• The microfinance puzzle

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    Ben D. Kritz

    Ben D. Kritz

    Here’s another interesting topic from my friends in Masbate, who upon reading my previous column about rural banking (Too big, or not too big? October 3) expressed some frustration that their province no longer has any rural banks. Technically, there is in fact one Masbate-based rural bank, the Rural Bank of San Jacinto (San Jacinto is the main town on Ticao Island), but its only branch is actually located across the strait in Bulan, Sorsogon.

    Since Masbate is one of the poorest provinces in the Philippines, access to some form of banking services for small borrowers and depositors could go a long way toward helping to raise standards of living. Without the presence of rural banks, some Masbateños have wondered if microfinance could possibly fill the gap.

    It’s a question that has relevance to a large part of the country, and the answer is: Maybe.

    The Philippines has a very active microfinance sector; the microfinance information clearinghouse MIX Market lists 118 microfinance institutions (MFIs), of which roughly 40 are also rural banks, including the aforementioned Rural Bank of San Jacinto. Altogether, the MFI sector has a loan portfolio of about $1.2 billion with $810.7 million in deposits, has about 5.1 million depositors and roughly four million borrowers.

    Much of the growth in microfinance has occurred in the past few years, in large part, thanks to a $150-million Asian Development Bank (ADB) project in 2005-2007 that nearly doubled the number of microfinance borrowers and introduced a variety of innovative financial products such as microloans for housing, mobile banking and remittance services and micro insurance. The MFI sector became more commercialized and in general better-regulated, but the program also exposed some of the key pitfalls of microfinance. ADB’s own assessment of the program found that it missed its target of reaching the poorest segments of the population; less than 4 percent of microfinance clients are from the lowest impoverished segment, those living on less than $1.25 a day, and only slightly more than 10 percent are within the higher $2 a day poverty threshold.

    That result illustrates a quirk of the Philippines’ regulatory environment: Rural banks fall under the supervision of the Bangko Sentral ng Pilipinas, which means that part of the MFI sector is reasonably stable. Unfortunately, the MFI alternatives to rural banks—credit nongovernment organization (NGOs) and financial cooperatives—are not regulated with the same rigor. NGOs fall under the jurisdiction of the Securities and Exchange Commission, while cooperatives are overseen by the Cooperative Development Authority (CDA), and neither of those agencies have the capabilities to regulate MFIs thoroughly.

    The regulatory bifurcation causes a couple problems. In order to stay viable, nonbank MFIs tend to follow the somewhat outdated model first devised by Bangladesh’s Grameen Bank founder Mohammed Yunus, focusing on group lending, mainly in agriculture, and primarily with a focus on income smoothing rather than enterprise development, because the high risks involved necessarily keep a tight ceiling on loan amounts. Group lending is problematic at best and does not work well in the Philippine cultural setting, and adding to that the high risk of external shocks—mainly from typhoons—and nonbank MFIs can quickly find themselves in financial trouble. The international standard for “PAR30,” which means “portfolio at risk of default for longer than 30 days” for MFIs is 5 percent, a limit the Philippine MFI sector has, on average, exceeded by a significant amount for years. To try to compensate for excessive risk, many nonbank MFIs shift their market targets to more viable areas, which leads to “credit pollution”—areas where large numbers of customers have multiple loans from different sources; Cebu and Iloilo are said to be particular hot spots. The virtually inevitable result is an increase in defaults, and added risk pressure on rural and community banks.

    In the meantime, a big segment of the poor population that would benefit from microfinance access is simply overlooked, falling into the wide gap between rural banks’ key market, customers with low but reliable incomes, and defined borrower groups who may only have subsistence-level, irregular incomes, but who have a reasonable aggregate collateral income—for example, groups of market vendors, tenant farmers, or transport drivers.

    Reaching the overlooked is not easy, which is partly why this government and others in different parts of the world resort to simplistic solutions such as conditional cash transfers, in spite of overwhelming evidence that support for income creation is not only strongly preferred by potential beneficiaries, but also has a greater and more sustained positive impact on poverty reduction. Microfinance can definitely play a role, but it has to be better managed and become more inclusive; this was also a general conclusion in ADB’s assessment of its Microfinance Development Program.

    The two biggest challenges appear to be in encouraging formal financial product providers—whether they are rural banks, retail banks, or nonbank MFIs—to move into “unbanked” areas, which include parts of the population as much as they do actual geographical areas; and in developing a more efficient and responsive regulatory environment to make microfinance a more attractive proposition for investors, improve consumer protection, and raise the quality of institutional governance. Given that those two challenges will necessarily involve some degree of risk underwriting and interagency compromise on the government’s part, whether steps can be developed to move toward those goals amid the current political chaos is probably not something to be optimistic about. Nevertheless, a sincere effort should be made; the market is there, the financial and organizational resources actually do exist even if they are a bit scattered, and the potential payoff to the economy as a whole—to say nothing of the substantial improvement it could bring to the lives of many—is too great to overlook any longer.

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