Constructing an Early Warning Index

Jacco

Very interesting post. I’m right this minute working in Medellin, Colombia, on a microfinance research project with my colleague Juan Pablo Duran Ortiz, who is Director of the International Bureau of Social and Economic Research (IBSER) in Medellin. We have been looking into microfinance outcomes in the poorest barrio communities around Medellin for some time now, and our work supports your posting about the rise of over-indebtedness in Colombia. In our key informant interviews on this latest visit, the issue of client over-indebtedness was touched upon many times, but mainly in the context of the successful efforts being made to avoid it. We have been looking at the operations of Banco de las Opportunidades, which is a Medellin city administration-funded and managed microfinance program that has been operating for nearly a decade. Banco de las Opportunidades has been able to screen out potential multiple borrowers, and so has almost entirely avoided over-indebtedness in its client base. It achieves this by using the personal identity card to check the credit register listing those who have existing microloans with the commercial banks. It is apparently a quite simple operation: if you have a microloan outstanding, you simply don’t get one from them. One important point here is that the funds provided by Banco los Opportunidades are in real demand, since they are significantly cheaper than the commercial banks (0.91% compared to 2.4%). So this screening not just avoids the dangers of over-indebtedness, it also helps to avoid the ‘no-impact’ outcome that would arise if an individual opportunistically tapped Banco los Opportunidades for a microloan simply in order to repay another more expensive microloan. The key point to reflect upon here is that Banco los Opportunidades is funded by the city of Medellin, so this gives it the freedom to promote development wherever it finds it, rather than (merely) pursue its own financial self-sufficiency through pushing as much microcredit on to the poor as possible.

Meanwhile, we have found that several of the private institutions working in the field of microfinance are much less concerned about over-lending, and, as I said, by all accounts your table on over-indebtedness in Colombia is right on the mark if the example of Medellin is anything to go by. There are many causes here, but most relate to the commercialisation issue I raised in an earlier posting on this blog. For example, we have come across several private and semi-private NGO-style business support groups that link their support to poor clients to them (their clients) accessing the more expensive microloans provided by the commercial banks, rather than accessing a much cheaper microloan from Banco de las Opportunidades, This is done simply because the business support institutions can extract a very useful commission on the more expensive microcredit deal offered by the commercial banks. These private business support institutions thus have a powerful incentive to push not just more microcredit, but more expensive microcredit, because they gain a very valuable income stream from so doing. The city administration funded CEDEZOs, on the other hand, do not have such a powerful incentive to push microcredit in order to survive. The CEDEZOs are the business support institutions set up and maintained by the city government in the main poverty centres around Medellin (they are actually an outgrowth of the project to establish Banco de las Opportunitidades). The poor clients that go to their CEDEZO for business advice are very easily able to obtain business advice and a microcredit at the much lower rate offered by Banco de las Opportunidades, thus saving themselves a considerable financial outlay into the longer term.

At the same time the key stakeholders have been telling us that the main commercial banks are encountering serious problems with their microcredit portfolios. The default rate has apparently risen to around 10%, and possibly to as much as 20%. This unsustainably high rate is quietly tolerated, we were told, at least partly because it is already costed into the operations of the commercial banks, reflected, among other things, in the high interest rates. We have no way to verify these views expressed to us, however, since none of the commercial banks have so far granted us an interview to discuss their microcredit work.

It seems to us, then, that any institution that is genuinely committed to try to develop the local economy rather than achieve mere self-survival, can quite easily take important steps to avoid over-indebtedness among its clients. The important thing is – do they really want to? The fact is that Banco de las Opportunidades unfussily uses the identity card system to check on whether clients have existing microloans, and refuses one if they find out that a potential client already has a microloan outstanding. The commercial banks, meanwhile, aided and abetted by many of the business support institutions in Medellin, are busy trying to foist on to their poor clients as much microcredit as possible, quite irrespective of whether it is doing any good for them or for the wider community. In other words, commercialising microfinance institutions and support institutions has once more, and inevitably I believe, pushed in the direction of client over-indebtedness.

Finally, the problems of growing over-indebtedness and, wider still, the sheer lack of evidence of a positive development impact arising from microfinance in Medellin this last couple of decades, has finally forced many policy-makers in Medellin to think again about microfinance. Some have have argued that there is a need to significantly downgrade, or even phase out, the microfinance offer in order to bring in an SME bank in its place. The important election for the position of Mayor of Medellin is due to take place in October, and already several of the candidates have publicly indicated that the city must move far beyond microfinance. According to one of the main candidates we interviewed, microfinance has does nothing more than inflate what many in Medellin call ‘the chasita economy’ (‘chasitas’ being the trolleys used by very many of the poorest to carry and sell trinkets, sweets and other nick-nacks to others in their community). Several of the Mayoral candidates are backing measures underway in Medellin to establish a powerful new Bank for SMEs to address the crucial absence of growth-oriented and innovative SME businesses in the city.

Milford Bateman
Research Fellow
Overseas Development Institute

Milton,
Thanks for your reply and interesting to hear from Colombia. I agree that there is often a missing middle and hence need for SME funding.

I am not an expert on Colombia, but as fund manager have access to data from the superindent and MF association. PAR > 30 days levels seem to have come down over the last 3 years and are 4.1% on average at the end of 2010 (This includes banks, financiera’s and NGO’s). The market is somewhat dominated by the four WWB “sisters”. Their PAR is lower than the average presented for the market. This data seems different from the claims of PAR levels rising to 10 or even 20%.

It would be interesting to hear how Banco de las Opportunidades is doing in this respect. Government run banks have been accused of offering unsustainbly low interest rates, while having poor repayment track records. Elections often play a role, as microfinance has been used to buy votes without much concern for repayment later.

Would also be interesting to hear from others about Colombia and other countries.

Thanks again for your contribution!

Jacco

Jacco

The people we spoke to were financial analysts and advisors, but not bank people. They tended to believe that there was a significant degree of massaging of the financial figures, possibly including the figures you are quoting. I can’t say what is true here. Certainly, in other countries the figures the banks and other MFIs released looked perfectly OK…. until the crash happened (notably in Bosnia, which I know quite well).

I think ‘unsustainably low interest rates’ are not the problem here. There is a cost for the government to meet, sure, but then you must look at the development benefit. If the longer-term development benefit outweighs the cost, then the policy is good: and vice versa. The problem with commercial microfinance banks is that they cover their costs and presumably make good profits too, but many see them as a development disaster, undermining and primitivising the economy is many varied ways. You must factor all things into account here if you are a development specialist: the concern for financial self-sustainability is misplaced and mainly a concern of bankers.

Milford (not Milton)