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A giant in microlending

"I learnt this trade from my father. I started helping him when I was 17 years old," says Juan Domingo Maggio, now 41, who makes decorative pieces in silver, brass and silverplated metal in a small workshop at his home in a working class neighborhood in Santiago, Chile. "At first we only did the metalwork, but we could not complete the last step, the silverplating."

This was a real problem for the Maggios. Their clients, the upscale gift shops and institutions that placed orders for trays, candelabra, conmemorative plaques and trophies, would always ask why they could not deliver the finished product, rather than passing them on to other people who did the silverplating and, in Juan Domingo’s own words, "ate all the cake."

And so it was until the Maggios obtained their first microloan, back in 1995. That’s when Banefe came into the picture. "We explained our situation and they gave us their support," says Juan Domingo.

With an initial loan worth about $1,000 from Banefe, the consumer credit arm of Banco Santander, one of Chile’s leading commercial banks, the Maggios started to improve their workshop. They got a second loan for the same amount, then a third loan for about $2,000 and last year a fourth loan for $3,000. Juan Domingo, who now works with his wife Rosa Zubarzo, was recently issued a bank card that allows him to draw cash from a preapproved credit margin.

While the loans have not made them rich, the Maggios can make plans for the future that would have been mere pipedreams if they lacked access to credit. Juan Domingo would like to expand his workshop and better separate it from his living quarters. And while the couple does hire temporary help when demand peaks, they would really like to employ a salesperson so they could have more time to do what they do best, their craft. "But we’ll see how things go. It’s not a matter of just hiring more and more people," he says.

Booming sector. There are some 400,000 microentrepreneurs like the Maggios in Chile, people who run tiny businesses that employ fewer than 10 workers. As in other Latin American and Caribbean nations, not only are microenterprises a leading source of jobs. They also constitute a safeharbour for millions of low-income people during economic downturns.

Institutions like the Inter-American Development Bank have strived for decades to nurture these fragile undertakings, especially by trying to expand their access to formal credit. Nevertheless, only about one in 20 microentrepreneurs have access to such financial services. Most rely on their meagre means or, at best, informal loans from family members and, at worst, usurious moneylenders.

In Chile, the ratio of microentrepreneurs with access to formal credit is probably closer to one in four. Some 100,000 have obtained small loans. This is largely explained by the success of a program launched by the Chilean government in 1992 to encourage commercial banks to issue microloans. Banefe, the Maggio’s lender, has been among the most successful participants in the program, which is known by its Spanish acronym IFIS. Banefe is the consumer lending arm of Banco Santander de Chile, a unit of Spanish banking behemoth Banco Santander Central Hispano (BSCH).

Just the fact that an institution as big as BSCH is interested in microcredit represents a watershed in the development of these services in Latin America. Megabanks cannot only mass-distribute their products through their networks (Banefe alone has 70 branches in Chile), they also have privileged access to capital markets, unlike most of the not-for profit institutions, foundations and nongovernmental organizations that have traditionally supported microentrepreneurs.

However, as was noted at the III Inter-American Forum on Microenterprise held by the IDB in Barcelona last October, Latin American countries have yet to overcome several structural problems before microfinance services can become a fixture at its commercial banks. For these large, profit-driven institutions, microloans carry relatively high costs and require specialized technologies and specifically trained staff. And while many governments express great enthusiasm for microenterprise, they often have laws and regulations that stunt its development.

A cautious giant. Through its Chilean affiliate, BSCH is the biggest banking concern in Latin America with a large-scale microlending operation. The financial group, which was formed by the fusion of the Spanish banks Santander and Central Hispano, has units in 37 countries with 8,500 offices and more than 24 million clients. In Latin America alone BSCH has nearly 50,000 employees and stakes in 17 banks, 7 pension fund management companies, 13 mutual fund firms, 9 insurance companies, 10 stock brokerages, and 10 leasing and factoring companies.

How did microenterprise fit into the strategy of a group whose mission statement proclaims that it wants to be the top financial franchise in Latin America? In a certain way, it was a legacy of Financiera FUSA, a Chilean firm acquired by Santander in 1995. FUSA had started to dabble in microlending in 1992 when the Chilean government launched the IFIS program, which offered commercial lenders subsidies to make loans to self-employed people who, due to their lack of assets, had no access to formal credit.

Through its IFIS program, the government’s Solidary Fund for Social Investment (FOSIS), grants subsidies to commercial banks that issue microloans. The subsidies, which currently are worth about $85 per loan, cover part of the cost of these small transactions.

When Santander took over FUSA it had some 2,000 microclients. Based both on its bottom-line interests and the social impact of this unusual line of business, the new owners decided to give it fresh impetus with a view toward becoming Chile’s leading microlender.

Five years later, Banefe has nearly 40,000 microclients. In October it won an honorable mention in the IDB’s Inter-American Awards for Excellence in Microenterprise Development. Its own borrowers also seem to have a very high opinion of the bank. According to a survey conducted by the marketing consulting firm Adimark, 90 percent of Banefe’s clients rated its services satisfactory or better.

A cautious entry. Their pace was purposely gradual, according to two Banefe executives, Osvaldo Barrientos and Pedro Pablo Ortiz. "When you talk about microfinance, you are really talking about many subsets, such as merchants, artisans, industry suppliers, and so on," says Barrientos, Banefe’s consumer lending division manager. "So the first thing you have to do is to learn about the segment."

In order to do that, Banefe had to develop effective tools to analyze microloans, which require technologies and methods that are different from those used in consumer lending. The bank also devised marketing strategies to reach microentrepreneurs, who tend to work in the informal sector. This called for building a sales force, which now numbers 400 microloan officers and 40 microcredit analysts who visit clients to advise them and gauge their financial needs. It also entailed educating its new clients, most of whom knew nothing about credit because they simply had never had it.

The learning curve starts with the first loan, which usually is just large enough to help clients improve their businesses but small enough to allow them to repay it in time, says Ortiz, Banefe’s entrepreneur lending division manager. The second loan may be bigger. Once they have repaid the third loan, clients may obtain a credit card and more complex financial products, such as life insurance, commercial vehicle loans, and programmed savings accounts.

This process is taken for granted in industrialized nations. But in developing countries, where most people have never written a check, it represents a giant step that allows low-income people to finance both their businesses and their personal consumption, as well as to keep their savings in a secure place. These services, which have long been available to the rich, can be further boosted by new technologies such as automatic teller machines, round-the-clock telephone banking and online financial services.

This prudent expansion helped Banefe contain the risk level of its microlending operations. "It’s not that this line is inherently risky, but rather that sometimes financial institutions rush in to service microentrepreneurs and either do a poor job or use aggressive tactics that leap over several stages but raise risk levels. If you give a machine gun to someone who does not know how to handle it, somebody will get hurt," says Barrientos.

Testing the model. There is nothing like a crisis to find out whether a bank’s business line is sustainable. Banefe underwent such a trial between 1998 and 1999, when Chile experienced its first recession after more than eight years of economic growth. The bank felt the impact in its recruitment of new clients, which dropped as consumer confidence plummeted. "Beyond the economic crunch, people’s perception of the crisis has been more persistent than the crisis itself," says Barrientos. "Almost everybody knows someone who has lost their job. This causes fear and restricts the demand for new credit." Nevertheless, as his colleague Ortiz points out, Banefe weathered the crisis without seeing an increase in the risk levels of its microloan portfolio. In fact, they remained below those of the consumer lending portfolio, which includes better-off clients.

In the meantime Banefe has been preparing new products designed for microentrepreneurs, such as health insurance plans. "For these clients, health is a major issue. In many cases the microentrepreneur is the enterprise itself. If they get sick or suffer an accident, everything stops," says Ortiz. While private health plans tend to be beyond the means of low-income Chileans, a creative solution may be forged between financial institutions and the public sector.

Banefe is also developing new strategies to reach potential clients in the informal sector. About 60 percent of the bank’s current borrowers are viewed as formal entrepreneurs because they have either been issued a municipal permit or they have registered their activities with tax authorities. But in Chile hundreds of thousands continue to work in the informal sector, and remain largely invisible to the rest of the economy.

According to Eduardo Casanova, chief of FOSIS’ Productive Development and Employment Division, informality is also a matter of education. "Some microentrepreneurs are more scared of the Internal Tax Service, others fear the municipal inspectors. But informality is also a question of education for growth. Any microentrepreneur who remains in the informal sector in unlikely to develop as a business," he said.

In order to reach the most elusive of the potential borrowers, Banefe and FOSIS are developing cooperation agreements with municipalities and other local institutions that are in touch with these microentrepreneurs. As part of this effort, FOSIS recently launched a portal called Zonaempresas.cl with information for owners of small and microbusinesses. Their goal is to give these entrepreneurs access to the Internet through a network of "community production centers" where facilitators will train clients on different computer applications and online services. In its initial stage, they will open 20 centers. The portal contains information, news and useful tips and contacts for entrepreneurs. One of its first services was to produce an online guide of the process to formally register a microenterprise and the advantages of leaving the so-called underground economy.

For export? The obvious question for a group like BSCH is whether the model it has developed in Chile will be transferred to other countries in Latin America. "We’ll have to wait and see," says Barrientos, who points out that Santander’s expansion has gone through several stages. For instance, it has been in Chile for more than two decades, but it only arrived in other countries much more recently. Once it has carried out any necessary reorganizations, many of the lessons it learned in Chile may spawn similar strategies in other countries where the group is present.

Naturally, Chile’s case has a few very particular traits. The Chilean economy was the region’s most stable during the 1990s, a factor that allowed banks to develop its services for retail clients. In neighboring countries with more volatile economies, banks tended to focus on large corporate clients and government bond trading.

Casanova singles out another element: the relatively high degree of credibility of the state in the eyes of the private sector. The FOSIS official has hosted delegations of bankers from other Latin American countries who were interested in studying the Chilean program to encourage microlending. More often than not, his visitors would leave feeling that such a partnership involving the public and the private sectors would never bloom in their countries. "Credibility is a very complex issue," he says.

Not that Chile is completely different. While it probably has advanced more than any other country in the region in terms of economic reforms, its financial system still carries a vestige from the past: a ceiling on the interest rates that credit institutions may charge borrowers. This sort of regulation was one of the most hotly debated issues at the microenterprise forum held in Barcelona. According to bankers, microlenders and even a few regulators, maximum interest rates do not reduce the cost of credit for microentrepreneurs but rather have the perverse effect of restricting their access to formal loans. In fact, private institutions like Banefe can only make microloans because the FOSIS subsidy covers part of the cost of issuing these tiny loans.

"The costs of these loans are higher because of the technologies they require. (Banks) have to keep a sales force, they have to have analysts, they have to employ inspectors, and they also have to finance their fixed costs. As long as we keep these ceilings, the cost of these transactions will never be fully financiable," says Casanova.

Some specialists harbor doubts about whether commercial banks are entering the field of microlending to stay. They note the enormous difference between the multimillion-dollar deals that net huge fees for banks and the paltry sums involved in most microloans. Fernando Lucano, manager of the Latin American Challenge Investment Fund, which serves as a bridge between microfinance institutions and capital markets, points out that while commercial bank’s participation in microlending has several advantages, it also has some weak points.

"If the bank does not view microfinance services as a strategic business line, one day it may decide to cut back their resources and withdraw internal support," says Lucano, a former official of the IDB’s Microenterprise Unit. "In a crisis, the bank could choose to drop these services simply because their top management knows little about them."

Nevertheless, Lucano adds that the potential market for microfinancial services is so great that there will be room for all sorts of institutions, from large banks capable of massifying their services to reach millions of clients to specialized NGOs that operate successfully in marginal neighborhoods and rural areas where there are no bank offices.

In Chile, this notion of varied providers seems to be working. Just one decade ago there was hardly any formal credit for microentrepreneurs. Now nearly 100,000 of them have access to this essential tool.


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