Micamericas

Feb 24, 2009

Microscope 2008: Peru is Taking the Regional Lead

Peru leads the microfinance ranking, surpassing Bolivia in a year full of regulatory changes. What will 2009 bring?

By Diego Fonseca

In June 2008, the Superintendence of Banks and Insurance (SBS in Spanish) of Peru did not yet know that a small legislative decree was going to enable its microfinance institutions to make the largest qualitative leap in the sector in all of Latin America. On 21 June, the SBS modified the General Law of the Financial System, changing the regulatory framework of non-bank financial intermediaries that provide microfinance services to expand their action capacity.

The decree opened the possibility for municipal savings and loan institutions – a type a non-bank - to compete in districts and provinces beyond their municipal borders. And while the requirement was eliminated for greater minimum capital levels and liquidity for more sophisticated and risky financial operations, starting in July 2010 the microfinance institutions (MFIs) that capture market resources will have to meet two mandatory annual risk ratings, just like the main banks in the traditional finance system. “With ever greater connection to the traditional industry, Peruvian microfinance institutions have become more solid and are expanding their portfolios and activities, including provision of services such as deposits and entering more firmly into all markets, even Lima. Now they compete at a national level while at the same time, regulatory restrictions are reduced,” explains Sergio Navajas, investment officer at the Multilateral Investment Fund (MIF) of the Inter-American Development Bank (IDB).

As a result of these changes, and of consistent top performances in the sector in 2007, the Peruvian microfinance industry rose to the top of the 2008 Microscope, the sectoral ranking prepared by the prestigious Economist Intelligence Unit (EIU), sponsored by IDB and Corporación Andina de Fomento (CAF).

In 2008, the Microscope expanded its rankings from 15 to 20 countries, where significant regulatory changes went into effect as part of a growing industry. According to Robert Wood, a senior analyst at the EIU, the cycle of growth in the region continued throughout 2007 and into the first half of 2008 with relatively low interest rates, which provided the microfinance sector with a supportive macroeconomic environment. “The investment climate has clearly been one of the most significant elements in modifying the positions, a product of the political and economic conditions in many parts of the region,” says Alejandro Soriano, Deputy Director of microfinance at CAF.

The results generally reconfirmed the existing split between size and wealth of the markets and the quality of their microfinance institutions. Countries such as Bolivia, Ecuador or Nicaragua, with weak capital markets and irregular environments for investment, have more developed institutions than other larger countries such as Brazil, Mexico or Argentina, or countries with lower poverty rates, such as Chile or Uruguay.

It’s worth a Peru

The Peruvian excitement was palpable last October, when the results of Microscope 2008 were announced during the XI Inter-American Forum on Microenterprise in Asuncion, Paraguay. Peru was the only country in 2007 that had been able to rank in the top five places in the three main categories – regulatory framework, investment climate, and institutional development – of the ranking.

Peru’s Superintendence is highly regarded, recognized by the World Bank, the International Monetary Fund, and the IDB for its high quality financial control regulations and features. The Edpymes –a type of non-bank institution- was established in 2007 to bring together MFIs and promote sectoral development – have achieved portfolios that surpass the sum of resources in rural credit unions. Previous NGOs transformed into financial organizations, the Edpymes will now be monitored by the Superintendence decree so that, together with the rural and municipal credit unions, they have greater access to financing in capital markets and financial operations that used to be conducted exclusively by traditional banks, such as negotiation of stock shares and bonds or mortgage loans and individual savings accounts.

Bolivian lament

Part of Peru’s success in coming out on top is at the expense of Bolivia, who had to cede the leadership that it enjoyed in 2007, when the Microscope was first conducted. The Bolivian government approved in 2008 fewer requirements for capital so that the industry could operate. The Superintendence of Banks and Financial Entities – which has significantly reduced top executives’ salaries and lost a significant number of skilled personnel  – arranged the incorporation in the banking law of a type of NGO called financial institutions for development (IFD in Spanish).

The IFDs are now set up to capture deposits from the public and this has brought specialists such as Ramon Rosales, president of the consulting firm ICC, to question how to manage the market exit of entities that are not easily liquidated by the Superintendence and that may have largely illiquid portfolios. The first complex example might be seen in the Banco de la Union, now under state control, which entered the market placing loans at 6% annual interest rates. Although little money has been released, this government intervention which artificially reduces the cost of credit, has not been the best signal for private operators.

Despite the recent uncertainty, Bolivia is still tied with Peru for first place in regulatory strength in Latin America. Bolivia’s greatest setbacks continue to be the underdevelopment of its capital market, political instability, and judicial weakness.

The star is regulation

Since August 2008, when its Superintendence of Banks and other Financial Institutions began focusing on credit risk management, Nicaragua has had one of the newest and most modern definitions of regulations in the region. The country, in sixth place in Microscope 2008, with a market largely made up of MFIs funded by donors, now differentiates microcredit from consumer credit when measuring risk management. Also, their supervision standards facilitate not only control activities to prevent over-indebtedness but also the onsite control of microfinance activities, which, due to distances and logistics, are labor intensive. It will be interesting to observe to what extent these new regulations are applied in 2009.

Ecuador, whose market has the best institutional development, remained in third place (as in 2007), thanks to a variety of strengths: a large market, a range of services, moderate standards on rates, and MFI regulations differentiated from the traditional finance industry. Nonetheless, its investment climate still requires improvement in key areas such as capital markets or the judicial system.

The investment climate is also a weakness in El Salvador, although the industry remains highly competitive. Its fourth-place ranking is sustained by the industry’s tendency to growth, strong credit bureaus and high credit solvency, according to the World Bank report Doing Business. The country needs to improve its politicized judicial system and the right to property, and its MFIs need to offer a wider range of services at the same time that they expand the availability of information, among other factors.

Big little ones

In 2008, Mexico improved its supervision of regulated MFIs by introducing firmer regulations to evaluate risk in savings and loans, and advancing the trend toward international accounting standards. However, although the number of microfinance institutions is rising, a certain inconsistency persists since the regulatory framework changes often, hindering the industry’s consolidation of its operations. “The Mexican model has certainly improved but its success will strongly depend on the consistency and stability of the regulatory framework” says Navajas of the Multilateral Investment Fund at the IDB.

In Brazil, there is an unspoken debate between the private operators and the public sector. The State, endorsed by the popular administration of President Luis Inacio Lula da Silva, has established itself as a successful manager, and participates actively in numerous microfinance programs with low-income families. As a result, private micro financiers may feel reluctant to participate in the activity, which they perceive to be a state option.

But in both countries, the size of their microfinance industry is inversely proportional to their   large-scale markets and multitudes in the base of the pyramid. These big markets face the issue of breaking the correlation between “more-developed country/weaker microfinance.” Yet are these economies really in the condition to do that, given the priorities of their governments? “The day seems far off when MFIs will be a motor of development in Brazil,” says Soriano of CAF. And in the case of Mexico, although MFIs are “almost nonexistent,” microcredit has been gaining territory through government policies, through the National Program to Finance Microentrepreneurs (Pronafim in Spanish), as well as private enterprises and associations such as Prodesarrollo (“Pro-development”).

A challenging moment

Peru’s leadership arrived through a complex route. It was reached before the explosion of the crisis on Wall Street and when the effects of the financial and economic debacle in the United States had not yet reverberated through Latin America, or as later, globally. The depth of these impacts in the regional microfinance industry will be seen in the 2009 rankings.

However, the business environment is still fragile. Navajas, of the MIF, turns to the metaphor of growth to reflect the situation: in the leading countries, he says, the MFIs have adolescent growing pains, since they are more integrated into the finance sector and it is important that they connect to solid and sustainable investment climates. In the lower-ranked countries, the pain is from the infancy of the industry, i.e. in countries such as Argentina or Uruguay where confusion exists on the role and importance of microfinance, which is perceived as an activity bordering on marginality.

The industry plays a vital role in preserving the environment. Nor is the commitment from regulators and governments to guarantee the conditions of sustainability of the macroeconomic activities a small issue. “We have to be very careful with the investment environment since it takes a lot to build, but little to knock down,” Navajas explains. “We need consistency in defining policies, and time to build institutionality; there is little value in having legislation that lasts only a year, rather we need rules of the game that are sustainable over time.”

But there are other relevant factors. Curiously, microfinance institutions have begun to experience the phenomenon of the curse of success. They have grown and been strengthened to the point that, in more than a dozen countries, they have become so visible that their independence may be compromised by outside pressure.. Some governments view the sector as a place where the state can influence the market, ranging from control of rates to direct participation in the private market with subsidized resources.

The very industry also has challenges to overcome. One clear hurdle is the need to regenerate the ladder of success, allowing the entry of new players into the formal and regulated market. Even in those countries where the expansion of the system has not yet slowed – such as Ecuador, where the formalization of MFIs continues – tasks remain, such as gaining strength to make the financial support for operators broader.

The leading countries need to keep their focus on improving the conditions of the sector to strengthen their position, particularly the governments and regulators, who need to reach consensus on policies. Analysts have suggested that the public authorities of the lowest-ranking countries create incentives to develop microfinance institutions, make efforts to set prudential regulatory standards and frameworks or liberate minimum reserve requirements for certain financing, among other measures.

What´s Ahead?

The 2009 Microscope will include a more rigorous search for information and analysis to measure progress in the market with greater precision and depth. “This is a year in which each number will have to be verified several times, given that 2009 promises to be a year marked by financial crisis in the industry.

A priori, that means that credit will adjust itself in Latin America, impacting on the MFIs, whose financing comes mainly from the market. Other MFIs that mainly use their own deposits or resources from donors to increase loans can be set up to gain market, although they will be hit by a slow-down in product growth. Consolidation can accelerate, and new players, with weak portfolios, will end up put out or excluded from the market. “I think we will see the leading markets and their followers consolidating their performance, while for the countries currently in the bottom third of the Microscope, a possible improvement in the attractiveness of their microfinance environments will be gradual,” says EIU’s Wood.

Soriano (of CAF) holds a margin of hope, as he does not see an inverse correlation between microfinance and the investment climate. “Experience shows that in the times of propitious development in the countries with favorable investment climates, the microfinance institutions have made enormous strides,” he says. “However, there is no evidence that in crisis situations, MFIs will suffer as significant deterioration as do other strata of the economy.”

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