The Third Wave

Once again, government development banks emerge that offer subsidized microfinancing. But watch out, sometimes cheap things turn out to be expensive.

When he appeared before a hundred participants in the Public Banking and Microfinance round table at the microenterprise forum in Cartagena, the moderator, Stefan Queck, started out by quoting United Nations Secretary General, Kofi Annan, with regard to 2005 being declared the International Year of Microcredit by this institution.

"Annan explained to us the problem of giving people access to financial services," said Queck, "and 50 years ago, state development banks emerged to solve this problem. And it was 20 years ago that financial markets were deregulated with the idea that this would enable private banks to give people access to financial services. Annan sets out as a new challenge for us something that was already presented in 1954."

History repeats itself, as the tango says. In the last five years, in several Latin American countries, government development banks have emerged to guarantee that people have access to financial services.

"Between 1930 and 1960, 132 public development banks were founded in Latin America," says Rommel Acevedo, secretary general of the Latin American Association of Financial Development Institutions (Alide), and first presenter at the round table moderated by Queck, explaining the two big peaks that these institutions experienced. The first occurred after the global depression in the early 1930's when governments assumed an active role in promoting production, and then during World War II, when the flow of goods to the region contracted and governments established inward focused development strategies using import substitution policies.

In the 1970's, these development banks, which subsidized credit, fell from favor, accused of distorting the market, hindering free competition, being an obstacle to the development of the financial system and the capital market. In short, they were held responsible for preventing the emergence of sustainable industries. These were years of abundant foreign investment and international credit.

The debt crisis of the 1980's brought about bankruptcies, bank closings and consolidations. In some countries, private banking had to be nationalized, the flow of credit disappeared and financing once again originated from multilateral institutions, while openness and deregulation were advocated to make lost capital return. The flow of credit and investment returned in the 1990's, then froze again late in the last decade, when the monetary crises in Russia and Asia affected Latin America, and then came the collapse of the first generation of Internet companies.

Thus began the third wave. The first bank in this wave was Banco del Pueblo Soberano, established in Venezuela in 1999 to encourage microenterprise development. "It was created to support microentrepreneurs, but produced a large distortion," explains Albí Rodríguez, chairman of the Comunanza Foundation of Venezuela. "In a country with 70% poverty, subsidies and non-recoverable support are needed, but not for microfinance."

Banco del Pueblo Soberano, which provides small amounts of money at subsidized rates, showed losses equal to 2 million USD for 2004, and 40% of its loans have serious collection problems compared to the 2% uncollectible portfolio in the rest of the Venezuelan financial system. "If you promote microfinance like this," emphasizes Rodríguez, "you are not supporting microentrepreneurs."

Evidence supports him. Development banks, when subsidizing their microcredit or their interest rates (see preceding article), leave out of the competition microfinance institutions that are trying to make microcredit a sustainable business.

The truth is that development banks, while they were in relative decline in recent decades, remained strong. In the late 1990's, there were still a hundred of them and today there are 108, according to figures presented by the secretary general of ALIDE. Their combined assets total 400 billion USD and their medium and long-term loan portfolio is approximately 150 billion USD, over half of which corresponds to small enterprise.

However, not all development banks compete with the private microfinance industry. Approximately 30% of them in fact finance the industry, acting as a second tier bank. And several, like the Mexican Nafinsa and Banco Nacional of Costa Rica, offer products and services that have helped to develop microfinance institutions: from support for productive chains, to factoring services and amassing groups of small sellers to supply large buyers.

Intervention on the part of development banks "must be intelligent" if they are going to grant credit directly, as explains professor Manfred Nitch of the Freie Universitat Berlin in Germany, another presenter at the round table that Queck moderated. This means acting with business discretion so that they can coexist with private microfinance institutions, being distanced from the government and saying goodbye to the "cronyism" that gives preferential treatment to some customers to the detriment of others.

Verónica López, of the Spanish International Cooperation Agency, the third participant at the round table on development banks, agrees that public development banks must act in an intelligent manner if they intervene financially. "They must act more as catalysts than parties that channel resources," she stresses, "and they must take into account the costs and long term benefits for all players."

According to her, however, the fundamental role of the government is not financial intervention, but promoting a favorable environment for the development of microfinance institutions, which is divided into five areas:

• Establishing an appropriate legal and regulatory environment with the ability to adapt to new innovations that the market adopts.
• Creating an environment of public policies that ensure macroeconomic stability and increased production capacity, at the same time that they simplify processes and facilitate formalization.
• Developing an infrastructure that facilitates transportation and access to communications.
• Ensuring the institutional environment so that institutions operate as they should, and are stable and protected in the event of government changes.
• Establishing an environment of basic securities adequate to the development of microfinance such as health and education.

"All participants in this round table talk about intelligent action by the government," Queck summarizes after all participants in the round table had spoken, "but I don't know any intelligent governments."

He believes that far from taking into account the costs and long-term benefits for all players, as López suggests, they are all concerned about the short term and their own political interests.

Queck also notes another element of consensus between the participants and the audience: the need to have competition so that the industry develops and interest rates drop, and the need for a sustainable microfinance industry to emerge based on the laws of the market. "But we wait and wait and coverage continues to be incredibly low; access to financing is minimal," he argues. "The truth in the real world is that there are imperfections in the market and the government has to intervene."

Jesús Antonio Vargas of Banco Agrario de Colombia, a state development institution, says that rural credit virtually disappeared in Colombia in the 1990's, and that his bank currently has 90% of its investments in the rural sector, with loans averaging 1,500 USD. "Banco Agrario may be inefficient and fail to encourage competition," he says, "but it is the only bank in 600 rural locations in Colombia. I do not see what is wrong with that. If a public bank can serve groups where there is no access, should it withdraw from the market because it is creating a distortion?"

Glen Westley of the IDB responded to him: "Perhaps, it is true that Banco del Estado de Chile and Banco Agrario de Colombia are a new generation of more effective public development banks," he explains, "but I would like to see them 10 to 20 years from now when the next government is in place, and the next and the next. Will it not serve its friends? Mixing politics and financial intermediation does not seem wise to me."

Perhaps the person to best summarize the situation was one of the participants from the audience, Carlos Roberto Santos, from the Brazilian Micro and Small Enterprise Support Service (Sebrae). "Government intervention does not resolve the problem, nor does private action," he says. "No one thing alone will resolve the problem because it is a complicated issue. It is not black and white."