2, May, 2013

ELLA Expert Review: Microfinance in Latin America

Here Prof. Janina León Castillo of the Catholic University of Peru, offers her perspective on the ELLA research conducted on Latin America’s experience with microfinance.

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ELLA Expert Reviews: As part of ongoing efforts to ensure quality in our research and communications, the ELLA team asks recognised experts to conduct reviews of the knowledge materials in a given theme and produce a short written response. The purpose is to highlight a range of distinct perspectives amongst experts in the field and link readers with additional research, cases and arguments that the original ELLA materials may not cover.

In the spirit of discussion and debate, we encourage you to share your own comments about the ELLA materials and the review in the comments section below.

The ELLA materials on microfinance provide a comprehensive assessment of current knowledge in developing countries, with a focus on successful experiences from Latin America. In the Guide and 4 Briefs, ELLA experts describe the historical context around microfinance in Latin America, and draw our attention in particular to the response capability of Latin American microfinance institutions (MFIs) as a key driver of the region’s success when compared to the rest of the world. This broad assessment includes examples of product design, institutional development, innovation and information management, as well as regulatory frameworks to provide insight into the main successes and enabling factors from across the region over the last two decades.

The ELLA Briefs provide a good summary of those Latin American experiences which could provide support to other developing countries to improve microfinance policy and practice. Moving beyond earlier, narrower approaches to microcredit, the Briefs adopt a broader definition of microfinance that not only incorporates loans, but also many other financial products such as deposits, leasing and insurance. As a result, the ELLA materials  provide information about the design and supply of a diverse range of financial products implemented by regulated and non-regulated microfinance organisations. In particular, the business environment is highlighted as a key determinant for driving the success of these financial products in Latin America.

The detailed discussion on aspects of information management and technology is of special interest since it contributes to debates about the risks associated with asymmetrical information, and highlights the crucial role of information management for private microfinance institutions. Other pertinent issues presented in the ELLA documents relate to the challenges of rural finance and microfinance. A lack of scale of loans and lack of financial education, as well as the small size of each loan which increases the cost of providing rural financial services, are identified as two of the main challenges to extending provision of microfinance to rural areas.

Last but not least, the ELLA research reviews key Latin American experiences in microfinance regulation, including how MFI operations have been modified to prioritise institutional sustainability and a solid microfinance market. The ELLA materials are right to affirm that Latin America is viewed as one of the best business environments worldwide for microfinance activities, thanks in large part to a cautious approach to regulating microfinance institutions, and in particular, successful experiences in  Peru and Bolivia.

The ELLA review covers topics that are not usually included in research on microfinance, such as product diversification, types of microfinance, regulated and non-regulated institutions, information management and technology, rural microfinance, and regulatory frameworks, among others. In methodological terms, the analysis of the MIX Market provides a good reference for representative databases of several microfinance institutions in Latin America, and for providing basic national statistics.

As commonly happens in research and policy reviews, the ELLA Briefs focus on certain topics while other important issues are either absent or only partially addressed, despite being relevant for current debate. Thus there is reasonable scope for the ELLA experts to continue contributing by broadening the spectrum of investigation.  One pertinent issue that is missing from the ELLA research is the co-existence of regulated microfinance institutions alongside – and probably competing against – other non-regulated microfinance institutions. The ELLA materials provide interesting experiences from cooperatives and non-governmental organisations, however they do not mention the significant presence of informal microfinance institutions. It has been widely documented[1] that informal financial arrangements are common practice among microenterprises and poor families in rural and urban areas of Latin America, as well as other parts of the world. While regulated microfinance activities have increased considerably, informal microfinance practices, for example supplier loans, loans from friends and relatives, rotating savings groups and credit associations, have maintained their importance among these populations. A lack of statistics and research means that knowledge on this aspect of microfinance is still very limited.  That being said, it is important to recognise the role of informal markets in rural and urban areas. The usual argument that the demand for microfinance has been almost fully satisfied in rural areas may only be considering formal supply, while informal arrangements may be largely ignored. Extending financial services and improving inclusion in rural areas are two ongoing challenges faced by Latin America today that need to be recognised.

It is common for analysis of microfinance to be limited to just the successful experiences of regulated institutions, such as the Cajas Municipales, Edpymes, Cajas Rurales and commercial banks in Peru. Moreover, ‘common wisdom’ still seems to mean that leaders and policymakers just refer to the regulated microfinance sector to identify market behaviour, trends, main challenges and policies, leaving aside the informal microfinance sector as if it were insignificant. To date, however, no empirical research has offered conclusive support to the hypotheses that regulated MFIs are the only – or most significant – providers of microfinance services.  It is possible that the larger the informal microfinance sector, the more complex the clients’ demands for formal microfinance products. To what extent can formal microfinance institutions, say Peru’s Cajas Municipales, broaden supply to meet demand from people who usually resort to informal microfinance options, either by increasing activity or opening new Cajas?  Beyond this issue of scale, strategies for adequate institutional building may be required if greater deepening of microfinance is desired.

In addition, the key issue of possible trade-offs between economic sustainability and social outreach is also absent from the ELLA materials. This has been a source of persistent tension among regulated and non-regulated MFIs, with unresolved questions about whether becoming regulated may in fact alienate the target population (generally microenterprises and families with no access to the formal financial system, but also other segments of society). In fact, the diversity of experiences worldwide supports both hypotheses; that sustainability and outreach goals are complementary and that they exist in opposition as a trade-off. To explore these issues further, empirical research is required to investigate beyond the limits of particular institutional forms. The joint aims of minimising risks of information asymmetries and guaranteeing sustainability has led to some microfinance institutions diversifying their client base and products. Notwithstanding, available statistics show large differences among regulated microfinance institutions in terms of the range and scale of their products; for example, the average microcredit issued by a commercial bank is significantly larger than that of a Caja Rural. These differences may reflect scope of outreach (with banks serving larger microenterprises and fewer poor families than the Cajas), symptoms of market segmentation and client preferences, among other factors.

Related to the previous topic, the issue of poor populations and microfinance is also overlooked in the ELLA documents. While the ELLA materials do acknowledge that there has been a shift in the clientele of microfinance institutions from poor microenterprises towards families and microenterprises in general, there is no discussion about the implications of such a change, nor that this shift mostly occurred among the regulated microfinance institutions.  Nor do the materials explore how this change means that microfinance is now being provided for both production and consumption purposes of clients (rather than just production, as was previously the case) or the role played by microfinance in national financial systems. In general, more empirical research is required to improve knowledge about these issues of demand. Limited availability of data about the characteristics of demand and how these are met by different types of microfinance institutions constrains the ability to conduct good research, leading to potentially biased inferences about the impacts of recent changes in microfinance, rather than evidence-based conclusions.

The great value added by these ELLA Briefs is that they provide a compendium of the main knowledge about microfinance today and highlight lessons learned from fruitful Latin American experiences. Another way in which the ELLA assessment adds value is that it invites readers to think about pending research issues that could facilitate the scaling-up of Latin American microfinance successes to meet demand in any area of a particular country. This is a particular challenge faced in Latin America where financial services are largely concentrated in capital cities and other urban centres; in Peru, for example, 72% of loans are made in Lima, while just 7% are made in the next three largest regions. Moreover, the majority of financial services are provided by commercial banks, which poses a challenge for strengthening non-bank regulated institutions; again drawing on the Peru context, 94% of loans are issued by commercial banks. Aside from older yet persistent challenges like strengthening institutions, product design, human resources, and so on, new issues have emerged, such as how to best stimulate technological innovation (beyond improving the physical infrastructure, also pointed out in the ELLA materials) in order to expand the coverage of microfinance services but in a way that is economically and socially sustainable.

[1] See, for example: Adams, D. Fitchett, D. (Eds.). 1992. Informal Finance in Low-Income Countries. Westview Press, Boulder.; Madestam, A. 2010. Informal Finance: A Theory of Moneylenders. IGIER Working Paper No. 347. Bocconi University, Milan.; Alvarado, J. et al. 2001. El Financiamiento Informal en el Perú (Informal Financing in Peru). COFIDE-CEPES-IEP, Lima.

Prof. Janina León Castillo is a Peruvian economist with more than twenty years of academic and professional experience in Peru and abroad. She holds a Ph.D. in Development, Agricultural and Environmental Economics, and is currently Professor and Researcher of the Department of Economics at the Pontificia Universidad Catolica del Peru. She has also been a consultant for a variety of development institutions and public sector agencies. She focuses on microenterprises and microfinance, applied microeconomics and impact evaluation analysis, as well as on other aspects of development economics and labour economics.


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