The Status of Post-Crisis Latin American Microfinance

The Status of Microfinance 1

The Status of Post-Crisis Latin American Microfinance

By

Susan Cornforth

St. Mary’s University of Minnesota

School of Graduate and Professional Programs


Introduction

Like many, many other ideas in international development,

microfinance was a brainstorm created to address a perceived

problem. The main research question in the field at the time, and

still, arguably, is: how do we help the poorest people on Earth

become less poor? In 1995, the UN defined extreme or "absolute"

poverty as "a condition characterized by severe deprivation of

basic human needs... [that] depends not only on income but also

on access to social services." (World Summit, 1995). The research

community immediately began to work with subquestions within this

context, looking for ways to eliminate poverty. The observation

was made that the poor had little or no access to capital,

leading to a cycle that kept them poor (no access to increased

funds to implement methods to increase income leading to no

access to increased funds). It was suggested that perhaps

establishing capital access for the poor could change this


dynamic and, thus, assist the poor in lifting themselves out of

poverty.

When Mohammad Yunus, the founder of the Grameen Bank, was

awarded the Nobel Peace Prize in 2006, it seemed to many in the

development community as though the answer to alleviating poverty

in lesser developed countries (LDCs) had been found. Programs in

rural areas meant to economically empower the poor by providing

them access to credit and operating capital in unprecedented ways

were the order of the day. Unfortunately, as the crises of the

past several years have shown, microfinance has its share of

problems, and some of them seem nearly insurmountable. The

future of microcredit programs currently appears to be very much

in question, and there are many different viewpoints on the way

forward for this type of institution. In the future, not only

will the type of microfinance institution (MFI) determine its

success, but its location will also have a very important impact.

Asia, where MFIs originated, and Latin America have very

different microcredit industries, and comparing them on all but

the grandest of scales is of limited value. Asian microfinance

arose on a nonprofit local cooperative model, whereas Latin


American microfinance has ever been a commercial for-profit

interest, providing a great contrast in how “advanced” the Latin

American market is. (MicroCapital Institute, 2004).

With the future uncertain, the microfinance industry and

related poverty alleviation initiatives worldwide need to re-

evaluate exactly how the current situation arose, and how to

overcome the challenges that have been raised. If used and

regulated properly, microfinance is a helpful tool to alleviate

poverty. As evidenced by the non-payment crisis in Nicaragua,

the trend toward future commercialization must be carefully

regulated to prevent abuse, and bias in lending must be

eliminated to ensure success.

Background

Microfinance began with noble intentions. For decades

people from developed countries had worked to alleviate the

poverty of those in lesser developed countries (LDCs), using

methods such as direct financial aid to governments of poor

countries, and aid to the poor themselves through programs that

sought to meet the needs of people who were impoverished, such as

food for the hungry, homes for the orphaned, education, medical


care, and many others. Unfortunately, poverty remained. After

much research, one gap between rich and poor that was identified

was a lack of capital. The poor remained poor due to an

inability to improve their income, in other words, a lack of

capital to better their economic situation. Traditional capital

investment was not open to them, as the only capital investment

in LDCs at the time was large-scale commercial investment.

Building capital through savings was not open to them, either, as

no safe financial institutions were available to for them to save

(Mahajan, 2007). The idea arose to provide capital to rural

cooperative groups, where the groups would earn their way to

larger capital investments by making their payments on time,

coming to all the meetings (usually weekly) and thus

demonstrating their creditworthiness. Later, the cooperatives

would receive a much larger investment that they would then

determine in which of the projects proposed by their members the

funds would be invested.

This was the original model of the Grameen Bank, which began

in Bangladesh as a non-government organization (NGO) that

administered peer-lending modeled loans and experienced a fair


amount of success, enough that the founder was awarded the Nobel

Peace Prize in 2006 (Craxton & Rathke, 2011). Whereas its

development had been slow to catch on in the 1990s, the

legitimacy conferred by the Nobel Prize caused the microfinance

industry to begin to grow exponentially as a way to alleviate

poverty all over the developing world. The pattern was quite

different in Latin America, where it was often initiated by banks

that were already commercial enterprises, or where existing

government-run taxpayer-based programs grew into nonprofit non-

governmental organizations (NGOs) and then into privately-funded

commercial enterprises. “Since 1998, virtually all of the growth

in the microfinance industry in Latin America has been fueled by

private investment.” (MicroCredit Institute, 2004). The vision

of these programs has become more of a community service to reach

out to more potential borrowers and grow the portfolio of the

bank. Often this is done more with urban small entrepreneurs,

rather than in the rural agricultural sector of Asian

microfinance institutions (MFIs) or older Latin American

government programs. At this time, the industry was largely


unregulated by the governments of the LDCs in which it operated,

and this led to problems over time.

In 2009, anger over perceived predatory lending practices

and abusive collection practices began to boil over, both in

Latin America and Asia, specifically in Nicaragua and Bangladesh.

In Nicaragua, this culminated in a true financial crisis as more

and more borrowers refused to make their payments while accusing

the industry of unfairness and dishonesty. As a result, the MFIs

in Nicaragua collapsed, and the Nicaraguan non-payment crisis

spread into other countries in Latin America, where microfinance

began to have a fairly tarnished reputation, making it an easy

target for the leftist regimes coming into power there in the

early 2000s. As a result, some regulations were put in place

that specifically target MFI operations, whether they are for-

profit or not, and these regulations are mostly unfriendly to the

microfinance movement.

Review of the Literature

The Nicaraguan non-payment crisis, the shutdown of the MFI

system in Bangladesh, and the subsequent near-loss of all

microcredit programming caused many inside and outside the


international development field to stop and re-evaluate the basic

assumptions of the microfinance industry. Researchers sought to

explore some key questions about the industry, including

determining whether it actually alleviates poverty and whether it

should continue. Economists attempted to quantify aspects of

microfinance to evaluate its viability as a policy, social

scientists studied whether educational outcomes had improved for

the children of the rural poor served by these programs, and many

within the industry itself began to question whether the idea

should be discarded entirely.

The most important issue discussed was whether poverty was

actually alleviated by these programs. The results of these

studies were mixed, showing that, while there was some

improvement, most of the improvement was for the transient poor,

those who dipped in and out of extreme poverty as their incomes

and quality of life changed depending on numerous factors. The

“core poor” saw very little improvement in their incomes or

quality of life as a result of MFIs working in the area (Weiss &

Montgomery, 2005, Agier & Szafarz, 2013, Bastiaensen et al, 2013,

Craxton & Rathke, 2011).


One reason for this lack of efficacy was clearly identified

as a gender bias in lending. “Women are… more likely to live in

poverty than men. In Latin America and the Caribbean, the ratio

of women to men in poor households increased from 108 women for

every 100 men in 1997 to 117 women for every 100 men in 2012,

despite declining poverty rates for the whole region.” (Way,

2015). Many authors concluded that this was at least in part due

to gender bias inhibiting women’s ability to start or grow

microenterprises that would create a better income for them and

their families (Agier & Szafarz, 2013; Haase, 2012; Prior &

Argandoña, 2009.) This gender bias did not seem to affect

whether a woman was approved for a loan, but rather how much she

received, and in some cases, what the interest rate assigned to

the loan would be. This was attributed to stereotype thinking,

where women were seen as less capable entrepreneurs who were less

likely to succeed in larger ventures and therefore less likely to

achieve the financial stability necessary to repay the loan.

(Agier & Szafarz, 2013). In addition, the data show that women

not only receive less money, but tend to invest it in less

profitable ventures, making it more likely that they will be


unable to repay the loan, or that the loan will not create the

opportunity for increased income as intended. (Haase, 2012).

The literature shows a consensus that microfinance alone is

not the solution to poverty or other social development issues,

although some would condemn the idea as, “unstable,

unsustainable, and exploitative.” (Craxton & Rathke, p. 32).

Others admitted there were problems, but saw the positive effects

of microfinance in some sectors, particularly in rural

agricultural settings, as a sign that the idea was worth saving.

(Bastiaensen, et al, 2013). One study compared the efficiency of

various type of MFIs, finding that commercial banks were the most

efficient at providing financing (in other words, did so in the

most financially sustainable way). This is a key analysis to the

long-term success of microfinance, because sustainability is an

issue. After the 2009-2011 worldwide crisis in the industry,

MFIs are increasingly commercializing in an effort to remain

financially viable. Producing numerous small loans is

administratively challenging and expensive, and because many of

the borrowers are persons with little or no credit history or

financial experience, the loans are naturally at a greater risk


of non-repayment. This makes the lenders unstable by their very

nature, if this type of lending is their only source of income.

In light of the rise of commercialization, there is great concern

that the mission of microfinance to provide access to financial

services to the extremely poor as a way to alleviate their

poverty will be lost in the need to maintain a level of

efficiency acceptable to commercial investors (“mission drift”).

The feeling among some that all financial institutions operating

in LDCs have the obligation to work toward alleviating poverty,

and that MFIs, therefore, are doing work that all banks should be

doing has gained some traction. (Prior & Argandoña, 2009).

There is a relatively new understanding that simply

providing operating capital to the poor is not enough to help

them lift themselves from poverty. “The structural causes of

poverty and exclusion are not limited to a problem of access to

finance alone.” (Bastiaensen et al, p. 882.) Some MFIs are

changing their programs to provide other types of assistance in

tandem with capital investments, such as market analysis, job

training, legal and regulatory help, and more. The regulatory

environment in LDCs has an important effect on the ability of


MFIs to remain solvent, to remain relevant, and to remain in

operation. In Nicaragua, Bolivia, and several other Latin

American countries, new leftist governments came into power

around a decade ago, and these governments are not necessarily

friendly to MFIs. (Bédécarrats et al, 2012 and Olsen, 2010.)

This has created a situation where regulation and government

policy are gradually driving MFIs out of business, due to

commercialization of the industry and government subsidy programs

that seek to pay the poor to act or buy in a certain way, for

example paying them not to clear-cut certain forest areas

(Bédécarrats et al, 2012 and Bastiaensen et al, 2013.) There is

a movement among some financial institutions to work with

governments to help create a regulatory environment that is

conducive to economic growth and resolving poverty, however,

there is some disagreement about how exactly to regulate for

those desired results. (Prior & Argandoña, 2009).

Discussion

As those who worked in international development began to

experience donor fatigue in the late 1980s, microfinance arose as

a new way to address poverty. The idea grew from asking why


poverty persists, and the presumed answer was that poverty is a

trap, from which the “core poor” can never escape because they

lack some essential ingredient or ingredients to better their lot

in life. Out of this idea grew the theory that the trap was a

cycle, caused by a lack of capital, meaning that the poor lack

capital to meet household expenses, so they work at whatever they

can find to do to meet those expenses, but this produces no

increased income, so the cycle begins again. The idea to break

the cycle by providing entrepreneurial capital at the household

level that would allow the poor to invest in some sort of

occupation that would generate higher income, thereby allowing

them to meet their expenses, build savings for future needs, and

repay the capital loan, was revolutionary at the time. The lack

of access for the extremely poor to financial services such as

lending and savings was well-documented, and the theory was that

meeting that need would solve the problem of poverty.

The rural poor were the initial target of microfinance,

largely due to the failure of subsistence agricultural practices

in LDCs to provide income to the families of the farmers, leaving

them often among the world’s poorest, chronically suffering on


the brink of starvation. Programs in Asia and Latin America

targeted this group, beginning in Bangladesh and Nicaragua in the

1990s. The programs seemed to be working, at first, at least

anecdotally, however there was little empirical evidence or study

to support this assumption. Like many economically liberal

programs targeting underdeveloped populations in the past, the

positive effects were local and limited, but they were eventually

expanded far beyond their presumptive usefulness.

In 2009, a crisis began in Nicaragua, one of the most-

heralded locations of microfinance success. Among accusations of

corruption, sky-high interest rates, and abusive collection

practices, large groups of mostly agricultural borrowers banded

together and refused to continue to repay their loans. This was

of course related to political upheaval in the region at the

time, but the crisis soon spread to Bangladesh and India, where

the problems were also predatory and abusive practices among

lenders. This crisis was, unfortunately, largely the result of a

lack of regulatory oversight. Competition between lenders and

programs meant that borrowers were seeking loans from multiple

MFIs, often seeking to pay one lender with the proceeds from


another, and at least in India, this led to a suicide rate among

borrowers that was quickly spiraling upwards. In Asia, the

response by governments was to temporarily halt all MFI

operations until regulation could be implemented. In Nicaragua,

the relatively new government immediately enacted emergency

regulatory measures to slow the violence resulting from clashes

between lenders and protestors. As a result, many MFIs went out

of business because they were unable to collect on loans, and the

ones that remained were damaged.

In most of the developing world, the trend is toward

commercialization of MFIs, both to make them financially more

stable (and less high-risk) and to insulate them from regulatory

crises such as that of 2009-2011. Commercialization comes with

its own set of problems, however. Critics say that microlending

programs were created largely because commercial banks were not

providing these services to the global poor, and they were doing

so for some reasons that have not changed, namely, high risk, low

return, technical “inefficiency,” and high costs to service

ultra-small loans. This means that by getting into the business

of microfinance, the banks are having to change the intent. This


phenomenon is called “mission drift.” One result is that there

is a new focus on established urban small business rather than

rural startups, and this means that there is again less capital

available to the poorest of the poor. There is also a gender

bias in modern microfinance, as women entrepreneurs tend to

invest in lower-income informal sector ventures, which do not

generate enough income to lift them from poverty. This is partly

due to other factors not currently addressed by most MFI

programs, such as social and human capital of the women

themselves (lack of education and job training, lack of

opportunity due to social structures such as being responsible

for a household rather than individual well-being). The most

successful programs in the future will be those which address all

of these factors and combine them to raise the livelihood of the

poor, not just their economic income. (Mahajan, 2007).

Conclusion

The literature shows an industry in crisis. Microfinance

programs throughout the developing world seem to have difficulty

providing the service they were created to provide, and they also

seem to be having trouble staying on-mission. It is clear that,


while MFI programs can have a positive effect on poverty, the

effect is limited in and of itself. One reason for the limited

effect is the gender bias apparent in lending practices

worldwide. The majority of the world’s poor are women, and as

long as women are treated as second-class, “lesser than,”

citizens, and therefore are excluded from full participation in

every aspect of development, the entire concept will continue to

fail to address the needs of all the world’s poor. Microfinance

seems to work best when used in conjunction with other tools,

such as education and government programs such as subsidies, to

address the many factors that cause persistent poverty. It can

be hoped that future endeavors to alleviate poverty are created

in a more sustainable way, with checks and balances to assess

progress and prevent abuses and misdirection. The lesson of the

microfinance crisis is that due diligence is critical to the

ultimate success of any large-scale venture to alleviate poverty

and improve development.


References

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The Status of Post-Crisis Latin American Microfinance

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