NOTE 8: ON MICROCREDITS
I will
address the issue of credit and Microcredit in this and the following Notes,
but keeping in mind that the Microcredit is a sensitive issue, which requires focusing
on many facets and due to the social and poverty alleviation view given to the
matter. I do not intend to create controversy, just express my personal views.
Microcredit
was born from Dr. Muhammad Yunus hands in 1976, without doubt, that made him to
deserved the Nobel Prize in 2006. The model has spread worldwide since the
creation of the Grameen Bank. The basis of the model were: (1) The poor need
small loans to generate income to overcome poverty; (2) Poor people respond by
returning the borrowed money and (3) This will have a significant positive
impact on poverty reduction. These concepts distanced the Grameen model from
the financial grounds, taking it mainly to the social supportive field; that,
in my opinion, has shown to be unrealistic and less likely to be a relief to
global poverty. BEWARE: I'm not
saying the Microcredit is not useful, necessary and important, what I say is
that the focus has been a repeated myth, more than a proven fact; which was
demonstrated as time passed and many successful MFIs that initially assumed
this model have modified it, to bring it closer to the financial reality of
their own sustainability and academic studies have conclusively shown that
there is not a clear relationship between Microcredits and poverty reduction.
As time passes and lived my experiences, without resting value to the merit of
its pioneer; Dr. Yunus, I became distanced from the traditional Microcredit model
that has shown a number of aspects that seem to threaten its sustainability, because:
(1) Only a minority of people are able to generate income and assets from money
lent; (2) A loan is a liability for the debtor and is a risk; both for their family’s
economy, and their mental health; (3) Not all people want to borrow for fear of
not being able to return the loan; (4) All persons are sensitive to saving
money to meet the unforeseen, even when they are not using a financial
institution; (5) A loan creates obligations; if these are not met, debtors
suffer pressures, threats and aggressiveness from creditors; (6) A loan,
regardless of its size, will always be a financial transaction, impacting the revenue
and sustainability of the creditor; (7) All people have a credit capacity and
have physical or fiduciary collaterals, regardless of their economic status;
(8) Everyone has a payment capacity according to their income: (9) The risk of
default has a double probability to occur during the term of the loan, than over
the initial qualification of the loan applicant; (10) The credit risk of a
portfolio is the sum of the quality of each loan, not an overall probability of
the portfolio; due to the complexity of the combination of debtors and the
particular situation of each of them; (11) The defaults must be attended
objectively and early, taking in account the situation of the debtor that is
causing them and (12) Credit is a psychological situation more than a financial
issue, because the wiliness and the financial knowledge can influence more the
payment of the debtor, than the financial capacity, since this last can change
suddenly. The only exceptions to this last point are the massive crises that
lead a country into a deep recession, due to the way it has been managed its
economy, of what the ordinary citizen has no responsibility, but has to pay the
broken glasses (Europe) and the exceptional nature’s disasters that are
uncontrollable; as in the case of floods in Bangladesh in 1998. But the
exceptional situations are not permanent, so the provisional lending policies
are an exception, these do not function as permanent policies. It must
be assumed a period of recovery adapting the lending policies to the circumstances
and once reached the normality, there must be a return to the appropriate
prudential financial policies, because otherwise inappropriate payment behaviors
and loose expectations are encouraged; and this is a very dangerous moral
hazard. This leads me to share with you some thoughts and concepts on lending
that have been developed during my long career and it also apply to Microcredit.
I will summarize these concepts in this first Note:
1.
Regardless of the purpose or
application of credit, all; poor or non poor have a payment capacity, so there
should never be denied credit to anyone; what has to be done is to lend the
maximum amount according to their paying capacity, stability and not what the
applicant aspires to get. Therefore, a person with a payment capacity of US $ 4.00 a week, at one-year term
and with 20% interest rate, could only receive a maximum loan of US $ 100.00,
to be able to pay it back without difficulty. That is about the average amount
of an ordinary loan in the Grameen Bank.
2.
Everyone has an income; either in
monetary form or in providing services or goods for use and/or consumption, the
last two can become liquid by selling them.
3.
A Microcredit is exactly like any
traditional financial credit transaction: it implies: A voluntary agreement to
receive money, to be returned in equal installments over a given period of time,
at a rate or commission and that, under normal conditions, the debtor will pay back
properly.
4.
Each loan has a price (Interest rate or
commission) that can be fixed or variable; calculated on the debtor’s
outstanding balance or calculated on the total amount and deducted from the
loan (Flat), as is the case of Islamic finance. But is not the same interest
rate if calculated on the outstanding balance, that when it is calculated on the
total loan, the second method generates a much higher rate. In fact; these are
two completely different interest rates, due to the gradual depreciation of the
capital, when calculated on the loan’s period balance.
5.
The characteristics of a Microcredit in
a MFI are the same as that of a credit in any financial intermediary. The
credits are fully linked to the results of the institution, which makes the recovery
a prerequisite for sustainability, regardless of the level of wealth or the poverty
of its debtors.
6.
A Microcredit is not a subsidy, but may
become so if it is not recovered, being initially affected the Microfinance
Institution (MFI), which is no longer sustainable and must close. However, the
main victims are the customers as they lose access to credit, that was
available before.
7.
The Microcredit is not a realistic
solution for poverty reduction, for several reasons:
a.
Poverty is a very complex situation,
which requires multi and interdisciplinary actions and an appropriate national
economic environment that is driven to avoid or reduce poverty. The Microcredit
is just a grain of sand on the poverty beach.
b.
Not all the people are able to
successfully become Microentrepreneurs, this includes poor people and those who
are not, so that only a minority has the features and innate personality to
undertake and therefore to convert a liability in revenues and create assets.
c.
Poor people can also choose to receive Microcredit
to solve specific unpredictable situations, but provided they are able to
return it comfortably.
8.
Not necessarily all people have access
to financial services; In part by the high amounts demanded, the minimum
balances required, the maintenance charges, the high lending rates and largely
by the attitudes and the treatment of the personnel in some institutions, which
inhibits many people from going to these institutions. This requires providing
everyone the possibility of using Microfinances, with a menu of options for savings
and lending tailored to the needs of each segment of the population, this has
been proven socially possible and financially sustainable.
9.
I have no objective evidence that the high
number and low balances of the accounts and loans affects the cost of
Microfinances, but the successful way to manage these is costlier, because it
is a completely different form of financial intermediation, based not on
operations, but centered on the customers: Perhaps this is product of its roots
in the NGOs that were created to help people. I may be too simplistic in my analysis,
but I would like someone to explain me how the greatest number and low balances
of the accounts and loans increases today the operative expenses: Disposing of
information technology and communications resources at very low cost and with
increasing capacity and speed; with the payrolls of employees varying little
(Many times reduced in the branches) despite customer growth; with the utilities,
leases or depreciation of the premises being fixed expenses and being the variable
expenses representing a minor part. As an illustration of my argument the case
of the costs of the two Bolivian most efficient Microfinance Banks, as
published by Mixmarket 2014. "100 best MFIs in Latin America" (BANCOSOL
and Banco FIE) will be cited and comparing their average costs with those of
the largest Multiple Banks (Commercial) in the country. The average operative
costs of the Microfinance Banks in 2014 represented 59.1% of the revenues and
in the Multiple Banks it was 62.0% (A 2,9% difference), the financial costs of
the first were 30.5% and that of the second was 32,7% (A 2,2% difference) and the
other expenses rose to 10.5% in the first and 5.3% (A 5,2% difference) in the
second. Compared to the Multiple Banks, the Microfinance Banks duplicate the other
expenses, due to the way that Microfinances must be managed, having to maintain
a force of Financial Advisers in the field, in permanent contact with the debtors
and promoting savings person to person, unlike the passivity of the traditional
Multiple Banks.
10.
As shown, Microfinance is a very
different and more expensive system to operate than the traditional bank’s finances
because:
a.
The loan approval requires the visit
and review of expenses, income and compromises of both; the households and the businesses
and/or work of the applicants, to determine the real paying capacity.
b.
Credit monitoring, debt collection and
recovery of portfolios is continuous, personalized and to detect potential
problems and solve them early, which involves visiting the customer in their
premises..
c.
There is a limited access of MFIs in
many countries to bank Credit Bureaus. The Bureaus of Banking Authorities take
much time to actualize the data and there is a lack of Microfinance’s Bureaus, this
increases risks, due to over indebtness; so some Latin American countries has
led to distance the Microfinance from the banking sector, opening the Supportive
Institutions Banking Authorities and creating new local legal figures for Non Banking
financial intermediation, allowing them to receive deposits from the public and
monitored by the new financial authorities.
d.
The high costs and traumatic process of
regularizing MFIs as full Microfinance Banks; applying to these the same requirements
as those applied to universal banks, despite having a national jurisdiction;
the high cost implied in the reporting and the disproportionate levels of demanded
capital, made this industry to become restricted and jeopardize its
sustainability. Experiences like the Delegated Regulation of the Non Bank
sector, reporting directly to the Banking Authorities, by federations, unions
and chambers, with independent units whose cost is borne by those organizations
and have proved in Latin America to be an effective solution that has
strengthened the Microfinance sector, enhancing transparency and avoiding its
disappearance.
In the
next Note I will continue with my analysis of Microcredit.
José
Linares Fontela
