sales. Small business is defined as having from 10 to 50 employees or monthly sales between $5,700 and $57,000. b SOFIPO and SOCAP are subject to a modular operating arrangement based on their capital. Entities with capital over $7,500,000 operate like banks. c There are finance companies in Panama, but they are not supervised by the superintendent of banks and are not allowed to mobilize savings. d All the specialized entities are subject to a modular operating arrangement based on their minimum capital. EDPYMEs can take savings and term deposits when they accede to module 1, which requires capital of about $1 million.
Entity
Country
Table 4.4 Characteristics of Specialized Microfinance Institutions in Latin America
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deposits. They have minimum capital levels that require some degree of financial strength but still allow nonprofit entities to contemplate becoming financial institutions. They are established as corporations, which—although far from being perfect—continues to provide the best series of checks and balances in terms of governance. The design of and justification for the other nine types of institutions are less convincing. In some cases, the minimum capital requirement appears to be too low to ensure that the entities establish sustainable operations. In other cases, the entities are not allowed to mobilize savings, and therefore it is not clear why they should be supervised. The minimum capital levels for institutions in Brazil, Honduras, Mexico, and Peru are low. Brazilian entities and the Peruvian EDPYMEs are not permitted to take deposits. The case of Honduras is an exception for a different reason: it is the only case in which nonprofit foundations are permitted to operate as financial intermediaries (taking deposits) while maintaining their legal status as foundations. In Venezuela, the high capital requirements for commercial banks, coupled with the absence of a type of institution with a lower capital requirement (for example, finance companies) means that the new institution is bridging a major gap. However, few microfinance organizations in Venezuela are sufficiently mature or successful to become formalized as financial institutions. In Panama, the creation of a new institution was spurred and justified by the high capital requirements for commercial banks. However, a different option could have been to allow existing finance companies (which are currently not supervised and cannot mobilize savings) to apply for licenses to become supervised financial intermediaries that mobilize savings. In Mexico, the creation of new institutions forms part of an effort to consolidate the large number of institutional types that exist today in the financial system. It is a unique initiative in that it deals with microfinance through the lens of credit unions. Credit unions play a leading role in microcredit in Latin America, since between 20 and 40 percent of their portfolio—between $825 million and $1,650 million—is lent to microentrepreneurs (Westley and Shaffer, 2000).
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Regulation of Other Financial Institutions Offering Microcredit Commercial Banks Today, more commercial banks are penetrating the microfinance markets. But before reaching this stage, there have been some mistakes and valuable lessons learned. In some cases, banks adopted flawed strategies and were forced to withdraw temporarily from the activity. The most common and costly errors are: 1. Lack of clear goals and a defined strategy for achieving a highquality loan portfolio of sufficient volume within a reasonable time. Often, banks pursue rapid growth without having an appropriate credit technology, trained personnel, or systems for monitoring and internal control. Banks that intend to enter the microcredit field to test the waters should be aware of the damage a failure could cause, not so much in the bank’s books, but in the microenterprise market. Successful institutions develop pilot projects that allow them to avoid excessive or incommensurate risks. 2. Failure to use an appropriate credit technology, particularly in the case of banks that are operating in consumer credit and enter the microcredit field using the same “assembly line.” That is, one bank officer promotes or sells loans and collects basic information (promoter), another analyzes the client (analyst), and a third is responsible for clients in arrears (collector). With microcredit, it is more efficient for the loan officer to perform all three functions. Microentrepreneurs have no fixed salaries or formal financial information to prove their ability to pay; thus loan promoters, who generally work on commission, can find themselves exposed to a conflict of interest between prudently compiling good information on the client and their need to bring in more approved clients. In the long run, this conflict can become an unmanageable risk for the bank.
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3. Failure to develop appropriate incentives for staff, particularly for loan officers whose work is carried out “in the street,” and who become an asset for the bank only when they seriously commit to combining security with productivity in building their loan portfolios. This situation also applies to branch managers, who should ensure that the loan officers’ operations and reports are transparent. The incentive structure and appropriate mechanisms for internal control should be clearly understood at each staff level. 4. Lack of a firm commitment to internal control systems by senior management and the board of directors. Since most credit decisions are taken in a decentralized fashion at the branch level, a bank does not have one microcredit portfolio; it has as many portfolios as it has loan officers. Lax application of internal controls means that in practice, the management of microfinance operations is at the mercy of the goodwill of each loan officer. 5. Inappropriate income and/or expense levels for the unit, section, or office in charge of microcredit operations. These can be reflected in excessive administrative costs (high salaries or too many administrative staff) that are covered by applying an excessive interest rate. This rate may derive from an oligopolistic position in the market, and could become unsustainable in the medium or long term. In other cases, the problem is charging an interest rate too low to cover all the bank’s costs, particularly provisions for bad debts. The errors mentioned above explain why in most countries, the entry of commercial banks into the microcredit segment has not fully materialized. They also shed light on the question of why, in countries like Peru, the traditional banks slowly withdrew from the segment between 1998 and 2001. A further reason is the lack of adequate regulation of microlending as a bank activity in general, which explains problems that have arisen in Honduras and Nicaragua . These problems further support the conclusion that regulations need to be developed
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for microcredit as a product, not just for specialized microfinance institutions.
Credit Unions Although in some cases credit unions have a larger volume of operations than banks and finance companies, in many countries they are subject only to the legislation and supervision governing cooperatives of all kinds, alongside thousands of commercial, transportation, education, and health care cooperatives. Therefore, the regulatory and supervisory practices of most countries place them in a virtual regulatory vacuum. Since the original tie between the members and the cooperative is weakened or disappears altogether as credit unions grow, this lack of regulatory attention is difficult to justify.6 If no genuine tie exists between credit unions and their members, they should be treated like any other financial institution that takes deposits; that is, they should be regulated and supervised by the same authority that supervises banks and finance companies. Given their large number and unusual management structure, the regulation and supervision of financial cooperatives is a great challenge for the supervisory authorities. The authorities often consider credit unions as unlikely to pose a systemic risk to the financial sector, and therefore prefer that credit unions be supervised by other agencies. To date, however, delegated supervision of the unions has not been effective in Latin America. Considering the number of depositors and borrowers that depend on these institutions, their failure could affect tens of thousands of people, most of whom have very limited means for coping with the loss of their savings or their access
6
Members of most large credit unions in the region do not have close ties to their credit union, which explains the members’ large absences from meetings. Simply presenting an identity document is often enough to become a member. When shares are not remunerated and deposits are paid a fixed rate, members may have little interest in participating in key decisions such as the election of the boards and approval of the financial results, much less in controlling the company. In other words, in practice, the vast majority of members are simply clients of the credit union.
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to credit. But supervisors are only beginning to understand that their intervention is justified, based on the systemic risk of credit unions in many countries. For the reasons mentioned above, supervisors should carefully examine how to approach the issue of credit unions. Efforts to improve their regulation and supervision have been made in countries such as Bolivia, Chile, Colombia, El Salvador, Jamaica, Mexico, and Paraguay. Although it is likely that this trend will grow in the region, implementation of these regulatory frameworks is just beginning. Finding effective models for regulating and supervising credit unions is one of the main challenges for the region’s supervisors today.
The Role of “Financial Infrastructure” Much has been written about the benefits of establishing credit bureaus to facilitate financial intermediation, particularly for consumer credit and microcredit. These public and/or private agencies use information provided by regulated and unregulated financial institutions on the size of their loans and the repayment status of their borrowers. They also establish databases of the clients of insurance companies and different commercial creditors and compile information about legal action. In many Latin American countries, however, there are legal, institutional, and practical obstacles to operating credit rating agencies that deal with information about small loans.
Legal Limits Although legislative trends in Latin America are gradually moving toward greater openness and flexibility with respect to the traditionally rigid rules concerning bank secrecy, in some countries it is still legally impossible for financial institutions to share information about borrowers or for unregulated financial institutions to participate along with banks in the credit rating process. In other cases, there are complaints that the agencies and bureaus do not observe minimum levels of security in the use, handling, and protection of information. Legislation must strike
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a balance between promoting the legitimate use of credit information, guaranteeing respect for individual privacy rights, and verifying the accuracy of data.
Institutional Limits Some countries aspire to opening access to information from credit agencies or bureaus to the credit unions and unregulated financial entities. There is much discussion about whether the agencies or bureaus should be public or private. In the latter case, there is discussion about what are the basic requirements that should be met by shareholders or owners. One of the advantages of bureaus and agencies is that their databases include all borrowers in the financial system, since there are no captive clients, and individuals can be borrowers from a considerable number of entities. Regardless of whether credit bureaus and agencies are publicly or privately owned, the superintendents of banks must also receive information about the size of loans and debt status in the financial system in order to carry out their supervisory functions. Private bureaus, where information on debts in the financial system is complemented and expanded with information from the commercial sector, are not excluded. As is to be expected, the financial entities themselves generally show a keen interest in owning private bureaus, often in association with specialized international companies.
Practical Limits Private bureaus may encounter practical difficulties, including the lack of reliable national identity documents that would allow them to consolidate borrower records, the (small) size of some markets that makes economies of scale impossible, and the fear that information may be improperly used by unscrupulous people and criminals. It is difficult for healthy microcredit activities to develop in a country where there is no credit bureau to lower the costs of information, prevent over-indebtedness, and monitor the spread of delinquency. Credit scoring makes it possible to identify the risk profile of the clientele,
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manage risk in the long run, and lower interest rates. Microentrepreneurs, like any other entrepreneurs, are highly dependent on credit and often borrow too much when they have easy access to microcredit operators involved in aggressive competition.
The Impact of Credit Rating on Microfinance in Peru and Bolivia In general, the information gathered by credit bureaus is used by lending institutions to evaluate the quality of an applicant’s repayment record. However, it also permits banking supervisors to perform analyses of the portfolios of participating financial institutions. Consequently, credit bureaus have played a major role in the development of microcredit in Bolivia and Peru. The establishment of a credit bureau takes two forms: legal and technical. Legal issues are related to banking secrecy laws and the development of rules to make the information as transparent as possible. The technical tasks involve developing computer systems, networks, security systems, infrastructure, and the like so that the information can be accessed in a timely manner and kept up-to-date. Private credit bureaus should receive objective information on all borrowers in the financial system from the superintendent (rather than the classifications of borrowers made by different institutions). In Bolivia, close to 60 percent of commercial loans are made to individuals, and housing loans can be obtained by microentrepreneurs as well as by salaried workers. Through bank information centers, the business community is able to gather information on all of the liabilities (loans, other financial commitments, billing and payment of utilities) of individuals and companies applying for credit. In Bolivia, the central credit registry run by the government was initially developed to generate information on larger loans granted in the traditional banking system. The potential importance of the system for microcredit was realized later, when information on small borrowers was included to prevent over-indebtedness. One big difference between Bolivia and Peru and the rest of Latin America is that in these two countries, microfinance NGOs became
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formal financial institutions earlier. In Bolivia, this growth involved building a bridge for NGOs that enabled them to expand their horizons and obtain better information on the credit history of their borrowers. In a context where credit history information is reserved for formal regulated financial institutions, the conversion of NGOs into private financial funds (FFPs) was quite beneficial for the healthy development of the microfinance industry in Bolivia. In Peru, the process of creating EDPYMEs (former NGOs) did not lead to marked benefits in the information obtained, since credit information was already available through private sources. Perhaps that is why the impact of deterioration in the quality of microcredit portfolios because of over-indebtedness was lower in Peru than in Bolivia. Apart from gaining access to credit information, the benefits of becoming a formal institution are primarily financial. Given the large unmet demand in the market, NGOs needed to increase their assets, and wanted to be able to do so by increasing their leverage (the vast majority of unregulated organizations involved in microlending today have this incentive). Becoming formal institutions offered access to new sources of financing and allowed microlenders to increase their leverage. In the case of Bolivia, access to improved information through the central credit registry was an added benefit that reduced risk. The transformation of NGOs into formal lenders also improved the transparency and availability of financial information for all financial institutions, as the reporting requirements became stricter and more widespread, thus helping make the financial system much less risky.
Microfinance Regulatory Concerns Today Latin American bank regulators and supervisors are facing the problem of how to handle portfolios containing thousands of small loans with no real guarantees, which have been granted to individuals who may not have fixed or known employment or who have lost it, who have no documents to prove regular or stable income, and/or who have an undocumented source or level of income. (In some countries in other regions of the world, small loans are even granted to people with no identity documents.)
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The regulators and supervisors encounter such situations when granting licenses to new types of financial entities, and also when existing banks or other financial institutions establish microlending portfolios or specialized microcredit subsidiaries. The main risks are summarized in box 4.3. To insure adequate supervision of microcredit portfolios, bank superintendents evaluate the methodologies used by the entities to analyze, grant, supervise, and collect loans—rather than measuring credit risk on a loan-by-loan basis. They also analyze the level of confidence offered by microcredit technologies as a whole, establish loss provisions in terms of arrears, and apply statistical techniques to measure the probability of losses in current portfolios. This exercise has permitted them to clearly differentiate the risks of credit operations that will be repaid with the product of the sale of goods and services from operations whose
Box 4.3 Most Common Regulatory Issues in Microfinance The concrete problems encountered by regulators and supervisors today are linked to how to deal with risks deriving from: 1. Straying from good credit practices in response to unfair competition or predatory lending practices (including rotation of loan officers from one entity to another) in geographic areas that are overpopulated with financial entities. 2. Over-indebtedness (to one or more financial entities) of a large number of people and the possibility that if they are unable to honor their obligations, the doors to the financial system could be closed to them permanently. 3. Abusive collection practices, deceptive loan contracts, and loan contracts that include unilateral changes in the agreed conditions at the discretion of the lender. 4. Charging excessive interest rates for small loans guaranteed with property. 5. Not giving borrowers clear information on effective interest rates and other financial charges applicable to their loans. 6. The unionization of small debtors and the concomitant politicizing of collections. 7. The lack of public information regarding the level of loan arrears at each financial institution. 8. Banks that levy excessive monthly charges for maintaining small deposits, which forces depositors to migrate to less-secure small deposit entities. 9. Charging excessive commissions for transferring small sums of money electronically or by fax.
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repayment depends on the future salaries and wages of employees. In sum, it separates the supervision of microcredit from the supervision of consumer credit. Supervision in Bolivia and Peru followed this path and thereby helped mitigate problems related to over-indebtedness and debtors’ unions. Regulators have recognized that well-managed microfinance institutions are no riskier than large banks specialized in corporate lending. That is why they have established similar capital adequacy requirements for MFIs and banks (between 8 percent and 10 percent). A properly managed microcredit portfolio can be one more line of business for any type of financial institution. A savings mobilization program, however, should be embarked upon only if sufficient assets—and solvent owners—are available to cover any potential loss. The regulatory framework for microcredit should permit individual and group microcredit methodologies to coexist, remaining neutral with respect to the changing views and practices of international networks of microfinance organizations. Care should be taken that specialized entities with smaller capital requirements do not offer large corporate loans or get tangled up in related operations, for which they lack a sufficient equity base. Concerns about how to monitor the governance of specialized financial entities with nonprofit shareholders should be taken into account, to prevent certain deficiencies in corporate governance, such as conflict of interests and insufficient duties of care and loyalty. Thought should also be given to the possibilities of inducing lower interest rates through market means and to the need to promote longer-term financing. In highly competitive markets, healthy competition should be promoted among the participants, avoiding over-indebtedness or widespread delinquency with good information on borrowers and strong provisions policies. The encounter between supervisors (and the financial system in general) and microcredit has cleared up certain preconceived ideas and appears to have demonstrated that the logic of evaluating client capacity and willingness to pay is similar for large corporations and for micro-
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enterprises. The main difference is that the processes and supporting documentation are different in each case. A clear differentiation must be made between loans to salaried workers (consumer credit) and loans to small business units (microcredit). Experience has demonstrated that small loans are not riskier than large ones and that MFIs have lower levels of arrears than banks.
Looking Ahead All Latin American countries claim that they comply with the principles of regulation and supervision recommended by the Basel Committee on Bank Supervision (Basel I). However, compliance is actually an imaginative patchwork, which results in lower capital requirements for banks. In the case of microcredit, supervisors should be trained to give technical opinions on the soundness of microcredit technologies and risk assessment methodologies, both when granting a license for a NGO to become a formal institution and during inspection visits to institutions with microcredit portfolios. Supervision should focus on evaluating how the institution’s management identifies, measures, controls, and monitors the risks posed by its numerous clients on a day-to-day basis. Supervisors should take special care to prevent predatory credit, the sale of loans, and the abuse of contractual position by the institutions. Supervisors should also perform special monitoring of institutions that offer consumer loans, microcredit, and small commercial loans simultaneously. One important tool in this work is a credit bureau that can be used to monitor compliance by large numbers of clients and promote fair competition among the participants. The changes introduced by the Basel Committee on Banking Supervision recognize that diversified small-loan portfolios at well-managed institutions are less risky than portfolios with only a few clients holding significant percentages of the institution’s net worth. This is good news for well-managed microfinance intermediaries, and in terms
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of solvency and capital, is a positive for MFIs—particularly in the area of consumer loans.7
Recommendations Financial sector authorities can play a key role in helping the regulatory framework reduce the costs and risks of financial institutions operating with microcredit. In particular, they could offer support for: 1. Reducing the emphasis on microcredit as a tool to alleviate poverty and gradually approaching it from the standpoint of managing unsecured credit risks granted to thousands of selfemployed persons who have no financial information or real guarantees—regardless of whether they are poor. 2. Establishing appropriate prudential rules for microcredit and for institutions that specialize in this type of financing, avoiding a relaxation of regulations that would raise the risk of microcredit portfolios and, consequently, net worth requirements. 3. Reducing uncertainty in information through the establishment of national-level credit bureaus (risk rating agencies or credit bureaus) that all microcredit operators would be required to report to and consult before granting any credit. 4. Promoting transparency in interest rates charged by financial entities for all types of operations, so that microentrepreneurs have adequate information with which to choose their creditors. 5. Developing effective instruments in the offices of the superintendents for the evaluation of microcredit methodologies; early detection of unsound, abusive, or inadequate policies; and signs of deterioration in credit technologies and practices.
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What is commonly known as “Basel II” refers to the updated version of International Convergence of Capital Measurement and Capital Standards: A Revised Framework, issued by the Basel Comittee on Banking Supervision in June 2004 (www.bis.org/pub/bcbs118. htm).
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6. Creating mechanisms for institutional coordination by international donors and government agencies that support microfinance activities. The establishment of a neutral regulatory framework, operation of a modern credit rating system, transparency in contracting and in interest rates, and application of differentiated supervisory systems are all aspects to keep in mind for any regulatory microcredit strategy in the future. Effective regulation can also help gradually lower interest rates, thus preventing attempts to place caps on interest rates or revive the old usury laws.
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References Jansson, Tor, Ramón Rosales, and Glenn D. Westley. 2004. Principles and Practices for Regulating and Supervising Microfinance. Washington, D.C.: Inter-American Development Bank. Portocarrero Maisch, Felipe. 1999. Microfinanzas en el Perú: Experiencias y perspectivas. Lima: Universidad del Pacífico. Westley, Glenn D., and Sherrill Shaffer. 2000. Credit Union Delinquency and Profitability. In Safe Money: Building Effective Credit Unions in Latin America, eds. Glenn D. Westley and Brian Branch. Washington, D.C.: Inter-American Development Bank.
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Microfinance Institutions in Times of Crisis: Impact, Actions, and Lessons Learned Armando Muriel, Victoria Muriel, Giulissa Franco, and Elsa Martín
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his chapter examines the ways in which Latin American microfinance institutions have responded to liquidity and solvency crises, and the lessons that can be learned from these experiences. Latin America experiences systemic financial crises more often than other regions. It is important to study these crises and their effects on microfinance institutions so that the institutions can act to attenuate the effects. This is especially important so that measures may be taken to protect clients, who generally come from low-income groups and who are particularly vulnerable in times of crisis. The scarcity of literature on Latin American liquidity and solvency crises is striking, especially when compared to the abundance of studies about Asia. Thus this chapter also examines available studies of systemic crises in Latin America. It focuses on two countries, Bolivia and Ecuador, and on two microfinance institutions in each country, so as to include organizations with different legal bases (banks, cooperatives, specialized institutions, and NGOs). The institutions selected were the ones the authors believe would shed the greatest light on the subject: two private financial funds in Bolivia—Caja los Andes and FIE (Caja Los Andes now operates as a commercial bank, Banco Los Andes Pro-
We would like to thank Banco Solidario, Cooperativa Jardín Azuayo, Caja los Andes, and FIE and their representatives for information and observations that made this chapter possible. The content is exclusively the responsibility of the authors.
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Credit)—and a bank, Banco Solidario, and a credit union, Cooperativa Jardín Azuayo, in Ecuador. Bolivia was chosen because it has had great success in microfinance activities; many other countries look to it as a model. Microfinance is carried out by sustainable, private institutions, mostly under a specialized legal framework known as private financial funds, which are highly competitive given the high levels of demand. The crisis focused upon in this chapter was caused by the entry of institutions from a different culture into the microfinance system, which then applied tested credit methodologies inappropriately. This happened in the midst of a general crisis, while the government was applying a series of measures that would directly affect the target populations of microfinance institutions, as well as microfinance institutions themselves. Ecuador was selected because of the breadth and depth of its crisis, which affected its entire economy (and particularly, its financial system); and also because of its supervised and unsupervised credit union system, which serves microenterprises and low-income populations. These entities have established an incipient microfinance system, together with two banks. Banco Solidario is considered a benchmark for the industry, and its crisis management is worth studying.
The Crisis in Bolivia Bolivia, like other Latin American countries, suffered a major economic recession in the late 1990s, after almost a decade of sustained economic growth. GDP growth of 5.2 percent in 1998 was followed by a sharp slowdown in 1999, a weak recovery in 2000, and a total absence of growth in 2001. In the aftermath of the terrorist attacks of September 11, 2001, enormous uncertainty dominated all markets, clinching any hope of the country’s economic recovery. A series of domestic and international factors help explain the crisis. The first set of factors was global in nature. While these factors also affected other countries in the region, the repercussions in the Bolivian economy were marked by certain idiosyncrasies, including the impact of adverse climatic changes and the onset of the international
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financial crisis, especially in neighboring Brazil, which accounts for about one-fifth of Bolivia’s total foreign trade. Sharp climate changes in 1998 caused by El Niño and La Niña and ensuing catastrophic droughts and floods in different parts of the country led to massive economic losses in the agricultural and livestock sectors. Crops and assets were damaged or destroyed, and products were sold at reduced prices—often below cost—given the pressing needs of many producers. The international financial crisis affected the Bolivian economy through two traditional mechanisms. First, reduced demand from abroad led to direct drops in exports and prices, and significant deterioration in terms of trade. In particular, in early 1999, Brazil devalued its currency. Second, the international financial crisis led to a significant decrease in external financing, accompanied by heavy flight of capital from Bolivia. Other variables affecting the crisis arose from domestic policies and responses. A series of public disturbances turned violent—roadblocks, destruction of highways, repeated strikes—and prevented small entrepreneurs, particularly crop and livestock farmers, from reaching markets. The result was a loss of income. Such social unrest also heightened the perceptions of international markets that Bolivia was a risky place to invest. Several domestic policy decisions affected the informal economic sector, including legislation aimed at controlling smuggling and eradicating the illegal coca crop. Despite the obvious long-term social and economic benefits of these decisions, their short-term macroeconomic effects were adverse. The interruption of informal imports was a major shock for producers and entrepreneurs who purchase their raw materials or merchandise through those channels, and for agents who transport goods into the country. Moreover, the macroeconomic impact of the program to eradicate the coca crop appears to have been substantial, in terms of the slow growth in agricultural value added and increased rural unemployment. The factors in question put an end to Bolivia’s economic boom. From 1993 to 1998, GDP grew an average of 4.6 percent a year. From 1999 to 2002, GDP grew an average of 1.3 percent; this rate did not compensate for population growth, leading to a 0.9 percent drop in per
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capita GDP. The slowdown in the growth rate was reflected in different sectors of macroeconomic activity—production, trade, investment, consumption—and in a significant increase in underemployment and unemployment (urban unemployment rose from 5.3 percent to 7.3 percent between 1998 and 2001). Because of the sluggish economy, the fiscal deficit rose—to an alarming level for a country experienced in hyperinflation. The nonfinancial deficit jumped from 3.8 percent to 6 percent of GDP from 1999 to 2001. However, thanks to central bank efforts, inflation was relatively curtailed during the crisis. The financial aspect of Bolivia’s economic crisis in the late 1990s was reflected in a sharp process of financial disintermediation, marked by a drop in deposits, in real terms, and in the size of loan portfolios, as well as in rapid increases in portfolio arrears. This crunch followed a boom, which caused serious problems for the financial system and the economy in general. In the midst of Bolivia’s financial system crisis, financial institutions from Chile that specialized in consumer credit penetrated the Bolivian microfinance market. These entities became legally formalized in Bolivia as “private consumer financial funds,” as compared to the “private microenterprise financial funds” that had traditionally been in the country. The Chilean entities entered the Bolivian market using a consumer credit strategy based on solidarity groups. Essentially, any microentrepreneur who was a client of a private financial fund or of BancoSol could get an instant loan. These consumer-lending outlets did not conduct specific risk analyses of individual microenterprises. Pursuing their goal to mass-produce loans, they did not adequately evaluate clients’ ability to pay or measure individual debt levels. Predictably, clients became over-indebted and fell behind in loan payments at every credit institution with which they did business.
Bolivia’s Microfinance Experience The first sign of a crisis among the clientele of microfinance institutions surfaced in the international arena. The income of export companies
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dropped, which reduced their debt-servicing capacity. The effect of the crisis on imports had significant repercussions in the microfinance sector, which is heavily involved in the import trade. The portfolios of several microfinance institutions were concentrated in these sectors. Moreover, several policies were enacted that served to increase the price of imported goods, and hence adversely affected the informal economy. Microfinance institutions failed to pay sufficient attention to these developments and to curtail their lending accordingly. Another important factor was the government’s decision to forgive the debts of certain clients in State banks that were going out of business. This measure was clearly untimely and increased the moral hazard of other debtors and intermediaries and eroded willingness to pay. Small enterprises accepted the tempting institutional offers for fast and easy credit, and as a result took on too much debt. They were in debt to a number of lenders and had to make payments on two or more loans at the same time—way beyond their repayment capacity. The inevitable result was failure to repay in some cases and to “chain” borrow in others (use funds from one institution to pay another). This situation led to an eruption of social conflicts and protests. Over-indebted debtors organized into associations that protested against consumer credit and microfinance institutions. This led to a negative shift in public opinion about microfinance institutions. The social unrest and the crisis occurred in a period of electoral uncertainty. A withdrawal of funds by medium to high depositors hit the traditional banking system, but this did not happen to microfinance institutions. In Caja los Andes, for instance, from year-end 1998 to yearend 2000, the total number of deposits jumped from 2,865 to 18,589 and the balance rose from $11.2 million to $17.4 million. The main impact was the significant deterioration in the number and quality of clients of microfinance institutions. This process was related to the bankruptcies caused by the economic crisis itself and by the exodus of clients (often the best), who consumer loan institutions were attracting through extremely aggressive marketing. Excessive indebtedness eventually led to the collapse of these consumer credit institutions.
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In 1999 and 2000, none of these institutions was able to recoup the growth rates in numbers of clients they had achieved earlier. The number dropped considerably in some. By contrast, others that focused on microfinance and made good use of a technology that included an analysis of the potential clients’ ability to pay and borrow were able to grow. Caja los Andes and FIE grew 20.8 percent and 11.1 percent, respectively, between December 1998 and June 2000. The results of both institutions stand in contrast with the rest. These results should be emphasized, since they show how flexible and timely attention and suitable application of an appropriate methodology have been able to maintain client loyalty. In the broader period around the peak of the crisis, from 1996 to 2001, Caja los Andes doubled its number of clients, from 22,000 to 45,000, and FIE’s client base grew from 14,000 to 23,000. In a 2003 presentation to Bolivia’s Office of the Superintendent of Banks and Financial Institutions in La Paz, Professor Claudio González-Vega of Ohio State University attributed the success of both FIE and Caja los Andes to the relative advantages of using loans to individuals rather than loans to solidarity groups in times of systemic crisis: that is, when the problems of debtors cease to be individual and become common to everyone (González-Vega 2003). From 1997 and 2001, while credit portfolios from consumer financial funds were devastated and those from commercial banks suffered badly, most microfinance institutions sustained a level similar to or higher than they had at the start. Portfolios at Caja los Andes and FIE doubled during that period. At the most critical juncture of the crisis, between December 1998 and June 2000, Caja los Andes’ portfolio increased 43.6 percent, from $28.6 million to $41.1 million, while FIE’s increased 36.9 percent, from $14.1 million to $19.3 million. Meanwhile, the degree of arrears in the portfolio was unprecedented. While arrears in regulated institutions were only 2.4 percent of the total portfolio in 1997, they rose to 11.2 percent by 1999 and to 12.6 percent at the end of 2000, not including rescheduled loans (Rhyne 2001). Even though increases in arrears was felt across all institutions, efforts made by the different institutions led to significantly different results.
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In relative terms, the increase in arrears was higher for microfinance institutions than for other intermediaries, although they had the advantage of starting out from very low levels of arrears. Once again, the institution least affected by the crisis in this respect was Caja los Andes, since its risk portfolio grew from just 5.7 percent in 1998 to 7.7 percent in 2000. In that same year, FIE had a risk portfolio of 7.9 percent, compared to 1.5 percent in 1998. Increased loan loss provisions contributed to a drastic decline in profits for all institutions. Nonetheless, Caja los Andes was able to maintain returns of 19.2 percent on its net worth in June 2000, compared to 27.1 percent in December 1998, while FIE’s return on net worth dropped from 31.9 percent to 4.6 percent in the same period. Return on equity plunged in other institutions. BancoSol’s return on equity fell from 29 percent to 4 percent between 1998 and 2000 (Rhyne 2001). Another major impact of the crisis on the institutions came from the increase in personnel costs and reductions in staff productivity. Loan analysts had to spend more time monitoring arrears and analyzing new loan applications (many would not be approved). Often, it became necessary to hire new assistants to collect payments on problematic loans. Costs related to court collections increased, as did the travel costs of personnel monitoring loans in arrears. During this period, FIE made great efforts to reduce administrative costs, which fell from 24.2 percent to 15.6 percent of its portfolio. At the same time, financial costs rose from 7.9 percent to 10.2 percent and loan loss provisions increased from 1.9 percent to 4.6 percent. The impact of the crisis on the liquidity of Bolivian institutions appears to have been insignificant. Nacional Financiera Boliviana (NAFIBO), a second-tier institution, provided specific support to institutions that requested it, at interest rates that fell markedly, as in the rest of the financial system. Caja los Andes, for example, borrowed from NAFIBO, but simply as a precaution. Some of its shareholders underwrote an increase in capital, which rose from 14.3 million bolivianos to 21.3 million bolivianos from 1998 to 2001, and supported management in defining the strategy.
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The Actions of Bolivia’s Microfinance Institutions The positive results of some Bolivian institutions, in sharp contrast to the poor response from others, stemmed from their capacity to innovate, optimize client relations, and effectively handle risk management. A good example of the capacity to innovate and adapt is the large market share Caja los Andes and FIE were able to capture by pioneering the offering of individual loans in Bolivia, as compared to traditional loans to solidarity groups. Caja los Andes also shifted away from the traditional model in its willingness to offer larger initial loans, based on a client’s future ability to pay and not solely on a good track record with smaller previous loans. In the case of FIE, direct contact with clients, understanding their problems, and attempting to help find solutions have also been crucial for attracting new clients and, above all, for ensuring that they honor their commitments. FIE’s strategy in this crisis is worth noting. All FIE staff, from loan analysts to the managers themselves, paid direct visits to people with problems, examining their difficulties in depth, rescheduling their payments, and sometimes even forgiving their debts. FIE also provided financing to some clients who faced problems with other financial institutions. Clients greatly appreciated this strategy and it was very successful in getting them to honor their obligations. While some institutions offered a variety of new products to attract clients, Caja los Andes followed a different strategy. It offered only a few products—but highly flexible ones that potential clients could more easily understand. Weathering the crisis meant that the institutions had to be much more cautious about risks than they had been before. The two institutions differed slightly in the way they went about tightening risk management. According to its president, Pilar Ramírez, FIE followed a policy of not making growth a priority objective. It preferred to grow solidly and steadily and focus on keeping known clients. As a consequence of the crisis, some of those clients abandoned their productive activities and
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went into trade, although the majority kept their machinery so they could return to their manufacturing activities after the crisis eased. FIE offered them credit to facilitate the process. Caja los Andes paid greater attention to analyzing the market and the environment: in particular, how they would affect clients and their future ability to repay. Pedro Arriola, General Manager of Caja los Andes, said that the key to their strategy was to be aggressive in winning clients and at the same time analyzing them rigorously. A different strategy, but with the same objectives of improving the quality of the portfolio and growth, was to promote the purchase of “healthy” loans from other institutions. This strategy benefited the institutions involved (sellers and buyers) and to a certain extent also benefited clients, who could then consolidate their preexisting debts with various institutions into a single debt in just one institution. In such a fragile and confusingly competitive environment, the institutions had to make major efforts to convince clients and “reeducate” them about honoring their loan obligations. In other words, they have had to distinguish themselves from the “bad” financial intermediaries. They took several steps to achieve this strategy. Branches were given the same physical appearance; promotion and publicity increased; and credit analysis was significantly strengthened to ensure that clients could manage their debts. FIE, with its traditional emphasis on credit for manufacturers, had no qualms about changing the makeup of its portfolio when that became necessary. After a careful process of compiling information, it made a thorough analysis of the different sectors, avoiding concentrating risk in sectors where problems were identified. As for geographic diversification, Caja los Andes changed its expansion plan, significantly reducing the number of new offices it opened and strengthening its position in the locations where it was already operating. Changes in client relations and risk management made it necessary to introduce certain changes in the organization and personnel of the institutions. In the case of FIE, the restructuring was significant. It decentralized certain functions and granted greater independence to
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branch managers, given that they had more and better information. Intuition might suggest the opposite: to centralize even more to address the crisis. However, FIE’s decision seems to have produced very good results, and branch managers reported and acted better once they were given greater responsibility. The incentive system was also changed to adapt it to the special nature and situation in each zone. The institution did not cut back its staff. Caja los Andes’ strategy focused on providing more training for human resources and, in some cases, dismissing personnel who were unable to adapt to the new situation and had become less productive. The institution also changed the responsibilities of its operating personnel. Analysts who had higher levels of arrears were given fewer possibilities of making new loans and were required to focus on maintaining the quality of the loan portfolio and monitoring loans in arrears. Caja also introduced a series of measures to improve portfolio control and management: it reduced the number of clients served by each analyst and adjusted the monetary incentive system for loan analysts and branch managers. Special prizes were given to employees with the best results in portfolio management. Teamwork involving all personnel at the branch level was encouraged and rewarded. Caja los Andes insisted on the importance of building the confidence of the credit analysts, who often feel some degree of discouragement and risk aversion in times of crisis. The changes that Caja los Andes made in its organization, according to Pedro Arriola, were the result of the institution’s evolution, growth, and diversification rather than a response to the crisis. Nevertheless, the creation of the position of assistant credit portfolio supervisor as well as strengthening the legal department and the internal auditing department can be attributed to the crisis. Microfinance institutions typically try to contain costs in times of crisis. FIE’s policies included elimination of all unnecessary spending, reduction in interest paid on deposits, repayment of the most expensive loans, and modification of its employee payment policy by reducing the fixed part of the salary and increasing the variable incentive pay. Representatives of the institutions interviewed for this study identified certain measures that could have prevented or mitigated the crisis.
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They stressed the lack of responsibility and initiative by the country’s authorities in controlling consumer credit institutions. Many problems could have been avoided if stricter regulation of those institutions had impeded over-indebtedness, in their opinion. Another useful prevention measure could have been the establishment of a credit bureau that included both regulated microfinance institutions and NGOs, such as the one created in 2003. Such a mechanism would have provided full information about all clients and their degree of debt. Microfinance institutions themselves should have been more aggressive in convincing and working with the authorities in this regard, particularly larger institutions that had access to information and knew about the problem before the others.
The Crisis in Ecuador Ecuador presents a particularly interesting case because of the extent of its crisis. GDP declined by more than 7 percent in real terms in 1999 (compared to zero growth, on average, in Latin America); consumer prices rose by 60.7 percent (compared to 10 percent, on average, in the region); and the unemployment rate grew considerably as wages fell sharply in real values. The sucre (Ecuador’s currency) lost nearly 200 percent of its value against the U.S. dollar (compared to 3.5 percent, on average, in Latin America), and poverty and income distribution worsened considerably. The Ecuadorian crisis was also marked by lax attitudes by the regulatory and supervisory authorities. The immediate causes of the crisis arose from a series of adverse events in Ecuador in the second half of the 1990s. First were natural disasters associated with El Niño. Second was the impact of the international financial crisis, which began in Asia in mid-1997 and spread to Latin America in 1998. Third was the fact that these external shocks took place in a context of great vulnerability in the financial system. This was coupled with the government’s implementation of a series of political responses—some of which were insufficient or inappropriate, or both. Losses associated with El Niño have been estimated as close to $3 billion, more than 14 percent of the country’s GDP (ECLAC 1998).
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Financing for rebuilding came mainly from abroad, suggesting that the impact was not included in the government’s accounts or the balance of payments. However, the nefarious consequences of the drastic impoverishment of affected farmers and the repercussions on the financial system should not be overlooked. The international financial crisis appears to have had even a greater impact on the country’s general economy than the natural disasters. The crisis affected Ecuador through two main mechanisms: first, a plunge in export earnings, largely due to a drop in oil prices; and second, the new risk scenario on the international markets, which resulted in a sharp drop in foreign financial flows into the country. Both impacts occurred in a highly vulnerable financial setting; together, they unleashed a serious solvency and liquidity crisis. The crisis was so severe that authorities intervened in 16 financial institutions between mid-1998 and early 2000, 45 percent of loans were nonperforming, and the fiscal costs reached an estimated 20 percent of GDP (IMF 2000). Monetary and exchange policies were adversely affected, creating a vicious circle that led to the announcement of dollarization in January 2000. Ecuador’s financial system has been marked by operating and management problems often arising from deficiencies in bank supervision and regulation, as well as the country’s tendency to bail out problem banks rather than enforce prudent standards. Bank supervision has been consistently challenging. Serious shortcomings in supervisory staff have played a part in these problems, despite efforts by external agencies such as the Inter-American Development Bank to strengthen the supervisory institutions. Staff were poorly trained, badly equipped, and lacked motivation, in the absence of a clear mission (IMF 2000). Also, supervisory staff had no legal protection and conflict-of-interest cases were frequent. Often, the needed disciplinary measures were not taken. Moreover, the existence of an overly permissive legal and regulatory framework has not helped the operations of the banking system or of the supervisory capacity of the Office of the Superintendent of Banks.
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Ecuador’s financial system was liberalized during the administration of Sixto Durán Ballén (1992–96). In May 1994 the General Financial System Institutions Act was established to promote liberalization of the sector and modernize different aspects of capital requirements. It included limits on related-party lending and credit concentration, as well as external auditing obligations. However, the limits established by the act were too broad and it relied too heavily on self-regulation by the institutions themselves, to the detriment of the development and strengthening of the capacity of the Office of the Superintendency of Banks, making it impossible to take any relevant corrective action. Also, under the new act, new financial entities were established in their different legal forms, with domestic and international capital (ING and Centro Mundo), and several finance companies were converted into banks. From 1994 to 1995, the number of banks rose from 32 to 39, finance companies rose from 33 to 46, and credit unions rose from 24 to 26. During the same period, a process of concentration of financial institutions took place through mergers, absorptions, acquisitions, and sales. At the end of 1996, the system included 44 banks, 32 finance companies, and 26 credit unions. The combination of inadequate legislation and ineffective supervision led to a 23.9 percent growth in the volume of loan portfolios, and an increase in related-party lending of nearly 300 percent of the technical net worth of the institutions. More financial income was recorded than was collected, with a gap of $688 million. In general, there was a lack of transparency in granting loans, including loans approved for nonexistent companies (Plitman Paulker 2002). In 1999, depositors’ nervousness and mistrust in the financial system led the government to contract international auditing firms to shed light on the accounts and establish the true status of the institutions. Only 19 banks passed the audit, including Banco Solidario, while three large banks in the system—Pacífico, Popular, and Previsora—were required to capitalize, but ended up collapsing. The combination of local uncertainty and the international financial crisis led to reduced lines of external credit and loss of confidence
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throughout the country as the problems in the banking sector became public knowledge. Substantial flight of capital occurred: some $422 million left the country in 1998, and $891 million in 1999. These events, combined with some policy measures, aggravated the problems in the financial system, resulting in a systemic liquidity and solvency crisis. Although the government tried to stem the flight of capital and reestablish confidence in the financial system by creating the Savings Security Agency (to protect savings through rigorous and ongoing supervision of financial institutions), the public perceived this measure to be an additional factor contributing to vulnerability and a tool used by the political-economic powers to salvage Filanbanco, the country’s largest bank at the time. In March 1999, the administration of Jamil Mahuad declared a bank holiday, and in June deposits were frozen for one year. The crisis in the real sector of the economy increased the nonperforming portfolio of the financial institutions. This forced them to set aside reserves for bad debts. However, lack of liquidity and low levels of equity limited the size of those reserves, which did not reach desirable levels. The reduction in liabilities and, to a lesser extent, the creation of a capital circulation tax in December 1998 meant that levels of financial intermediation shrank considerably and, as a consequence, so did financial income from that activity. Institutions were forced to generate income from other operations, such as foreign exchange transactions and real estate investments. Banks began to put strong pressure on the government to devaluate the sucre. The series of devaluations of the sucre before the introduction of dollarization created incentives to minimize holdings in monetary assets, which were replaced by real estate and dollar-denominated assets. As a result of the reduced volume of their intermediation business, the banks had to make a great effort to adjust their available capacity to the new operating levels, closing some branches and dismissing employees. However, this reduction in expenses could not compensate for the reduced operating levels. Expenditures were reduced by 19.1 percent, while the portfolio shrank by 28.1 percent. The ratio between operat-
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ing costs and the gross portfolio of the banks rose from 11 percent in 1997 to 12.4 percent in 1999 (according to financial information from Ecuador’s Superintendency of Banks).
The Response of Ecuador’s Microfinance Institutions to the Crisis The deepening mistrust of Ecuador’s financial system led to continuing withdrawals by people who feared losses during a widespread bank failure. Of the few funds left in banks, most were in U.S. dollars. By the end of 1999, 41 percent of term deposits in banks were in dollars, with maturities not longer than 90 days. Such short-term choices supported liquidity and purchasing power to some degree. The macroeconomic crisis and the ongoing devaluations of the sucre reduced the ability of customers to repay debt and further limited borrowing capacity. High interest rates for loans in sucres (from 49 percent in 1998 to 59 percent in 1999) and uncertainty discouraged new borrowing. Unable to repay the existing debt, clients became increasingly risk averse. Further, decreased liquidity in the financial system constrained new credit creation, thus squeezing potential borrowers. By contrast, the withdrawal of funds from microfinance institutions (while significant) was less severe than for banks. In 1999 deposits dropped 45 percent in credit unions and 69 percent in banks, respectively (according to financial information provided by Ecuador’s Superintendency of Banks). Credit unions were less dependent on international borrowing and government deposits because their sources of funds came primarily from member deposits, a more diversified and stable source of funding. Among Banco Solidario’s product offerings were long-term savings instruments linked to housing purchases. Clients strongly resisted redeeming these, and along with large government deposits from the Corporación Financiera Nacional (CFN), Banco Solidario enjoyed great stability as compared to other banks. Two primary factors restricted liquidity in the financial institutions. First, dollarization in January 2000 effectively eliminated the role of the central bank as lender of last resort. The central bank did not support
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banks through bond operations or permanent lines of credit. Second, the government allowed bank debtors to pay banks with certificates of deposit that originated in financial institutions that had been taken over or reorganized. Banks could rediscount these certificates to repay their debts, with the CFN as a second-tier entity. A lack of liquidity and the absence of long-term funding sharply reduced both the quantity and maturity of lending, with predictably negative effects on medium- and long-term financing in areas such as mortgage lending. The performance of cooperatives was generally better than that of banks. In 1999 and 2000, the gross loan portfolio of banks fell by 23 percent and 47 percent, respectively. Although the portfolio of the cooperatives decreased by 59 percent in 1999, it rebounded strongly, growing by 63 percent in 2000. In spite of this variability, cooperatives consistently maintained their credit operations, and loaned money (although with smaller loan amounts) at lower rates than the banks. The economic crisis had a dramatic impact on the ability of borrowers to repay loans. Nonperforming portfolios soared from 5.6 percent to 29.7 percent between 1998 and 1999 in banks, while they rose on average from 2.8 percent to 3.2 percent in credit unions, and from 3.6 percent to 11.4 percent in Banco Solidario. There are several reasons why arrears were lower in microfinance institutions than banks. Foremost among these were better portfolio diversification and little or no exposure to corporate lending. Moreover, clients were motivated by a moral obligation to honor debts, and in the case of credit unions, institutions had strong social ties to their clients based on their local presence and identification with the community. The immediate impact of the crisis was a reduction in institutional income and net worth. Faced with lower returns from financial intermediation, institutions attempted to generate profits through the exchange rate differentials and by investments in property. Banco Solidario invested $6 million in real estate to speculate on property appreciation. In common with other institutions, it increased its position in dollars to benefit from devaluations. In 1999, these tactics delivered extraordinary income that was 140 percent of its gross financial margin, and 900 percent of profits.
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The Actions of Ecuador’s Microfinance Institutions Banco Solidario established new internal financial structures and exchanged its own bank certificates at 100 percent of their value for certificates of institutions in receivership or in liquidation. The certificates of these institutions were trading at a discount of about 70 percent. It used these certificates to repay lines of credit that it had contracted before the crisis, at 100 percent of their face value. Since the certificates were trading at a discount, this operation allowed it to earn some profits without affecting the currency match. Central to the bank’s survival was quick and effective shareholder support, particularly from international shareholders and some aid agencies. Led by ProFund International, a group was established to provide rapid liquidity (composed of Hivos-Triodos-Fonds, Calvert, and ACCION, and guaranteed by USAID). ProFund and Hivos-TriodosFonds, along with other institutions such as Belgian Technical Cooperation, Oikocredit, Citibank, and CARE, provided longer-term resources. USAID and ACCION’s Latin American Bridge Fund provided various guarantees to back continued financings. International shareholders also participated in the expansion of capital. All of these timely interventions enabled Banco Solidario to honor its financial obligations and boost client confidence. To keep its deposits, Banco Solidario introduced term-deposits with periodic advance payments of capital, thereby allowing it to capture a source of stable funds and to reassure clients concerning the safety of their savings. The results were a smaller loss of deposits and a rapid recovery in deposit levels. Meanwhile, credit unions—and specifically, Jardín Azuayo—implemented a policy of transparency with their members. Member loyalty became a strength in time of crisis, and withdrawals and cash flows were managed at reasonable levels. Those cooperatives not subject to supervision by the Superintendency of Banks took advantage of their ability to keep their offices open during the bank holiday, thus increasing members’ confidence. Faced with a new risk scenario, a sharp increase in arrears, and difficulties in making new loans, institutions put in place several strategies
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to rapidly grant new loans and improve institutional risk policy. Banco Solidario met this challenge with a strategy that tailored specific payment plans to individual debtors based on their historical performance and specific circumstances. This strategy was implemented with the help of ACCION International, using a technique for identifying potential candidates for refinancing. This technique was designed to maximize loan recovery and to minimize the loss of clients, and had been successfully tested in the case of BancoSol in Bolivia, and in MiBanco in Peru. In addition, reserves for risk coverage were increased. This approach to new lending took a broader view of the environment in which the microentrepreneur operated, looking beyond an individual view of the client. Standard risk-mitigating measures were also used, such as reducing loan amounts and payback periods and increasing required guarantees. At the institutional level, the bank toughened its risk policy and created the capacity to measure macroeconomic risk and its impact on the institution and clients. In addition, it designed and implemented a sophisticated information system to measure and control institutional risks.
Lessons Learned The preceding discussion has analyzed how a systemic crisis can affect the operations and coping strategies of Latin American financial institutions. This study gives rise to a series of final observations. The lessons learned can be of use two ways: for understanding the results and strategic actions that have characterized Latin American microfinance institutions in recent years; and more importantly, for guiding future actions by institutions, governments, and the different players involved in the world of microfinance. Identification and adoption of a series of “good practices” extracted from the lessons learned can help deflect future adverse effects on microfinance institutions and reduce or eliminate trauma for their clients. Five lessons learned, and their implications, are discussed below. First, in times of systemic crisis—which, by their nature, affect all financial intermediaries—microfinance institutions have certain
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advantages that may enable them to survive the critical period more successfully than other financial intermediaries. Notably, in the institutions examined in this study, depositors withdrew smaller amounts from microfinance institutions than from other institutions, with a consequent smaller loss of liquidity. The greater physical and financial proximity of microfinance institutions to their clients and the greater confidence they inspire play a determining role in this outcome. A stricter culture of repayment exists in microfinance institutions than in the rest of the financial system. Deepening the personalized relationships between institutions and their clients will also deepen mutual understanding and confidence. The specific formula or strategies applied by each institution may vary. Institutions may offer credit or savings products adapted to each client’s situation and designed to promote loyalty to the institution (such as long-term financing, or differentiation between savings and investment products). Or institutions may respond flexibly to unusual situations that are not the client’s fault (such as debt rescheduling, debt forgiveness in extreme cases, or legal advisory services). The institution’s staff may pay personal visits to people affected by the crisis to learn first-hand about their problems. Or microfinance institutions may distinguish themselves from other credit institutions that are less involved with their clients by increasing promotional or publicity activities, changing the physical appearance of their branches, and the like. Second, the information that microfinance institutions collect is valuable in two ways. The institutions capable of identifying the early signs of an approaching crisis can get a head start in their decisionmaking, and more successfully weather the situation, as this study shows. Not only general information about the context in which microfinance institutions operate, but also information about clients, their individual capacity, and the context in which they carry on their entrepreneurial activities is extremely valuable. All institutions in this study became much more cautious in evaluating risks in response to the crisis. However, they varied in their response. Some were more inclined to use the past performance of their clients as a benchmark. Their strategy consisted of keeping clients they knew, rather than attracting new clients for whom
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they had no information. Others devoted considerable resources to performing an in-depth analysis of the market and the context in which clients operate, to obtain information about their future ability to pay. A combination of both types of measures is a necessary strategy. Third, the advent of a crisis creates a more competitive environment for microfinance institutions; in turn, they must pursue concrete actions to attract and retain the best clients. The most successful institutions are the ones that make the greatest efforts in this area, by offering new credit or deposit products (or even other types of products, such as the sale of insurance or tax payment facilities), new technological innovations (smart cards, interconnected branches), new types of client relations (greater flexibility, improved client service), or by diversifying into new sectors of the economy. Hand-in-hand with these observations is the need for microfinance institutions to engage in internal restructuring to provide sounder operations. Restructuring can extend to the institution’s organization, managerial capacity, personnel, installations, and/or equipment. Certain measures appear to help an institution weather a crisis successfully. These include human resource training; introducing a well-designed incentive system to motivate staff; promoting teamwork; creating or strengthening departments for risk analysis, collections management, and/or legal advisory services; and improving installed capacity and information systems. The last general conclusion concerns the importance of support from shareholders, public institutions in the country, and/or various international agencies. In cases where the crisis translated into problems of liquidity, the need for such support was more evident. Even when liquidity problems were absent, timely and effective regulatory and supervisory actions by the authorities were a determining factor in the magnitude of the impact of the crisis. In some cases, efforts from national and international shareholders and institutions (in the form of immediate contributions of funds and design of institutional strategy) also played a significant role in buffering the impact of the crisis.
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References Economic Commission for Latin America and the Caribbean (ECLAC). 1998. Ecuador: Evaluación de los Efectos Socioeconómicos del Fenómeno de El Niño en 1997–1998. Santiago, Chile (July). González-Vega, Claudio. 2003. El Manejo del Riesgo Idiosincrásico y del Riesgo Sistémico en las Microfinanzas. Presentation to Bolivia’s Office of the Superintendency of Banks and Financial Institutions, 11 February, La Paz, Bolivia. International Monetary Fund (IMF). 2000. Ecuador: Selected Issues and Statistical Annex. IMF Staff Country Report No.00/125. Washington, D.C. (October). Plitman Pauker, Ruth. 2002. La crisis bancaria en el Ecuador. Quito: Fundación Friedrich Ebert (http://www.ildis.org.ec/articulo/ banca.htm). Rhyne, Elisabeth. 2001. Commercialization and Crisis in Bolivian Microfinance. USAID–Microenterprise Best Practices (MBP) Project. Bethesda, Md.: Development Alternatives (November).
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The Right Technology for Microfinance Sergio Castello and Carlos Danel
N
ew technologies represent huge opportunities for microfinance institutions (MFIs) to dramatically expand outreach, reduce transactions cost, and introduce new products. Technology is providing Latin American MFIs with new ways to expand outreach and improve services to microentrepreneurs in both urban and rural areas. This chapter presents a broad overview of how technological developments have transformed the financial services industry in the past three decades, highlights the differences specific to microfinance technology, and explores special opportunities and challenges. The chapter begins by briefly presenting the context in which Latin American microfinance institutions operate and explaining how technology can help the microfinance field meet several key challenges. The second section looks at the “new economy” and how the revolution in information and communication technology has influenced the development of the financial services industry. The third section explores how Latin American MFIs are using innovative technologies such as automatic teller machines (ATMs), smart cards, personal digital assistants (PDAs), interactive voice technologies (IVR), credit scoring, and biometrics. The fourth section offers concluding remarks on how technology might realistically help the Latin American microfinance industry overcome obstacles to expanding outreach, reducing costs, and developing new product: challenges that the traditional banking sector has thus far been unwilling or unable to tackle, in developed and developing countries alike.
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CHAPTER 6
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Introduction to Microfinance Technology As they increase their presence in the formal financial sector, Latin American MFIs are feeling some of the same pressures as banks and other financial institutions, as chapter 3 on downscaling notes. Banks continue to be challenged to reduce costs to maintain market share. Some have engaged in downscaling or moving down market, increasing pressure on MFIs to become more competitive. Because of the very nature of the microfinance industry—based on large numbers of small transactions—MFIs have always felt the need to reduce transactions costs, perhaps even more than banks. MFIs are also constantly looking for ways to expand outreach. Latin America has long been a leader in the microfinance field, but it continues to face significant challenges, such as increasing penetration in some of the region’s largest countries and expanding financial products and services to rural areas and their poorest citizens. The use of technology can help develop more effective delivery channels so that MFIs can meet these challenges. Technologies such as automated transaction services and personal digital assistants, for example, can enable MFIs to access and process real-time information efficiently, so as to meet client needs right away through ATMs or during loan officer visits. The result could be significantly increased customer base with more products and services, and higher loan officer productivity—all while reducing transactions costs.
Technology’s Impact on Financial Services and Microfinance In the late 1990s, the “new economy” became a catch phrase to convey the way in which the world was being transformed by revolutionary advances in information and communications technology. These advances began as early as the 1940s and accelerated rapidly through the 1970s, 1980s, and 1990s. Economists announced a “new paradigm” in which the traditional factors of production—capital, labor, and natural resources—were no longer the main determinants of economic growth. The 2001 stock
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market crash and subsequent global recession dampened enthusiasm for the ever-growing powers of the Internet and appeared briefly to confirm the viewpoint of skeptics who resisted the new paradigm. However, the economic performance and characteristics of the recovery since have shown that the new economy is still with us—and is probably here to stay. The relatively new information technology sector continues to exist as an industry in its own right. Computer chip performance keeps increasing, and Internet connectivity speeds are improving even more quickly. The Internet is bringing new products and services to markets in all sectors, from manufacturing to health care, education, banking, and microfinance. Perhaps more importantly, productivity increases linked to the new technologies appear to be significant, lasting, and continuous (Alcaly 2003). While advances in information and communications technologies (ICT) are at the heart of the new economy, its strength and vitality is also due to changes in the way businesses operate (Alcaly 2003). Alcaly traces what he calls the “new business practices” back to the Toyota Motor Company and notes that these practices have continued to develop, incorporating the latest technological advances and spreading to more and more firms. Rather than producing mass quantities of standard products, companies try to respond more directly to customer demands and orders, a seemingly simple change in perspective that has had far-reaching consequences. It entails producing a variety of goods in smaller batches; closely coordinating operation with suppliers, designers, and distributors; giving workers more responsibilities to make decisions; and supporting and encouraging them with more training and pay commensurate with performance, such as profit sharing and ownership of stock. Studies have found productivity growth is key to the development and competitiveness of a number of sectors, and that these gains are related to technological investments and organizational innovations (Alcaly 2003). Many companies that are large users of information and communications equipment, such as in the health, financial services, and insurance sectors, are likely to make large investments in information technology. While productivity growth and business performance in
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these sectors has been high, other sectors that have made large investments in the same kinds of information technology, such as retail banks and hotels, have not fared so well. Capital investment in technology is necessary, but organizational innovations must be sufficient to complement new technologies and boost productivity. In some ways (such as leaner operations and staff incentives), microfinance business practices may come closer to the “new” norm than banking does. The lesson cited above is also essential: increased productivity through the use of new technologies is likely to happen only when technology investments are complemented by organizational innovation. The story that follows of how technology has transformed banking sets the scene for a discussion of what microfinance should expect to gain—or not—from the information technology revolution. The information and technology revolution (ITR) began long before anyone had ever heard the term “new economy.” The ITR started with the standard mainframe systems of the 1940s and 1950s, gained momentum with the microprocessor in the 1970s, and was further advanced by the use of commercial mainframes, personal computing, computer networks and real time transactions in the 1980s. The ITR exploded with the World Wide Web in the mid-1990s, bringing along innovations such as wireless communication with open standard systems. The Internet of the 2000s emerged jointly with digital convergence and interconnectivity of trade and commerce (see figure 6.1). The transformation of the United States banking sector into an information business was due in large part to technology and its data processing and retrieval capabilities, which reduced the cost of information, Mayer (1997) argues. From the 1970s onward, the increasing capabilities of machines to do what bank staff had once done by hand, combined with the ease in obtaining and analyzing information (such as interest rates at various maturities) that had previously been available only to banks, made it possible for nonfinancial institutions such as retail stores and data processing firms to compete for banking business. In the 1980s and early 1990s, a second wave of specific technological innovations, such as real time transactions, automated teller machines (ATMs), and debit cards, provided new delivery channels for a banking
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Figure 6.1 Evolution of Information Technology, 1940–2000 1990/00 Global Computation 1970/80 1950/60 1940 First Mainframes Military use 1946 ENIAC and 1946 US Navy Atlas Basic languages and no standards
Commercial Mainframes IBM 70, IBM 650, and 1962 IBM 360 design Basic standards Banking use of IBM 360
Personal Computing & Computer Networks Consumer Power Telephone Banking and Credit Cards Banking and Real Time Transactions, ATMs and Debit Cards
Global (24 x 7) Public Data Base Internet Applications, Wireless Access, and Digital Convergence Automated Telephone Banking, Interactive Voice Response Internet Banking, PDAs, Smart Cards, Credit Scoring, and Biometrics
Sources: Carvajal (2003); Trejos (2003); Castello (2004), as adapted by the authors.
sector that had redefined itself as an expanded financial services industry. These changes in banking have reduced, if not completely eliminated, the relationship-based nature of the business as it used to be, and new processes have made business loans a relatively less attractive product for banks. Microfinance, on the other hand, has emerged as an industry whose core product is relationship-based lending to small businesses. There are important differences between the way that technology has impacted banks and the role it can play in microfinance.
How Technology Almost Drove Banks Out of Business . . . Then Saved Them In 1973, there was a man honored for fifty years of service at a Virginia bank, who was asked at a party in his honor what he thought had been “the most important change that you have seen in banking in this halfcentury of service.” The man paused for a moment and then announced, “Air conditioning.” To those who have followed the rapid changes in banking since the 1970s, this story seems almost prehistoric, and indeed it is representative of a time before technology transformed the banking industry. In The Bankers: The Next Generation, Martin Mayer (1997) takes his readers
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even farther back to the early twentieth century, in the days when banks were linked directly to their communities, and their main business was lending to local companies. Banks were open from 10 A.M. to 3 P.M., and business was conducted in person. Men with green eyeshades sat on tall stools at the end of the day to close out the accounts. Banks were symbols of power and prestige in a community, and many bankers knew all their clients. While banks may have thought they were being paid to take risks and lend money, they were, in large part, simply exploiting an information advantage that they had over nonbankers, Mayer points out. They could spread over a number of loans the cost of gathering information about interest rates at various maturities, foreign exchange rates, industry trends, and the creditworthiness of companies in a given industry. Larger banks often performed this service for their small town affiliates. In addition, banks had a monopoly on processing information: linking individual transactions such as checking withdrawals and deposits to personal and corporate accounts. The fellows with the green eyeshades were indispensable for this, and no one else was about to hire them. With the appearance of machines that automatically processed transactions, and as financial and economic information became available to the general public at almost no cost, the doors were thrown wide open to a host of other players. It gradually became possible for nonbank businesses to compete successfully for banking business. A few representative cases of this general trend appear below: •
The banks’ best customers became competitors. Sears Roebuck originally offered consumer loans to its customers through a partnership with a bank. As the lending business grew, and technologies appeared that made it possible for Sears to manage its own portfolio, the retail giant moved beyond its partnership with a bank. Sears found it was able to raise money more cheaply than the banks could. Other players, such as car dealers, figured out how to offer financing for purchases without ever going through a bank.
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New companies emerged to take advantage of the new technologies. Automatic Data Processing (ADP) grew as it took over lines of business traditionally operated by banks, such as company payroll processing. ADP also dominated the credit card processing business early on. New financial instruments, made possible by computers, helped nonbanks hedge their financial risk. One reason many large companies had let banks manage their finances was because it was simply too risky to have such large amounts of money in the company treasury. With the development of futures and options, nonbanks began to feel more comfortable storing, moving, and managing large amounts of their own money.
By generating competitors for banks, technology made them more profit-conscious. Managers became less interested in a loan officer’s arguments that a specific loan was worth making because a relationship with a small manufacturer would pay off later when the company had become a big manufacturer. Technology, by making new standardized products possible, also allowed banks to pursue economies of scale and scope for the first time. Loans to businesses have to be developed, priced, and supervised one at a time; the cost of making the next loan is roughly the same at a big or small bank. However, credit cards, home mortgages, securities processing, foreign exchange and “derivatives” trading are all businesses that require elaborate and expensive computer installations and telecommunications expertise. But once these services and products are in place, the next loan or transaction can be made at virtually no cost. In 1994, banks invested $19 billion in technology. That year, a series of mergers began a trend for banks to grow bigger that has remained in place ever since, driven by the need to maintain such a large technological infrastructure. Moreover, banks began to move out of the conventional lending business and to compete in the new areas made possible both by information and communications technology and changes in regulation (electronic payments services, trading, derivatives, mortgage processing, credit card issuance, syndicated lending, and
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the like). These financial processes that reveal economies of scale are today defined as banking. And these days, bankers—the protagonists of Mayer’s history of the U.S. banking industry—are as likely to be found at insurance companies and brokerage firms and finance companies as they are at banks. The information technology revolution has continued and in recent years has become increasingly intertwined with advances in the communications sector. In the 1990s, Nokia revolutionized the wireless communications industry, allowing millions of people to use laptops, handheld computers, personal digital assistants (PDAs), and cell phones for a variety of purposes. Wireless and digital technologies have brought more sophisticated technological innovations, new banking products and financial services, including automated telephone banking and interactive voice response (IVR), Internet banking and PDAs, smart cards, credit scoring, and biometrics. Meanwhile, the smart card has become the portable computer for the third millennium, with more than 50 million rechargeable cards in consumers’ hands around the world. The stored-value card system first became popular in the United States in the mid-1990s.1 The “smart card” was pioneered by the Bay Area Rapid Transit System in San Francisco. In 1996, New York Metropolitan Area Transit Authority adopted the system. It is easier to run than a credit card system because a specific money value can actually be stored in the card. Today, these cards are also used in conjunction with biometric technology for personal identification and security, authorizing banking transactions through digitized fingerprints or signature.
Financial Services and Technology in Latin America What happened first in the banking sector in the United States gradually spread to the rest of the world, especially the trend of increasing automation. When the first computer was introduced to a Mexican
1
The first marketable smart card was developed and sold in France in 1974.
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bank in the late 1960s, it replaced the work of 240 people.2 In the 1970s, the networking of computers through modems and telephone systems brought the first credit cards to Latin American banking. In the 1980s, online real transactions became a reality, allowing the introduction of new technologies such as ATMs and debit cards, increasing both convenience and transaction volume. In Brazil, hyperinflation during the 1980s and 1990s forced banks to develop sophisticated systems for indexing loans and processing payments; to this day, the Brazilian banking sector boasts some relatively advanced features, such as the processing of all checks within 24 hours (much faster than in the United States). Finally, the recent entry of foreign banks into local Latin American markets has helped accelerate the pace of technological development in the Latin American banking industry. However, some obstacles remain, such as the state of the telecommunications industry. Countries with poor information technology infrastructure, financial institutions with lack of technology know-how and resource constraints, and markets with a low level of consumer penetration may experience difficulty in implementing innovative technologies in the banking sector. The information technology sophistication and ereadiness of countries can be measured by wireless penetration and its usage in financial services. The wireless device penetration is highest in Western Europe and North America, with rates of 70 percent and 53 percent respectively, and lags behind in Africa and in Latin America and Caribbean nations, with rates of 5 percent and 18 percent respectively (Assaad 2003). The strength of the wireless infrastructure differs from one Latin American country to another, influencing the decisions of financial institutions as to what services to offer. Consumer receptivity and demand for wireless services also varies by country, as reflected by use of the Internet and mobile and alternative technologies, and the sophistication of established payment and banking channels. The number of wireless financial users in Latin America and the Caribbean totals 250,000, reflect-
2
Interview with former director of Banco del Comercio, Mexico City.
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ing the low sophistication of information technology in these regions and posing a huge obstacle to the growth of integrated systems in the financial services and microfinance industries.
Microfinance in Latin America The discussion of banking and technology has yielded several insights with relevance to microfinance in Latin America. First, technology has pushed modern banking toward standardized processes and away from relationship-based transactions—although there have been persistent signals from customers who want personal service. Clearly the convenience and speed of automated transactions can complement face-to-face contact, but cannot fully replace it. During the height of enthusiasm for the new economy, some bankers announced the end of brick and mortar branches; this trend has been reversed. In New York City, for example, bank branches have begun to sprout up on every corner. In general, traditional channels continue to dominate banking in developed nations. The main methods of conducting bank transactions are still through branches and loan officers, accounting for 85 percent of financial transactions. Telephone and online banking account for 12 percent and 3 percent, respectively. Second, banking has become ever more intertwined with communication. Indeed, Mayer’s vision of the future includes banks eventually becoming subsidiaries to telecommunications companies. However, in developing countries, communication technology is less widespread and customers may not be technologically savvy. The microfinance business has several characteristics that will drive its particular information and communication technology needs. The core product in Latin American microfinance originally consisted of character-based loans to small informal businesses. These tiny transactions make up a portfolio that basically is uncollateralized and undiversified. Clients may have no financial statements to speak of, and no credit history. Loan delinquency in high-performing institutions is typically very low, but can be volatile if not kept in check by frequent and personalized reminders to customers.
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The essence of the microfinance revolution has been a series of lending methodologies, combined with institutional incentives, that have allowed microfinance institutions to rely on peer pressure, positive incentives (such as future access), and local knowledge as the primary mechanisms to ensure repayment. Operations of the pioneer microfinance institutions in Latin America and around the world (including Grameen, BRI, and Prodem) were technologically and administratively simple in the early days. Once it became clear that microentrepreneurs would repay their loans, interest rates could cover costs, and the number of clients would continue to grow, microfinance institutions had to increase the attention paid to back-office processes, management information systems, and communications technologies. Many microfinance institutions are still struggling to master the basic information management processes used by formal financial institutions: in some cases, to acquire a new status as regulated entities. There are few shortcuts, and many Latin American MFIs will spend the next five to ten years making marginal improvements to their efficiency as they learn to better manage the information in their loan portfolios. For those that are ahead of the curve, however, or that dare to experiment with alternative organizational configurations, new technologies represent huge opportunities to access new delivery channels that will allow them to dramatically expand outreach, reduce transactions cost, and introduce new products. Leading microfinance institutions have been able to adopt and customize some of the new technologies that are used in banking to make their operations more efficient and streamline and standardize procedures. However, recognizing that their business has some special characteristics, microfinance institutions have also looked beyond the limits of the financial services industry, putting gadgets such as Palm Pilots and cell phones to use in new ways. Meanwhile, banks are using information technology (IT) to engage in downscaling: moving down market and providing loans to small informal enterprises. These banks are watching the leading microfinance institutions to see what technologies are the most useful. MFIs in Latin America today use technology mainly for three purposes: to increase outreach; to offer new products and services; and
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to reduce back-office and transactions costs. New technologies such as ATMs, smart cards, PDAs, telephone banking and IVR, credit scoring, and biometrics can help microfinance institutions create value while reducing transactions costs and increasing outreach in rural and remote areas. The use and implementation of innovative technologies can also help MFIs develop new products and services to meet individual consumer needs, thus improving and expanding the reach and richness of client relationships. Some of these technologies may also improve database and back-office functions, and contribute to risk management. The following section provides examples of how Latin American MFIs are combining technologies into packages that work for them.
Technology and Latin American MFIs Latin America is home to the majority of the world’s viable microfinance institutions (35 out of 64), and arguably has made the most progress of any developing region in integrating microfinance with the formal financial sector (Miller 2003). However, large nations such as Brazil and Mexico have a combined microenterprise population of more than 15 million, of which less than 2 percent are served by microfinance institutions.3 In contrast, small countries such as Bolivia, Nicaragua, El Salvador, and Paraguay have a combined microfinance clientele of about 600,000 clients, representing MFI market penetration rates of 163 percent in Bolivia, 72 percent in Nicaragua, 69 percent in El Salvador, and 36 percent in Paraguay (Nichter, Goldmark, and Fiori 2002). Thus the level of penetration of microfinance in large countries is extremely low when compared to smaller nations. Bolivia, a small nation, has developed a flourishing microfinance sector with solid, regulated institutions, healthy loan portfolios, and a client base to rival that of conventional banks. However, even the most developed microfinance markets, such as Bolivia, Paraguay, and Nicaragua, still face a number of challenges. They need to increase productivity and efficiency, expand product offerings beyond microcredit, 3
Westley (2001); Christen (2001); Nichter, Goldmark, and Fiori (2002).
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increase outreach to the poor in remote rural areas, and continue the microfinance industry’s integration with the formal financial system (for example, through the use of common infrastructure such as credit bureaus and central bank reporting mechanisms). It appears that the “big-country” markets might best be penetrated by MFIs or banks equipped with creative, high-tech solutions that either leap-frog the sophisticated banking, consumer credit, and communications industries in those countries—or more likely, work in tandem with them. The examples below illustrate the use of specific technologies and systems, such as ATMs, smart cards, PDAs, IVR, credit scoring, and biometrics now available in the Latin American microfinance sector.
Automated Teller Machines ATMs offer several benefits. Clients can access their accounts at their convenience, MFI personnel are not required to be present for transactions, and MFIs can increase hours of operation and better coordinate with client schedules and locations. Financial institutions can leverage existing infrastructure such as stores, pharmacies, and supermarkets, thus reducing branch space and increasing customer base. ATMs also facilitate the provision of savings services, thus making possible a lower cost-funding source through deposits. ATMs have a certain appeal to financial institutions seeking to channel capital to an underserved part of their customers (Whelan 2003a). They can be efficient transaction handlers, freeing up scarce staff and possibly acting as vehicles for a broader range of financial products. They are, however, expensive to own and operate. Few microfinance institutions are in a position to acquire a $30,000 machine, let alone operate many machines in a network. In addition, customizing ATMs for microfinance use may be expensive. Where literacy is an issue, supplementing written text with verbal instructions in the local language may help. Where most ATMs use a magnetic stripe card and PIN to identify account holders, other approaches may use smart cards with fingerprint validation.
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The ATM forwards client information read from the card to a host processor, which routes the transaction request to the cardholder’s institution. If the cardholder is requesting cash, the host processor causes an electronic funds transfer to take place from the customer’s bank account to the host processor’s account. The communication, verification, and authorization process is linked to a host system through a leased line, dialup or wireless, depending on the cost and reliability of infrastructure. For example, Banco Ademi in the Dominican Republic participates in an existing service network for ATMs, the A Toda Hora (ATH) network, and owns only a single ATM located in its main office. Banco Ademi has enhanced customer service and convenience by using ATMs and smart cards with the greatest benefit of mobilization of savings. Meanwhile, MiBanco in Peru purchased seven ATMs to start its network when existing ATM network operators refused it access. MiBanco was forced to pay a higher price per unit by placing a low-volume order.
Smart Cards A smart card is a plastic card the size of a credit card, with an embedded computer chip. The chip can either be a microprocessor with internal memory or a memory chip with non-programmable logic. Smart cards offer highly secure, off-line processing while protecting the integrity of the data and the privacy of the cardholder. Since smart cards contain all essential client financial information, transactions can be processed immediately. There is no need for online access to a network for each transaction, only twice-daily updates to the central processing site. The smart card can be used for services such as managing savings accounts, disbursing loans, or effecting transfers. At the time of enrollment, all pertinent client information can be loaded onto the card through a recording device attached to a PC. The types of services a client can access would be identified along with account balances and any limits that may apply. The use of smart cards offers several benefits. The cards are convenient, since they can be used through ATM or point-of-sale machines. They also offer customer control over security, intelligence, and data,
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and tamper-proof storage of user and account identity. Smart cards can manage and control expenditures with automatic limits and reporting, avoid weak or costly communications infrastructure, reduce the need for repetitive form filing, speed administrative functions, and improve transaction accuracy. As applications multiply, smart cards in various forms are beginning to appear as a common mechanism to identify the cardholder and process transactions (Whelan 2003b). In some instances, MFIs have found they help replace paper transactions and improve the speed and accuracy of services. There are two general categories of smart cards: contact and contactless smart cards. A contact smart card requires insertion into a smart card reader, with a direct connection to a conductive micro-module on the surface of the card (typically gold-plated). Through these contact points, transmission of commands, data, and card status takes place between the card reader and an application typically running on a PC. Contactless smart cards are not inserted into a smart card reader, but only need to be placed in proximity to a reader to transmit data. These cards are being used around the world in applications involving traveling and public transport. Combining smart cards, ATMs, and biometric technology. Prodem in Bolivia introduced smart cards and installed 34 automatic teller machines (ATMs) to operate its own network. in order to reduce operating costs of delivering services in rural areas (Bazoberry 2003). Smart cards now serve as an electronic passbook, allowing Prodem’s clients to transact money orders, currency exchanges, cash deposits, and withdrawals. Prodem saved $800,000 a year by avoiding frequent dial-up calls or fixed leased line charges, and it also protected itself from fraud, since the card carries the latest customer financial data. Smart cards for use with suppliers. Financiera Visión of Paraguay is a leading user of credit and debit cards, pre-paid cards, smart cards, and ATMs (linked to Visa International and Credicard). For example, it offers a card called Tarjeta Mayorista, which is a joint effort with
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established vendors, allowing deep discounts and other advantages to microenterprises. Visión, as a principal member of VISA international, is replacing the use of cash in its microfinance operations with debit and credit cards through ATMs and its point-of-sale network at 3,500 small businesses. Banco Solidario in Ecuador recently introduced a smart card called La Chauchera, which clients can use as a debit or credit card (Ribadeneira 2003). It acts as a smart or electronic purse, allowing microentrepreneurs to buy raw materials from big industries at wholesale prices. The smart card also serves as a revolving credit line and debit card. At the end of 2003, the smart card product had 14,774 users, a network of 25 wholesalers with 164 points of sales, and 1,082 ATMs. This $1.2 million smart card project is expected to eventually reduce the MFI’s branch infrastructure and administrative costs. These technologies have been tested and partially implemented in urban areas and will be implemented in rural areas by 2005 (Hernandez 2004).
Personal Digital Assistants (PDAs) PDAs are small, handheld digital computers that can run customer data and perform financial calculations (see Waterfield 2003). Using PDAs, loan officers work with little or no paper at all. While working in the field, officers can consult an electronic list of borrowers in arrears to plan collection visits, review clients ready to apply for their next loans, and refer to historical client information. They can also fill out loan application forms and calculate the indicators for loan review and approval. All client data and visit records can be stored electronically and be immediately available. PDAs can contribute to standardizing credit methodologies and operating policies, improve loan officer efficiency, and increase data accuracy and access. They complement the MIS of financial institutions. Although some MFIs are researching wireless technology to transmit data, virtually all currently use a physical synchronization process in which the PDA is connected to a personal computer.
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The growing use of PDAs in Latin American MFIs. Banco Solidario of Ecuador, Bangente in Venezuela, Finamerica in Colombia, BancoSol in Bolivia and FinComun of Mexico have all implemented PDAs to update loan officers’ portfolio information on new and outstanding credit applications, with loan payments, loan renewal and loan delinquency. For example, Banco Solidario in Ecuador still relies on loan officers and word of mouth to recruit new clients; some 45 percent of its new customers come through loan officers in the field and another 45 percent are referred by existing customers. However, the Ecuadorian MFI uses hand-held computers to input loan applications and leverage payment histories for prior and existing customers to approve new loans, thus reducing paperwork at the branches and permitting loan officers to spend more time with clients. MFIs report that the technology has improved workflow efficiency, reduced operational costs, and made better information available to loan officers. The results: better client retention, faster credit approval and cash disbursement, and increased loan officer productivity. Banco Solidario of Ecuador reports seven new operations and 20 new loans per loan officer per month, 720 new clients and a $1.2 million increase in the loan portfolio under management (Hernandez 2004). Banestado Microempresas, a subsidiary of Chile’s Banco Estado, reduced its loan cost 18 percent through the use of a data transmission system that is accessible through a laptop computer using a Windows-based operating system. Compartamos of Mexico recently suspended its use of PDAs, acknowledging that it was simply too much work to develop the PDA software at the same time as a set of new urban lending products were being developed and tested. Compartamos intends to launch a new PDA experiment in the near future.
Interactive Voice Response Technology Interactive voice response (IVR) technology helps callers conduct business with an automated system by speaking into a telephone (see Frederick 2003a). For an MFI, this information can include locations of branch offices, account or credit balances, client payment information, and general
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product information. IVR seeks to enhance customer service and reduce the bottlenecks in day-to-day operations that are caused by a large number of clients requesting simple information at the branch office. This technology is only cost effective for large institutions having a significant number of technologically informed clients. EDPYME Edyficar of Peru, a regulated microfinance institution, has implemented a pilot IVR technology to gain a better understanding of potential demand for its services by specific geographic area. Within three or four months the institution was receiving 1,500 calls per month about service and account information.
Credit Scoring Scoring technology analyzes historical client data, identifies links between client characteristics and behavior, and assumes those links will continue to predict how clients will act in the future (see Salazar 2003). This technology can help MFIs make more reliable loan application decisions, design more effective collection strategies, and increase targeted marketing efforts and customer retention. This technology can also help calculate more advanced analyses such as loan pricing based on client risk and more accurate provisioning against loan default and losses. MFIs that implement scoring tend to be large institutions making individual loans in a well-established client base. BancoSol in Bolivia implemented a collections scorecard to increase the effectiveness of its loan recovery efforts, and they have improved even though loan officers have been resistant to the process of capturing and recording information. MiBanco in Peru reports that in the first year after deploying credit scoring, it reduced loan origination costs by 10 percent by automating the loan approval process. Other savings are expected as the scorecards are applied to a broader range of products. Scoring can be developed for credit eligibility and analysis, visits, collections, and tracking desertion statistics. Credit scoring with Palm Pilots and PDAs. BancoSol has begun using a credit scoring technology, accessible on Palm Pilots and PDAs, to increase
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outreach. The Palm provides three scores: a collection score based on compliance probability, a segmentation linked to a recommended credit limit, and a selection score that approves or rejects credit applications submitted by new customers. BancoSol started classifying its clients based on payment history and credit scoring, while working to improve the bank’s selection, segmentation, and collection methodology. Default rates decreased from slightly above 8 percent to about 5 percent from December 2002 to December 2003 (Hernandez 2004).
Biometrics Technology Biometrics technology measures an individual’s unique physical characteristics, such as fingerprints, facial characteristics, voice pattern, and posture, to recognize and confirm identity (see Whelan 2003c). This technology can be an option for MFIs that use physical cards, passwords, or identification numbers to secure data stored in electronic format on a computer or ATM. Smart cards are required to store a customer’s biometric template. The main purpose of biometrics is to capture and store information to later compare for verification purposes. During verification, the system scans the client’s biometrics and matches this scan against the stored template and approves or rejects. A secure audit trail is recorded for each match attempt. Biometrics as a solution for savings. Prodem in Bolivia is a successful example of biometrics at work in the microfinance sector. Prodem initiated its savings accounts using the smart card and biometrics technology in March 2001, after a successful pilot test in a rural community of 50,000 people. During the pilot, Prodem learned that customers valued the security, status, coverage, access, and simplicity of the use of smart cards and biometrics when opening a savings account. This solution helped Prodem overcome a number of obstacles, including illiteracy, insecurity, and lack of personal identification cards among clients.
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Biometrics and smart cards have allowed Prodem to expand its microsavings portfolio from less than 1,400 to 12,000 clients by 2001, while deposits grew from $280,000 to $3.6 million. As of March 2003, savings had reached $10.38 million, with more than 38,300 accounts with an average of $271 per account. Prodem tasked an in-house development team to integrate biometric and card software with its MIS. Managers and loan officers who log into Prodem’s MIS must be identified by their fingerprints. The technology has reduced fraud, error, and repudiation of transactions and has also improved staff availability and customer service (Bazoberry 2003). Prodem’s experience with savings services is especially instructive. The MFI managed to combine several innovative technologies for use in rural Bolivia, a setting with limited telecommunications infrastructure. By integrating various efforts—the smart card, biometrics, and its MIS system—Prodem leveraged its investment and contributed to organizational efficiency as well. MFIs must carefully consider a number of factors, such as ease of use, clients’ familiarity with technology, security, language preferences, and literacy when designing delivery channels such as the ones discussed above. In addition, MFIs must evaluate the requirements for different technologies, which may not be available within the institution or in less-developed areas such as rural Bolivia. Each technology described above requires some of the following elements: reliable electrical power, easy telephone access for customers, affordable telephone charges, reliable card and card reader suppliers, 800 telephone numbers, staff for handling lost or stolen cards, currency supply, secured databases, frequent updates, technologically capable in-house staff, a stable and well-functioning MIS infrastructure, and the capacity to handle and maintain software integration. The implementation of new technologies in the microfinance sector of Latin America has already yielded some lessons. Technology is extremely expensive and should be scrutinized as to whether it will bring positive results in the short run as well as the long run. This process is time-consuming, but it is important to analyze whether or not to buy or develop new technology. Within institutions, the support of top
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management is essential for the project’s success. To ease in change and increase flexibility, it is necessary to educate consumers and employees. Technology design must come before implementation. Pilot programs are necessary to check the viability of the process. In sum, a great deal of work is needed to ensure that innovative technologies make MFIs more flexible and not more rigid.
Conclusion Microfinance institutions throughout Latin America are combining new technologies into unique packages that meet their specific needs. The importance of maintaining the personal dimension of client service has driven the shape of many innovations to date, such as the use of Palm Pilots and PDAs. The relatively disappointing experience with interactive voice technology suggests that reducing client-staff interaction may not work for microfinance. Pressure to minimize transactions costs does, however, make the automation of service delivery attractive. MFI investments in technology are made in the context of limited investment capacity, often in countries or regions with relatively lessdeveloped electric and telecommunications infrastructure. In Latin America, a new breed of fast-growing and adaptive MFIs is taking the lead in applying innovative technologies and creative solutions to difficult problems that most financial institutions have thus far been unsuccessful, unwilling, or uninterested in tackling. This fact, combined with microfinance’s unique features, has sometimes led to greater creativity among MFIs than that shown by banks in developed countries. These big banks may be meeting the challenge of implementing mass delivery channels that can standardize transactions, but they do not satisfy the human element of customer service. The earlier discussion of technology and banking showed how the financial services industry has moved away from business credit. If current trends continue, a large portion of the population in developed countries may be left unbanked, Mayer (1997) predicts, in his tale of the evolution of banking services. As specialized microfinance institutions (and also Latin American banks active in microfinance) continue to in-
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novate with unique technology packages, they may have some valuable lessons to teach developed country banks in the near future. The great hope for the microfinance field is that application of new technologies can help solve the problems of outreach (specifically, serving the rural poor and increasing penetration in big countries), offer new services, and contribute to back-office efficiency. Prodem in Bolivia (profiled in this chapter) has developed an especially innovative technology-based strategy to reach rural markets, and reports that the investment is generating positive returns. However, all the experiments discussed here are still quite new, and no rigorous cost-benefit studies exist yet. Thus at this stage, it would be premature to attribute huge jumps in productivity to these apparently successful experiences. The highest gains in productivity are to be expected when organizational innovation and investments in technology are combined. MFIs are still struggling with this balance. As MFIs test the levels of personal interaction they need to maintain customer loyalty and loan portfolio quality, they will continue to experiment with automating parts of the service delivery process. Microfinance also requires investments in technology to achieve optimal scale in operations. MFIs need solutions customized to their business model—and sometimes to their geographical context. When possible, MFIs should collaborate to ensure the standardization of technology implementations, thus reaping economies of scale and scope. An MFI alliance could help to avoid duplicating technology research, reduce the costs of technology products and services, and provide a forum for developing common technology standards. The challenge in the big countries of the region could actually represent a major opportunity to apply creative technological solutions. Some private players in those countries (Bradesco in Brazil, for example) have developed technology-based strategies to reach the vast underserved market of low-income clients, including microentrepreneurs. These initiatives, however, still lack the personalized service and creative stamp that is the trademark of microfinance innovations in other Latin American countries. Since they also are new, it is unclear how successful they will be at managing the credit risk associated with this new clientele.
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Increasing integration with the financial sector will pose both technological opportunities and challenges for microfinance. The pressure to keep costs down and standardize processes will need to be balanced with the imperative to maintain some aspects of personalized service. If technology continues to be used as creatively as it has been to date, the chances are good that the microfinance industry will be able to catapult itself to new levels of customer service, product innovation, and efficiency.
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References Alcaly, Roger. 2003. The New Economy and What It Means for America’s Future. New York: Farrar, Straus, and Giroux. Alfaro, Luis. 2003. A Toda Hora. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica. Assaad, Hanny. 2003. Mobile Financial Services in Emerging Global Markets. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica. Bazoberry, Eduardo. 2003. The Bolivian Experience of the Prodem Private Financial Fund, S.A. Paper prepared for Paving the Way Forward: An International Conference on Best Practices in Rural Finance, 2–4 June, Washington, D.C. Carvajal, Marco. 2003. Gestión efectiva de la función de TI de cara al siglo XXI. Actividades del Club de Investigación Tecnológica (CIT), 26 February, San Jose, Costa Rica. Castello, Sergio A. 2004. Innovative Technologies in Microfinance for Latin America: Building Effective Delivery Channels. Summary of the Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica. Castello, Sergio, and Paul Huszar. 2003. Evaluation of Financial and Environmental Operations of Sociedad Financiera Ecuatorial. Working Document, Multilateral Investment Fund and InterAmerican Development Bank, Washington, D.C. (August). Christen, Robert. 2001. Commercialization and Mission Drift: The Transformation of Microfinance in Latin America. CGAP Occasional Paper No. 5. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. (January). Frederick, Laura I. 2003a. Interactive Voice Response (IVR) Technology. CGAP IT Innovations Series. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. (October).
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———. 2003b. Mainstreaming Microfinance: A Scalable Solution. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica. Hernandez, Monica. 2004. An Approach to Technological Innovation. Banco Solidario Working Document. Quito, Ecuador (March). Holden, Paul, Sarah Holden, and Jennifer Sobotka. 2002. Micro-Credit Institutions and Financial Markets. The Enterprise Research Institute Working Paper. Washington, D.C. (September). Lopez, Cesar. 2003. Servicios Financieros Móviles. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica. Mayer, Martin. 1997. The Bankers: The Next Generation. New York: Truman Talley Books/Dutton. Miller, Tomás. 2003. Cobertura y rentabilidad de las microfinanzas en América Latina. In Ensayos en honor a Claudio González-Vega, eds. Grettel Lopez and Juan Carlos Obando. San Jose, Costa Rica: Academia de Centroamérica. Nichter, Simeon, Lara Goldmark, and Anita Fiori. 2002. Understanding Microfinance in the Brazilian Context. Rio de Janeiro: PDI/BNDES (July). Ribadeneira, Santiago. 2003. El caso de la tarjeta inteligente. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services. 16–17 October, San Jose, Costa Rica. Salazar, Daniel. 2003. Credit Scoring. CGAP IT Innovations Series. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. (October). Segura, Emilio. 2003. Self-Service: New Paradigm. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica.
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Trejos, Ignacio. 2003. Innovative Technologies in Microfinance for Latin America Building Effective Delivery Channels: Opening Remarks. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica. Waterfield, Charles. 2003. Personal Digital Assistants (PDA). CGAP IT Innovations Series. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. (October). Westley, Glenn. 2001. Can Financial Markets Reduce Income Inequality? Sustainable Development Department Technical Papers Series. Inter-American Development Bank, Washington, D.C. (October). Whelan, Steven. 2003a. Automated Teller Machines. CGAP IT Innovation Series. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. (October). ———. 2003b. Smart Cards. CGAP IT Innovation Series. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. (October). ———. 2003c. Biometrics Technology. CGAP IT Innovation Series. The Consultative Group to Assist the Poor (CGAP), Washington, D.C. (October). Yalinas, Juan. 2003. Technology and Personalized Service at a Regional Level. Presentation for Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San Jose, Costa Rica.
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icrofinance in Latin America has always been strongly linked to enterprise development. Indeed, this book’s definition of microfinance as “small-scale financial services for microenterprise owners and workers” emphasizes the target clientele’s occupation rather than any feature of the products offered. The central innovation is a set of techniques that can be used to manage the risks inherent in lending to small informal businesses, and which have been used for decades now around the world to offer microcredit: short-term working capital loans offered to microentrepreneurs. In the early days of microfinance in Latin America, however, enterprise credit was rarely a stand-alone service. Instead, it was often bundled with other financial services such as savings, social services (health and education), or business development services such as management training, technical assistance, and access to markets. In the late 1970s and 1980s, when the Inter-American Development Bank (IDB) began supporting microenterprise development through its Small Projects Program, the vast majority of programs offered financial services (primarily credit but sometimes savings) only after their clients had completed a mandatory training course. The training often focused on managerial skills and included the development of a business plan. In these early days, the fact that low-income microentrepreneurs could—and would—pay back their loans was not entirely proven. Many institutions felt that they needed to “teach” borrowers how to manage their money. By the mid-1980s, some institutions had modified this practice and
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required training only for repeat borrowers.1 This policy was especially common for institutions affiliated with ACCION International since they used a solidarity group, “step-loan” methodology, whereby repeat clients became eligible to borrow larger and larger amounts of money. In the early 1990s, most loan officers still strongly encouraged their clients to participate in training programs, but by the end of the decade many institutions had phased out their training and other nonfinancial activities, adopting the minimalist credit model. A number of exceptions exist. In both rural and urban areas, many organizations consider it part of their mandate to deliver more than just financial services to their clients. They may offer health, literacy, or legal services, as well as products specifically aimed at helping their clients’ businesses stabilize and grow: today referred to as business development services. There is also an important legacy from a generation of programs supporting multipurpose cooperatives or producer associations, in which credit was just a side activity, offered in support of production and marketing services. When one looks at the broad landscape, however, and considers the trends and issues addressed in this book, it is clear that the commercialization of microfinance is integrally related to the “unbundling” of microcredit from business development and other services. As microfinance organizations have increasingly specialized in the provision of financial services, and as regulated financial institutions have entered the field, the number of multiservice programs has decreased. Even the most vociferous advocates of the minimalist credit model, however, recognize that entrepreneurs of all sizes and shapes face a number of internal and external constraints, and may need access to services other than credit if their businesses are to survive and grow. Knowing which are the critical missing ingredients and how to make them available is one of the challenges faced by the business development services field. The story of the credit-plus model—how it originated, why it was abandoned, and what variations exist today—often takes a back seat
1
Interview with Carlos Castello, Senior Vice President, ACCION International, 2 January, 2004.
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to the topic of the commercialization of microfinance. Certainly the shift to minimalist microfinance was important for many institutions in enabling them to increase their profitability. However, this shift also brought with it a reduced focus on enterprise development per se, with the assumption that sustainable institutions and repeat clients were a proxy for impact—and that impact would be felt at the enterprise level. Latin American microenterprises today, however—even those with access to credit—continue to face numerous constraints beyond the financial. As microfinance institutions gradually shed their nonfinancial services, the IDB and other donors have looked to the broader field of enterprise development, originally concerned with small and medium enterprises, for guidance on how to develop interventions that provide growth opportunities for the smallest firms. This chapter will explore how microfinance and enterprise development were first intertwined, then moved apart, and are now coming back together again in a different way. The discussion highlights recent shifts in thinking, along with some promising experiments that offer a window into the future of microenterprise development in Latin America.
Credit and Nonfinancial Services, Then and Now Nonfinancial services was the term originally used to refer to any of a wide variety of activities that included everything under the sun—except finance. Many early Latin American microenterprise development institutions offered nonfinancial services in an effort to help their clients do such diverse activities as learn to read, manage their money, grow their businesses, start new businesses, be healthier, and develop their communities. Some of these services are still offered today, while others are less common. The services most often offered in conjunction with microfinance are discussed below, according to the degree with which they aim to address substantive aspects of the borrowers’ existing business. General education—including literacy, health, nutrition, women’s empowerment, and community development—has traditionally been of-
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fered by institutions that support community development or poverty alleviation, primarily village banking institutions and cooperatives. While cooperatives and credit unions have tended to keep education programs separate and voluntary, some village banking programs deliver education and even health services such as vaccinations and breast exams as part of the weekly meeting. While an argument can be made that the whole set of services should help entrepreneurs develop and grow their businesses, client satisfaction surveys for village banking institutions have revealed that benefits are most clearly perceived by clients in terms of health and empowerment, and less so in terms of business advancement. Impact studies have also identified behavior changes related to health but not to business management.2 Financial education has been almost universally offered by microlenders, to a greater or lesser degree. A credit orientation may provide information on how to obtain a loan, or may focus on what is expected of a borrower. For group lending, this includes information about the responsibilities of group members. Specialized microfinance institutions such as Caja los Andes (in Bolivia) offer a 20-minute charla or presentation to potential borrowers each afternoon. Village banking organizations such as CARE Guatemala or FINCA in Haiti may spend days or weeks working with future borrowers on group management issues. Also, many village banking programs offer savings services. In addition to helping clients build assets, many of these programs design their savings programs with the explicit goal of helping clients “learn” to save. Financial education may also include practical skills such as filling out a check, using a financial calculator, or even paying bills. More advanced courses may address the management of household and business income and expenses. An early microenterprise project offering financial education to its borrowers was Projeto UNO in Brazil (1972–79). This pioneer project was unique in its era for prioritizing credit and offering various types of training. 2
Dunford (2001), as cited in Westley (2004, p. 63). See also Promujer (2004).
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While financial education was typical of early programs, recently there has been a resurgence of interest in the topic.3 As microfinance institutions offer a wider range of products to their clients, in a context where most clients have other forms of debt, some have begun offering counseling or training services to help clients understand the bewildering array of choices they face and how to make strategic financial decisions. This phenomenon mirrors the situation of more developed economies such as the United States, where the availability of multiple forms of credit, especially consumer credit aimed at low-income households, has brought with it an apparent need for financial literacy training and materials: both those developed commercially and those offered by nonprofit organizations. In addition, a number of large corporations offer financial education to their employees, including some in developing countries.4 In the context of microenterprise, the new financial literacy programs—unlike the older programs that focused on managing the finances of the clients’ business—explicitly recognize the mixing of household and enterprise cash flow that is so common among clients of microfinance. Enterprise development programs targeting small and medium businesses frequently offer links to banks or other sources of finance. Usually these firms are a bit more sophisticated than the typical microenterprise and may need investment finance as well as working capital. This approach is characteristic of institutions that consider it inappropriate to offer financial services themselves. Links usually include help in preparing business plans and prescreening of loan applicants. Early initiatives used guarantee funds to encourage banks to participate in such partnerships. The Brazilian agency for small enterprise promotion, SEBRAE (Serviço de Apoio as Micro e Pequenas Empresas), has operated a guarantee program for small businesses for over a decade. In most countries in the region, this type of guarantee fund has been
3 4
See Sebstad and Cohen (2003).
Several large companies in Brazil have begun to offer some form of financial education to their employees: Coca-Cola in Rio Grande do Sul, Volkswagen in São Paolo, Mahle (a steel company), Brastemp (domestic appliances), and Mercedes Benz.
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largely discontinued.5 Today, most programs limit their involvement to business plan preparation, charging clients a fee if financing is indeed obtained. Management training was perhaps the most common nonfinancial service offered by urban microenterprise programs in the 1980s and much of the 1990s. Courses covered such topics as inventory management, accounting, tax planning, and legalization. Training might begin at the most basic level, encouraging entrepreneurs to keep written records, for example, and might include developing a simple business or investment plan. In the early days, entrepreneurs were often grouped together regardless of sector or educational level, and courses were taught by NGO staff who did not have much business experience. In the past, MFIs offered management training because they hoped it would help their clients better manage their money and ultimately, repay their loans. Today, few microfinance institutions offer this type of generalized management training, although there are exceptions. Centro ACCION in Colombia has developed a series of training modules that it sells to MFIs in Colombia and elsewhere in the region. Another interesting case is Financiera Solución, which was motivated by increasing market saturation in Peru to offer complimentary management training to certain clients (see box 7.1). Technical training and technical assistance has frequently been offered by microenterprise programs involved with small producers in sectors such as handicrafts, furniture, and textiles. Course content might include production techniques, new designs, and the use of technology, for example. While most microfinance institutions today have a core client base engaged in small-scale urban commerce, some organizations
5
Guarantees are used to reduce risk on the part of a lender in the case of default by the borrower. The most common models used for lending to small and medium businesses, the portfolio and individual models, are not considered an effective way to facilitate lending to microenterprises, primarily because of the small size and high transactions costs of microloans. More recently, microfinance institutions have been able to obtain institutional guarantees to access funds from commercial banks. See Young, Goldmark, and Londoño (1997).
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started out by focusing especially on small producers. Fundación para Iniciativas Económicas (FIE) in Bolivia is an older example; Actuar Famiempresas in Colombia is a more recent one (see box 7.2). In the
Box 7.1 Management Training to Increase Loyalty in a Competitive Market Financiera Solución (recently purchased by Banco del Créditor del Peru; see chapter 3), a consumer lender in Peru, has recently begun offering microcredit to self-employed individuals and informal business owners. Faced with increasing competition, Financiera Solución created a number of incentive schemes to increase client loyalty, including offering complimentary management training to its most successful clients. No fee is charged, and the training’s major emphasis is on developing an investment plan for the client. Of the clients selected by Financiera Solución to receive this service, only 10–15 percent completed the course (about 6,000 clients). Although relatively few clients have chosen to take the training, Financiera Solución maintains that for those who do, the course has a strong positive effect on client loyalty. Source: Sievers and Vandenberg (2004).
Box 7.2 An Integrated Approach to Enterprise Development: Actuar Famiempresas Actuar Famiempresas, an organization based in Medellin, Colombia, offers credit to a target group of low-income “family enterprises.” Although there was already a supply of technical assistance services in Medellin, Actuar analyzed the market and found that these services were inappropriate to the needs of family enterprises. They assumed a certain level of education; did not accompany the entrepreneur to see if knowledge was assimilated and applied; and were too specialized, not allowing for an integrated focus on the whole enterprise. Actuar received support from the Multilateral Investment Fund (MIF) to develop a customized curriculum for technical assistance, in which the consultants adopt an integral approach to the enterprise. The process begins with 15 hours of diagnostic work, followed by 97 hours of consulting assistance aimed at improving performance in a number of areas: production processes, management and administrative procedures, sales, product quality, distribution channels, and market positioning. Technical assistance focuses on areas of need and opportunity identified during the diagnostic, and specialized consultants are brought in for each module. The Actuar consultants follow up to make sure knowledge has been assimilated and is being applied. Entrepreneurs pay 60 percent of the cost (credit to cover these costs is usually available through Actuar), while Actuar subsidizes 40 percent of the cost. Source: Tabuenca and others (2004).
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agricultural sector as well, there has been a decades-long tradition of combining technical assistance with small loans to small farmers. Recently, as State-owned banks in rural areas have failed and have been restructured or replaced, private lenders have tended to adopt minimalist credit. In many countries, extension services provided by government agencies have been phased out. Today the largest providers of technical assistance to small farmers are probably input suppliers and/or buyers. Services are often embedded in the transaction. Thus small farmers need not pay cash; however, the cost is reflected in the price the farmer pays for inputs or the buyer pays for the crop. Buyers may be large commercial players, such as supermarket agents, or they may be affiliated with community organizations and have developmental goals. Through its Social Enterprise Program, the IDB has a long tradition of supporting local cooperatives and associations that offer a package of financial and nonfinancial services to their members in rural areas. Market linkages have long been a popular way for microenterprise organizations to combine finance, information, skills, and market access in one package. Since 1978, when the Small Projects Program was launched (the Program was recently transformed into the Social Enterprise Program), the IDB has been supporting groups or associations of small producers in sectoral programs that combine several elements. These include institutional strengthening or other assistance to organize producers (increasing their ability to produce at a larger scale); access to credit and/or specialized inputs, and access to technical assistance in production or processing (increasing their ability to produce the right quality); investments in infrastructure (in some cases, helping producers perform value-added functions so they receive an increased share of the profits); and strengthening existing relationships as well as building new ones with buyers (thus diversifying the producers’ distribution and sales options). Dozens of such projects have been financed since 1978 (Meissner 1991). Many were in agricultural sectors where small producers may have some competitive advantage, such as fruits, coffee, honey, and diverse or-
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ganic products.6 More recent projects have shifted their focus slightly from a supply-side approach (helping the producers to produce more and better products) to a demand-pull approach, beginning with a diagnostic of market demand for the products in question and working backward to determine whether or which elements of the local organization’s proposal the Bank should support. The IDB also supported a number of early projects in the handicrafts sector, including some that were successful in creating linkages, such as Mãos de Minas in Brazil (1994–98), Fundación Maquita Cusunchic in Ecuador (1994–98), and Asociación Mexicana de Artes y Culturas Populares in Mexico (1996–2000). Organizations providing market linkages are commonly engaged in grouping producers and purchasing goods for resale or linking them to buyers. Additional services such as training and product design are often included in the producer-marketing intermediary relationship. More recently, the Multilateral Investment Fund (MIF) has approved projects in support of market linkages in other sectors, such as a project to support small tailor shops through a business association, INDEPCO in Haiti (1999–2002). Other activities developed in conjunction with microfinance deserve mention: community development initiatives including small-scale infrastructure projects; environmental projects such as solar energy; and general entrepreneurship training for would-be microenterprise owners. Overall, training has undoubtedly been the most commonly offered service in conjunction with microenterprise credit. In the past, the providers of such training assumed that educated borrowers would be better equipped to manage their businesses—and consequently, repay their loans. This “urge to train” that initially motivated so many microenterprise programs has suffered a great deal of questioning over the years, as program managers observed that microentrepreneurs rarely sought—or applied—the lessons from formal classroom training. 6
Research has shown that small producers tend to locate in sectors where they have a competitive advantage: where there are few economies of scale, or ones that favor laborintensive, low-cost, flexible labor, or intensive supervision to oversee labor (see Tybout 1998).
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The disappointing results associated with early microenterprise training programs may have been due to the low quality of such training. Some recent evidence also suggests that formal training may not be the most useful way for entrepreneurs to learn. Most small and microenterprise employees in developing countries report learning their skills on the job. For enterprise owners, necessary information is often “embedded” in commercial transactions, such as training in the use of new equipment at the time of sale, or design feedback integrated into the purchasing process for handicrafts. In addition, entrepreneurs consistently report that they prefer peer-to-peer learning: that is, learning from other entrepreneurs who have “been there, done that.”7 A recent study by the IDB also highlights the importance of role models and contact networks during the process of business creation (Kantis 2002). Thus while it is argued that learning is central to the entrepreneurial process,8 the most effective pathways for such learning appear to be those developed during interactions with customers, suppliers, and competitors, and directly related to the day-to-day experience of operating a business.
The Pioneers and Their Models Most institutions funded by the IDB in the late 1970s and early 1980s took an integrated approach to microenterprise development. This section tells the story of a few early innovators, each of whom viewed the business of microfinance—and the needs of their client entrepreneurs—in a different way. Three models are outlined below: the training-led model, the market linkage model, and the integrated credit-plus model. These three approaches have evolved significantly over time, with implications for the fields of both microfinance and enterprise development.
7
Results from a survey of high-potential entrepreneurs conducted in seven Latin American countries. The findings are consistent with similar research findings from the United States and Russia (Pegram 2003).
8
Smilor (1997), as cited in Pegram (2003).
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“Entrepreneurs Need Training First, Then— Sometimes—Credit” Fundación Carvajal of Colombia, an early partner of the IDB, is recognized as one of the first Latin American nongovernmental organizations (NGOs) to develop a model for working with small and microentrepreneurs. In the late 1970s, Jaime Carvajal of the family-owned group of companies Grupo Carvajal visited Brazil and witnessed the operations of Projeto Uno. This program was offering a relatively simple loan product to microentrepreneurs in the state of Pernambuco, with unexpected success. Repayment rates were excellent, demand was high, and the loan portfolio grew steadily over a number of years. The Brazilian program introduced some innovative features that would become standard fare for microfinance institutions in Latin America. Projeto Uno was the first in Latin America to hire young, proactive loan officers charged with accompanying the loan cycle through all steps. Also, the project was the first to identify the relative importance of speed in approving and disbursing loans, and the relative unimportance of the interest rate, from the borrowers’ perspective.9 Projeto Uno offered a complimentary “financial education” course to its clients, focusing on how to open a bank account, make deposits, and fill out a check. This reveals an interesting principle common among early programs that would be abandoned later: the idea that microcredit programs are a “training ground” in which microentrepreneurs learn to be good bank clients. Jaime Carvajal returned to Colombia to visit and talk with microentrepreneurs in his native city of Cali. Despite what he had seen in Brazil, Carvajal became convinced that many of these entrepreneurs did not actually need credit, but rather training that could help them develop the skills to manage and grow their businesses. Carvajal hired a team to develop a pedagogic methodology and then invited small and
9
Interview with Maria das Graças de Andrade Borges, former employee of Projeto Uno and later superintendent of the Brazilian microfinance institution, CEAPE-Pernambuco. See also Jackelen (1982) for a detailed review of Projeto Uno.
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microentrepreneurs to take a course, which ended with an analysis to see if an investment was needed. Unlike Projeto Uno, the Carvajal program took shape primarily as a training intervention, followed by a credit referral if deemed necessary. Although the organization experimented with internally managing a loan fund, Fundación Carvajal’s board of directors ultimately set a clear long-term policy of maintaining the credit operations outside the institution. Over the years, Carvajal has worked in partnership with a number of banks or nonprofit financial institutions, with different degrees of involvement, sometimes sharing the risk and even providing the loan capital, at other times simply referring clients. Early on, the IDB considered Carvajal’s program a model of success and funded visits to Colombia for practitioners from other countries. Unlike the majority of microenterprise development programs of its generation, Carvajal has maintained the primary emphasis on training, while diversifying its client base to include youth, small farmers, and community development programs. Today, small businesses and microentrepreneurs are just one subset of a number of target groups trained by Fundación Carvajal—a trend that reflects the institution’s mission as well as the characteristics of the demand pool for training services.
“Entrepreneurs Need Market Linkages, Supported by Credit and Training” One of the most important lessons learned through the large number of sectoral microenterprise development projects funded by the IDB was that understanding the nature of market demand—and enabling producers to cater to this demand—is the key to success. As mentioned earlier, early projects often supported groups of agricultural producers through multipurpose cooperatives, as well as artisans producing functional wares (such as kitchenware), traditional art, or souvenirs for local or tourist markets. Promotora del Comercio in Colombia was one institution that developed the local market for handicraft production. Seeking higher prices and ready to produce larger volumes, others such as Maquita Cusunchic in Ecuador attempted to penetrate export markets with functional wares or designer goods. Whether working with simple
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or sophisticated market channels, the successful market linkage projects all had one thing in common: they helped to channel knowledge back from the buyer to the producer in a continuous way, so that design and production were able to quickly adapt to buyer preferences (HagenWood and Mikkelsen 1998). Figure 7.1 illustrates the different market channels, highlighting the all-important feedback loop: the information and service flow from buyers’ markets to intermediaries, and from intermediaries to producers. In the case of most handicraft projects, credit was simply a mechanism to ensure that production was not held up because of lack of working capital. In some cases, producers received advances of raw materials; in others, they received loans. Payment, however, was usually linked to continued sales. Thus these programs did not often encounter individual delinquency problems. Further, as was true throughout the microenterprise field in the early days, institutions that did not think of themselves as financial institutions often lacked adequate tracking systems or trained staff to manage fast-growing loan portfolios. In 1997, the IDB’s Microenterprise Unit conducted a survey of 100 handicrafts market intermediaries throughout Latin America (Mikkelsen 1997). One expectation was that profitability, as well as outreach, would somehow correspond to the types of institutions; that is, NGOs and cooperatives would be more socially focused and thus tend to have lower profit margins, while private intermediaries might be more cost-conscious, offering fewer services to their producers but achieving greater success in penetrating sophisticated markets. Interestingly, however, there was absolutely no correlation between the legal structure of such entities and their profitability, the types of services offered, or the number of producers reached. A much more important factor appeared to be the manager’s vision and entrepreneurial style. Projects that create sustainable market linkages continue to be supported by donor agencies, and some projects target small and medium-sized enterprises, or work with the whole range of enterprises in a sector. While the role of the intermediary is recognized as critical, donor organizations have yet to reach a consensus on how best to support these organizations so that sales grow and small producers benefit.
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Figure 7.1 Market Channels in the Handicraft Sector PRODUCTS Producers
Channels
DIRECT SALE Household producers
Markets
Domestic: • Tourism • Retailers
INTERNET
Individuals/small groups
Producer groups Associations Cooperatives
INDIRECT SALE THROUGH INTERMEDIARIES: NGOs ATOs
Scale production (semi-industrial)
(Alternative Trade Organizations)
Export: • Importer • Retailers/department stores • Catalogues/mail orders • Trade fairs
Commercial wholesalers
SERVICES AND FEEDBACK FROM INTERMEDIARIES TO PRODUCERS
FROM MARKET TO INTERMEDIARIES
• Raw materials
• Information on trends
• Design and product development
• Product specification
• Training and technical assistance
• Technology
• Financing
• Quality control
• Marketing
• Financing
• Quality control Source: Compiled by author.
“Training Is an Integral Part of Our Credit Delivery Model” Perhaps the best-known model that integrates the delivery of credit with financial education, training, and other business development services (credit-plus) is the village bank lending methodology. Pioneered as an
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emergency lending scheme in Bolivia by John Hatch of FINCA (Rhyne 2001), the methodology is similar to the one used by Grameen Bank in Bangladesh. Community banks of 20 or 30 borrowers—usually women—are organized into groups in which the members guarantee one another’s loans. Grameen Bank, as well the Latin American village banking institutions, originally developed compulsory savings programs as a hybrid product (part education, part financial service). Educational elements cited by village banking practitioners include compulsory savings; training for the village bank leaders in the calculation of loan payments, interest, and record-keeping; and management of the internal account.10 For clients who have never had contact with a financial institution, village banks introduce them to a number of practices so that they may feel more comfortable using the services of a local cooperative or bank—as well as having the opportunity to build assets through the village bank’s own savings program. Although FINCA has transitioned toward a more minimalist-style model, using training only as necessary to prepare groups to manage the loan distribution and payback process, a number of village banking organizations in Latin America still offer business development services to their clients. Promujer, a U.S.-based nonprofit with programs in Bolivia and Peru, offers training in business plan development to firsttime borrowers, credit orientation and financial education to groups, and management training to repeat borrowers. In addition to business development services, the program offers health services and referrals. One of the first and most famous Latin American institutions to adopt the individual lending methodology began with a decidedly developmentalist approach. Pedro Jimenez, former Executive Director of ADEMI (Associación para el Desarrollo de Microempresas, Inc.), explains that while most Latin American MFIs were recruiting sociology or philosophy graduates, and, through the solidarity group methodology, “outsourcing” portions of the risk analysis to group members, the
10
The internal account is used to make supplemental loans to village bank members, and in some cases, to outside members of the community. It is funded through fees, fines, interest income, and various forms of savings.
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loan officers he hired had degrees in business or accounting, and were expected to understand every detail of their clients’ business.11 ADEMI was the first Latin American microfinance institution to introduce financial performance incentives for loan officers, a practice that is now almost universal. Because their pay was linked to the performance of their loan portfolio, loan officers did everything they could to make sure their clients’ businesses were profitable. For example, a woman who made caramels might call her loan officer at ADEMI when the price of sugar went up and ask what she should do. Make the caramels smaller, the loan officer would suggest. This type of practical advice characterized the loan officer-client relationship, and ADEMI referred to this service as “technical assistance.” The service, however, was never independently priced or systematized, and as the institution grew and transformed into a bank, loan officers felt pressured to minimize the time they spent observing clients’ businesses. As opposed to the integrated delivery model, the training-led and market-linkage models have evolved primarily outside the microfinance field, and continue to exist as interventions that form the core of the enterprise development field. In many cases, the institutions using these models have diversified or expanded their clientele to include youth, the unemployed, low-income families, community groups, or small and medium enterprises. Meanwhile, the integrated “credit-plus” model has been somewhat discredited, and no longer dominates the microenterprise development field as it did in the 1980s and even the early 1990s. The next section discusses how and why the shift to minimalism occurred (box 7.3).
The Road to Minimalism As early as the mid-1980s, microfinance institutions in Latin America began offering rapid, convenient services to microentrepreneurs at cost-covering interest rates. ACCION International, after conducting a 11
Interview with Pedro Jimenez, former Executive Director of ADEMI, 29 January, 2004.
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Box 7.3 The “Minimalist” versus “Maximalist” Debate In the late 1990s, a popular electronic Web site run by Ohio State University (devfinance) was home to many fiery debates on the part of microfinance practitioners around the world. Some of the more senior academics and researchers who participated clearly enjoyed stimulating these debates, making light of the subject (using the term “microdebt”) and generally trying not to let the microfinance field become too enamored of its own success. The following pair of poems was posted by J. D. Von Pischke in 1997: Minimalist A loan alone It can be shown Will on its own Increase the wealth Improve the health Of micro clients No rocket science Self-realization God’s own creation
Maximalist A loan alone It’s widely known Is often blown Without support Plans will abort So show the way And give TA Building skills Reduces spills
Source: E-mail communication with J. D. Von Pischke, October 2004.
number of surveys, found that many borrowers were attending training courses only because they were told they must do so in order to receive a loan—but they were not retaining or applying the knowledge they acquired through training.12 The time that they spent being trained was, in the eyes of the clients, simply an opportunity cost of credit. ACCION’s affiliates began a gradual process of phasing out their training activities. Other organizations perceived the situation differently, insisting that their loan portfolios performed better when clients were trained, and the clients benefited from the training. The evidence, however, did not support MFI assertions about better loan portfolio quality or client benefits. Two influential studies published by the United States Agency for International Development (USAID) during the 1980s argued that the nonfinancial side of creditplus programming was not very effective. 12
Interview with Carlos Castello, Senior Vice President, ACCION International, 2 January, 2004.
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First, a rigorous cost-benefit study, “Searching for Benefits,” compared programs that offered training and technical assistance to their borrowers with programs that did not, and found that there were no additional benefits from offering these services, either for borrowers at the enterprise level or in the form of improved portfolio quality for the lending institutions (Kilby and D’Zmura 1985). Then, in 1988, USAID undertook a major stocktaking of its experience in microenterprise development, with the aim of identifying the patterns of project intervention that generated success. “The Microenterprise Stocktaking Report” analyzed 32 projects and programs in 20 countries. Since almost all programs offered several types of services, both financial and nonfinancial, the categorization used to group the programs referred to the stage in the target enterprises’ life cycle: the enterprise formation approach, the enterprise expansion approach, and the enterprise transformation approach (Boomgard 1989). Using the criteria of scale, impact, and institutional sustainability, researchers found that programs specializing in the provision of financial services (categorized under the enterprise expansion approach) were much more successful, and posited that training and technical assistance services appeared to be the weak link in programming. While author James Boomgard recognized that capital constraints were not always the main obstacle encountered by small and microenterprises, the stocktaking did not yield evidence of success among programs providing credit and nonfinancial services as part of a package. Bloomgard asserted that few practitioners understand the needs of microenterprise, and that training and technical assistance for microenterprise development are not far advanced (Boomgard 1989). During a series of program reviews conducted in the early 1990s, the IDB also discovered that microenterprise borrowers were not enthusiastic about mandatory training services.13 Services were not affecting
13
Unpublished evaluations of the early global microenterprise loans noted that the training programs were characterized by empty classrooms and/or the common practice of sending family members—children or relatives—to attend the training, so that the entrepreneurs need not leave their businesses unattended.
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business performance, and entrepreneurs exhibited little demand for them. In some cases, it appeared that this disinterest was due to poor quality of the services offered and the difficulty NGOs and financial institutions had in offering relevant training to their clients. By the end of the 1990s, donors were less willing to subsidize training programs offered by microlenders. The Donor Secretariat managed by the World Bank, the Consultative Group to Assist the Poor (CGAP), published guidelines recommending that all microenterprise organizations separate their accounting by program, in order to identify the true costs and revenues of their credit programs, as well as other nonfinancial services (Helms 1998). The difficulty in recovering the costs of training, whether through donor subsidies or fees, combined with the increasing focus on the institutional sustainability of microfinance organizations, led many more microfinance institutions to discontinue their training programs. As the minimalist trend gathered momentum, the most notable exceptions were those village banking organizations that viewed training as an integral part of their microfinance lending methodology. U.S.-based village banking organizations such as Freedom from Hunger have been among the most vocal proponents of the integrated model, claiming that village banking is an effective way to reach poorer borrowers and that the integrated service delivery maximizes social impacts (Dunford 2001). The Freedom from Hunger model is appropriately called “credit with education” and includes other services such as literacy training and health that go beyond the purview of business development. In the 1990s, a new generation of studies—this time, rigorous impact evaluations of microfinance programs—again found no evidence that credit linked to business development services enhances enterprise growth. To the dismay of some village banking practitioners, the impact studies supported the theory that microfinance helps clients increase their income, but found no clear evidence that one lending methodology produces superior results. Most surprising and important to note—at least to those who view microfinance as integrally linked to enterprise development—the impacts on borrowers were most frequently observed in relation to the reduced vulnerability of the borrowers’ household
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income and the ability to withstand shocks, rather than to enhanced business performance or growth (Snodgrass and Sebstad 2002). As Latin America approached the new millennium, it became clear that microfinance could be sustainable, which was an exciting accomplishment for the development field. Microfinance had proven lending methodologies and clear ways to measure success: quantitative indicators based on financial performance and outreach. Indeed, an important accomplishment of the microfinance field during the 1990s was the definition of core performance indicators in such a way that they can now be applied consistently—and widely understood—across programs, institutions, and countries. In hindsight, many practitioners assert that training and other business development services were a drag on financial performance of microfinance institutions. In some cases, the trend toward transformation and commercialization literally dictated the minimalist path: the Bolivian banking superintendency expressly prohibits regulated financial intermediaries from offering nonfinancial services. While the reasons for the shift may appear simple from the perspective of financial service provision, the discussion on the side of those concerned with enterprise development is much more complex (box 7.4). The core of Boomgard’s assertion in the 1989 Microenterprise Stocktaking Report still holds: there is little understanding, and less proof, in the microenterprise development field about what makes tiny firms grow. Indeed, the long period during which business development services were automatically linked to the provision of finance may have obscured important learning. Certainly, the bundling of services made it difficult for program administrators to read the signals entrepreneurs were sending about what they wanted. Until the late 1990s, demand for business development services was a relatively unexplored topic.
The Importance of Understanding Demand for Specific Business Development Services When credit and training or technical assistance are bundled together, it is difficult to know whether entrepreneurs truly demand business services or to understand how they judge quality. Many early microfi-
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Box 7.4 The Trend towards Minimalism in the Region Recent surveys show that while there has been a shift away from providing nonfinancial services, the change may not be as dramatic as the rhetoric implies. While most of the region’s leading institutions have embraced minimalism, one village banking practitioner, Lynne Patterson of Promujer, put it this way: “We have simply stopped talking about the additional services we provide.” The typical institution offered credit and management training in a bundled form, according to a 1997 survey of 145 microenterprise development programs in Latin America (see Goldmark, Berte, and Campos, 1997). Most used credit revenues to support the provision of business development services, complementing these resources with donated funds. About 20 percent of 39 leading microfinance institutions in Latin America, currently bundle financial and nonfinancial services, while 45 percent had in the past, a 2002 survey conducted by Development Alternatives, Inc. found. About one-fifth (21 percent) of business development service clients had received these services through some mechanism linked to the provision of credit, whether as a prerequisite for obtaining a loan, as a reward for being a “good client,” or as related to some other incentive, a 2002 survey of small and microenterprises in Bolivia found (Nisttahusz and others 2002). Twenty-five of the 35 nonprofits in the SEEP Network (SEEP is a U.S.-based member organization of 51 international nonprofits working in the field of small enterprise development) that are active in Latin America and the Caribbean (71 percent) currently offer both finance and business development services, a 2003 survey found (the SEEP Network 2003; responses to the survey were not broken down by region of program operation, and some institutions follow different policies in different regions). The majority of these are village banking programs, where credit and business development services are bundled together as part of the weekly or monthly members’ meeting. Second in frequency are agricultural programs, which include technical assistance to farmers, market linkages, and finance as part of a multipronged intervention. A few programs, such as Trickle Up, focus on start-up enterprises and provide training alongside equity start-up grants.
nance institutions that provided business training to their clients did so based on what management thought the entrepreneurs needed—rather than according to client demand or by gaining a detailed understanding of the markets in which their clients worked. Under these circumstances, it is not surprising to find, as ACCION did in the 1980s, that borrowers simply view a training course as an opportunity cost of
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credit. Unfortunately, the dynamic in Latin America has at times been one where MFIs push training (of dubious quality) on clients who simply do not want it. Interestingly, in developed countries, the trend is often the reverse; training has been used by microfinance programs and commercial lenders alike in the United States as a carrot to bring clients in the door. There is some evidence that of the heterogeneous group of firms in developing countries collectively referred to as microenterprises, microloan borrowers are often the group least likely to need business training, or to demand other services. The loan portfolios of most Latin American microfinance institutions are made up primarily of borrowers engaged in petty commerce, buying and reselling products for the local market. This is to be expected, as credit tends to be relatively more important in capital-intensive activities that do not require any demanding skills and in which backward and forward linkages are not problematic (ADB 1997). In recent years, a number of stand-alone experiments with business development services have yielded promising results in stimulating demand for business services. These experiments have in common their use of market forces to promote competition among service providers and to pressure small firms to improve their products—both of which result in a more positive dynamic than the old integrated model. In 1995, an innovative program appeared in Paraguay. It was developed as an alternative to the typical credit-plus-classroom-training formula, in the context of an IDB microenterprise global loan project. The project offered loan funds and technical assistance to regulated financial institutions interested in creating their own microlending programs. A training component was managed out of the local center for the support of small enterprises. There, any entrepreneur operating a business with fewer than ten employees could obtain up to six vouchers worth 40,000 guaranies (about $20). The value could be applied toward a training course at one of about forty participating institutions. The financial institutions participating in the global loan program distributed information about the training, but there was absolutely no obligation
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for borrowers to attend the courses. In addition, nonborrowers were eligible for the vouchers, as long as they owned and operated a small business. A survey of participants in the voucher training program found that less than a third had obtained credit from the financial institutions participating in the global program (Goldmark, Berte, and Campos 1997). While some of the training participants used other sources of finance such as a local cooperative or family and friends, the survey found that almost half were in the early days of operating their business and had not yet even approached a financing entity. This somewhat surprising result continued to manifest itself in other programs, and has often been recorded since: when training is voluntary, a relatively small proportion of credit clients opt to participate. However, other types of microenterprises show interest in training and other business services. This observation raises the interesting possibility that the demand profiles for credit and business services may be quite different. The voucher training programs attracted a specific subset of small businesses. As the voucher model evolved, it was recognized as a useful one for delivering training to microentrepreneurs in a demand-driven way. The IDB financed a number of similar projects throughout Latin America, and other donors also adopted the intervention. Both Swisscontact14 and the IDB tried to use a voucher system to offer training to small and medium-sized enterprises to enhance their competitiveness. These firms were simply not interested. Instead, it was the smaller microenterprises, and low-income entrepreneurs just launching new ventures, who appeared in droves to claim the voucher and take the training courses: practical courses such as pie baking, electronics repair, haircutting, and sewing. The voucher programs allowed observers to detect and track clear patterns in the demand for microenterprise training. Short, practical, modular courses, offered in the evening or on weekends, and usually
14
Swisscontact implements a number of enterprise development programs throughout Latin America and the rest of the world. It is a nongovernmental organization supported by the Swiss Development Corporation.
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focusing on technical rather than managerial skills, were the most popular. Voucher programs required a co-payment, and interestingly the course prices did not seem to be the most important variable in determining success. For highly relevant courses, even low-income entrepreneurs were willing to pay more. The most important demand attributes were the reputation of the training institute and the direct applicability of the course material to the day-to-day operations of the trainee’s business. Another promising intervention model uses a demand-driven strategy to show entrepreneurs what the market requires of them. In this type of endeavor, business services are perceived by entrepreneurs as just-in-time problem solvers, without which the future of their businesses might be at risk. One well-documented program in northeastern Brazil focuses on a community of small woodworkers who participate in a government procurement program (Tendler and Amorim 1996). Judith Tendler tells how the firms struggle to upgrade their own capacity as they are pressured to produce goods on time, adhere to strict quality standards, and cooperate to fill orders together. SEBRAE, the Brazilian small enterprise promotion agency, provides technical assistance and plays a broker role, earning a small commission on orders that are successfully filled. When just one producer is late in delivering his product, all the woodworkers receive a lower price for their goods. Thus peer pressure helps produce the right quality, on time. Two key lessons emerge from the story. First, quality and other standards enforced by a demanding customer that purchases high volumes is the most effective stimulus for small firms, pressuring them to upgrade their production capacity in both qualitative and quantitative terms. The result is naturally an increased demand for business services that can help them achieve these goals. Second, correctly aligned incentives, such as the broker commission earned by the service provider (in this case, SEBRAE), and peer pressure among firms, are other important ingredients to upgrade firms and improve their performance and growth. In a well-designed, demand-driven intervention (where demand refers to demand for the small firms’ product), the urgent need to fill
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orders catalyzes a dynamic process in which bottlenecks are quickly identified and addressed. This leads to a healthy demand for relevant business services. Many successful handicrafts and agriculture projects have used this model as well.
The History of Enterprise Development The story of credit-plus programs and the tentative beginnings of microenterprise BDS interventions represent only a small window into the older and much broader field of small enterprise development. The tendency to “unbundle” credit from nonfinancial services parallels a major change in thinking that has recently dominated the field of business development services.
The Indian Model The origins of small enterprise promotion as a development goal can be traced back to the mid-1900s, when Mahatma Ghandi’s call to rebuild India’s “cottage industry,” damaged by colonial economic policy, was taken up by the Indian government. In the 1950s, a number of donors—including the Ford Foundation, the United Nations Industrial Development Organization (UNIDO), and the World Bank—began to replicate the Indian model for promoting small industry in a number of developing countries. This approach relied on government implementation and tended toward investments in large, expensive facilities to serve as a base for delivering free services to small enterprises (such as common production facilities and joint input purchasing schemes, market linkages, and technical assistance). Stanford University researchers Eugene Staley and Richard Morse were advocates for this model, referred to by some as the “cradle-tograve” approach. In their seminal work, Modern Small Industry for Developing Countries, they presented the principle of “combination and interaction” as it applied to the productivity of firms. In their view, any approach to productivity improvement that stressed only a single factor was bound to be ineffective. Instead, improving perfor-
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mance would depend on a combination of interacting factors, such as capital, credit, management quality, training, technical advice, market information, product design, raw materials supply, entrepreneurial spirit, an enabling social and political climate for business growth, among other factors (Staley and Morse 1965). Staley and Morse further warned that special protections for small firms could discourage their growth and constrain their competitiveness. In India, for example, the government sheltered a class of less competitive enterprises that had little incentive to grow beyond the government-defined size thresholds. It is telling that until recently, India had the world’s largest population of 49-person firms.15 In the long run, the Indian approach toward developing small industry proved limiting at best and extremely wasteful, at worst. On the one hand, the Indian small enterprise sector did develop—although there were some productivity trade-offs that have lasted for decades.16 On the other hand, this model was replicated in a number of other countries, where it proved not only to be ineffective but wholly unsustainable in terms of the resources required to maintain such a system.
Appropriate Technology and the “Discovery” of the Informal Sector The 1970s ushered in a wave of new thinking on economic development, particularly regarding the role of informal sector enterprises. In the mid-twentieth century, discussions among economists and academics revolved around characterizing the economy as “traditional” versus “modern.” Staley and Morse argued that traditional enterprises in sectors appearing to hold no future were to be phased out—or at the very least, benignly neglected—while others could be transformed into productive units of the modern economy.
15
Although the 50-employee limit has been removed, some size restrictions still exist for certain sectors. For example, there is currently a size restriction in the apparel industry that limits factories to $200,000 in fixed investment.
16
See the “Small Is Not Beautiful” discussion in Lewis (2004).
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E. F. Schumacher’s influential 1973 book, Small is Beautiful, argued against the prevailing belief that “industrialization” by larger companies was inherently more productive and better for society, and introduced the concept of appropriate technologies that could be developed to fit the needs of smaller enterprises in developing countries. Schumacher had spent time in Burma and India and came to believe that the cause of moral and physical impoverishment lay in the demoralizing impact of the industrialized West on traditional, formerly self-sufficient cultures. Schumacher was convinced that a role existed for useful employment in rural areas, even if such firms did not reach “optimal productivity” standards as defined by economists. He helped found a British nonprofit, the Intermediate Technology Development Group, which developed variations on simple products adapted to traditional village life, such as ovens and water pumps, while drawing from advanced technological knowledge. The appropriate technology projects developed as part of Schumacher’s legacy tended to focus on rural, nonfarm enterprises. Meanwhile, the International Labour Organization (ILO) was investigating the important nuances between unemployment and underemployment in developing countries. The term “informal sector” was coined in the early 1970s by researcher Keith Hart, encompassing the wide range of entrepreneurial activity in which poor people typically engage. A well-known 1972 report of an ILO country mission to Kenya emphasized the important role informal enterprises played in providing productive employment and income, and the significant linkages between the informal and formal sectors. This work concluded that governments should improve the incentives facing informal enterprises by streamlining trade and commercial licensing procedures, curtailing the destruction of informal sector housing, increasing applied research in the area, and assisting informal enterprises in making suitable products for use in the informal sector (Moser 1979). Thus the 1970s brought a new viewpoint to development: rather than seeing informal enterprises as an undesirable “residue” of the formal economy, there was a gradual recognition of the informal sector’s positive and dynamic contribution to employment and equitable growth. Research funded through USAID’s PISCES project found that microenterprises,
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although using simple technologies, make productive use of resources, occupy an important niche in low-end markets, and can serve as a seed bed for entrepreneurial talent. Early research also identified the main constraints facing small enterprises, including limited access to credit, training, and technical assistance, and difficult regulatory environments. Donors encouraged developing country governments to look at the smallest enterprises as contributors to equitable growth. The 1980s were the era of credit-plus, as discussed earlier in this chapter. In the 1990s many donors focused on minimalist microfinance. Early in the decade, the emerging field of stand-alone business development services programs and institutions was overshadowed by outstanding achievements in microfinance. During the second half of the 1990s and into the new millennium, however, there has been renewed interest in interventions aimed at supporting enterprise development.
The Market Development Paradigm The enterprise development “revival” began in the mid-1990s and developed from an interesting meeting of the minds between two groups. The leaders in microfinance began to talk about business development services to a group of European and multilateral donors that had traditionally focused their efforts on small and medium enterprises (SMEs) and that until then had defined BDS in extremely narrow terms (training and technical assistance). The microenterprise development staff of USAID, because of their mandate to alleviate poverty, were drawn to revisit Boomgard’s unanswered question about how to reach enterprises whose needs were not satisfied by minimalist credit alone. Research based on empirical data consistently showed that both microenterprise and SMEs—a combined group called MSMEs—in most developing country regions identified their two main constraints (in varying order of priority) as lack of capital and lack of access to markets (Webster 1997). During this period of renewed interest in BDS, a broader and more flexible definition emerged to include both “operational” services (such as photocopying, fax, telephone, Internet, advertising, and outsourcing), and “strategic” services aimed at improving performance and
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productivity (such as training, consulting, technology access, market access, and the provision of information). By the mid-1990s, lessons from program performance within institutions such as the World Bank had already contributed to a trend of moving away from direct support for enterprises. In addition, it was increasingly believed that BDS activities should be kept programmatically separate from finance. A generation of SME projects linking credit to technical assistance (in the 1970s and 1980s) had given way to larger projects with components to support SMEs. Support mechanisms were indirect, and included public works projects to stimulate demand for SMEs; capacity-building of institutions that, in turn, worked with SMEs; and general policy reform, which presumably would have positive effects on SMEs. This era also brought a new focus on SME competitiveness rather than finance. The “meeting of the minds” between SME and microenterprise professionals was formalized when the Donor Committee on Small Enterprise Development decided to develop a set of best practice guidelines on BDS, as had previously been done for microfinance, with great success. The challenges included still-diverging definitions of BDS, a large number of intervention types and tools, and a limited pool of successful models. The challenges forced researchers to question previously accepted principles, asking why the performance of BDS programs had been so disappointing to date, and what lessons could be learned from some of the more promising recent innovations. Over three years, between 1997 and 2000, the Donor Committee supported a major research effort, which commissioned a series of case studies categorized by service area, with a required set of issues to be addressed, as well as issue papers addressing cross-cutting themes such as sustainability and performance measurement. The IDB has sponsored several discussions among donors and consultants from diverse backgrounds who had formerly seen themselves as working with two very different populations: micro versus small and medium enterprises. The group reached broad consensus on several principles key to the success of enterprise development projects: the importance of clearly identifying the market failure (or failures) that an intervention is attempting to address; a reduced role
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for governments, donors, and project implementers, which should act as market “facilitators” rather than players, in combination with an expanded role for private firms; avoidance of highly subsidized or entirely free services; and sustainability through a combination of increased local capacity and a carefully planned exit strategy by donors and implementers. A motivated group emerged from the Rio conference, determined that donors should adopt a more hands-off approach, where projects would aim to develop markets for a broad set of business development services. Services might include training and technical assistance, market information, market access, accounting, legal services, information and communications technology. Interventions, however, should be limited to supporting product development and related activities, rather than subsidizing direct provision of services to small firms. The shift in thinking that occurred in the BDS field between 1997 and 2000 was not limited to donors, but reflected the results of experiments that had been taking place throughout Latin America.17 It originated from a combination of realism and optimism. First, there was wide recognition that neither public institutions nor NGOs had been successful in delivering relevant or sustainable BDS to significant numbers of enterprises—with or without credit attached. Second, there was optimism about the potential of private, for-profit providers to fill this role. Third, flexible and expanding definitions of BDS itself demanded a broader paradigm.
What Next? Since the 2000 publication of the Donor Guidelines, there has been some questioning of the market development paradigm. Unlike the commercialization of microfinance, which is a relatively simple concept supported by numerous examples, the BDS market development approach lacks a clear set of “demonstration projects.” Positive results,
17
Notably, a number of government agencies in Chile had begun using demand-driven mechanisms to finance enterprise support programs in the early 1990s.
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by their very nature, are more linked to the development and strengthening of systems and markets and thus may be less evident in terms of tangible, short-term transactions. Some of the most common and relevant questions or criticisms are listed below: •
•
• •
What type of institution should be a facilitator? Is this a sustainable activity? Is it possible for the same institution to be a facilitator and a direct provider of business development services? Does it make sense to develop the BDS market for its own sake? Is there a direct relationship between the growth or competitiveness of small firms and the use or purchase of BDS? Why is demand for business services often so weak? Are business services really the missing ingredient? Saying that providers should be private and for-profit does little to make an unviable business model viable. What should be done when the private sector does not respond to incentives?
As development professionals have struggled to answer these questions, the cross-fertilization process between microenterprise professionals, SME development practitioners, and academics has continued. In response to some of the apparent weaknesses of the BDS market development paradigm, and following the lead of a few institutions that have refocused their SME development efforts around “competitiveness,” the concept of market development has recently broadened to include the entire value chain, or subsector, in which small firms operate, as opposed to just business service markets. The context of globalization, as well as recent trends in the world economy, have also influenced thinking on how best to catalyze small firm growth. The globalization of business has brought with it new opportunities and challenges for small firms. As multinationals and even medium-sized firms in developed countries become global buyers and coordinators rather than producers, products and components are increasingly sourced in developing countries. While most suppliers to
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large international buyers are small or medium-sized firms, microenterprises play a role in certain sectors or portions of the value chain. In textiles and manufacturing, they can serve as a flexible production or labor resource for developing country firms unwilling or unable to invest in permanent plants, equipment, or labor capacity. In a number of agricultural sectors with labor-intensive harvesting or post-harvest processes, small farmers can organize themselves to supply large buyers with products such as coffee, cotton, herbs, spices, and certain fruits and vegetables. In the growing market in developed countries for authentic-looking housewares, international buyers are looking to source from skilled artisans. Participating in global value chains can be difficult for small firms because products must meet global safety and quality standards. Therefore, local and regional markets may be a better alternative for some small producers. Small firms that link successfully to international buyers, however, can tap into major growth opportunities. Because their buyers push them to upgrade their products and processes, these firms tend also to become more competitive in local markets. Organizing an enterprise development project around these new opportunities requires a mix of old tools (such as those used in the market linkage projects of the 1980s) and new thinking. Specifically, implementers may want to hold to the following principles: •
•
Understand the value chain. A project that works to provide growth opportunities for small firms must have an understanding of the entire value chain. Project implementers need to identify problems or “weak links” and find commercial solutions—which in turn should produce benefits that ripple through the entire chain, helping firms of all sizes. Specific constraints to small firm participation can also be pinpointed. Start with consumer demand and work backward to develop a viable business strategy. The analysis should include specific information about the characteristics of consumer demand. Implementers can then work backward to develop viable busi-
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ness strategies for groups of firms in the chain, rather than individual firms. Some strategies that have been successful both in stimulating sector-wide growth and increasing micro and small enterprise participation in value chains include: national or regional branding and marketing initiatives; penetrating niche markets; developing creative outsourcing arrangements by linking micro and small enterprises to lead firms as subcontractors; and focusing on local and regional markets where there is demand. Work closely with private sector partners. The ideal partners are lead firms: private intermediaries or buyers with access to markets and interest in sourcing from small producers. A project should benefit lead firms and small producers alike. Rather than circumventing the “malicious middleman,” as some earlier projects tried to do, this approach works to maximize the value-added provided by market intermediaries, such as market information, guidance on producing to specifications, and finance. In other words, projects should work to enhance this type of “virtuous cycle,” as has been done in the handicrafts sector (see figure 7.1). If necessary, projects can also help lead firms establish partnerships with private business service providers.
Some of these principles, while not entirely new, may represent a departure from typical donor practices. Focusing on the value chain rather than small firms per se implies that program designers should remove the “size lens” that has so often constrained them. Interventions that are successful will benefit lead firms as well as small producers—an outcome that may cause some discomfort for funders that operate within strict small enterprise promotion mandates, or that do not think that subsidies should be used to benefit private sector intermediaries. By engaging intermediaries in the development process and using interventions to strengthen vertical and horizontal linkages among firms, however, donors have a greater chance of generating sustainable opportunities for small and microenterprises.
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A number of donors have had success in supporting sector-based enterprise development programs along these lines.18 As mentioned, IDB-supported projects in the handicrafts and agricultural sectors have a long history of working with and through market intermediaries. More recent iterations of this project model are partnering with private companies, as well as starting with an analysis of market demand, then working backward to evaluate which interventions or business services may be necessary. USAID has recently supported an NGO, Action for Enterprise, to work with exporters in Ghana and Mali. Both projects work by increasing sales opportunities for medium to large exporters, which in turn provide embedded services to small producers that supply them with goods. In Bangladesh, the USAID-supported JOBS project experimented by bringing foreign buyers and designers to source handmade shoes from small producers. The rapid success of the shoe pilot motivated JOBS staff to begin working in a similar way with a number of other sectors. The JOBS approach to demand-driven intervention has three critical ingredients: group together small producers (so that they are attractive to large buyers); create backward linkages between intermediaries and small suppliers; and stimulate the provision of embedded services so that small producers can upgrade their production processes, develop new products, and keep pace with market demand. While the ingredients are few, none is simple to implement. Building trust among small producers so they may work together effectively can be quite challenging, whether or not formal association or cooperative structures exist. Also, providing one-time inputs such as design expertise or a round of finance may be easy, but ensuring institutional and human capacity to develop new solutions to new problems beyond the life of the project is much trickier.
18
Over the past few decades, USAID has supported a large number of sectoral programs aiming at increasing income and employment for micro and small enterprises, sometimes as stand-alone microenterprise interventions and other times as part of larger private sector development projects in agribusiness, trade, or competitiveness. The IDB has also continued its programming along these lines (begun in the 1980s). A recent evaluation of the Multilateral Investment Fund’s enterprise development portfolio found that sector-based programs had been the most successful (IDB 2002).
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The Finance Connection What do new perspectives on enterprise development, and the new wave of integrated sectoral projects, mean for the link to microfinance, or finance? In many such projects, finance is perceived as just one of a number of critical ingredients. Building partnerships with local financial institutions, or helping them develop services appropriate for small and microenterprises (downscaling) may be one strategy to increase the availability of credit and other services needed by small businesses. In cases where the financial sector and microfinance institutions may not be able to provide access to credit on a profitable commercial basis, such as in the agricultural sector, a common market solution is for buyers to provide financing (supply chain credit). With minimal investment, donor interventions can help structure and initiate such arrangements in ways that provide a sustainable source of financing beyond the life of the project. Supply chain credit can help overcome many of the traditional obstacles to micro and small enterprise lending. From the lender’s perspective, these types of transactions have several advantages. First, monitoring the activities of the value chain will be easier than monitoring single farmers or businesses in remote locations. Second, cash flow for repayment of the loan is more assured, as the borrower can irrevocably assign sales proceeds to be paid directly to the lender. The buyer is not guaranteeing the loan, but will add value to the loan transaction as a reliable payer. Third, making several small loans with identical terms will reduce the transaction costs for the lender. Conversely, as the borrowers are effectively applying for credit as a group, they can negotiate better terms and pricing. Fourth, it may be possible to provide finance through another participant in the value chain, in an expanded version of the credit provided by suppliers to farmers. That is, an off-shore buyer may be able to arrange for a letter of credit that can be pledged as collateral for the exporter. In addition to supply chain credit, some programs have been experimenting with leasing and inventory financing (warehouse receipts). In practice, when lead firms have adequate access to loans,
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equity, or trade finance, they in turn offer some form of credit to their small suppliers.
Conclusion The twin histories of microfinance and enterprise development in Latin America hold some important lessons for both fields. It appears that after almost four decades, the debate about whether or not to bundle financial and business development services is somewhat of a false dilemma. The answer will depend on the context, and on the goals of the institution or development intervention in question. •
•
•
Microfinance institutions wishing to reach commercial levels of profitability should evaluate the commercial rationale for providing business development services. Are these likely to attract new clients or increase loyalty? Can they be provided at a minimal cost? Is there in-house expertise that would allow the institution to provide high-quality services? Are there mechanisms, such as surveys, by which the institution can gauge client demand and satisfaction so that the bundling does not lead to “missed signals”? With a commercial motive, attention to costs, and a mechanism to read demand signals, providing limited business development services need not distract an MFI from reaching superior growth and performance goals. Microfinance institutions with a developmental motive for offering business development services should carefully evaluate which services really have impact: financial education as part of the loan delivery process, social services, or services targeted at improving clients’ business performance? In the case of village banking programs that offer all three, the strongest evidence is related to social programs and the weakest to business development services. Sectoral enterprise development programs that identify and solve constraints to microenterprise participation in value chains should analyze whether lack of access to financial services repre-
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sents a key constraint and to whom; then identify existing financial service providers, and decide which combination of partnerships, institutional strengthening, and product development might be needed. Here, lessons from both fields apply. On the one hand, experience has shown that an institution does not have to be a traditional, or regulated, financial institution to provide financial services to microenterprises on a sustainable basis successfully. On the other hand, the laws and principles of finance remain and must be respected even in such a context. Lenders should develop mechanisms to evaluate and reduce risk when lending to non-typical borrowers, pay vigilant attention to portfolio quality and transaction costs, and avoid subsidizing interest rates. Sectoral programs that work through lead firms, or intermediaries, can offer opportunities for producers to access a package of services. These services may include finance, technical assistance, training, or market information. They will by their nature be tailored to the needs of the final consumer of the product(s) in question. Cash outlays are not necessary to pay for services, although the cost should be reflected in the sale price of inputs or final products, and may be shared by lead firms and small producers. This approach represents a market-driven way to provide an integrated set of services tailored to the needs of small producers.
At the end of the day, comparing microfinance to business development services is like comparing apples to an assortment of fruit. Returning to the definition of microfinance given at the beginning of this chapter, “small-scale financial services for microenterprise owners and workers,” and acknowledging that the original product that launched the microfinance revolution was the short-term working capital loan, one ends up with a product that, by its very nature, has been designed for a specific type of clientele. Loan terms, credit analysis, repayment procedures—everything about the core product of microfinance, and many characteristics of other products that are now offered as well—have been specifically designed to be appropriate to a target group with a few
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common characteristics related to the size and nature of their primary income-generating activity. As the field broadens to include all types of services such as savings, remittances, transfers, and insurance, and as loan products become more varied and sophisticated, it is likely that microfinance practitioners will discover new opportunities to integrate some form of business development into their products, in cases where there is a commercial rationale. The example of venture capital funders in the United States that link management assistance to equity investments, for example, or consumer lenders that offer financial education, shows that even in sophisticated markets there may be commercial incentives to offer value-added business services beyond the financial. It is clear, however, that the days of affirming that microcredit linked to business development services improves portfolio performance are gone. Business development services, on the other hand, are made up of a variety of products that must be customized to fit the needs of different-sized firms in different sectors. The idea of a one-size-fits-all microenterprise management course is one that was tried by many microfinance institutions and networks and has not had broad success. Indeed, demand-driven voucher training programs have shown clearly that microenterprise owners are interested primarily in sector-specific technical training courses—because these are most likely to teach them practical skills that help them make more money the next day. Meanwhile, the experience of organizations such as Fundación Caravajal in Colombia shows that many target groups such as youth, the unemployed, and potential entrepreneurs tend to respond more favorably to formal training opportunities than busy entrepreneurs. Building on early experiences with producer organizations and responding to today’s global business environment, a new generation of sectoral programs in enterprise development may offer fertile ground for delivering integrated business solutions, including finance, to small producers through market intermediaries. In cases where financing can be provided profitably, the microfinance field will be watching to see if these products can be adapted, increasing the variety and reach of services offered to clients. In other cases, banks or microfinance institutions might be able to provide technological or information services to
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intermediaries that are not by nature financial institutions, and that do not wish to invest in loan-tracking systems. Thus while supply-chain programming offers promise for enterprise development, supply-chain financing represents a promising new frontier for microfinance practitioners to explore.
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References Asian Development Bank (ADB). 1997. Microenterprise Development: Not by Credit Alone. Manila: Asian Development Bank. Boomgard, James. 1989. Microenterprise Stocktaking Report. Report prepared for the United States Agency for International Development (USAID). Development Alternatives, Bethesda, Maryland. Dunford, Christopher. 2001. Building Better Lives: Sustainable Integration of Microfinance with Education in Child Survival, Reproductive Health, and HIV/AIDS Prevention for the Poorest Entrepreneurs. Discussion paper commissioned by Microcredit Summit Campaign. Available at http://www.microcreditsummit. org/papers/healthintro.htm. Goldmark, Lara, Sira Berte, and Sergio Campos. 1997. Preliminary Survey Results and Case Studies on Business Development Services for Microenterprise. Inter-American Development Bank, Washington, D.C. Hagen-Wood, Margaret, and Lene Mikkelsen. 1998. Experiences in Taking Crafts to Market. Microenterprise Unit, Inter-American Development Bank, Washington, D.C. Helms, Brigit. 1998. Cost Allocation for Multi-Service Microfinance Institutions. CGAP Occasional Paper No. 2. Consultative Group to Assist the Poor (CGAP), Washington, D.C. Inter-American Development Bank (IDB). 2002. Evaluation of the MIF Projects: Microfinance. Office of Evaluation and Oversight, InterAmerican Development Bank, Washington, D.C. (November). Jackelen, Henry. 1982. O programa da UNO de assistência a microempresas em Caruaru, Brasil. Consultant report prepared for the World Bank, Washington, D.C. Kantis, Hugo. 2002. Entrepreneurship in Emerging Economies: The Creation and Development of New Firms in Latin America and East Asia. Washington, D.C.: Inter-American Development Bank. Kilby, Peter, and David D’Zmura. 1985. Searching for Benefits. AID Special Study No. 28. U.S. Agency for International Development, Washington, D.C.
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Lewis, William. 2004. The Power of Productivity: Wealth, Poverty and the Threat to Global Stability. Chicago and London: The University of Chicago Press. Meissner, Frank. 1991. Seeds of Change: Stories of IDB Innovation in Latin America. Washington, D.C.: Inter-American Development Bank. Mikkelsen, Lene. 1997. Benchmarking Survey. Washington, D.C.: InterAmerican Development Bank. Unpublished mimeo. Moser, Caroline O. N. 1979. Informal Sector of Petty Commodity Production: Dualism or Dependence in Urban Development? World Development 6(9/10): 1041–64. Nisttahusz, Sandra, Montaño Hernández, and M. G. Lavayén. 2002. La importancia de los servicios de desarrollo empresarial en el desarrollo de la micro y pequena empresa y su relacion con las microfinanzas. La Paz, Bolivia: FUNDA-PRO. Pegram, Kenny. 2003. The Learning Needs of High-Potential Entrepreneurs in Latin America. Presented at the Second Research Conference on Entrepreneurship in Latin America, 26–28 October, Viña del Mar, Chile. Promujer. 2004. Summary of Findings: Impact Assessment of Promujer’s Credit and Training Program in Bolivia. La Paz. Unpublished mimeo. Rhyne, Elisabeth. 2001. Mainstreaming Microfinance: How Lending to the Poor Began, Grew, and Came of Age in Bolivia. Bloomfield, Connecticut: Kumarian Press. Schumacher, E. F. 1973. Small is Beautiful. Washington, D.C. and Vancouver: Hartley and Marks. Sebstad, Jennefer, and Monique Cohen. 2003. Financial Education for the Poor. Financial Literacy Project Working Paper No. 1. Microfinance Opportunities, Washington, D.C. (April). The SEEP Network. 2003. Statistical Directory of Members. Washington D.C. Sievers, Merten, and Paul Vandenberg. 2004. Synergies through Linkages: Who Benefits from Linking Finance and Business Development
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Services? SEED Working Paper No. 64. International Labour Organisation, Geneva. Smilor, Raymond. 1997. Entrepreneurship and Community Development. Los Angeles: Ewing Marion Kauffman Foundation, Center for Entrepreneurial Leadership. Snodgrass, Donald, and Jennefer Sebstad. 2002. Clients in Context: The Impacts of Microfinance in Three Countries. Report developed under Assessing the Impact of Microenterprise Services (AIMS) project, supported by USAID. Management Systems International, Washington, D.C. Staley, Eugene, and Richard Morse. 1965. Modern Small Industry for Developing Countries. New York: McGraw Hill. Tabuenca, Antonio García, Justo de Jorge Moreno, Fernando Coral Polanco, and Carolina Perondi. 2004. Lecciones aprendidas en la promoción de mercados de servicios de desarrollo empresarial: Un análisis de la experiencia del Banco Interamericano de Desarrollo en el Periodo 1995–2002. Washington, D.C.: Inter-American Development Bank. Tendler, Judith, and Mônica Alves Amorim. 1996. Small Firms and their Helpers: Lessons on Demand. World Development 24(3): 407–26. Tybout, James. 1998. Manufacturing Firms in Developing Countries: How Well Do They Do and Why? Policy Research Working Paper No. 1965. The World Bank, Washington, D.C. Webster, Leila. 1997. World Bank Support to Micro, Small and Medium Businesses. The World Bank, Washington, D.C. Westley, Glenn. 2004. A Tale of Four Village Banking Programs: Best Practices in Latin America. Washington, D.C.: Inter-American Development Bank. Young, Robin, Lara Goldmark, and Rosario Londoño. 1997. Microfinance Guarantees: A Basic Primer and Review of Experiences in Latin America and the Caribbean. Microenterprise Unit, Inter-American Development Bank, Washington, D.C.
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Future Challenges in Latin American Microfinance Robert Peck Christen and Jared Miller
M
icrofinance in Latin America has a long and detailed history. Since the term “microenterprise” was coined in Recife, Brazil in 1972, an entire industry has developed to provide millions of self-employed and microentrepreneurs with credit so that they can expand their businesses, face inevitable financial crises, or provide health and education for their families. Microcredit is on the tongues of most national politicians and is believed by many to be a powerful tool in the fight against poverty. Yet the story of microfinance, in spite of its obvious accomplishments, leaves much to be written. In Latin America, the field faces many challenges that will determine its shape and character well into the future. In some basic ways, it has yet to live up to the promise many held for it years ago when it passed out of the realm of charity and social work into the realm of banking—albeit, a special sort of banking. After acknowledging the accomplishments of the Latin American microfinance community, this chapter will focus on ways in which it has not yet met the challenges of serving the informal sector with a broad array of financial services. The chapter will highlight four challenges: broadening outreach in the region’s largest markets; deepening outreach farther down the socioeconomic ladder; broadening the offerings of noncredit products; and accomplishing these three tasks while under increasing competitive pressure. These challenges amount to increasing the access of a much larger number of low-income families to financial services, while reducing the industry’s dependence on donor subsidies.
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CHAPTER 8
ROBERT PECK CHRISTEN
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JARED MILLER
This chapter refers to data from two primary sources: the set of Latin American institutions that report regularly for inclusion in the MicroBanking Bulletin (MBB) of the Microfinance Information eXchange (MIX); and the set of institutions that were included in the global survey of alternative financial institutions done by the Consultative Group to Assist the Poor (CGAP, the consortium of microfinance donors housed at the World Bank). The MicroBanking Bulletin data contain detailed performance information on a select group of MFIs, while the CGAP global survey data comprise less detailed data on a more comprehensive set of institutions. The CGAP survey was originally completed in 1999 and updated in 2003. It is important for the reader to take note of which set is used for constructing each table or figure. Generally, the MBB data are used for performance indicators. The CGAP data are used for tables and figures that address the general issue of broad outreach. Over the past 30 years, Latin American microcredit has grown considerably. During the first 15 years, NGOs experimented with a number of lending techniques and ultimately found several that were capable of producing extremely high repayment rates when compared with traditional development finance initiatives. Complicated technical assistance and training packages that initially accompanied credit fell away, costs dropped dramatically, and early pioneers saw that programs could become sustainable when interest rates were higher than those normally found in targeted credit programs. From these two related insights—that the poor had better repayment rates than the less poor, and that the poor would pay higher interest rates, which could in turn provide a financial base for the operations of the lending institution—was born the belief that microcredit could grow exponentially and provide dramatic underpinnings to economic development and prosperity in the Latin American informal sector. During the mid-1980s, many NGOs were founded that incorporated this new belief and sought, over time, to reach out to ever-growing numbers of clients, create sustainable and profitable financially driven institutions, link up with the commercial banking sector as a source of funds, and place microlending squarely within the national banking sec-
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tors. Since then, growth has been impressive. The most comprehensive set of estimates counts over 4 million borrowers in the region. Over the past 15 years, increasing numbers of institutions have achieved remarkable rates of repayment. A substantial number of industry leaders have managed portfolios with late loans (in excess of 30 days) running at 3 percent or less. This record has been achieved in the face of important challenges stemming from the generalized economic downturn, localized disturbances, and heavy competition in some markets. An even smaller percentage is written off. Microcredit organizations display fundamentally different performance than that of traditional development finance projects, which typically experience repayment rates of between 35 and 85 percent, a range that does not permit lenders to end ongoing subsidies. During the past 10 years, an increasing number of leading Latin American MFIs have become fully sustainable. These include NGOs, nonbank financial institutions, and banks. Table 8.1 depicts this evolution. In the first edition of the MicroBanking Bulletin in 1997, 12 Latin American MFIs had reached operational self-sufficiency. Ten were able to cover the erosive cost of inflation on their equity and would have been able to fund themselves commercially. By mid-2003, 43 of the 50 MFIs reporting to the MicroBanking Bulletin in Latin America could cover the full cost of their operations with interest and fee income, while 28 were
Table 8.1 Latin American and Caribbean MFIs Reporting to MicroBanking Bulletin, 1997–2003
Latin American and Caribbean MFIs reporting to MBB Operationally sustainable MFIs Financially sustainable MFIs Borrowers in financially stable MFIs (average) Borrowers in financially unstable MFIs (average)
November 1997
July 2003
20
50
12 10 9,847
43 28 6,633
17,944
31,010
Source: Analysis of MicroBanking Bulletin database, 1996–2003; MicroBanking Bulletin, Issue 1, 1997 (November); and MicroBanking Bulletin, Issue 9, 2003 (July).
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FUTURE CHALLENGES
ROBERT PECK CHRISTEN
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JARED MILLER
fully financially sustainable in a completely commercial world. These institutions also serve the majority of microfinance clients. Initially, Latin American MFIs became profitable by charging relatively high interest rates—among the highest in the world. They correctly perceived that clients were flexible regarding interest rates paid on loans, since alternative sources of credit in the informal finance market were far more expensive and they had high returns on the increased capital represented by the microloan. Sometimes MFIs charged interest rates as high as 100 percent per year. The Latin American MFIs reporting in the first issue of the MBB had an average portfolio yield of 53 percent. Since then, rates have fallen, as competitive pressures have increased. Currently, the MFIs report an average yield of 43.6 percent, in nominal terms. To a great extent, this decrease in average yields has been facilitated by increased efficiency in lending organizations. Through scale and technological improvements, MFIs have been able to drive down their operating costs to levels that make them viable at commercially acceptable interest rates. Operating costs of a group of industry leaders fell from 39 percent to 18.4 percent of loan portfolio from November 1997 to July 2003. Microcredit in Latin America has moved into the regulated banking sector to a degree not seen in other regions. While only a handful of affiliates of ACCION (a world leader in microcredit) had accessed bank loans to fund some portion of their loan portfolios in 1993, MFIs in the region had grown decidedly commercial five years later. Regulated financial institutions in Latin America channeled half of all microfinance funds to roughly the same percentage of the total clients in 1998, according to CGAP data. Approximately a third of the regulated MFIs were nonbank financial institutions, while about a fifth (22 percent) were banks or finance companies servicing a broad range of clients. By 2003, banks represented a much larger share of the regulated sector. Taken together, the number of clients of NGOs and regulated MFIs grew in equal proportions. Many NGOs grew by leveraging funds from banks and other financial intermediaries. As of July 2003, 21 Latin American NGOs reporting to the MicroBanking Bulletin averaged 1.2 times as much
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debt as they had in equity. An increasing percentage of the liabilities are priced at market levels and originate in commercial institutions instead of donors. In spite of these significant accomplishments, the microfinance community must face a series of additional challenges to achieve its promise. Extending the economic and geographical borders of microfinance with more appropriate financial services in the context of increasingly competitive markets are the keys to generating the level of social and economic impact long desired.
A Big Country Problem? Earlier stocktaking exercises identified a monumental problem of access to microfinance in the largest Latin American countries (Christen 2001). The population in Latin America is heavily concentrated in five countries. Argentina, Brazil, Colombia, Mexico, and Venezuela account for nearly three-quarters (73 percent) of the region’s total population: some 382 million people. Poverty is also concentrated in these same countries. Four of the five have the dubious distinction of falling into the group of 25 countries with the worst income distribution in the world. Between 30 and 65 million self-employed individuals and microentrepreneurs work in these countries, according to various estimates. Three of the region’s most notable programs—CrediAmigo in Brazil, Compartamos in Mexico, and Cooperativa Emprender in Colombia (which encompasses more than 40 NGOs)—account for almost half a million of the 4.4 million microfinance clients in Latin America that CGAP found in its most recent global survey. Yet they have barely made a dent in the potential demand of the millions of potentially qualified and interested borrowers, despite the fact that Brazil, Colombia, and Mexico all were home to some of the early industry leaders of the 1970s and early 1980s (figure 8.1). Perhaps the model of choice in Latin America, the NGO, is an inappropriate vehicle for reaching large numbers of potential clients in the relatively well-developed financial markets of the region. By contrast, in Asia, several hundred NGOs in India reach an estimated 8 million
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Figure 8.1 Microfinance Penetration in Latin Americaa 8 7
Millions of Clients
6 5 4 3 2 1 0 Group 1: Bolivia, El Salvador, Honduras, Nicaragua
Potential clients
Group 2: Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, Guatemala, Paraguay, Peru
Active clients, 1998
Group 3: Argentina, Brazil, Mexico, Venezuela
Active clients, 2003
Sources: Christen (2001); Christen, Rosenberg, and Jayadeva (2004). a Potential clients represent 50 percent of the total number of individuals in the target group. This percentage has been reduced to take account of the fact that some do not want a loan, others would not be creditworthy, and others do not live in the areas served.
clients through a partnering relationship with commercial banks and development finance funds. In Bangladesh, while over 1,000 NGOs offer microcredit, over three-quarters of the total number of clients are served by the top five organizations (BRAC, 3.5 million; Grameen, 2.5 million; ASA, 1.5 million; Proshika, 0.5 million; Buro Tangail, 0.3 million). No Latin American MFI has reached the scale of the top five Bangladeshi programs. In fact, the average Latin American program has fewer than 15,000 clients, and only a small number exceed 100,000. Given the average number of clients in Brazilian NGO MFIs, Jaime Mezzera of the International Labour Organization calculated that it would take 2,358 NGOs in Brazil to cover the estimated 13.5 million clients who would want credit (Mezzera 2002). South Asian NGOs have proven relatively inexpensive to create; most are built with low levels of funding, from
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multiple sources, for multiple programs, with multiple purposes. By contrast, NGOs in Latin America have required subsidies measured in the hundreds of thousands of dollars to reach their break-even points. Ultimately, the microfinance community in Latin America may not yet have developed the appropriate products to be attractive to a large segment of the population, especially in these five relatively middle-income countries. The financial sector in these five countries has developed more thoroughly than in most of the rest of the region. In the retail financial sector, when products are right, hundreds of thousands of new clients sign up in a matter of months. In Brazil, consumer finance has developed considerably over the past two decades, but it has really taken off during the past few years of relative economic stability. Today, with a labor force of about 80 million, Brazilian banks have extended over 40 million credit cards, 66 million checking accounts, and US$20 billion in consumer loans and installment credit. Undoubtedly, banks have offered financial services to several tens of millions of low-income clients over the past decade. In Mexico and Brazil, dedicated microcredit institutions have traditionally failed to attract clients in the largest cities. In 2002, Compartamos and CrediAmigo had fewer than 15,000 clients in Mexico City, Salvador, Recife, and Fortaleza, cities with a combined population of 32 million. If the combined population of almost 30 million in the cities of Rio de Janeiro and Sao Paulo is added, where NGOs served an estimated 30,000 clients, the picture is not much better. Perhaps the population in these mega-cities has access to finance through other means and does not prefer the type of microloans offered by MFIs. It is hard to imagine that these microentrepreneurs, who are generally more prosperous than their rural counterparts, would have less intrinsic interest in finance. Though not one of the big five, Chile built a consumer finance market with 3.2 million loans (to a total workforce of 6 million individuals) in the ten years from 1988 to 1998, while the dedicated microenterprise lending sector financed just 100,000 businesses. An estimated 300,000 microenterprises accessed loans during this same period through consumer finance companies, three times the number that borrowed from the MFIs.
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The microfinance community may need to reassess its basic assumptions about microcredit in markets where parallel financial services are developing at an exponentially greater rate. In the large economies, a far greater portion of the workforce is employed in the formal sector than in those countries where MFI market penetration is highest. Perhaps microentrepreneurs can access finance through consumer lenders by going through a salaried member of their households. Or perhaps consumer lenders and suppliers have simply discovered, without help, that they can lend to this sector with a model similar to the one they use with their traditional clients. Lessons from a Peruvian bank illustrate the point. At the end of 2002, Banco del Trabajo had approximately 349,000 borrowers; roughly half were microentrepreneurs. While Banco del Trabajo participated in an IDB global loan program and received low-cost funding to develop its microenterprise loan portfolio, it did so without external technical assistance or a separate lending technology. It offers loans to both salaried and microenterprise customers, side by side, with little differentiation in approach. The average outstanding balance of all loans in the gross portfolio equaled $479 in 2002, an amount similar to that at poverty-focused NGOs. Banefe, now a subsidiary of Banco Santander, took the same approach in the smaller Chilean market, reaching tens of thousands of enterprises. These examples show that the general perception of low microfinance penetration is not wholly correct in the largest countries. The normal penetration calculus, including the preceding example, does not always capture the diversity of sources of small-scale financial services. A broader definition of microfinance—one that extends to nontraditional providers (those not normally considered within the purview of development finance) and encompasses a wider variety of services—reveals that the average client in the hemisphere’s largest and richest countries may actually have better access to diverse financial services than previously imagined. The variety of types and sources of microfinance offered by nontraditional finance institutions create a more complex nexus of supply and demand—one that is incompatible with the limited and costly offering of many specialized microfinance
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institutions. In this context, the performance of specialized MFIs or programs is not a useful benchmark to measure the access of the poor to financial services.
Broadening the Scope of Financial Services The mix of microfinance services offered in large countries and the emerging understanding about the financial needs of microfinance clients demonstrate that a broad scope of services is key to development of the sector. This section explores diverse services in the context of the relationship between the individual or household and microfinance. Examples from pioneering MFIs, however, should not overshadow the challenges faced by the sector as a whole. Development finance scholars and operators have come to an important new understanding about poor and rural households and their economic and financial activities. Contrary to the traditional view, poor households usually have more than one source of income, and in terms of economic strategy, more closely resemble a portfolio manager than the head of a single-product firm. Depending on circumstances, low- income households employ various income strategies, including performing paid labor, operating microenterprises (particularly in the production and trading sectors), cultivating their own food, hunting and gathering, and obtaining small loans or subsidies (Hulme and Mosley 1997). In fact, the poor are both economically rational and risk averse, as demonstrated by diversified “portfolios” of productive activities (Wright 2000). Finance plays a vital role in the coping strategies of the poor. Lessons learned as early as the 1970s and 1980s about poor families and how they use informal finance (rotating savings and credit clubs, loans from family and friends, and in-kind savings mechanisms) have been confirmed by more recent studies about the link between poverty and finance in microcredit programs (Adams and Fitchett 1992). A five-year evaluation of the impact of microenterprise credit by Sebstad and Cohen (2000) enriched the general understanding of small-scale enterprises. Indeed, their conclusions were surprising to some in the microcredit community, who had always assumed that the purpose of micro-
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credit was to expand enterprises. The results of this study support the proposition that microcredit helps clients protect against risks ahead of time. Clients use their loans for a variety of purposes. Loans help to improve and smooth incomes through enhanced enterprise and other productive investments. This finance facilitates the accumulation and retention of physical assets, including investments in housing, vehicles, other equipment, and physical assets used as a form of liquid savings such as jewelry or livestock. Loans also support human capital accumulation in the form of investments in children’s education and family health care, as well underwriting assistance to friends and relatives and help to fulfill social obligations such as contributing to funerals, weddings, and birth ceremonies. Field studies for the World Development Report confirm that clients go to great lengths to repay loans, even in times of crisis. Maintaining multiple sources of credit is a key risk management strategy for many of the poor (Sebstad and Cohen 2000). Development practitioners are starting to understand the dynamics of poverty. Families move in and out of extreme poverty. They accumulate for some time, rise a bit, and then are set back by illnesses, poor harvests, or some other major life event. Access to a broad range of financial services can protect the vulnerable poor from the full effect of these events. Impact studies across countries and programs show positive impacts of finance on variables related to reduced vulnerability: diversified income sources; increased assets of all kinds (including human and social assets); and women’s empowerment. In addition to the dynamics of poverty, the stage of evolution of a country’s financial sector may influence the nature of microentrepreneurs’ financing needs. There appear to be core similarities, for example, between the large Latin American markets discussed above and the relatively sophisticated markets of the United States and Canada. Microfinance clients in the United States and Canada generally access a broader range of financial services than clients in poorer countries. In one comparative study, a majority of microcredit clients in developing countries had not previously borrowed from any source, while only 22 percent of clients of U.S. MFIs had not borrowed from formal institu-
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tions. Over half the borrowers from MFIs in the United States had used a bank account, a credit card, or both (Hung 2002). Large Latin American markets are strikingly similar in the aggregate. For example, the most comprehensive study of access to financial services in Brazil (World Bank 2004) suggests that 43 percent of lowincome Brazilians (with a median income of R$358, or 1.8 times the minimum wage) have bank accounts. An even larger number of Brazilian clients access some sort of credit service through retail suppliers, factoring agencies, and especially consumer finance companies. Commercial banks in Argentina and a network of cooperatives coordinated by Bansefi in Mexico are the largest providers of small-scale financial services in their respective countries, including noncredit services such as savings. These institutions attract less attention from international donors because they mobilize their own funds and offer services to a much broader range of clients. Not surprisingly, microfinance clients in larger countries such as the United States and Brazil are among the most discerning in the hemisphere. They tend to administer a larger number of small-scale financial services than the average client in other countries (Nichter, Goldmark, and Fiori 2002). The services are also relatively complex. One study in the mid-1990s demonstrated that 40 percent of households in the United States near or below the poverty line had a credit card (Bird, Hagstrom, and Wild 1997). One-quarter to one-fifth of low-income Brazilians in urban areas use credit or debit cards. The percentage is gradually increasing. Checking accounts and credit cards are among the most requested services in both Canada and Brazil (Frankiewicz 2001). Latin American MFIs have lagged behind those in other regions in recognizing the important role of a broadened scope of financial services for achieving their objectives. There are also regulatory and structural obstacles. MFIs that are organized as NGOs are prohibited from mobilizing deposits. Additionally, the relatively small scale of Latin American MFIs largely reduces their attractiveness for channeling services such as insurance and remittances. A few pioneers, including Caja Los Andes and PRODEM of Bolivia, broker insurance products of external
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carriers. Others have begun to experiment with products designed to attract remittances. Many low-income families do not operate a bank account. Instead, they often use the money transfer systems of the local post office or international companies such as Western Union when receiving remittances from family members or friends abroad. The volumes that move through these systems can be huge, dwarfing the development lending that is channeled to those same target populations in the same countries (see box 8.1 and Terry and Wilson 2005). Yet unlike credit unions in several Central American countries and Mexico, traditional MFIs have been slow to offer remittance services to their clients. Whereas credit unions in the region have aggressively sought to position themselves as the recipients of remittances that end up in rural areas, fewer Latin American MFIs seem to have done the same. One financial institution in Ecuador, Banco Solidario, has designed a particularly far-reaching program named “My Family, My Country, My Return,” which serves Ecuadorian migrants in Spain. It provides loans to clients who have migrated legally to Spain and who have obtained
Box 8.1 The Potential of Remittances The total value of remittances to developing countries reached $80 billion in 2002, according to the World Bank’s Global Development Finance report (World Bank 2003). This amount is double the total aid provided by rich nations and dwarfs the $16 billion of net government and bank lending in those same countries. In fact, the total value of remittances is probably far higher. The World Bank study does not consider the value of funds that are transferred by informal couriers. To cite the case of Mexico, remittances to Mexico in one year alone—2001—from workers living in the United States reached a record $9.9 billion, surpassing income from tourism (World Bank 2003). By contrast, the World Bank held $11.5 billion in accumulated loans outstanding in Mexico in mid-2002, or 9.4 percent of its total portfolio. Some 42 percent of these funds went to places with fewer than 2,500 residents, according to the Government of Mexico—like much remittance income. Another study (done by researchers in Monterrey) shows that remittances from the United States financed almost one fifth of the capital invested in microenterprises throughout urban Mexico, for a total additional cumulative investment capital of $1.85 billion (Woodruff and Zenteno, 2001).
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employment there. Products include loans to underwrite the travel and settling-in expenses of the Ecuadorian migrant to Spain, and also provide savings and loan products for housing and business purposes. The scheme allows clients in Spain to designate how specific amounts remitted to relatives should be used, such as how much to go into savings products or into loan repayment. Relatives who are receiving remittances in Ecuador are able to collect the funds sent to them using a Smartcard issued by the bank branch in Ecuador (Buchenau 2003). While evidence conflicts as to just how much of the volume of remittances ends up in savings accounts, various accounts suggest the magnitude. In El Salvador, remittances receivers who use cooperatives save up to 10 percent of the amounts received, and about 37 percent of the families deposit some portion (Grace 2002). In the late 1980s, the World Council of Credit Unions (WOCCU) supported credit unions that focused on channeling remittances into rural areas, and as a group, these have experienced very large growth. The transformation of financial NGOs into regulated nonbank financial intermediaries was intended to facilitate the extension of savings to the working poor, arguably the most important financial service for poorer entrepreneurs (Rutherford 2000). Although 15 years ago the microcredit movement “discovered” the importance of savings as a funding source (and to a lesser extent as a service for clients), performance in this area has yet to measure up to expectations (Otero 1989). Originally, transformed MFIs used their new-found status to mobilize funds through apex organizations and from large institutional investors. The premise was that over time they would develop the systems to capture the deposits of the poor. In fact, the Bolivian Banking Superintendency has prohibited transformed MFIs from mobilizing savings from the general public until they have proven their capacity to take on this service. Not one of the specialized MFIs in Peru (EDPyMEs) has yet been authorized to mobilize savings. Over time, a diminishing percentage of Latin American MFI debt has taken the form of loans from financial institutions. Meanwhile, the volume of deposits has been growing as a percentage of total assets for many regulated MFIs. Deposits have proven to be a successful source
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of funding. Currently, deposits in Latin American MFIs represent a larger percentage of gross loan portfolios and total assets compared to international benchmarks (table 8.2). However, the primary balance of deposits in many Latin American MFIs comes from institutional investors, rather than small-scale entrepreneurs or the general public (Jansson 2003). Latin American MFIs do not extend savings products to the poor on the same scale as MFIs in other regions, despite the larger deposit volumes. Regional disparities in savings are not simply a matter of institutional scale. A sample of diverse financial intermediaries in Africa and Asia demonstrates that the number of savers far exceeds the number of borrowers (table 8.2). In Latin America, the number of savers and borrowers is roughly equal because much of the deposit volume comes from a few very large institutional accounts. While a tiny number of industry leaders are increasing the provision of savings services, the transition from microcredit to microfinance is still in its infancy in Latin America.
Deepening the Outreach of Microcredit Despite recent progress, it is still difficult for most entrepreneurs in Latin America’s rural, poor, and marginalized communities to access any formal financial services. Poverty remains highly concentrated in rural areas throughout the region. Few MFIs operate in these areas, such as in northeastern Brazil, northern Mexico, northwestern Venezuela, the Pacific coastline and central areas of Honduras and Nicaragua, and the northern parts of Peru and Chile. The microcredit industry still has a great amount of work to do if it is to extend the promise of access to the lowest end of the economic spectrum: those who typically self-exclude from programs because of the unreliability of their income flows or prohibitively high transactions costs. With the notable exception of two commercially oriented and regulated MFIs that draw their base in rural areas and small cities and towns outside the provincial capitals (CrediAmigo, of Banco do Nordeste; and Compartamos), most regulated industry leaders are urban-based. NGOs have grown just as rapidly as regulated MFIs and
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16,604,539 1,931,992 12,571,780
21 12 11
Deposits to total assets (percent) 29 15 17
Deposits to loans (percent) 15,174 22,142 59,337
Active borrowers (average) 16,418 38,033 90,022
Active savers (average) 850 74 191
Average savings balance ($)
1,642 385 284
Average loan balance per borrower ($)
LATIN AMERICAN MICROFINANCE
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IN
Source: MicroBanking Bulletin, Issue 9, July 2003. Note: The sample consists of 27 institutions of varied regulatory status, 13 from Latin America. The groups are composed exclusively of financial intermediaries, significantly varying the composition with respect to other figures. The Latin American example is primarily comprised of established institutions, to avoid the distortion that would be caused by including immature savings programs. Global outliers are excluded.
Latin America Asia Africa
Region
Average deposits ($)
Table 8.2 Regional Comparison of MFIs with Savings Products FUTURE CHALLENGES
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represent approximately the same proportion of the total number of clients reached today as they did five years ago (Christen 2001). Many of these NGOs have a strong base in rural areas—although the lack of a standard, applied classification of urban and rural clients precludes any real estimate of market penetration outside the cities. Anecdotal evidence would support the general observation that rural areas are underserved when compared with their urban counterparts and that these areas are largely attended to by NGOs offering microcredit, if they are served at all. There is great concern in the microfinance community that the process of commercializing and mainstreaming microfinance may leave the poorest behind, even those with viable microenterprise activities. As figure 8.2 shows, regulated institutions have significantly higher average loan balances than NGOs. Today’s Latin American NGOs are far more likely to have a defined poverty alleviation agenda and use targeting techniques to reach farther down market than their commercialized peers. To be fair, most commercialized MFIs did not originally get into microfinance strictly from the perspective of alleviating poverty, but rather to support enterprise formation, job creation, and the development of the informal sector. Thus they have always had a larger average loan balance than many of the poverty-focused MFIs that choose to remain NGOs, even in countries where the regulatory framework offers NGOs the opportunity to transform. Since 1998, loan sizes have increased slightly for both NGOs and commercial banks (see figure 8.2). While some institutions may demonstrate mission drift, changes to the aggregate average balances fall within the bounds of expected movements commensurate with improvements in information about borrowers over time. Evidence does not support the notion that MFIs are drifting upward as they become more commercial. In fact, it seems that new entrants into the microfinance industry come in at the same general levels as established players in any given market. Many transformed MFIs have eagerly embraced larger business clients while claiming to continue to service the low end where they started. Broad-based portfolio composition is not generally available, so it is difficult to measure the veracity of this claim.
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Figure 8.2 Average Oustanding Loan Balances, Regulated and NGO Microfinance Institutions, 1998 and 2000 900 800
Loan balance (US$)
700 600 500 400 300 200 100 0 Banks
Nonbank financial institutions
1998
NGOs
2003
Sources: Christen (2001); Christen, Rosenberg, and Jayadeva (2004).
Despite recent discussions regarding the role of commercial banks and the provision of financial services for low-income customers, it should be noted that the central mission of banks has never been to serve the poor. If policymakers buy into a commercial microfinance model prematurely, before NGOs have established the viability of a broad range of microfinance services to poorer clients, they run the risk of truncating this industry’s development and denying the very poor access to the banking sector. In Chile, Fosis (the government’s Solidarity and Social Investment Fund) decided in the early 1990s that NGOs were not a viable vehicle for channeling microcredit. Fosis shifted its support to commercial banks that built microenterprise loan portfolios. As a result, NGOs were starved of funds. Today, they serve fewer clients than they did when Fosis made its decision, while banks serve 15 times more clients. Unfortunately, banks dropped the lower 30 to 50 percent of the loan market. These clients will probably remain unserved, since the remaining NGOs do not seem to be able
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to run a sustainable business at this end of the spectrum. Anecdotal evidence suggests that now, almost ten years later, these same banks may be moving down market, pressured by competition and market opportunity. While the aggregate data do not support a generalized move up market, or more precisely, the abandonment of the lower end of the market by regulated MFIs, the fact remains that unregulated povertyfocused MFIs have mostly chosen not to transform, even when that option is available locally. It may be that the cost structure imposed on a transformed institution is too high to be sustainable, or that they simply do not choose to add the collateral services and infrastructure required. Perhaps the “commercial” approach to microfinance long promoted by industry leaders in Latin America may not be attractive to those organizations that reach farthest down market, some of which do so sustainably. Some observers question whether microfinance that reaches far down market can be commercial. The evidence from Banco do Nordeste and Compartamos suggests that given a large scale and sufficiently high interest rates, programs can be both regulated and reach down market. These two programs count themselves among those that reach furthest down in the region, while maintaining the highest return on equity ratios for Latin America, as of 2002 (Miller and Fonseca 2004). To date, there has been no general rule regarding the connection between regulatory status and depth of outreach. In the future, frontier markets may contain social and market opportunities that specialized microfinance programs and institutions are well positioned to exploit. Such opportunities include solidarity group lending to borrowers with few assets, intermediation of savings, cross-selling of related services, redefinition of service areas, and provision of nonfinancial services such as marketing support or training for small businesses and microenterprises. The local member-based cooperative tradition of rural Mexico exemplifies local responses to the problem of geographical and social marginalization. While commercial retail institutions will offer appropriate and profitable services with previously unimaginable breadth and efficiency to large segments of society, the magnitude of the gap between supply and demand for appropriate services, especially in harder-to-
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reach populations, suggests that traditional microfinance institutions will continue to be important niche players for years to come. A central challenge will be to profitably develop the opportunities of frontier markets. Few NGOs are able to marshal sufficient resources to transform into regulated MFIs and offer a broad range of services such as savings, insurance, or remittances, or be able to grow and invest in the necessary infrastructure to reach the millions of potential low-income clients. Therefore, policymakers should look for ways to encourage hybrid models that combine NGOs’ capacity to explore new products and services (and their commitment to serve low-income clients) with the infrastructure and funding the banking sector can offer. Government officials, MFI managers, and donor staff who are most concerned with reaching far down market in the supply of financial services must focus on those types of institutions, organizational arrangements, and techniques that offer the largest scale, the lowest unit cost, and the potential to break out of the current mold.
Broadening and Deepening Outreach in a Competitive Market The ultimate challenge for the microfinance community in Latin America will be to penetrate unserved markets in big countries, reach farther down market into ever more rural areas throughout the region, and broaden the range of financial services offered—while operating in increasingly competitive environments on a steadily diminishing net interest margin. In some ways, the work done to this point may have been the easier half. From now on, if microfinance is to realize its potential, it must penetrate farther into harder-to-reach markets, which are more expensive to reach, with less potential profit margin. At first glance it may seem inconsistent to suggest that there is great unmet demand and that an increasingly competitive environment will drive down interest rate margins. Competition will come in several guises. First, the geographical accumulation of basic microcredit services in some urban markets results in direct competition between MFIs. Second, MFIs in other markets, such as urban centers in larger
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countries, compete with a variety of other financial services that narrow the attractiveness of the limited product offering of most MFIs. Third, recent political attention given to microcredit in rural or harder-toreach regions will inevitably increase the supply of politically driven government-sponsored credit schemes with low interest rates and low repayment— which can result in “unfair” competition that disturbs the normal development of healthy credit markets. Large banking institutions of the sort that might be required to service these communities are naturally reluctant to come out with a program that charges a substantially higher interest rate, because of political sensitivities. Although microfinance clients are not highly sensitive to interest rates (they do not use the interest rate as a primary factor in deciding whether to borrow), over time, competition among providers does drive down rates charged to borrowers. MFIs must be able to respond by driving down costs in a corresponding manner, or face declines in profitability. Certain competitive markets in Latin America demonstrate these patterns. Figures 8.3 and 8.4 draw from an analysis of the financial performance of 17 industry leaders over five years. Financial revenues and operating expenses are compared between two samples. The first sample is of MFIs from Bolivia and Nicaragua, countries that are often considered to have more competitive national-level environments for microfinance. The second sample consists of MFIs from Colombia, Ecuador, Honduras, Mexico, and Peru, countries that are home to many MFIs but with less competitive national-level environments. In both data sets, financial revenue ratios came down over the past five years, at roughly the same rate, losing about 10 percentage points during the time period in both cases. However, in the competitive environments of Bolivia and Nicaragua, profit margins remained slimmer, while they actually increased in the rest of the region. Figure 8.5 indicates the effect of competition on profits in more competitive environments. In Bolivia and Nicaragua, interest rates were driven down to a point where profits essentially disappeared in 1999 and 2000. They increased slightly in 2002, but not to levels of the mid-1990s. In contrast, profit margins in the sample of MFIs from other countries actually increased between 1998 and 2002 because of decreasing finan-
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Figure 8.3 Revenues and Expenses, Selected MFIs in Bolivia and Nicaragua 60
50
(percent)
40
30
20
10
0 1998
Adj operating expense ratio
1999
Adj loan loss provision expense ratio
2000
2001
Adj financial expense ratio
2002
Adj financial revenue ratio
Source: MicroBanking Bulletin, Issue 9, 2003 (July).
Figure 8.4 Revenues and Expenses, Selected MFIs in Colombia, Ecuador, Honduras, Mexico, and Peru 60
50
(percent)
40
30
20
10
0 1998
Adj operating expense ratio
1999
Adj loan loss provision expense ratio
Source: Microbanking Bulletin, Issue 9, 2003 (July).
2000
Adj financial expense ratio
2001
2002
Adj financial revenue ratio
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Figure 8.5 Adjusted Return on Assets of Two Samples 12
10
(percent)
8
6
4
2
0 1998
1999
2000
AROA (Non-Bolivia and Nicaragua sample)
2001
2002
AROA (Bolivia and Nicaragua sample)
Source: Microbanking Bulletin, Issue 9, 2003 (July).
cial costs. Even the low profitability levels of the MFIs in competitive environments would still be considered as quite acceptable levels for mainstream commercial banks in those same countries. Competition also affects the behavior of loan portfolios. The loan portfolios grow substantially in each of the country sets in figures 8.6 and 8.7. However, in Bolivia and Nicaragua, that growth is driven by a considerable increase in the average loan balance. In other countries, average loan balances hardly grow at all; the increase in total portfolio comes principally from the addition of new clients. These data suggest one of two things: mission drift, or growing demand and capacity for larger loans. In the aggregate, the institutions in less competitive markets have not left their original client segment; their combined average loan balance is $600 dollars less, or roughly half the amount in the sample from Bolivia and Nicaragua. While Bolivian and Nicaraguan MFIs maintain that they have not left their original target clients behind, those claims are difficult to verify. So either they are moving up market, into wealthier
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Figure 8.6 Comparison of Growth and Average Balances in Competitive and Less Competitive Settings
50 30
30
20
20 10 10 –
1998
1999
2000
2001
–
2002
800 100
600 400
50 200 0
1998 1999 2000 2001 2002
Loan balance/GNP per capita (percent)
Loan balance, US$
150
30
40 30
20
20 10 10 1998 1999 2000 2001 2002
–
Average Balance per Borrower in Absolute and Relative Terms (Sample of MFIs from less competitive country environments) 1,200 200
Average Balance per Borrower in Absolute and Relative Terms (Bolivia and Nicaragua Sample) 200 1,200 1,000
40
50
–
0
Adj gross loan portfolio
1,000 150 Loan balance, US$
40
60
800 600
100
400 50 200 0
1998 1999 2000 2001 2002
Loan balance/GNP per capita (percent)
40
Adj. gross loan portfolio (millions)
Adj. loans outstanding (thousands)
60
Adj. loans outstanding (thousands)
50
70
Adj. gross loan portfolio (millions)
Loan and Portfolio Growth (Sample of MFIs from less competitive country environments) 50 70
Loan and Portfolio Growth (Bolivia and Nicaragua Sample)
0
Adj no. loans outstanding
Source: MicroBanking Bulletin, Issue 9, 2003 (July).
client groups, or they are raising the debt burden of their original client group. Either result carries fundamental implications, not all bad, for the future of microfinance. MFIs in less competitive environments might want to evaluate these implications.
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Figure 8.7 Portfolio at Risk Greater Than 30 Days and All Refinanced Loans, Four Bolivian MFIs
percentage of gross loan portfolio
12
10
8
6
4
2
0 1997
1998
1999
2000
2001
2002
Source: Boletines Informativos, Superintendencia de Bancos y Entidades Financieras, Bolivia. Available at http://www.sbef.gov.bo/fondos_financieros.php.
Competition has also degraded the quality of loan portfolios—at least in Bolivia, where this phenomenon has been more closely tracked. The Bolivian competitive situation was further complicated by economic recession and government policy that put even further pressure on microloan clients and dramatically increased late payments for a number of years before trends were reversed recently. This evolution is shown in figure 8.7. Over the past five years, leading Latin American MFIs appear to have increased access to services while lowering their costs. Certain financial efficiency ratios have improved substantially (table 8.3). Operating expenses declined from 33 percent to 23 percent of the average loan portfolio from 1998 to 2002 as the industry leaders matured. The apparent gains, however, stem primarily from the growth of the average loan balance, not the expanded breadth of clients or new technologies. MFIs with the largest decreases in the operating expense/period gross loan portfolio ratio are typically MFIs with the fastest-growing average loan balances. Moreover, the unit cost of administering a loan grew from $96
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Table 8.3 Selected Performance Indicators for Leading Latin American MFIs 1998 Adjusted number of active borrowers 26,174 Adjusted loan balance per borrower 478 (US$) Adjusted balance per borrower/GNP per 43 capita (percent) Adjusted operating expense/average 33 gross loan portolio (percent) Cost per loan (US$) 96 Adjusted loans per staff member 164
1999
2000
2001
2002
27,526 31,155 504 585
36,128 752
44,559 839
45
54
73
84
29
29
24
23
104 158
126 170
127 168
137 167
Source: MicroBanking Bulletin database.
to $137 from 1998 to 2002. Improving financial efficiency by increasing average loan balances did not imply better services for clients. They paid higher operational expenses per loan in 2002 than ever before. In the aggregate, the purported cost savings from going to greater scale, improved borrower information, credit scoring, Palm Pilots, and other technological solutions does not seem to have materialized. Productivity ratios reinforce the message. The remarkable productivity of Latin American loan officers was lost at the institutional level, where overall staff productivity was consistent with global averages. Loan officers accounted for merely 41 percent of all Latin American MFI staff, in comparison with a global benchmark of 48.3 percent for all MFIs worldwide (Miller 2003). Thus it appears that the gains made by frontline staff were negated by structural inefficiencies—or costly reporting requirements—in the back office operations of Latin American MFIs, in comparison to their global peers. Many Latin American MFIs seem to be locked into a credit product that is too expensive to be attractive as a stand-alone proposition if it were to be placed in the commercial banking sector. Few banks would want to invest heavily in a technology that cost 20 percent of its volume to administer. While promoters of microfinance in the region have correctly identified efficiency as the most important operational issue they must address, results from the past five years show that much needs to be done if microfinance is to become a part of the mainstream
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financial sector. As markets become more competitive, MFIs will find themselves ever more challenged, especially by financial intermediaries such as commercial banks that wish to add services down-market and can consider microfinance on a marginal cost/return basis.
Recent Innovations Some innovative MFIs in the region are experimenting with organizational and efficiency breakthroughs that may represent partial solutions to the conundrum of market penetration in the big countries and underserved rural areas throughout the region. These solutions may actually generate real scale economy in microfinance. Unlike the previous generation of innovation, which focused on credit methodology, the emerging leaders are bringing new technology to bear on the credit decision as a means to increase efficiency; taking advantage of previously installed retail infrastructure to disseminate financial services; and building special-purpose vehicles to organize the provision of services within corporate cultures that are not intrinsically adapted to the requirements of best practice microcredit. In this, microfinance promoters are working closely with regulated banking institutions to mainstream the lessons learned through NGOs and develop new approaches based on the potential offered by the formal financial sector. Service partnerships enable different MFIs to intermediate products from other financial institutions to complement their own products. They effectively act as product extension agents for other institutions and generate revenues from commissions, as Banco Procredit of El Salvador and PRODEM of Bolivia have done in serving as outlets for Western Union. Service company and subsidiary models take the relationship further. For example, Banco Estado of Chile created a wholly owned subsidiary, Banestado Microempresas, to manage its microcredit portfolio outside the confines of the traditional bank culture. Banco do Nordeste of Brazil hires its loan officers and their immediate supervisors through independently
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administered foundations for the same purpose. Credi Fe, a service company of Ecuador’s largest bank, led the Latin American MFIs in portfolio growth in 2002 (Miller and Fonseca 2004). Assuming the incentives can be properly aligned, the model plays to each institution’s strengths. The MFI specializes in loan origination and enforcement, while the supporting bank supplies financial infrastructure and low-cost capital. Infrastructure partnerships allow MFIs to extend their services to many locations, over large distances and to smaller places. In effect, the MFI bundles transactions on existing retail infrastructure. Service providers save operational costs through outsourcing the high transactions onto lower-cost infrastructure. These correspondent banking systems are common between financial institutions, but are now being extended to include nonbank retail service providers. These nonbank retail locations can generate revenue on financial transactions and concomitant sales of other products. Clients save indirect transaction costs through enhanced proximity to financial infrastructure. This type of convenience matters particularly to the self-employed, who can rarely leave their businesses. Infrastructure partnerships are diverse. The current government in Brazil, for example, has embarked upon a dramatic program to increase the availability of credit through Point of Service (POS) devices. It has created a virtual microbank, Banco Popular, to distribute small consumer loans through POS devices located in thousands (and eventually tens of thousands) of sites in lottery outlets, retail chains, banks, and post offices. While not directly targeted to microenterprise credit, it seems likely that with the growth of credit bureaus in Brazil, this system will ultimately serve independent entrepreneurs. More traditional approaches are also achieving broad outreach. In Brazil, Banco do Nordeste’s Crediamigo program offers some transactions at post offices, multiplying by ten the number of outlets through which the program’s clients can pay their loans to the bank. Caixa Economica Federal currently offers limited banking services through almost 8,000 lottery outlets. Bradesco, a private bank, has begun offering similar services in Brazil’s 5,532 post offices. Most financial transactions in Brazil now take place at a bundled retail location. Banco de Galicia, one of
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Argentina’s largest deposit-taking institutions, began setting up minibranches in post offices in 1998. Correspondent services are found in numerous other countries. That the financial institutions with the largest outreach in the world—including the Post Office Savings Bank of India, with an estimated 124 million savers, and the Post Office of China, with an estimated 110 million savers—are built upon shared infrastructure is not surprising. Their example demonstrates that capacity is perhaps best borrowed, not built. Credit scoring and financial sector infrastructure continue to be areas that leading organizations are investing in heavily. Banco Estado in Chile has developed a highly effective credit scoring tool to aid the credit decision. This tool is particularly important in a country where loan officers may be located several hundred kilometers from their supervisors in a thinly populated target market. Several Central American countries are developing the credit bureaus needed to develop these scoring techniques, and soon may be able to reduce the cost of obtaining information on the creditworthiness of potential borrowers. In Chile, Paraguay, and Peru, finance companies provide substantial credit to microentrepreneurs, using scoring methods and credit information systems developed primarily for consumer loans. They claim the repayment rate is equal to those of specialized MFIs. Ultimately, the development of these utterly commercial enterprises, such as POS technologies, credit bureaus, credit scoring techniques, and retail payment infrastructure, may provide the means through which to reach even poor clients profitably. These options may allow service providers to drive down the transaction costs of microfinance to a point where even the smallest of transactions can be profitable, on a marginal cost basis. These commercial infrastructures and techniques may provide a solution that allows microfinance institutions and banks to achieve the economies of scale necessary to achieve the dream of universal access to finance. The future role of NGOs, donors, and governments, which are the repository of the mission to increase access, may be to find the way to embed what has been learned about the poor and their financial
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needs and relationships into commercial infrastructure that can best provide services inexpensively.
Realizing the Promise of Microenterprise If the microfinance community is to fulfill the vision of providing millions of microentrepreneurs and self-employed individuals with access to financial services, it must overcome four main challenges over the next decade. First, the microfinance community must penetrate the market for microcredit in the largest counties of Latin America. This means increasing the portion of the market served in countries such as Argentina, Brazil, Colombia, Mexico, and Venezuela. Second, MFIs must take on a broader scope of financial services for the poor, the self-employed, and informal businesses and their employees. Institutions in Latin America must recognize that the poor require a variety of financial services—from deposit accounts to insurance to remittances—and begin working aggressively to address these needs. Third, MFIs must work to make sure that the process of commercializing and mainstreaming microfinance does not leave the poorest behind. NGOs that attend to the lowest-income clients in the microcredit world have been slow to develop links with banks or become regulated. On the other hand, regulated MFIs have a higher average loan size, which suggests that the poorest clients may have been excluded. Fourth, MFIs operating throughout the region must improve efficiency levels, increase profits, and find creative ways to achieve economies of scale. While competition has produced positive results for clients in a greater variety of product offerings, reduced transaction costs, and lower interest rates, MFIs operating in competitive environments have seen profits squeezed because of systemic portfolio risk, staff turnover, lack of technological breakthroughs, and pressure on financial spreads. If profits are to attract private entrepreneurs and investors, and outreach is to continue to grow in competitive markets, MFIs in the region must innovate beyond the traditional lending and operating technologies they have used up to now.
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Taken together, these four challenges represent the final step toward realizing the promise of microfinance to offer access to financial services such as loans, savings, transfers, and insurance to millions of microentrepreneurs, especially those in the informal sector who are without other options. Meeting these challenges will probably require adopting a hybrid solution that ties together the lessons learned from the NGO community about the poor and their money, basic principles of sound lending to unsecured entrepreneurs, and organizational discipline with the vital infrastructure and funding capacity of the banking and retail sectors. A few initiatives throughout the region point the way.
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References Adams, Dale, and Delbert Fitchett. 1992. Informal Finance in Low-income Countries. Boulder, Colorado: Westview Press. Bird, E. J., P. A. Hagstrom, and R. Wild. 1997. Credit Cards and the Poor. Discussion Paper No. 1148–97. University of Wisconsin, Institute for Research on Poverty. Buchenau, Juan. 2003. Innovative Products and Adaptations for Rural Finance. Paper prepared for Paving the Way Forward for Rural Finance: An International Conference on Best Practices, 2–4 June, Washington, D.C. Available at: http//www.basis.wisc.edu/ live/rfc/theme_products.pdf Christen, Robert Peck. 2001. Commercialization and Mission Drift: The Transformation of Microfinance in Latin America. CGAP Occasional Paper No. 5. Consultative Group to Assist the Poor (CGAP), Washington, D.C. Christen, Robert Peck, Richard Rosenberg, and Veena Jayadeva. 2004. Financial Institutions with a “Double Bottom Line”: Implications for the Future of Microfinance. CGAP Occasional Paper No. 8. Consultative Group to Assist the Poor (CGAP), Washington, D.C. Frankiewicz, Cheryl. 2001. Calmeadow Metrofund: A Canadian Experiment in Sustainable Microfinance. Toronto: Calmeadow. Available at: http://www.calmeadow.com/metrofund.htm Grace, David. 2002. Innovative Savings Products: The Role of Remittances. Presentation made at the Seminar of Best Practices in Savings Mobilization, World Council of Credit Unions (WOCCU), 5–6 November, Washington, D.C. Hulme, David, and Paul Mosley. 1997. Finance for the Poor or the Poorest? Financial Innovation, Poverty, and Vulnerability. In Who Needs Credit? Poverty and Finance in Bangladesh, eds. Geoffrey D. Wood and Iffath A. Sharif. Dhaka: University Press. Hung, Chi-Kan Richard. 2002. From North to South: A Comparative Study of Group-based Microfinance Programs in Developing Countries and the United States. In Replicating Microfinance
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in the United States, eds. James H. Carr and Zhong Yi Tong. Washington, D.C.: Woodrow Wilson Center Press. Jansson, Tor. 2003. Financing Microfinance: Exploring the Funding Side of Microfinance. Washington, D.C.: Inter-American Development Bank. Mezzera, Jaime. 2002. “Microcredit in Brazil: The Gap between Supply and Demand.” MicroBanking Bulletin, Issue 8(November): 22–24. Miller, Jared. 2003. Benchmarking Latin American Microfinance. MIX Regional Benchmarking Report No.1. Microfinance Information eXchange (MIX), Washington, D.C. Miller, Jared, and João Fonseca. 2004. “Championship League: MicroEnterprise Americas and the MIX Report on Latin America’s Top MFIs.” Microenterprise Americas Edition 2004 (October): 15–21. Nichter, Simeon, Lara Goldmark, and Anita Fiori. 2002. Understanding Microfinance in the Brazilian Context. PDI/BNDES, Rio de Janeiro. Otero, Maria. 1989. A Handful of Rice: Saving Mobilization by Microenterprise Programs and Perspectives for the Poor. Washington, D.C.: ACCION International. Rutherford, Stuart. 2000. The Poor and Their Money. New Delhi: Oxford University Press. Sebstad, Jennefer, and Monique Cohen. 2000. Microfinance, Risk Management, and Poverty. Assessing the Impact of Microenterprise Services (AIMS). Prepared for Office of Microenterprise Development, USAID, Washington, D.C. Terry, Donald F., and Steven R. Wilson, eds. 2005. Beyond Small Change: Making Migrant Remittances Count. Washington, D.C.: InterAmerican Development Bank. Woodruff, Christopher, and René Zenteno. 2001. Remittances and Microenterprises in Mexico. Unpublished manuscript. Graduate School of International Relations and Pacific Studies, University of California, San Diego. World Bank. 2003. Global Development Finance 2003: Striving for Stability in Development Finance. Washington, D.C.
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———. 2004. Brazil: Access to Financial Services. Report No.27773-BR: Washington, D.C. Wright, Graham, 2000. Microfinance Systems: Designing Quality Financial Services for the Poor. Dhaka: University Press.
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The Future of Microfinance in Latin America Tomás Miller-Sanabria
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wo milestones in Latin America marked the beginning of the worldwide phenomenon known as microfinance. The term “microcredit” was first used in a United Nations project in the 1970s in Recife, Brazil (Fiori and others 2004). In 1978, a multilateral development organization, the Inter-American Development Bank, began providing financing in support of microenterprise projects without requiring a sovereign guarantee. Between 1978 and 2003, the IDB’s Small Projects Program extended $120 million in concessionary finance to help fund 212 microfinance projects (Luna and Saenz 2004). The successes of this program and of direct work with incipient private microfinance institutions are reflected in the high level of development achieved by many of these institutions. Nongovernmental organizations that began operations with concessionary support today operate as banks and as specialized financial intermediaries integrated into the financial and capital markets of their respective countries. Only 25 years ago, the ability of microenterprise operators to repay commercial loans was in doubt. Today it is understood that microenterprises not only pay off their loans, but they pay fully and promptly and demand an entire range of financial services (see chapter 7). The progress of the sector in this timeframe is evident in the growth of institutions and the institutional structure of the microfinance industry, including regulatory agencies, investment funds, rating agencies, private investors, socially oriented institutional investors, international networks, and consulting firms. The growth of their financial intermediation can be appreciated by comparing the level
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of their financial assets to the volume of operations handled by these institutions. In 2004, of 212 institutions that received initial financing in the late 1970s or early 1980s, the top ten disbursed close to $500 million in microcredit, through a broad range of financial services reaching out to some 660,000 borrowers. Chapter 2 describes the “upgrading” process of Latin American nongovernmental organizations into formal supervised financial institutions. The current level of microfinance activity comes in the wake of financial reforms undertaken in most Latin American and Caribbean countries in the 1980s and 1990s. These reforms were intended to encourage competition and to open up and deregulate financial markets; thus they have helped reduce the State’s role as banker and lender and its intervention in setting prices and interest rates (see chapter 3). Because these reforms were not made simultaneously to reinforce the regulatory framework, many economies remained vulnerable to the external effects of international macroeconomic crises. In the mid-1990s, the financial systems in several Latin American countries fell into crisis, with downturns in credit supply and economic growth. Both regulators and financial institutions in this period gave top priority to crisis management in the financial sector. In some cases, they adopted rescue measures, made adjustments in prudential regulation, and sought out ways to protect depositors. The crisis management of financial institutions was based on the need to closely manage credit risk, improve creditworthiness, and manage liquidity. Development of new services for such nontraditional sectors as microenterprise and small business was not part of the agenda for most financial intermediaries in the region. The financial crisis systematically affected all financial intermediaries, including microfinance institutions, in the region. The case studies for Bolivia and Ecuador (chapter 5) show how these institutions successfully met management challenges during a systematic crisis. Proper prior selection, close customer contact, personal dealings with entrepreneurs, mutual trust, a culture fostering prompt and full repayment, and appropriate financial technologies used by the microfinance institutions placed them in an advantageous position vis-à-vis traditional financial institutions. Not only are microfinance institutions capable of riding out crises, but
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they may emerge from them in an even stronger position. Since their loan portfolios are much less cyclical than those of traditional commercial banks, their presence reduced volatility in the financial systems. This achievement is all the more remarkable, given that Latin America exhibits the highest country average of systematic bank crises in the world (IDB 2004). About one-third of Latin American countries experienced repeated crises between 1974 and 2003. Amidst this volatility, microfinance institutions have performed extraordinarily well, showing consistent growth, maintaining quality control of their assets, and in some cases acting as a haven for depositors from other institutions. Development of the industry has not been uniform. The countries in the forefront of microfinance in the region are those in which the regulatory framework was tailored to facilitate microcredit operations (see chapter 4). These legal structures acknowledge that such operations merit different—not preferential—treatment, consistent with the intrinsic characteristics of credit operations that rely on assessments based on cash flow and informal, incomplete information without hard collateral. In addition to a specialized regulatory framework, microfinance, in order to prosper, requires a broad potential market and well-managed institutions supported by solid structures of corporate governance. Notwithstanding the uneven development of the sector in the region, the good results produced by the early institutions have had an important demonstration effect. At the national level, this effect induced new stakeholders to enter the market, with additional resources and an increase in supply, leading to greater competition and a larger range of options for entrepreneurs. With current advanced communications systems and the possibilities for sharing financial information over the Internet, the transfer of know-how and the dissemination of project results have transcended national boundaries. Against this backdrop, the challenge (in terms of finance for development) in those countries that have subjected microfinance institutions to regulation and prudential oversight is to increase the depth of penetration, strengthen the financial and institutional capacity of these intermediaries, and to broaden the options for financing by introducing new products and services. In the large Latin American countries with
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greater populations and thus more entrepreneurs, the development of the sector is following a different path. It has evolved not from nongovernmental organizations but from nontraditional financial institutions that do not specialize in microcredit but that have the capacity to mass market and distribute services to a very broad population. As this book describes, microfinance in Latin America and the Caribbean is distinguished by high growth rates, stiff competition, and extensive integration with financial systems. This growth and competition contrast significantly with the recent performance of the financial systems in the region. In a recent assessment, the IDB characterized the credit supply offered by the region’s banking sector as scarce, costly, and volatile (IDB 2004). Despite these constraints, the credit provided by the region’s banking sector constitutes the major source of financing for Latin American businesses and homes. Accordingly, the high cost and lack of reliability in this financing source undermine economic growth and poverty reduction. No single model of Latin American microfinance exists; rather, a multitude of approaches coexist to meet demand for financial services from small economic units. These operational forms should take into account the circumstances of each place, notably the degree of development of local financial markets, macroeconomic conditions, and the regulatory framework. Despite their diversity, the commonalities among these models are indicative of a high growth rate in the sector, an increasing level of integration with financial systems, greater competitiveness, the initiative of local private stakeholders, and a capacity for survival and growth in times of financial and macroeconomic crises.
Competition for Diverse and Stable Financial Services Competition, technology, and economies of scale have allowed the region’s microfinance sector to bring down the costs of services. Competition has forced credit institutions to adjust their price policies according to the demand for financial services from entrepreneurs who head small economic units. Market conditions and the state of the industry in each country influence pricing decisions. Countries with few sources
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of financing for the sector exhibit high margins, higher interest rates, and less availability of products and services. In countries with deeper market penetration, preferential customers receive favored treatment, and significant efforts have been made to diversify the range of services to win customer loyalty and avoid dependency on a single product. The microfinance institutions in the vanguard are all-in-one intermediaries, offering multiple services to both borrowers and depositors. Microcredit in Latin America has penetrated the formal banking sector more deeply than in any other developing region in the world (see chapter 8). Nevertheless, in several of the region’s most populous countries—Argentina, Brazil, Colombia, Mexico, and Venezuela—supply is insufficient to meet the enormous demand for financial services from the microenterprise sector. The evolution in financial services is in turn influencing entrepreneurs’ behavior and demand. Thus in countries where credit cards and checks are widely used, credit is trickling down to microenterprises through ingenious uses of existing financial instruments—despite the lack of specialized microfinance institutions. Because the intermediated funds are mobilized locally without the need for financing from international donor agencies, the true impact of these financing methods is not known (see chapter 8). Just as funds lent to a microenterprise can wind up being allocated to the entrepreneur’s family, consumer credit and other financial services extended to an entrepreneur and his/her family can wind up boosting the liquidity of the entrepreneur’s business. In the region’s more advanced financial systems, traditional bankers are more familiar with the concept of consumer credit than commercial microcredit. Consumer credit has many characteristics similar to microcredit, including small loans with short repayment periods, low transaction costs, and high operating expenses for credit management. Both types of credit are aimed at the middle- and low-income sectors and do not require collateral. Credit assessments are based fundamentally on an analysis of information regarding the credit applicant. For consumer credit, the source of information required to process the credit is the individual’s salary information, which is easy to obtain when the person has formal employment. The information required
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for processing microcredit is obtained from an analysis of the cash flow of a productive activity, typically undertaken in informal markets. This information is not readily available, and the procedures used to obtain accurate information efficiently are an important part of the credit methodology (see chapter 3). Despite their similarities, microcredit and consumer credit differ significantly, and the ability to offer one kind of credit is no guarantee of success in handling the other. Erroneous applications of these concepts can lead to systemic crises (see chapter 5). The main difference between these products is tolerance of arrears and the organization and administration of the procedures for analysis, disbursement, and collection. For a financial institution, the most important feature of microcredit is the set of procedures used to collect information on productive activity. This information, which will identify the size and volume of business generated by the economic unit and serve as a basis to determine the quantity and characteristics of the loan, will be updated constantly as feedback on the customer’s credit history is received. Commercial interactions between the institution and the customer grow over time, as larger loans extended over longer maturities are made, and the financial operations diversify in range. Microcredit was the Model T for this financial sector, but it is no longer the only product.1 Credit, savings, and other services now abound, as many microcredit institutions are offering different types of credit for micro and small enterprises: individual and group credits, investment loans, working capital, housing and consumer loans, and lines of credit. Deposit operations include several kinds of savings structures, passbook savings, fixed-term deposits in different currencies, and checking accounts. Other types of services include national and international wire transfers and remittances, currency exchange, local tax and users’ fees collections, discounted paper, and public utilities collections (for water, electricity, and telephone service), and recently, microinsurance services. 1
The Model T was the first automobile designed by Henry Ford. In the early 1920s, 25 years after the vehicle’s introduction, its creator recognized that the trajectory of its life cycle was complete and he launched the Model A. Many other models soon followed.
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Appropriate Technology Unlike microcredit—which in general is specific, undifferentiated, and focused on a single product—microfinance offers extremely diverse alternatives, better suited to customer tastes and preferences. The total cost of debt for micro- and small enterprises includes two components: the interest rate and transaction costs. In some countries, competition has driven down interest rates. Technology applied to microcredit has facilitated the use of methods specifically designed to lower transaction costs. In combination with greater economies of scales, these two effects have resulted in a reduction of the total cost of debt in those places where the sector has developed. Integrated provision of an array of financial services has changed price-setting policies. Given the cross-elasticity of prices for different microfinance services, the sale of a gamut of services has further lowered service prices. This effect is even stronger when an appropriate technology platform is in place. Well-applied technology allows for the design of new products, a broader range of distribution channels, and increased productivity among microfinance providers. The adoption of modern technologies is an economic decision based on costs and benefits, and subject to technological constraints existing wherever the institution conducts its operations (chapter 6). Technology alone will not have an impact on an institution’s efficiency unless it is used in combination with organizational innovations. Even though technology helps standardize processes, it cannot substitute for a credit analyst’s interaction and contact with customers. In microfinance, this relationship is a critical factor in assessing the customer’s character and payment capacity. Microfinance, with its extensive data management and data processing requirements, is greatly facilitated by technology in handling such essential inputs for risk management as the collection, processing, and interpretation of information. As opposed to the credit analysis performed by commercial banks, based on the quantification of accumulated wealth, the risk assessment for micro and small business depends on processing information. Business transactions and transactions between businesses
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and financial service providers are evolving at such a pace that one can barely imagine how business will be conducted in the near future. Only if microfinance institutions maintain an open mind, a willingness to meet changes head on, and engage in continuous improvements will they be able to tailor the services they offer to the needs of entrepreneurs. Technology makes this ongoing adaptation possible. New technologies open a broad array of opportunities that allow entrepreneurs to make better decisions regarding savings and consumption at a given time and over periods of time. The availability of more financial services facilitates payments and makes it possible to shift purchasing power over time and physical distance. A significant example is the transmission mechanism for sending and receiving family remittances. Advances in technology and decreases in costs are bringing about important changes that facilitate the ability of households and businesses alike to manage liquidity; the result has been a reduction in transaction costs in the markets for goods, services, labor, and capital. The next few years will see more transformations and advances in the way that small economic units conduct their market operations. In countries where microfinance has reached a greater degree of maturity, technology provides the opportunity to continue to raise productivity and efficiency and to extend coverage where services are not currently received, such as in rural areas and in the provision of financial services to migrants. Another area where technology will play a more visible role in the future is the integration of the microfinance sector with financial systems. The growing flow of information among banks, subsidiaries, and risk centers will most certainly create requirements for new technologies (see chapter 6).
Economies of Scale In the area of financial services, it is difficult to achieve a satisfactory level of efficiency with a small volume of operations. Without reaching critical volumes that achieve economies of scale, services tend to be costly, limited, and lacking in depth. The entities in this sector require a minimum amount to cover evaluation costs and other operating expenses.
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Economies of scale allow microfinance institutions to reduce the administrative costs for each lending operation and open the way to develop a structure for larger lending and service operations. Microfinance institutions and finance providers can significantly increase the scale of commercial operations they undertake. The biggest microfinance institutions are able to put together and issue instruments that are large enough to attract private investment. By mid-2005, perhaps 20 Latin American microfinance institutions had already built up the size of their holdings to exceed $50 million in assets. Annual growth rates on the order of 30 to 40 percent indicate that the size of institutions and the industry at large is doubling every couple of years. This critical size and the corresponding growth prospects are attracting new funding sources that heretofore had dealt only with the traditional banking sector. New investors include pension funds, investment banks, and international investment and capital development funds. The larger volumes of financial assets that these institutions have amassed will consolidate their linkages to financial and capital markets through mergers, acquisitions, and the securitization of loan portfolios. As microfinance institutions begin to operate as regulated financial institutions, they become integrated into the local financial system and expose themselves more to macroeconomic oscillations and instabilities, and the international fallout originating in other regions. The advantages of deposit mobilization can be undercut by incremental operating expenses subject to the peaks and valleys of external shocks outside the control of banking institutions. Thus systematic crisis management and prevention policies, liquidity management capacity in times of crisis, and the availability of financing mechanisms of last resort become ever more important.
Microfinance, Human Capital, and Corporate Governance As growth accelerates and integration with financial systems deepens, human capital requirements will increase in terms of the quantity and degree of specialization required of top managers and governing boards of the institutions. The dynamism of a financial intermediary special-
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izing in microfinance is a function more of its human capital than of its financial capital. Microfinance credit operations are growing throughout the financial sector, as evidenced by the number of banks that gradually are entering into the sector, the number of existing profitable microfinance institutions, and the base of customers served by them. The most successful microfinance institutions have managed to grow through their linkages to financial and capital markets, which has enabled them to integrate steadily into the financial systems. Linkages to financial markets attract greater public and private finance and investment. In turn, the responsibility for handling higher levels of financial assets brings with it the need for greater controls and oversight mechanisms, which then require greater human capital. However a microfinance institution is formed, it is important that it have several decisionmaking bodies, composed of members and associates, directors, and managers. The rules and regulations under which these bodies share power and oversee control define the governance of the institution. Traditionally, the role of the board of directors is to steer the outlook of a group of shareholders and to mediate between the owners and managers of a company. As the volume of assets managed by these institutions grows at an accelerated rate, the role and responsibilities of the board become more important and more complex. This is particularly true when the funds managed by these institutions come from the public, taxpayers, and investors. For a board member to bring value added to a company, he or she must contribute new ideas, bring relevant professional experience to the business, and offer a network of contacts, helping lead to new projects or additional financing. A board with a good understanding of its fiduciary responsibility should protect the interests of all its shareholders, including minor shareholders. A board should analyze, weigh, approve, and carefully scrutinize management’s plans and proposals. Management makes decisions—but it is the board’s responsibility to approve them. While management has the daily responsibility of handling the resources of a business, the board of directors must review and approve the budgets, because the board ultimately has the final word on allocation of funds
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and efforts. A board of directors should promote performance reporting to systematically evaluate management and determine whether proposed goals are being met. Solid corporate governance in a microfinance company is essential for promoting accountability, transparency, and appropriate business conduct. The way in which shareholders and management share the control of their institution is defined by the rules of corporate governance. However well-established a country’s regulatory framework and prudent control, these can never substitute for directors who have a clear sense of “duty of care” and “duty of loyalty.” “Duty of care” holds a director to act in good faith, with the same care and caution that a prudent person would show in a similar position with the same conditions. Following this principle, a director should use his/her best judgment to protect the interests of the company. “Duty of loyalty” means that directors should hold company interests above their own individual interests (NACD 2003). Under the principle of “duty of loyalty,” board members use the assets and information of an institution to meet the institution’s stated goals and objectives—and never for personal use. “Duty of loyalty” may be put to the test in conflicts of interest when a board member is vested in a transaction in which the company is also participating. Microfinance institutions may face conflicts of interest when investors act in two or more roles simultaneously, such as creditor or provider of supplies or of technical assistance. Transparency, open and frank discussions, and the willingness to provide information all help diminish the chances of conflicts of interest. Evidence shows that good practices in corporate governance correlate with higher returns of the companies. When the rights of shareholders are weak and not upheld by the directors, the institution’s value diminishes and its operational performance suffers (Gompers, Ishii, and Merrick 2001). Well-established microfinance institutions need capable, responsible, and well-informed directors who hold to basic ethical standards and who are mature and cautious in decisionmaking. The regulatory framework is important, but it is even more important to be able to rely on a board of directors that consists of qualified people
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with integrity and unquestionable business ethics. The growing volume of public funds attracted to intermediary microfinance institutions calls for a significant investment in human capital, not only at the management level, but also at the board level, as board members are ultimately responsible to the public (to depositors, shareholders, investors, financers, and clients) for honest management of the resources entrusted to their professional care. The rapid proliferation of microfinance institutions and ever-growing volume of financial assets calls for a big investment in human capital in terms of training, recruitment, and education of qualified personnel. The market is responding to this need, and several universities have added microfinance study programs to their curricula. The need for educating and training specialized personnel will only become more acute. To get qualified youth to seek careers in microfinance, more investment needs to be made in human resources and management staff. To date, microfinance institutions have assumed the bulk of this cost. As the sector continues to expand, there are compelling arguments for sharing this cost with students themselves and with the public sector. The continuing build-up of skills and training, and professional updating of microfinance personnel and board members, will determine the ability of these institutions to continue attracting resources and expanding their framework of activities. Microfinance institutions need directors who understand how capital markets operate, who know economics and psychology, have a healthy understanding of humanity, are skilled in making decisions, and above all, have a solid understanding of the essence of credit.
Globalization of Microfinance and Remittances As the world globalizes and local markets increasingly integrate into a larger economy, labor markets and financial markets expand or contract depending on the available opportunities. This behavior is reflected in the flows of migration, remittances, and in investment and consumption of the low-income population. Microfinance has become globalized.
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As a finance development tool, remittances have much in common with microfinance in Latin America and the Caribbean, in their evolution as well as their inherent characteristics as financial services. As financial services, both were initially offered outside of the traditional commercial banking systems—perhaps because both services have targeted nonpriority clientele of the banking systems. The profile of a microfinance client is similar to that of a remittance receiver: low socioeconomic status, frequent utilization of the service, and small transaction amounts. Remittance receivers and microloan clients tend to live in poor places where effective allocation of aid has been extremely difficult. Remittances are an important development tool because the wellbeing of millions of people and dozens of countries’ economies depend on them (Terry 2005). Remittances not only cover many families’ basic economic needs; they also provide resources to invest in people through education and health. Remittances provide seed capital for thousands of micro- and small enterprises, and down payments for a plot of land or a house. Despite their enormous leverage potential, remittances continue to face a shortage of distribution routes. The options of poor households to optimize their use of remittances are not being maximized. Business opportunities for microfinance institutions to provide transaction and distribution services for these funds are enormous, even though money wire services such as Western Union and MoneyGram are still extremely popular. Other less-used distribution methods exist, such as cooperatives, microfinance institutions, banks, postal services, and personal carriers. In 2000, almost 3 percent of the world’s population of 6.1 billion people were emigrants; more than 175 million individuals were living far from home, all in search of better opportunities (Martin 2004).2 The lack of formal employment in Latin America and the possibilities of better-paid employment in the North have led to a flow of workers from the South to the North—mainly to the United States. Besides this
2
Statistics based on data from the United Nations Population Division and World Bank Development Indicators. Immigrants are defined as those people who have lived outside their country of origin for 12 months or more.
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northward migration, intraregional migrations have also increased, including Bolivians emigrating to Argentina, Nicaraguans to Costa Rica, Guatemalans to Mexico, Peruvians to Chile, and Haitians to the Dominican Republic. Approximately 5 percent of the people living in the United States (14.5 million people) immigrated from Latin America and the Caribbean, according to the 2000 U.S. population census. Recent estimates put the number at 17 million. While millions of people migrate from South to North, billions of dollars of remittances flow from North to South. Latin America and the Caribbean receive more in remittances annually than any other region in the world. In 2005, more than $54 billion in remittances were sent to the region—easily outstripping the total of foreign direct investment and (nonmilitary) official development assistance to the region. Despite the enormity and growing impact of these flows, the impact of migration and remittances on development have yet to be adequately analyzed and studied (for an in-depth discussion, see Terry and Wilson 2005). The creation of new alternatives in financial services (such as credit, and the transfer of remittance and savings) for this segment of the population would reduce dependency and increase variety for clients. Supply of services would increase, and demand would become more elastic. For the same service, the client would pay a lower price, thus increasing his/her welfare. In 2000 the average cost of sending a remittance to Latin America was equal to 15 percent of the amount of the transaction. Today, the cost has been cut in half, thanks to competition, advances in technology, and availability of more information. The social impact of this reduced cost is significant, since remittance receivers are people from the lowest economic groups. In general, poor immigrants send remittances to even poorer relatives. The same reduction of margins that has occurred in the microfinance industry is also transpiring in the remittance transfer service. Technology has allowed the design of new services, and competition has generated new alternatives, in an effort to differentiate and win over clients, thus improving services and reducing the total cost for the client. Several dozen Latin American microfinance institutions are adding remittance transfer services to the array of services they are offering to
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their clientele. The economic potential of leveraging the impact of remittances through financial institutions is enormous and is only beginning to be recognized. The role of microfinance institutions in channeling resources through financial systems, increasing the mobilization of deposits, and the marketing credit to micro- and small enterprises will undoubtedly grow. Through alliances between microfinance institutions in remittance-receiving countries and financial institutions and remitters in remittance-sending countries, it has been possible to reduce transfer costs and increase the amounts of financial intermediation, thus contributing to economic growth. The cross-supply of loans, savings, and transfer of remittances makes it easy for the client to allocate funds between consumption and saving. A broader range of financial options helps increase the chances that the home-businesses of the informal sector can take advantage of good productive projects. Remittance transactions now tend to depend on cash. To move remittances through banks, the access of microenterprises to financial services must continue to expand. Moreover, only about 14 percent of the microenterprise market in Latin America is currently served by microfinance (Marulanda and Otero 2005). Moreover, significant numbers of remittance receivers are unfamiliar with financial institutions. The business opportunities for banks, cooperatives, and microfinance institutions to address these gaps are huge, in both sending countries and in the less-developed receiving countries (Terry 2005). As microfinance institutions are able identify the legitimate and real demand for financial services by micro- and small enterprises and to allocate credit in the microenterprise sector, increased remittance flows through microfinance institutions will have significant economic impact on the microenterprise sector and low-income households. Despite the low propensity of remittance receivers to save, even small amounts can make a big difference at the margin. The cumulative effect can significantly improve microenterprises’ stores of capital and wellbeing (Woodruff and Zenteno 2001). To offer remittance services, microfinance institutions must look for commercial ties and associations with institutions in remittance-
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sending countries. To strengthen these transnational alliances and generate the trust needed between large finance institutions located in different countries, an ongoing flow of available finance information is needed. Large banks in developed countries will establish ties and do business with microfinance institutions in developing countries only if the volume of transactions is significant, the financial performance of the institutions is satisfactory, business practices are appropriate, and information is transparent. Another consequence of globalization is the increasing number of international financiers supplying large amounts of loans to microfinance institutions. Along with foreign funding comes the need to manage foreign exchange. Financial dollarization is a distinguishing feature of the banking sector in many Latin American and Caribbean countries. MFIs that lend dollars to firms operating in the nontradable sector may be trading exchange risk for default risk, as they attempt to shift the currency mismatch from their own financial instruments to those of their credit portfolio clientele (IDB 2004). As the industry advances, the need to address the foreign exchange risk calls for actions at various levels. At the institutional level, the solution is to continue focusing on savings and deposit mobilization. As the microfinance industry becomes more integrated into local financial markets and more commercial banks incorporate microfinance as a core business, foreign loans will become less important. At the industry level, the use of hedging instruments will be more widespread, such as currency swaps, domestic currency guarantees, forward contracts, and currency futures and options. The ultimate solution, however, is macroeconomic; to a large extent, dollarization has macroeconomic causes.
Expansion across Borders In recent years in Latin America, several microfinance institutions have expanded activities beyond their geographical borders. Led by businesses and institutions seeking to expand their operations to bigger markets, this cross-border integration will continue to grow and strengthen for several reasons: as a strategy to integrate and utilize technology and in-
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formation systems; as a way to diversify systemic risk through an effort to take full advantage of “back-office” services; and as a means to increase the level of operations and fully utilize technological and human input. This regional integration will help disseminate best practices and proven models in geographic areas where microfinance has not yet found fertile ground. Alliances also allow the exchange of products and services, thus reducing start-up costs, as well as the costs of development, transfer of knowledge, and training (Castello 2004). Although this international expansion is predicted to continue growing, each institution will most likely continue to be managed as a separate bank, and not as an agency or branch of a transnational company. There are two reasons for this separation: the inherent nature of microfinance institutions, which depend on the particular characteristics of each market; and the different levels of development of regulatory systems, which are not synchronized. Methods of doing business, the ways and customs of each country make it difficult to establish a universal standard. However, the alignment of regulatory frameworks and integration of supervisory systems will help lead countries to adopt a common work plan. Standard supervisory procedures help avoid regulatory arbitration and promote more equal development of microfinance in the region. Some Latin American microfinance institutions have invested in other microfinance institutions in other parts of the region. For example, FIE in Bolivia invested in FIE Gran Poder in Argentina and is a majority shareholder. MiBanco in Peru invested in BancoSol in Bolivia. The ProCredit bank group has investments in Bolivia, Ecuador, El Salvador, Haiti, and Nicaragua. Member banks in the Alta Cumbres Group are in Costa Rica, the Dominican Republic, Ecuador, Guatemala, and Peru. This tendency toward crossborder investing will most likely continue, along with investment by shareholders in domestic microfinance institutions in different countries, all as a way to diversify, expand and penetrate new markets. This expansion is already happening among Latin American banking groups, which are expanding regionally, breaking geographical barriers, and forging integration that is no longer simply political, but also commercial and business-driven. In the not-too-distant future, the
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region’s bigger microfinance institutions will inevitably attract the interest of private investment groups, in light of possibilities to regionally diversify risk. The integration of microfinance into the region’s financial and capital markets is an irreversible reality.
Financial Services to Combat Poverty Financial services allow poor people to diversify their sources of income, smooth out their consumption patterns over time, and protect themselves from emergencies and unexpected events. Access to financing is important not only because it offers opportunities to business to take out loans to grow, but also to give poor households safety mechanisms to manage risk and reduce their vulnerability (see chapter 8). In addressing poverty and social equity, it is important to recognize the functions of and limitations of financial services. Poverty is not reduced by promoting particular financial services, such as microloans or remittance flows. What is needed are solid institutions with the ability to facilitate financial intermediation and accumulation of capital in the niche of the smallest economic units. To reduce poverty, it is necessary to have solid institutions that help small businesses accumulate reserves for handling emergencies and investment opportunities, manage liquidity, facilitate decisions whether to save or invest, transfer purchasing power in time and space, and allocate funds from less profitable uses to more profitable ones. Institutions that are successful in serving the poor use their close relations to clients and knowledge of specific circumstances to understand the behavior and needs of poor households. For example, migration has become a strategy of poor households to try to evade poverty; accordingly, several dozen Latin American microfinance institutions have incorporated distribution of remittances as a service they can offer to customers. What is important is not simply to offer services to transmit remittances, but to provide an integrated array of diverse financial services to emigrants and their families and relatives. The multifaceted offering of remittance transfer, credit, and savings helps clients allocate their funds between consumption and saving.
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It is not the supply of a single product, but rather an integrated approach and the availability of an array of financial options, that increase the possibilities that household businesses in the informal sector can take advantage of productive projects. To the extent that remittances can move between bank accounts of the sender (the emigrant) and the receivers (the emigrant’s relatives), the costs of transfer can diminish, and the growing flow of remittances will move more efficiently through the financial system. In these cases, the positive impact of microfinance on the poor can be very significant.
Challenges Ahead Microenterprises and small economic units face many problems that cannot all be blamed on lack of credit. Man does not live by bread alone—and a microenterprise needs more than just financial services to develop. Although financing is often mentioned as a key restriction, the real limiting factor is lack of permanent access to an array of financial services, not just credit. Microenterprises that operate in specific sectors are demanding business service development programs, as well as financial education programs. These kinds of programs are crucial to developing the capacities needed by the sector to better service more clients. An enduring challenge will be to tailor affordable business service development and similar programs to the specific needs of each institution. The customer service of all financial institutions remains low, but is improving rapidly. Efforts should continue to expand sustainable financial services for low-income populations. Commercial bank initiatives should be promoted so that these banks keep entering the sector, with growing determination. Private banks willing to increase financial services to the microenterprise sector are natural partners of multilateral organizations such as the Multilateral Investment Fund (MIF), whose mandate includes supporting innovative financial plans for micro- and small enterprises. Other kinds of microfinance institutions, such as NGOs or cooperatives that have the potential to be sustainable and that have developed new and innovative instruments for the microenterprise sector also deserve to be supported.
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Rural areas—where a significant portion of the Latin American population lives, and where some of the poorest sectors can be found—is the frontier that needs to be conquered in the coming years. The limitations in physical infrastructure, low population density, and the systemic risk of rural activities call for new approaches and innovations. Nongovernmental organizations and nonprofit organizations that do not manage deposits from the public have high tolerance for risk; thus they are an excellent conduit for research and experimentation with new services. These institutions will also have an important role in providing nonfinancial services such as training and development of business skills. Their close client relations and their ability to adapt to the local market will allow these institutions to specialize in niches that have been of low interest to or under-serviced by full financial intermediaries. Participation by the industry’s private investors and traditional banks, as well as international development agencies and socially responsible investors in the microfinance industry, will continue to increase in upcoming years (INCAE 2004). While the former are drawn by profit, the latter seek social impact, coverage, and improved well-being of the least-favored socioeconomic groups. The virtue of microfinance is that it brings positive results in both orbits, thus attracting funds from both sources. In sum, the growth and evolution of this business has shown that small can indeed be beautiful—and profitable as well.
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References Castello, Sergio. 2004. Innovative Technologies in Microfinance for Latin America: Building Effective Delivery Channels. Summary of the Microfinance Workshop on the Use of Information Technology to Deliver Financial Services, 16–17 October, San José, Costa Rica. Fiori, Anita, Lara Goldmark, Carlos Assumpção, Alexandre Darzé, and Marco Aurélio Cardoso. 2004. Entendendo a história das microfinanças. In O desafio das microfinanças, eds. Angela da Rocha and Renato Cotla de Mello. Rio de Janeiro: Estudos Coppeard. Gompers, Paul A., Joy L. Ishii, and Andrew Metrick. 2001. Corporate Governance and Equity Prices. National Bureau of Economic Research (NBER) Working Paper No. 8449. Cambridge, Mass. (August). Instituto Centroamericano de Administración de Empresas (INCAE), Business School. 2004. Case Study. Profund Internacional S.A. Alajuela, Costa Rica. Inter-American Development Bank (IDB). 2004. Unlocking Credit, The Quest for Deep and Stable Bank Lending. Economic and Social Progress in Latin America. 2005 Report. Washington, D.C. Luna, Elba, and María Victoria Saenz. 2004. Macro impacto con micro dinero: 25 años de apoyo a la microempresa. Washington, D.C.: Inter-American Development Bank. Martin, Philip. 2004. Migration. In Global Crises, Global Solutions, ed. Bjørn Lomborg. Cambridge: Cambridge University Press. Marulanda, Beatriz, and Maria Otero. 2005. Profile of Microfinance in Latin America in 10 Years: Vision and Characteristics. ACCION International, Boston. Unpublished manuscript. National Association of Corporate Directors (NACD). 2003. Corporate Director’s Ethics and Compliance Handbook. Directors Handbook Series. Washington, D.C. Terry, Donald F. 2005. Remittances as a Development Tool. In Beyond Small Change: Making Migrant Remittances Count, eds. Donald
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F. Terry and Steven R. Wilson. Washington, D.C.: Inter-American Development Bank. Terry, Donald F., and Steven R. Wilson, eds. 2005. Beyond Small Change: Making Migrant Remittances Count. Washington, D.C.: InterAmerican Development Bank. Woodruff, Christopher, and René Zenteno. 2001. Remittances and Microenterprises in Mexico. University of California, San Diego (UCSD), Graduate School of International Relations and Pacific Studies. Unpublished manuscript.
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Marguerite Berger is Principal Country Coordinator in the Caribbean Division of the Inter-American Development Bank (IDB). She joined the Bank in 1990 and has served as Chief of the Bank’s Microenterprise Unit and Senior Advisor and Acting Chief of the Micro, Small and Medium Enterprise Division. She established and served as the first Chief of the Women in Development Unit at the IDB. She holds a doctorate in economics from American University and has more than 20 years of experience in economic development in Latin America, the Caribbean, the United States, and Asia, focusing on micro- and small enterprise, financial institutions, women in development, and economic policy. She is the author of numerous books and articles on microfinance, including The Second Story: Wholesale Microfinance in Latin America (Inter-American Development Bank 2003). Sergio Castello is a professor of global business and economics at the University of Mobile. He has published books and articles on global business, multinationals, and international production. He also has published in the area of microfinance in Latin America and serves as a consultant to the Inter-American Development Bank. His research and practical experience is in the area of financial sustainability and implementation of technological innovation at MFIs. Robert Peck Christen is President of the Boulder Institute of Microfinance, home of the Microfinance Training Program (MFT), which trains industry leaders from around the world in the provision of financial services to the world’s poor. He has worked for 25 years in the microfinance field in more than 40 countries; most recently for 6 years as Senior Advisor to the Consultative Group to Assist the Poor (CGAP), where he helped place microfinance into commercial banks. He is founder and director of the MicroBanking Bulletin, the industry
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benchmarking publication for financial performance. He was a founder of the Microfinance Information eXchange (MIX) and the Microfinance Management Institute (MMI). He has advised a number of leading Latin American microfinance institutions in developing products, strategies, and financial management capacity. Carlos Danel is Co-Chief Executive Officer of Compartamos, the largest microfinance institution in Latin America, serving 400,000 low-income microentrepreneurs, mostly women. He is also a member of the Directors Council of ACCION International and a faculty member at the Microfinance Training Program in Colorado. He is a frequent speaker at conferences and seminars, and was nominated to participate in the Forum of Young Global Leaders at the World Economic Forum in Switzerland. He holds a degree in architecture from the Universidad Iberoamericana and an MBA from the Instituto Panamericano de Alta Dirección de Empresa in Mexico City Giulissa Franco is a specialist in risk systems and evaluation and rating of financial institutions. Her work is focused primarily in Latin American countries. In the past several years she has participated in many projects and studies related to her area of specialty and to financial systems in general. Lara Goldmark is a senior development specialist with Development Alternatives, Inc. (DAI) in Bethesda, Maryland. She has written and taught extensively on microfinance and enterprise development and formerly worked for the Microenteprise Unit of the Inter-American Development Bank. As advisor to the Brazilian National Development Bank from 1999 to 2003, she produced a complete set of Portugueselanguage microfinance management tools, as well as a series of articles that have shaped the debate surrounding the big-country challenge faced by the microfinance field in Latin America. She started up DAI’s local affiliate in Brazil and is currently a lead researcher for the DAI group on enterprise development.
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Elsa Martín is a lawyer working at NODUS Consultores S.L. as a senior specialist in microfinance. She has an MBA with a focus on socially responsible entrepreneurship from the University of São Paulo, Brazil. She has worked on many technical assistance projects in Latin America and Africa for bilateral and multilateral organizations such as the IDB, the Multilateral Investment Fund, the Spanish international cooperation agency AECI, and the German finance cooperation group KfW. Beatriz Marulanda, an economist and consultant, has worked for the last 14 years in areas of microfinance, including analysis of financial systems and institutions that are developing financial services for low-income people. She has completed projects for the Colombian government, the World Bank, the IDB, the Andean Development Corporation (CAF), and the GTZ GMbH of Germany. Ms. Marulanda spent 12 years with Colombia’s central bank, the Banco de la República. She currently serves as president of the board of directors of Fundación Social, the owner of Banco Caja Social, a pioneering institution in the provision of financial services to Colombia’s poor. Jared Miller is Director for Latin America at Planet Rating, a specialized microfinance rating agency. Previously, he was Manager for Latin America at the Microfinance Information eXchange (MIX), where he established the regional office, led the expansion of regional data services, and authored several articles about the performance of Latin American microfinance institutions. He holds joint degrees in geography and Spanish from Middlebury College. Tomás Miller-Sanabria is a Senior Investment Officer with the Multilateral Investment Fund (MIF) at the Inter-American Development Bank in Washington, D.C. He previously worked as an executive at the Corporación Andina de Fomento (CAF) in Caracas, Venezuela, as ViceDean in the Stvdivm Generale College in San José, Costa Rica, and in a brokerage house in Costa Rica. Dr. Miller currently serves on several boards of directors of Latin American microfinance institutions and regional investment funds. He holds an MBA (1986) from the University
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CONTRIBUTORS
CONTRIBUTORS
of Dallas and a Ph.D. (1996) in agricultural and resource economics from Colorado State University. Armando Muriel is Managing Partner of NODUS Consultores S.L. Since 1993, he has worked throughout Europe, Latin America, Africa, and Asia in the finance sector with different international organizations, including the IDB, the MIF, the World Bank, and the United Nations Development Program, as well as bilateral organizations such as KfW, GTZ, AECI, and ASDI. He holds an MBA in quantitative business administration. Victoria Muriel is a professor at Salamanca University in Spain and a consultant at NODUS Consultores S.L. She holds a doctorate in economics and has participated in many microfinance technical assistance projects and studies throughout Latin America and Asia for international organizations such as the MIF and the Spanish international cooperation agency AECI. Maria Otero is president and CEO of ACCION International, which serves some 1.8 million clients with an active portfolio of more than $1.3 billion. She directs ACCION’s work in 22 countries in Latin America, the Caribbean, and Africa. Ms. Otero serves as president of the board of directors of ACCION Investments in Microfinance, SPC, an offshore segregated portfolio company, and is the chair of the MicroFinance Network, a global network of 32 of the world’s most respected microfinance institutions. She is on the board of directors of BancoSol (Bolivia), MiBanco (Peru), and Compartamos (Mexico), as well as the Calvert Foundation (USA) and the U.S. Institute for Peace. Recognized worldwide as an important voice in microfinance, she is author of a number of monographs about microfinance and was co-editor of The New World of Microenterprise Finance: Building Healthy Financial Institutions for the Poor (Kumarian Press, 1994). Ramón Rosales is founder and president of International Consulting Consortium, a U.S. consulting firm specializing in the development of financial markets. He has more than 30 years of experience in regulation
Copyright © by the Inter-American Development Bank. All rights reserved. For more information visit our website: www.iadb.org/pub
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and supervision of financial markets, and has worked with more than 20 organizations that regulate and supervise microfinance institutions in Latin America and the Caribbean, as well as in Africa and Asia. He worked for 17 years as Deputy Superintendent in the Superintendency of Banks and Insurance in Peru. He holds an MBA in business administration and public accounting from the Pontificia Catholic University in Peru. Gabriel Schor is a member of the managing board of ProCredit Holding AG; chairperson of the supervisory board of ProCredit Banks in Ecuador, El Salvador, and Nicaragua, and Banco Los Andes ProCredit in Bolivia; and a board member in Micro Credit National in Haiti. Dr. Schor has been a managing director at International Projekt Consult GmbH (IPC) since 1990, with overall responsibilities for Latin America. Dr. Schor and his team seek to create practical incentives for commercial banks to develop innovative products for microentrepreneurs and small farmers and to increase the supply of low-income housing. After completing his studies, Dr. Schor worked as research associate at the University of Trier.
Copyright © by the Inter-American Development Bank. All rights reserved. For more information visit our website: www.iadb.org/pub
CONTRIBUTORS
Copyright © by the Inter-American Development Bank. All rights reserved. For more information visit our website: www.iadb.org/pub
