By Diego Fonseca


Ecuador indisputably holds first place in two different categories in Latin America. First, it is the top remittance-receiving Andean nation: some US$1.7 billion in 2005, equal to 4.8% of the country’s GDP. Second, its micro-lending market is one of the largest in the region. In 2005 alone, the country’s 61 regulated microfinance institutions approved more than US$1 billion in micro-loans, while 170 NGOs and 330 credit unions loaned another US$295 million.

The high remittance levels are mainly due to unemployment and poverty, which have spurred many Ecuadorians to leave the country; the sizable micro-lending market is a response to the activity of private microfinance institutions, which generate 99% of that distribution of capital. Things may be about to change, however, if some of President Rafael Correa’s plans to increase microfinance regulation are put into place. His “5-5-5 Plan” presents many questions. Will it lead to greater public support of private development or a return to direct state intervention, such as in the 1990s? Is it really concerned with helping bring microfinance to under-served areas? Or is it more of a populist measure to sweet-talk the affected people? Will the plan be sustainable, operationally and financially? Or will it drown in the ocean of political bureaucracies and patronage?

The 5-5-5 Plan

In the last five years, Bolivia, Peru and Ecuador have experienced a microfinance revolution. Ecuadorian portfolios, for example, have more than doubled annually, according to Fermin Vivanco, a specialist at the Inter-American Development Bank, who collaborated in the 2006 report, “Microenterprise in Ecuador: Perspectives, Challenges and Patterns of Support.”

Ecuador’s success is based on a wide distribution of financial services in most of the country’s urban areas. The process has included good performance of private portfolios, low delinquency rates, rational use of credit bureaus and sustainable rates of returns. Along with the scale of the microenterprise sector and the dollarization of the economy, the overall conditions have lent stability to the system and facilitated the influx of massive international resources.

Yet nothing is perfect. In areas such as Guayaquil, the main economic orb of the country, many microenterprises still have no access to financial services. The panorama is worse in the countryside, especially in areas where monocultures and mono-production predominate. Why? There are many reasons. The scale of the financial institutions—even those with the most growth, such as affiliates of the Red Financiera Rural (“Rural Finance Network”)—has not allowed services to reach many producers. Also, appropriate technologies do not exist, and in many cases, clients represent a higher risk given the poor diversification of their businesses, and thus less possibility of sustainability for lenders.

Several sources close to the government blame this situation on reticence of microfinance institutions to support more needy producers. And critics of this view have detected there the grounds for the government’s 5-5-5 Plan.

In early 2007, when President Correa announced his economic plan to fight unemployment and poverty, he devoted a fair share of attention to microfinance. He also announced the 5-5-5 Plan, which will distribute five-year loans through public banks for up to $5,000 at an interest rate of 5%.

Previously, Ecuador’s public sector had acted only with second-tier lines of credit from the Corporación Financiera Nacional (CFN, or “National Financial Corporation”), which focuses on nongovernmental microfinance institutions, and with direct agricultural loans from the Banco Nacional de Fomento (BNF, or “National Development Bank”).

Now, however, the BNF will lead the 5-5-5 Plan and the Instituto Ecuatoriano de Seguridad Social (IESS, or “Ecuadorian Institute of Social Security”) will manage the unsecured loans for up to 10 years, which its participants can borrow for any purpose. At the beginning, according to the proposed plan, an individual with a monthly salary of US$50 can access a US$700 loan, paying US$14 per month for 10 years.

Many people are concerned about the issue. Some economists have pointed out the risks of offering subsidized loans that could strain public accounts. In the specific case of the 5-5-5 Plan, private microfinance institutions have backed out of the project (which they were initially supposed to manage), since the 5% interest rate would not cover their operating costs.

This is a serious problem, since the long-term sustainability of the 5-5-5 Plan could be affected. Observers are asking whether the BNF can cover its costs and count on sufficient operating capacity. Likewise, analysts have reservations about management of arrears, a problem previously experienced by the bank.

Even so, the program, which will need more than US$150 million in resources, is being launched by the BNF. In early May 2007, the BNF had already offered US$38 million in micro-loans, although this figure does not separate loans approved under previous formats from those under the 5-5-5 Plan. According to Ecuadorian media, BNF expects to lend a total of approximately US$130 million in 2007.

Is the Paternalistic State Returning?

“NO!” was the private sector’s response when it saw the costs engineering. But will that stop the state project? Experts confirm that in principle there is nothing wrong with governments being involved in microfinance activities, so long as such involvement is carried out with criteria of sustainability and appropriate technology in an open market. In fact, examples of good public administration of microfinance can be seen in Banco del Estado de Chile (“State Bank of Chile”) and Banco del Nordeste de Brasil (“Northeast Bank of Brazil”).

The Ecuadorian government’s concern is understandable. Coverage by microfinance institutions—which have extended micro-loans to one million Ecuadorians—is still not the norm. The sector has not been able to offer competitive rates or terms that allow financing investments in equipment or housing. “I am especially concerned with how the fees charged to clients lead to higher ultimate costs that threaten the viability of microenterprises financing their work capital with microcredit,” says Vivanco from the IDB.

And while doubts persist about the government’s management capacity, the need for the state to actively participate in sectoral regulation and control appears to be indisputable. At the beginning of 2007, for example, the Superintendency of Banks in Ecuador published the final prices of micro-loans in the system. The effect was immediate: several microfinance institutions improved their terms. The state measure was applauded. “I believe that the government has an important role in regulating and supervising the norms of the game,” says Vivanco. “Also, it should help microfinance institutions so they are able to offer efficient financial services, and give incentives for offering services to people who, due to their geographical isolation and low income levels, are not of interest to microfinance institutions because it is difficult to serve them in a profitable way.”

In this framework, dialogue between the government and popular organizations—especially small savings and loans networks and some NGOs active in rural areas—has become an important factor. In keeping the 5-5-5 Plan as a government policy, experts think that the BNF would do well to incorporate better microfinance practices. Through collaboration with other governments such as in Chile or Brazil, and with the appropriate microfinance institutions, the goals can be met.

In any case, an enormous challenge exists for a government that has a portfolio full of commitments. In fact, satisfactory operations of CFN loans and BNF micro-loans will call for both institutions to adhere to rigorous financial performance in credit scoring or risk assessment and quality of guarantees, as well as optimal distribution of resources to balance profit and risk. “There should be a double-blind in order to avoid political manipulation,” says ex-Congressman Francisco X. Swett, in a study for the Chamber of Commerce of Guayaquil. “Both institutions—which in the past played protagonist roles in national development—were supplanted by patronage, the condoning of interests, their use as financial ‘trash cans’ and progressive capital depletion as a result of the political disparagement of which they were victims.”

Rain Is All Right—IF Your Umbrella Works

Analysts predict an abundant downpour of micro-lending if the public initiatives prosper. However, this success will largely depend on portfolio performance and the lending institution’s operating and financial sustainability. Otherwise, if clouds begin to gather on the horizon of management, the government could begin to question the political wisdom of maintaining the microfinance projects. Such uncertainty still surrounds the 5-5-5 Plan.

Meanwhile, with or without the plan, the critical issue continues to be how to help microfinance institutions penetrate into areas where they do not yet have a presence and how to add value to current portfolios. “A revolution is needed in appropriate technology, because this is a problem of technology, not of politics or will,” says Sergio Navajas, a microfinance specialist at the IDB. “Solving a technological problem calls for a technological solution, since the political solution is not sustainable.”

At the end of the day, it is quite possible that the public sector will not have a significant impact on microfinance, given its current low penetration and the financial and operating challenges it faces to gain share in the future. On the other hand, greater state participation is desirable in order to sustain the penetration of regulated financial institutions in under-served markets. Some researchers believe that with well-defined objectives and markets, the government would not need to subsidize interest rates and could earmark some resources for partial coverage of the private microfinance institutions’ costs to enter these markets.

Public-private collaboration is not an impossible dream. Chile and Brazil once again present clear examples of joint operations. And in Ecuador, programs already exist to support better regulatory frameworks that favor transparency of commissions. Also, greater efforts are needed for inter-sector dialogue to reduce fragmentation in the sector—there are some 500 financial institutions, including credit unions and NGOs, etc., in the country—as well as to achieve scale and efficiency in service availability.

While the government can promote conditions needed to achieve better performance, it is the microfinance institutions’ responsibility to offer more modern, innovative, and affordable services, as well as to contribute intelligent and robust ideas to meet the needs of the still under-served markets.