NEWS WIRE: United States: The Crisis and Microfinance in Latin America

WASHINGTON June 1 – What will happen to the Latin American microfinance industry in the wake of the crisis in the United States? Uncertainty reigned and responses were feeble while the storm continued to grow.

On 10 October 2008, the XI Inter-American Forum on Microenterprise in Asuncion, Paraguay hosted the panel “International Crisis and Microfinance,” an urgent discussion accompanied by spontaneous conversations and debates in the hallways and dining halls.

The day before the round table, Wall Street began a spectacular free fall that would bring it, by March 6th, to 6469 points, its lowest level in five years and less than half of the 1997 peak level. What would the industry’s future be? In these months, the industry has begun to suffer a significant restriction of funds; financial costs have risen and financing growth has decelerated. With the real economy reeling, clients’ pockets are shrinking and defaults have surged. Is it chaos? No, but it is important to call on cold reasoning, review business models, invest cautiously, and of course apply better management strategies.

Expensive Money

Regional funds have serious difficulties in accessing coverage operations through swaps and have begun to implement defensive operations to reduce risk and damage resulting from problems of liquidity. Money has become more expensive not only as a result of its scarcity but also because of the drop in the exchange rate of local currencies with respect to the dollar. Some microfinance institutions (MFIs) even face net income losses of 7% – 43%, according to the Consultative Group to Assist the Poor (CGAP).

In light of the growing external debt, many argue for the diversification of funding sources, anchoring the leverage in the domestic market to sidestep the changing global risk. However, the crisis is a gripper that pinches both ends. According to Planet Rating, an agency that ranks MFIs, at the end of 2008 the cost of external financing rose in a matter of months from 0.5% to 1.5% in dollars, while in local currency it grew three times, from 1.5% to 5%. Nowhere is there cheap money, not in Europe nor Bolivia. The sector is tied up in a Gordian Knot. One common administrative move is to transfer credit costs to the consumer, but it negatively impacts default and delinquency levels, since the cost of debt rises at the same time income is falling. On the other hand, the rising costs of food, transportation and housing hinder the capacity of families and microenterprises to make payments, as they also have less resources due to the reduced flow of remittances from the United States and Europe, the fall of domestic commercial activity and loss of jobs in the export sector.

Less income for families and microenterprises and less sales and purchasing and payment capacity do not create a good scenario. Finally, there is a feedback cycle. When delinquency increases, portfolio risk also increases and with that the costs; thus microfinance institutions expand their prerequisites, reduce liquidity, make fewer loans, reduce transactions, do not recuperate and, finally, collapse.

Slower growth

The triple impact of the crisis – on markets, operators, and clients – will not be uniform. The first to suffer will be the indebted markets and clients and MFIs that have been too aggressive in approving loans. In all, these will not face the same tensions as traditional commercial banking.

The industry’s growth rate in 2009 is expected to slow down rather than come to a full stop. The most cautious predictions estimate a growth rate of 15% to 30%, about half that projected before the crisis and below the average in recent years (40%). “The second trimester of the year will reveal the real dimension of the crisis, through income levels and growth shown in Latin American economies, and it will be possible to take more appropriate measures for 2010,” says Alejandro Soriano, adjunct director of SMEs and Microfinance at the Andean Development Corporation (CAF).

In the markets, the red and black lines are clear. Bolivia, Peru and Colombia will be in the less-affected group. They are home to a large portion of the region’s industry, with consolidated institutions, better able to absorb delinquency and increased costs. Guatemala also finds itself in the process of maturity and progressively less dependent on international resources.

At higher risk, on the other hand, are Nicaragua, El Salvador and Mexico. Nicaragua, under profound social and political pressures, mainly relies on outside donations and funds. The others have extremely indebted urban and peripheral clientele. In Mexico, in addition, inflation rates and the country’s restrictive monetary policy were rapidly driving up the cost of money.

Some analysts assure that the dividing line is also clear according to MFI type. The Emergency Liquidity Fund (ELF), which provides short-term loans to institutions with liquidity problems, outlined the different levels of vulnerability in its study presented at the XI Forum in Paraguay. Unregulated NGOs operating in small countries such as those in Central America will be the first to suffer the impact, since their financing depends on international resources or second-tier loans and loans from regional banks.

Regulated MFIs will fare better. This group –banks, financial companies, savings and loans, and credit unions– is better covered. Approximately 60% are based on public deposits and have diversified their funding sources and improved efficiency and internal controls. They also have more solid lending methodologies and appropriate information systems and have extended their operations geographically and into various sectors of economic activity, thus diversifying risk. While the industry faces raising and/or reducing the margins, these institutions will have more flexibility in defining their rates, explains Juan Carlos Pereira, ELF manager.

Action and Reaction

With less capital available, the pressure to consolidate institutions through mergers and acquisitions is an option that is gaining attention. That process is accelerating in the more mature markets to optimize the use of resources, reduce costs, and in general improve efficiency levels.

Colombia is an example. In early 2008 the tendency arose there with the MFIs Bancamia and ProCredit, which were absorbing Spanish and German capital, and continued in October with the operations of Brysan Global Partners, a fund whose members include JP Morgan and Citibank. Brysan put up US$10 million to buy 19% of Banco Caja Social Colmena, which controls 25% of Colombia’s microcredit portfolio and 8% of the mortgage loans.

New MFIs that take risk are going to operate more actively to maximize short-term benefits, but most institutions will reduce operating costs and become more efficient to survive. Many will sharpen their inventiveness to gain space or perform damage control. In the Philippines, for example, the country’s third largest bank, Bank of the Philippine Islands, which registered losses of 30% in the first nine months of 2008, is creating a mobile microfinance bank in partnership with Ayala Corporation and Global Telecom to confront a 2009 that is predicted to be arduous.

There will undoubtedly be a concentration in more secure markets and assessment criteria and more rigid monitoring. It is predicted. Some methodologies will migrate to individual credit, demanding greater securities and guarantees to ensure payments, as occurred in the Mexican loan institutions such as BBVA, Coppel and Azteca, and the MFI Compartamos.

In fact, traditional banking will continue to show a profound interest in microfinance. While the surveys available in December 2006 showed that 60% of the banks assured that the industry is an important niche for their operations, the proportion had increased to 80% in recent surveys conducted by the Latin American Federation of Banks. In fact, according to Epaminondas Jacome of the Fondo Internacional de Garantías (International Securities Fund), a guarantor that operates in Latin America, Africa and Europe, large-size banks will most likely continue to expand their business in the base of the pyramid, since even with the crisis the yields are higher than in the traditional operations.

Of course, the business if not for everyone. Banorte, the fifth-largest bank in Mexico, is an example of aversion to risk. In 2008, almost at the same time that it stopped offering 20-30-year mortgages to the middle classes in the country, it cancelled its microcredit program when it saw the steady increase in the delinquency portfolio of Pronegocios, its subsidiary for the sector established 2005.

Management Moment

The new sign of the times is caution. “Management” is a word that becomes popular in turbulent times, as well as careful lending, refinement of risk assessment, and construction of a high-quality portfolio. The sub-prime experience revealed that innovations such as credit scoring, outsourcing and alliance models require careful instruments. It is essential to create appropriate incentives for personnel, managers and associates to balance volume and quality, when the providers expand to double-digit rates and the competition is one step ahead, a recent CGAP report on the region suggests.

It is never too much to be cautious in placing capital. Since microfinance is a local business, MFIs must pay close attention to the level of indebtedness of their clients and to their own position in the market. Understanding consumer patterns, costs, and client investments will help in redirecting tools and strategies. The administration and synchronization of assets and liabilities must be done with great care. “It is necessary to reinforce efforts to channel remittance flows,” says Tomas Miller, senior investment officer at the MIF. “Remittances have not dropped precipitously, they have shown to be more stable than international credit lines and they offer a great opportunity for growth since only 30% to 50% are sent through bank accounts in the region.”

At the end of the day, the market will calm down and everyone hopes that the result will be a stronger, more focused and professional industry. The list of positive results includes long-term sustainable growth with lower but stable rates, solid lending procedures and policies, products better adapted to the necessities of the demand and protection policies and practices for the client. “MFIs should try to operate with bulletproof solvency levels to have greater opportunities for regional penetration and development when the storm passes,” says Soriano, of the CAF.

If the crisis has a message, it will be to persevere, since the industry was born to combat poverty and favor inclusion with a model of proximity, which all proclaim but not all accomplish. To grow takes time for one reason: it takes years to solidify foundations and accommodate the concrete conditions that allow the entire structure to sustain itself. Whichever institutions have forged close relations with their customers and long-term commitments with microenterprises, markets, and localities will have generated relations of confidence, key in times of uncertainty. “Caveat emptor [no security, single low risk of the client],” says Miller, “it’s the entrepreneurs who will determine which institutions emerge favorably from the crisis, and they will do it based on the quality of services received.”

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