An Inside View of Latin American Microfinance

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Author: Marguerite Berger; Lara Goldmark; and Tomas Miller-Sanabria; Editors

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Copyright © by the Inter-American Development Bank. All rights reserved. For more information visit our website: www.iadb.org/pub


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Marguerite Berger Lara Goldmark Tomás Miller-Sanabria Editors

Inter-American Development Bank


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

LCCN: 2006932322

All dollar amounts are in U.S. dollars unless otherwise specified.


©2006 Inter-American Development Bank 1300 New York Avenue, N.W. Washington, D.C. 20577

And to the pioneers of microfinance who are partners in their quest.


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


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.


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


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.


CHAPTER 1

MARGUERITE BERGER

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).


THE LATIN AMERICAN MODEL

MARGUERITE BERGER

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.



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,



MARGUERITE BERGER

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.



MARGUERITE BERGER

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



MARGUERITE BERGER

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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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.



MARGUERITE BERGER

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.


36

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-


CHAPTER 2

MARGUERITE BERGER, MARIA OTERO,

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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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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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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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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.


44

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


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)

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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


46

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


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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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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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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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


52

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

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