Features and Web Stories

Apr 16, 2008

The Duty of Champions

The microfinance industry continues growing but there is no time to rest on one’s laurels. The triumphs call for more responsibility to resolve the unmet demands.

By Diego Fonseca


Nobody would expect that a research study full of statistics, graphics with X and Y axes, and terms such as “per-capita income,” “non-salaried workers” and the hardly dramatic “investment climate” would awaken passions usually associated with a championship football match. Nevertheless, something like this happened in October 2007 at the 10th Inter-American Forum on Microenterprise in San Salvador after the presentation of the Microscope, a new tool to rank the business environment for microfinance institutions, a study by the Inter-American Development Bank (IDB), the Corporación Andina de Fomento (“The Andean Promotion Corporation”), and the Economist Intelligence Unit.

It was like a World Soccer Cup, only in reverse—one in which the traditional top players in regional soccer watched as players less accustomed to the brilliant lights took over the field. In the Microscope, countries such as Bolivia, Peru, Ecuador, El Salvador, the Dominican Republic, and Nicaragua showed that to have the best regulatory framework, business climate, and institutional development for microfinance performance, a country does not have to be large and wealthy. To the contrary, these six countries led the ranking, while Brazil, Uruguay, and Argentina were at the bottom of the list.

A strong lesson from Microscope is that even the most powerful countries in Latin America must continue working better and harder to combat poverty and social exclusion. But this is not the only lesson. Perhaps the best lesson is that all—especially the leaders in the evaluation—understood that the results obtained do not seat anyone on the throne but instead call for even greater responsibilities. And one of those responsibilities, ten years after the first Inter-American Microenterprise Forum, is to determine what demands in the microfinance industry are still unmet and how this situation can be remedied.

This is the duty of the champions, and microfinance institutions (MFIs) in El Salvador have been among the first to address the matter. During the 10th Forum, in a debate sponsored by Banco ProCredit, the leading Salvadoran institution offering credit to microenterprises, credit providers and borrowers began to examine the issue of debit and—especially—credit in the industry. The results of that exchange have led to further discussions on how to improve the industry’s performance in the country and how to contribute to dialogue and interchange on best practices throughout the region.

El Salvador’s Task

In the last decade, El Salvador has become a star in Latin American microfinance. In 1996, there were 397,581 microenterprises in the country, accounting for some 24% of the gross domestic product. Nevertheless, barely a quarter of those businesses had ever used some form of credit—and half of those had obtained it through informal sources.

The situation, definitely complex, was even more so in the countryside, where one-third of El Salvador’s microenterprises were located, but where financing reached only 12% of rural homes, according to statistics from the World Bank and the Salvadoran Foundation for Economic and Social Development (Fusades, in Spanish). It was not a good sign, and even worse, six out of ten of those campesino homes were found to be subsisting beneath the poverty line in those years.

But things have changed considerably. Rural poverty continues to be high but has dropped in recent years to 50%, and the nearly 70 MFIs existing in the country have made it the region’s third-largest credit market, after Peru and Ecuador, according to statistics from the Microfinance Information Exchange (MIX), which maintains its own database with information from the institutions and the IDB. These MFIs, in addition to the traditional banks, have succeeded in reaching 12% of the poor families in El Salvador, a level surpassed in the region only by Paraguay, Nicaragua, Chile, Mexico, and Peru.

Such results have required training. There have been various noteworthy results. According to Estela Cañas—director of Maestría en Finanzas (“Masters in Financing”) and of the Centro de Gestión de la Micro, Pequeña y Mediana Empresa (“Center for Management of Micro, Small, and Medium-Sized Enterprises”) at the Central American University (UCA) in San Salvador—during the last ten years several NGOs and foundations with credit programs successfully established associations to oversee their rural development activities. Some separated their legal entity responsible for their association processes from technical assistance and credit, and more than a few were able to make inroads in replacing the highly developed profiteering market in El Salvador.

Numerous resources from international organizations such as the IDB, international cooperation, and money from entities and funds donated by microfinance contributed to development of the industry. Finally, by the end of the decade, El Salvador found itself in the Microscope’s top-4 ranking, as one of the more advanced countries. The country’s strength, according to the Microscope, resides in its credit bureaus, the formation and operation of its NGO-based microfinance institutions, and use of very good accounting standards.

But all is not rosy. In El Salvador, as in other countries in the region, there are still few regulated MFIs (in 2005 there were seven in Bolivia and 30 in Peru). The Microscope also points out that the industry in El Salvador still has areas for improvement in its mediocre investment climate, development of a more specialized capacity for microfinance regulation, and institutional standards for governance and transparency.

Another important issue to address is that the level of competition between the institutions remains quite weak, which may explain why coverage has not been extended further. The study “The Profile of Microfinance in Latin America in 10 Years” by microfinance expert Beatriz Marulanda and Acción International CEO María Otero, shows that coverage in El Salvador in 2004 reached 27% of the potential market, or 333,590 people. This figure is not deplorable, as it is almost twice the regional average (14%). However, although similar to the coverage in Chile (28%), it is still far from the Bolivian reality, where in the last couple of years the country’s MFIs have reached more than 56% of the targeted market.

Unmet Demand

But those are not the only lessons possible. Participating in a panel sponsored by ProCredit at the 10th Microenterprise Forum as bank representatives were Pablo Eliseo Alvarado of Caja de Créditos Nueva Concepción—with 2,000 rural clients in the north of the country—and Brígido García of Fundación Campo, established in 1997 with resources from CARE and which now offers credit to 3,500 microenterprises and families in the eastern areas of El Salvador. Seated across the table were Arelí Velasco, who began informally selling cheese and now produces commercial milk products, puts on banquets and is negotiating to buy a small inn; Pedro Abrego, an upholsterer turned mechanic-workshop proprietor employing seven people; and Teresa Chávez, who rose out of the informal sector into managing three locales selling juice, food, and telephone plans and accessories in the historic center of San Salvador.

These three entrepreneurs, who began their business activities more than ten years ago when they were barely willful teenagers, were the voice of the demand. The bankers sometimes had to give responses that had not yet crystallized into concrete processes. However, ideas from the panel have already led to a series of proposals that the Salvadoran market is now considering to redirect its future. What is next, then, for the country’s microfinance industry? Work is needed in the following areas to help resolve these complex issues:

Risks of Saturation. The market in El Salvador has a large number of microfinance institutions, but market penetration is not growing at the same rate. Thus, many MFIs are fighting for the same clients. With a population of some 2.6 million poor people, the country has one MFI for each 38,700 inhabitants, in comparison to the region’s leaders that are more consolidated. In Bolivia, for example, there is one MFI for every 195,000 poor people, and the figure is similar in Peru (one institution for every 187,850 people), while in Ecuador, whose market ranks third in the region in terms of quality (according to the Microscope), there is one institution for every 85,400 low-income inhabitants.

Market Concentration. The MFIs not only share with traditional banking their participation in financial business, but, like the banks, they also keep an eye on the efficiency of operations. In El Salvador, as in other markets, this has meant that most placement of credit has been concentrated in the capital’s metropolitan zones, Santa Ana and San Miguel. The areas that lose out are the outer-urban and rural zones. According to Cañas, while some 1,000 loans per month are placed in the urban municipalities, the number reaches only 15 per month in rural municipalities. The MFIs must also balance their desire for productivity, profitability and sustainability with the difficulty of access, lack of guarantees due to poverty or extreme poverty, and widely dispersed and distant potential clients.

Insufficient Availability of Services Locally. In a 1999 study for Ohio State University, Rafael Pleitez, head of the UCA’s Economic Department, established that microentrepreneurs needed local financial services such as secure facilities for depositing their money and agile instruments for making or receiving payments or transferring funds such as remittances from abroad. Eight years later, many of these needs are still unmet.

Failure to Combat Profiteering. According to many seeking credit, the microfinance industry has not been able to thwart speculative loaners. To the contrary, the profiteers have entered new geographic areas or have multiplied in zones where they were already present 10 years ago. The speculators—who charge rates ranging from 15% per month up to 50% per day, according to the amount of the loan—sometimes come from an unfortunate place: they are ex-clients of the MFIs who have prospered and have become moneylenders to individuals in the informal sector or in microenterprise, according to Cañas.

Perception of Sluggish Demand. If the speculators survive, say the borrowers, it largely has to do with how quickly they can make loans, which do not require paperwork nor a waiting period. Such informality seriously competes with the amount of time it takes in El Salvador to review and approve a prospective loan—eight days in urban zones and 15 days or more in rural areas. Even though institutions such as ProCredit have reduced the time it takes for approval—depending on the amount, beginning with one day for first-time credit—the procedure will continue favoring informality.

Financial and Social Costs. When individual clients lack real guarantees, they tend to obtain group credit. This solution, which represents 20% of microcredits granted in El Salvador, has its difficulties. Approval can take more than 15 days, but implementation is even more complex. One example is penalization for missed payments. Clients complain that the irresponsibility of some members raises the costs of credit for the group, sometimes so much so, they say, that it becomes less onerous to take a speculators’ loan; the banks respond that the group must assume some financial responsibility, or first, adopt mechanisms of social sanction to prevent delinquency. During the last decade no one could determine which problem is the egg and which the chicken, but an experience of Fundación Campo could shed some light. The institution makes a communal loan, but holds the credit obligation and guarantee at the individual level. A lending committee of community members supports management of recouping the financing. This year, the IDB’s Social Entrepreneurship Program of the Multilateral Investment Fund will begin to systematize this experience.

Individual Volume vs. Dispersion. One ongoing issue is that an indvidual’s credit saturation can lead to delinquency in payments. The complainants insist that such a situation occurs through “the lack of payment capacity of a client” based on the commercial volume of their business. The banks defend themselves. “We aren’t interested in competing with other institutions to see who gives a larger credit to a client, but rather to evaluate if a person has real capacity to pay with a current business, without the additional investment,” says Stefan Queck, ProCredit’s general manager. “If not, the credit is denied, while other lenders may consider that business to be good.”

More Information—and More Transparency. Efficiency and attention have improved with competition, but clients still demand better and more transparent information. The main issues: improve communication about the real cost of the loans contracted, especially for the extra commission costs added to the interest rates. “MFIs should work more on the issue of efficiency to offer lower-cost products,” says García, of Fundación Campo. “One weakness is the lack of technical tools to measure objectively the impact of microfinance on improving the clients’ quality of life.”

Lack of Monitoring. What level of involvement should a lender have with clients? Borrowers do not agree whether an MFI should monitor them or not in the management of their business, providing technical assistance and training for support of their growth. Should banks try to guarantee repayment by getting involved in the long-term sustainability of their clients? The answer may come from other sources. An ongoing debate among traditional businesses is whether they should commit themselves to social responsibility programs with the communities or concern themselves only with generating profits for their shareholders. The balance is gradually inclining toward social responsibility, whenever the businesses are social actors—in some cases even more powerful than the nation states. In El Salvador there still is no answer. Some financial executives believe that banks should limit themselves to doing good work evaluating credit to make sure they offer solid financing, so they can ensure the growth of the institution and thus the coverage. Salvadoran entrepreneur Teresa Chávez shares that vision. “My credit adviser is not going to tell me how to make my fruit drinks,” she says.