MICROFINANCE INSTITUTIONS CREATE OPPORTUNITIES DESPITE THE

UNCLAS SECTION 01 OF 03 MONTERREY 000219 SIPDIS DEPT PASS TO AGENCY FOR INTERNATIONAL DEVELOPMENT E.O. 12958: N/A TAGS: EAID ECON SOCI PGOV MX SUBJECT: MICROFINANCE INSTITUTIONS CREATE OPPORTUNITIES DESPITE THE ECONOMIC CRISIS AND BUREAUCRATIC HURDLES MONTERREY 00000219 001.2 OF 003 ¶1. Summary: The state of Nuevo Leon is home to a number of private and public sector sources of microfinance which have helped borrowers to start informal family businesses. However, the unforeseen devaluation of the peso versus the dollar has put significant pressure on microfinance institutions that borrowed loan funds in U.S. dollars. Also, loan repayment rates have been declining due to the ongoing economic crisis. To facilitate a greater volume of microfinance lending, the state government will have to improve the governing legal framework, perhaps by removing barriers to the seizure of collateral on defaulted loans. End Summary. The Promise of Microfinance ¶2. NGO microfinance institutions and government microfinance programs see significant unmet demand for microfinance loans in northern Mexico. As a result, microfinance lenders continue to sprout in Monterrey. Microfinance is generally more available in urban areas than rural areas and can be delivered in a number of ways, including through NGOs, government programs, credit cooperatives and banks. While the leading NGO lender in Monterrey, ADMIC, has been making microfinance loans for 30 years, new microfinance organizations, such as Credito Familiar and Credito Si are entering the market and Comportamos, a bank with its roots in microfinance, is also lending in Monterrey. Criditos Pronegocios, a microfinance subsidiary of Banorte Financial Group, is offering microfinance service as an outgrowth of its traditional banking activities. Even with these new entrants, there is room for greater market growth. ¶3. Private sector microfinance lending tends to carry high interest rates; five percent per month is not unusual. The government microfinance program has much lower rates at eight percent per year, but its repayment rates are considerably worse than NGO and private microfinance institutions. Banks do not generally see microfinance institutions as competitors. ¶4. By spurring the creation of informal family businesses, microfinance can make a big difference to families working their way out of poverty. Access to microfinance loans is of great importance to these family businesses and it does contribute to greater family stability. ADMIC has a loan portfolio of 12,000 loans, of which 90% are for informal, family businesses. Typical enterprises that rely on microfinance are taco stands, small corner grocers, beauty salons and craftsmen. These businesses often do not increase employment beyond immediate family members, and the businesses usually do not grow beyond their humble beginnings. Often, their accounting is basic at best, with family expenses often paid from the same cash box used to run the business. Nuevo Leon's state government-backed microfinance programs also recognize the limits of creating jobs through traditional microfinance lending. Its FORECE program is working together with prestigious Monterrey TEC University to finance more sophisticated micro businesses through a business incubator. Note: In meetings with state officials last year, conoffs urged greater cooperation between government and academic institutions such as Monterrey Tec. End Note. ADMIC has also lent to micro enterprises through this incubator with loans of four to twenty thousand US dollars. The Emerging Legal Framework for Microfinance Institutions ¶5. As the legal structure of Nuevo Leon's microfinance institutions (MFI) continues to evolve, the regulatory uncertainty is sparking institutional reorganization. Initially, microfinance organizations often started as civil associations that did not take savings. Mexico approved a new savings and credit law in 2001 that has stimulated growth of credit cooperatives, similar to US credit unions, that are allowed to take savings. This form was called the Sociedad Financero Popular (SUFIPO); dozens of microfinance NGOs changed their legal status to SUFIPO to take advantage of attracting savings depositors. ADMIC remains an NGO that does not take savings deposits, but notes that other NGO MFIs have reorganized MONTERREY 00000219 002.2 OF 003 as cooperatives that can take savings deposits, thus lowering their loan costs. Yet another form for MFIs is the Sociedad de Objeto Multiple (SOFAM). This kind of MFI can be established with as little as US$5,000 in capital. Opinion is split among financial practitioners whether there is too little regulation of MFIs. The future for regulation is uncertain as some legislators want new laws that could further fracture MFIs into even more legal entities. Economic Crisis Hampers Microfinance Lenders and Reduces Repayment Rates ¶6. Leading NGO lender ADMIC notes that it along with other microfinance institutions and banks made the mistake of borrowing in dollars without hedging the risk. Lulled into thinking that the dollar peso rate was more or less constant, ADMIC borrowed up to 30% of its funding in dollar denominated loans, so the deterioration of the exchange rate from 10 pesos per dollar to 13 or 14 pesos per dollar caught the institution off guard. ADMIC, however, is carrying the burden of the exchange rate risk; its clients borrowed only in pesos and are therefore shielded from the exchange risk burden. The president of ADMIC averred to us that microfinance institutions should carry foreign currency exchange risk; its clients are not sophisticated enough to plan for that kind of risk. ¶7. Microfinance repayment rates have worsened over the past six months, further aggravating microfinance operations. Although part of the lower repayment rates is due to the worldwide economic crisis, another cause could be easy lending practices. One microfinance practitioner saw a parallel with Bolivia's microfinance market that heated up a decade ago when Chilean investors injected easy credit into that market, distorting it and spoiling credit discipline among borrowers. ADMIC has seen its repayment drop below 90% and is taking administrative actions to tighten policies. The state government microfinance program based in Monterrey, FORECE, stated that its repayment rate has dropped to 80%. Easier lending practices are part of the problem but another part is lack of good credit bureau information that results in undetected refinancing of loans by borrowers in financial distress (see paragraph 9). ¶8. Group lending along the Grameen model (to cooperatives, for instance) is not as popular in Monterrey as compared with areas in southern Mexico. Compartamos uses group lending successfully in southern Mexico and in rural areas, but it is having difficulty expanding this approach in Monterrey. ADMIC, while having 86% of its MF loans in individual loans, notes that its small portfolio of group loans does have an excellent repayment rate in Monterrey. Legal Limitations Limit the Growth of Microfinance Lending ¶9. Microfinance lenders recognize that due to the increased numbers of microfinance providers, it is difficult to know how much a borrower is in debt to other MFIs. The lack of complete and consistent credit bureau information hampers the lender's ability to control its risks. New services, such as Circulo de Credito, are attempting to provide better credit information to microfinance and consumer lenders, but these services still must develop further before microfinance lenders get complete credit information on their clients. ¶10. Both government-sourced lenders and microfinance lenders agree that one additional barrier to more efficient lending is the difficulties experienced when an MFI tries to recover collateral from a lender in default. The process involves the courts and is expensive and time consuming. Lenders lack a stream-lined approach to seizing collateral. The cost and difficulty collecting on collateral also contributes to greater risk for the lenders. MONTERREY 00000219 003.2 OF 003 ¶11. Comment: Microfinance loans in Monterrey typically help to keep micro businesses afloat, but usually do not lead to significant business expansion. But microfinance does provide a credit lifeline to poor families who can shore up informal businesses, thereby increasing family stability. Microfinance will continue to grow in Monterrey despite the legal and economic challenges it faces today. End Comment. WILLIAMSON