Everyone knows that microfinancing, the business of offering tiny loans to the poor, can help farmers and small business owners worldwide to eke out a living. The United Nations has embraced the concept with vigour, declaring 2005 the Year of Microcredit. Political powerhouses such as former US president Bill Clinton have created hefty microfinancing funds, and international conferences on the subject are now fashionable.
Worldwide, the microfinance business has grown at an annual rate of about 30%, with leading microfinance institutions boasting an average rate of return of about 2.5% of total assets, according to the World Bank. Loan repayment rates are also strong.
In Mexico, commercial bankers talk up microcredit and attend conferences on the subject. But ask a major bank for details about its microfinance activity and it will reply with a shower of information about its products geared toward small and medium-sized enterprises (SMEs).
SME lending is a market segment that Mexican banks have historically ignored. “It is a more costly process and we are still learning how to go about it,” says Luís Villalpando, head of SME banking at Banamex, Mexico’s second largest bank. “But we have realised that small businesses can be extremely responsible and a good bet. We now look at the behaviour of their stockholders, their taxes, other income statements, risk studies in their line of business.”
Tighter regulations have also helped risk-averse commercial banks to take on less wealthy clients. “Before, you had few guarantees when you took on riskier customers,” Mr Villalpando told The Banker.
The more down-market mindset is welcome but, strictly speaking, lending to an established, on-the-books business is not the same as micro-business finance. Offering working capital to the self-employed poor in the form of, say, $300 loans takes a pioneering attitude. It involves a commitment to financial literacy programmes, creative credit checks, catering to clients in geographically remote areas and, all the while, working at maximum efficiency so that the effort pays off.
Profitable business
Despite the challenges, some commercial banks, including India’s ICICI, Indonesia’s Bank Rakyat and others in Africa, are either taking on microlending directly or striking partnerships with microfinanciers.
“Microlenders have shown that they can be profitable,” says Kate McKee, who heads the US Agency for International Development’s Office of Microenterprise Development. “This is creating competition among commercial banks and forcing them to dig down.”
The idea is that commercial banks will benefit from microfinance by sticking with tiny clients that may manage to grow and eventually upgrade to more mainstream products. Yet Ms McKee is unable to name any Mexican bank that is enthusiastic about microfinance. Why the resistance in Mexico?
Bankers there point to traditional hurdles. “It is volatile and there are no guarantees with microfinance,” says Roberto Martínez, head of SME business banking at BBVA-Bancomer, Mexico’s largest bank. “Plus, the high grade of informality that still permeates Mexico continues to hinder this type of business. We require a certain level of formalisation that, say, a woman sewing in her home cannot offer. I simply cannot lend to someone who is not registered with the authorities. It is against our stakeholders’ wishes. We need to see a declared income, check the sustainability of a business.”
Also, Mexico’s financial sector has bounced back after the country’s 1994-95 peso collapse. Banks are profitable again and foreign heavies, including US-based Citibank, Spain’s Grupo Santander and the UK’s HSBC, have moved into Mexico with force. Competition among banks is fierce and the race is to woo upper-class urban clients, a customer segment that is far from reaching saturation point. There is also plenty of room to develop the capital markets, including corporate bond issuances and private banking – far more attractive initiatives than doling out tiny loans to rural women in Chiapas without credit history.
Small lenders
The elite mentality leaves the heavy lifting of microfinance to community-run savings and loans co-operatives, credit unions and local Mexican microlenders such as Mexico City-based Compartamos and FinComún. Their potential client base: Mexicans who can demonstrate earning power but lack the credit history and connections that would make them acceptable to a commercial institution. Many work in the country’s vast informal economy, running mom-and-pops (small independent businesses), working as small-time farmers or as self-employed artisans, and do not have a bank account.
Now, with years under its belt, Mexico’s microcredit industry, like others worldwide, has demonstrated its ability to survive and even profit. Microloans have evolved from philanthropic handouts into ways of making money. To loan recipients, they represent a bridge to more modern banking services.
Mexican microlenders also benefit from new industry-wide standards and norms that require more precise financial data and subject microfinanciers to stricter audits. The consensus is strong that the tightening standards have added a needed professional veneer to microfinance institutions.
Business decision
What will bring Mexican banks on board? First, adopting a more entrepreneurial mindset toward microbusinesses and understanding that backing them may pay off. “Today, the standard vernacular of microfinance includes savings accounts, deposit insurance payment and transfer systems and any other service that is critical for managing a poor household,” says Elizabeth Littlefield, who runs the World Bank’s Consultative Group to Assist the Poor (CGAP), a consortium of donor agencies. “Institutions of all shapes and sizes are understanding that they must offer more of these services if they are to be competitive.”
Building ties between Mexican banks and microlenders would also move microfinance along. To date, such alliances are barely visible. Where relationships do exist, they are usually in the form of bond underwriting.
In 2004, Banamex issued a peso-denominated bond on behalf of Mexico’s largest microlender, Compartamos. The microcreditor can offer loans starting at $100. The funding can help to finance everything from tractors and potters’ wheels to carts and refrigerators: the equipment that can keep a small business alive. The microlender’s know-how of the low-income market, its return on assets and years of experience in assessing a client’s creditworthiness convinced Banamex to underwrite the bond. The Banamex issuance is helping Compartamos reach its goal of a microcredit customer base of 1 million by 2008 (it currently has more than 300,000 such clients).
“When microlenders get this type of funding, they are suddenly free to work on their core strengths,” says Gautam Ivatury, a microcredit analyst at CGAP.
A rare deal
The Banamex-Compartamos deal marked the first time that a major Mexican bank linked a microfinance institution with domestic, local currency capital markets. Yet such deals between banks and microlenders in Mexico remain rare. Technology and its cost-cutting possibilities may also convince commercial banks to serve the less well off. Human resources, or the personnel it takes to administer and oversee small loans, represent about 75% of the cost of microfinancing, according to CGAP.
“It’s no secret that ATM transaction costs are far less expensive than those of a bank teller,” says Ms Littlefield. “The challenge will be to transform software and hardware into a delivery channel that can perform all, or nearly all, of the functions of a microlender or bank branch.”
Microcredit gurus believe that such technological innovations, along with software that streamlines credit checks, will eventually allow banks to leapfrog into microfinancing.
“A lot has to do with changing mindsets,” says Mr Ivatury, who also manages CGAP’s Microfinance Technology Programme. “Bankers need to see possible options in a significant way, that there is a way to enter this market.”
