Too Big to Fail (Just Got Bigger)

Credicorp bought MiBanco for $179m. According to the stated equity on the MixMarket, this would suggest they paid 1.25x the net equity of the bank, for a 61% stake. This is a low price compared to most microfinance transactions, but let’s face it, it wasn’t Peru’s best bank. The owner already has the second biggest microfinance bank in Peru (by number of clients), Edyficar, thus the combined bank is a monster – a fifth of the entire sector. If this was too big to fail before, it’s just got bigger. And of course, while the initial fears over the fate of MiBanco have momentarily subsided, the underlying problems remain identical to last week. Over-indebtedness is still a problem, MiBanco has a poor quality portfolio and is bleeding clients. Shifting shareholders doesn’t change that. Indeed, some might argue that paying any premium over book value for this bank was generous. Obviously Grupo ACP are out of the hole for a while, flush with cash, and there is no danger of defaulting on the bond now.

They’ve sold off the family silver, however. An undignified outcome for both ACP and MiBanco without the underlying problem solved – little to celebrate.

And technically speaking the deal has not yet been approved. Indeed, one might suspect that political manoeuvrings behind the scenes got the deal on the table in the first place, so it is unlikely it will fall at the final hurdle.

Needless to say ACP had another spin on this. This was not a firesale apparently, but part of a cunning plan: “We do also believe that the main goal that motivated us for 45 years has been accomplished.” It is probably true that they set out to financialize the poor of Peru, and have played a stellar role in that process for better or for worse. They have left a mature microfinance sector in their wake. Perhaps too mature? But the reality is that this was a firesale prompted by a looming default on a bond due to declining earnings in their rather undiversified portfolio in a country that looks worryingly over-indebted. I doubt this was the plan hatched nearly half a century ago.

An interesting article appeared in the Peruvian press. Those bright journalists dug up all the data on ACPs other investments, and ACP really had nothing else they could sell:

Semana Economica ACP holdings

There were a couple of marginally profitable Peruvian assets, and they had already flogged the Bolivian bank (once again, all part of the plan apparently). To raise the sums ACP required, trying to sell a loss-making Mexican asset in a hurry was hardly ideal. They had no option, but don’t kid yourself – there was nothing either clever or strategic about this deal, their back was against the wall because they had over-leveraged themselves. Ring any bells?

But the Semana Económica article points out some other fascinating items:

  • Obtaining an equity injection from the other investors, such as Triodos was not possible as these minority shareholders were none too impressed with ACP.
  • ACP had previously tried to raise equity capital in Luxembourg, but had been unable to due to its legal structure as an NGO.
  • The relationship between ACP, MiBanco and Credicorp has a history. In 2011 Credicorp had tried to buy MiBanco from ACP. When Edyficar was up for sale, ACP tried to buy it. So, finally the family is reunited.
  • The article estimates the value of MiBanco as of the end of 2013 at US$311. The actual deal was $179m to buy 61% of the bank, suggesting the total value (i.e. 100%) of the bank to be about $295m, so a little lower than their valuation. But in fact this valuation is 37% below what the bank was worth in 2007, according to the article. So, since 2007 the management team actually did quite a spectacular job of destroying value for MiBanco’s shareholders. ACP clearly suffered as a result of this, but microfinance investor Triodos are unlikely to be too pleased about this erosion of value at one of their principal investments. Remember also that in 2013 the equity on the balance sheet of MiBanco fell by 7% alone. Triodos will have to explain this rather awkward result to its own Dutch investors, and while this was not Triodos’s fault necessarily, that doesn’t make the case any easier to justify.

What is interesting here is that in fact Credicorp paid relatively little for MiBanco. The once heralded star of Latin American microfinance was sold for a song. (For readers that are not familiar with equity valuation, skip this section). Basically the bank was sold at 1.25x book value, based on the relatively limited data available on Mix. This is at the very lowest end of the 1.3x to 1.9x range suggested by CGAP as the usual pricing. Presumably this incorporates Credicorp’s discount applied to compensate for restructuring costs, write-offs, integration expenses and redundancy payments. To put this in context, Credicorp paid a 25% premium over the book value of MiBanco in 2014. When Credicorp bought Edyficar in 2009 they paid a premium of 150% over book value. This was a firesale.

So, what is Credicorp going to do? First of all, it will probably find that half the clients of MiBanco are their clients already, which will be a little worrying. Paying off your loan at Bank A with a loan from Bank B is one thing, but they are now the same bank.

They will presumably cut a significant portion of the headcount, at all levels of the bank. It will be astonishing if any of the senior management team at MiBanco are allowed to stay on, but friendships run deep in these banks, and likely the main lay-offs will be the junior staff, but we shall see. You don’t need two CEOs, and right now it is pretty clear which one is doing a better job. Redundancy costs will be high in Peru.

Another pertinent question is whether the newly formed entity will operate under the Edyficar brand, or MiBanco’s, or remain separate. Edyficar is a solid, well-run bank and seems the obvious choice, but common sense should not be taken for granted in this sector – MiBanco is bigger and has a stronger brand name, so maybe that is perceived as better?

Edyficar is in far better shape than MiBanco. According to the MixMarket its return on assets is 4.23%, return on equity is 40.95%. MiBanco wrote off approximately 5% of its portfolio in each of the last two years, while Edyficar wrote off a mere 2.22% in 2012 (2013 data not available). Only 4.38% of Edyficar’s clients are overdue on loan repayments by more than 30 days, and 3.16% at 90 days – a little over half the levels reported by MiBanco.

The deal may provide some respite to ACP, but there are two major problems that have not vanished. They are exactly the same as before this crisis struck Grupo ACP. Over-indebtedness is high, and MiBanco’s non-performing loans are high. Its clients are not repaying their loans. Just because the shareholder abruptly changed will not change that. Compared to MiBanco, Edyficar is well-run, its portfolio is notably better quality, with fewer write-offs. Merging the portfolio of MiBanco is going to deteriorate the overall picture. And it seems unusual to suppose that Credicorp bought MiBanco in order to slow down lending, in all likelihood it will clean up the mess and ramp up the growth once again. Whatever the strategy is, do we expect the merged company will somehow try to manage, or even reduce, over-indebtedness? And now Peru is debatably even less prepared for a systemic crisis in the microfinance sector. A collapse of MiBanco could have triggered a broader collapse across the sector, and now the MiBanco/Edyficar union is even bigger. Too big to fail?

Frankly, anyone thinking this problem is over is deluded. This might be just the beginning.

So, is there a crisis looming? I don’t know. Many ingredients for a storm are present while others are notably absent, as I blogged previously. All it would take is a spark, as in previous crises, often from unexpected sources. There are certainly warning signs, but hopefully this “incident” will send a valuable warning signal to the sector, and in particular to the regulator, that they need to do something. What could this be? I reckon there are a few key steps here that would reduce the chance of the situation deteriorating.

  1. The regulator needs to take pro-active steps to reassure the Peruvian microfinance sector and the international investing community that it is in control, aware of the problems, willing to take action if the situation deteriorates, and is credibly run. It has mud on its face that it permitted this recent debacle to occur in the first place, but no point crying over spilt milk, it needs to look forwards and with confidence.
  2. A possible step, taking a leaf out of Bolivia, Ecuador and Colombia’s books, would be to declare an interest rate cap. This essentially stops poor people being exploited. Interest rates are not that high in Peru in general but there are outliers, charging up to 200% in cases. Get these out. Placing a cap at 50% will have minimal impact on the vast majority of the sector. The banks that really cannot survive without charging rates of 200% – does Peru need them anyway? This would take a little steam out of the sector (not a lot: such loans are thankfully rare), but it would reinforce the signal to the market: “we are not messing about, 50% isn’t so bad, those Ecuadorians are on 30%, step in line as we could always reduce this again”. It’s a warning shot. The free-market fanatics will complain that it is anti-free-market, and also anti their bonuses. Ignore them, a 50% cap is fine.
  3. Insert a minor tax on capital departing the country, perhaps 1% (Ecuador is at 5%). This prevents short-term speculative funds bidding up the sector too rapidly. Again, the idea is to take a little steam out, but on the investing side, and also to send a warning shot. This will not create a panic, but it will have an impact at the margin, and a psychological effect. Plus this would generate tax revenue for the Peruvian government to ideally do something useful with. An alternative to this is to place some sort of minimum capital requirement at the banks.
  4. The regulator didn’t intervene soon enough in the case of MiBanco, and now it has an even bigger beast to manage, and more people watching it, so it should keep an extremely close eye on this merger, and not hesitate to intervene at the first sign of trouble. Something going wrong at a bank that controls 20% of the sector is never pretty.
  5. The regulator may wish to extend its oversight to the shareholders of their banks. How many others are as wobbly as MiBanco? The unusual element in this case was that it was triggered not by the bank itself, but by its main shareholder. So, keep an eye on the shareholders. I have no idea if the regulator was doing this previously – if so it wasn’t doing it very well. If not, now might be a good opportunity to start.
  6. Tighten client protection rules. I am not sure what sort of ombudsman there is in the country, but the last thing the regulator wants is civil unrest against the banks. If there is animosity against banks amongst over-indebted borrowers there ought be a formal channel they can vent their frustration through, and that will offer some form of bankruptcy protection to the poor and rigorous deposit insurance. This might sound overly interventionist, but bear in mind most “developed” countries have precisely this sort of provision, and one need look no further than Nicaragua to see what happens when the borrowers take matters into their own hands. Plus, again, this is wise signalling. Not just to the banks and their investors, but also to the borrowers.
  7. Tighten the rules for measuring clients’ borrowing ability. Indeed, the regulator could limit the number of loans a client may have simultaneously. When a client is managing more than five loans simultaneously one has to wonder if this is healthy. Plus it would force clients to think carefully about who they borrow from, essentially using up one of their five “permits” each time, rather than walking onto any street corner in Peru and getting a loan over the counter.

There will be a continued “period of consolidation” in the sector. This is investor-talk for a period of collapses, with a nice spin applied. This is not necessarily a bad thing, but it has to be managed in a controlled way. A string of collapses is never nice, better to anticipate this and wind them down slowly. A bit like demolishing a building.

The banks need to calm down the relentless competitiveness and desire to perpetually steal one another’s clients, constantly rise in the ranking tables and retain market share. In the short-run such behaviour may produce results, in the long run it is cannibalism and leads to over-indebtedness and possible crisis. Is it too much to ask that they collaborate somehow? Fierce competition is so engrained in the Peruvian microfinance sector (for better and for worse) that this will be a hard cultural shift to initiate. External prompting from the regulator will be required, but soft intervention can also work. Ideally this would also come from the investors, who may have the prudence to suggest that a healthy 10% growth rate is preferable to a 30% dash towards an imaginary finish line. But here I am entering into the role of pure fantasy, the odds of investors with the whiff of profit in their nostrils turning down a quick buck is not the most likely outcome highlighted here.

The fact that the Economist Intelligence Unit declared, for the sixth year in a row, that Peru is the best regulated microfinance country on Earth suggests at least one word in their name might not be entirely valid. Any false confidence this imparts upon the regulator should be re-assessed in light of this recent mess.

But there is no crisis yet. There is time to fix this. It is not too late. But the warning signs are clearly visible, the fact that the entire sector hasn’t collapsed does not imply the warning signs should be ignored. Alas the global microfinance sector has established an incredible tendency to ignore such warnings and wonder aimlessly off cliffs. But this is neither inevitable nor unavoidable.

There are no doubt 100 other measures that the regulator is looking into currently that I am unaware of, and I sincerely hope they can act wisely in the best interests not only of investors but also of the Peruvian public. The trick is confidence. The SBS should activate all the tools at its disposal to fine-tune the sector – no brash moves that could trigger a crisis/exodus/bankruptcy etc. Subtle moves that restore confidence and protect not only the banks, and their investors, but also the poor.

Too much to hope for? Yes, probably.

 

Correction to previous post: Accion had already been flogged to Bamboo some years ago. Thanks to an anonymous reader for the correction.

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Brief Analysis of MiBanco

Introduction

It seemed appropriate to take a closer look at the bank in the centre of the emerging “incident” in Peru’s beloved microfinance sector. In a later post I may do a comparison of MiBanco to other banks in the sector, but for now I shall focus only on the data presented in the MixMarket. I examined data for the years 2011 and 2012, and the quarterly data to the end of 2013 (i.e. 4th quarter – the most recent, but incomplete data available. Select 2010 for “Start Year” and click all boxes for “Report Type”. Mix data is self-reported and not always entirely reliable, but it’s the best we’ve got).

I must stress here that this analysis is entirely from publicly available information. The results are disturbing. I’ll go through this broadly in the order that the data appears on the Mix.

The Mix Data

  • The number of offices has barely changed, from 117 to 119 in two years.
  • Leverage (the amount of debt compared to the amount of equity) has increased from 7.5 to 8.1 (2011 to 2013), suggesting MiBanco may struggle to raise additional debt capital. This is not chronically high, but particularly in the circumstances it may struggle to extend this further.
  • What is far more worrying is the decline in the number of active borrowers. This is worse than I had previously suggested. From the end of 2012 to Q4 2013 borrowers fell from 505,000 to 364,000, a decline of over 140,000 in a single year, or nearly 30%. The number of loans outstanding fell even further, from 565,000 to 369,000, a decline of 35% in a single year. The gross loan portfolio fell by less (from $1.86 billion to $1.60 billion, as mentioned previously), which is a fall of 14%. The reason why the portfolio fell by less than the client numbers is that MiBanco offered larger loans to its clients.
  • The average outstanding loan balance increased from $3,284 to $4,325 from 2012 to 2013. This is quite a notable shift in focus – some may call this mission drift, but we would need to examine the components of the portfolio in more detail to conclude this. The average outstanding loan balance increased by 31.7% in 2013 and by 7% in 2012.
  • Looking at the other side of the balance sheet, the number of deposit accounts actually increased dramatically from 2012 to 2013. However, the average deposit account balance fell almost as dramatically, from $3,759 to $836. More people saving less, in a nutshell. The combined effect of this was a 1.7% decline in the total deposits held by MiBanco. However, this should not be underestimated – MiBanco currently holds over $1.4 billion of client deposits, thus a run on the bank would be extremely serious were Peruvians to lose faith in its integrity. This is cause for concern for the regulator – a run on a small Edpyme is not too serious, a run on MiBanco would be dangerous.
  • As mentioned previously, profits have plunged. The profit margin was a healthy 12.6% in 2011. By 2012 it had fallen to 2.2%. Of course, this led to reduced dividend payments to the shareholders, which contributed to nudging Grupo ACP into technical default of its loans (the Fitch downgrade occurred this same year). The contagion spread from MiBanco to ACP – this is a critical point to grasp.
  • The other expense ratios actually remained relatively healthy – operating expenses as a percentage of loan portfolio (i.e. how much it cost to lend $1) rose marginally from 11.9% to 12.1%, but this is within normal boundaries. The bank is quite efficiently run, operationally, although for a bank of this size perhaps greater economies of scale might be expected. I would need to compare MiBanco to its peers to confirm this.
  • Interestingly the number of clients per loan officer or staff member also declined, driven by the fall in the number of clients, but not by a significant amount. This is because MiBanco laid-off substantial staff during the last year. Personnel fell from 4,419 to 3,847 in a single year: 572 lay-offs, or 13% of the workforce. Alas personnel expenses are not reported for 2012 or 2013, but in 2011 they stood at $95 million, i.e. a substantial expense, which has presumably declined. Redundancy payments are alas not reported on the Mix, but in Peru these are likely to have been quite high (and not over yet!).
  • I previously mentioned the declining portfolio quality, but I failed to pick up the write-off ratio. This is the amount of the portfolio a bank simply deems uncollectable, and removes from the balance sheet as an expense. Naturally, when portfolio is removed from the portfolio (the “bad loans”), the remaining loans appear better quality. What we see in MiBanco’s case is quite shocking. In 2011 the bank wrote of 5.4% of its portfolio, and an additional 4.6% iMiBanco head officen 2012. And yet (presumably to the grave disappointment of management) the non-performing portfolio remains at alarmingly high levels by the end of 2013 (7.8% delinquent for over 30 days, and 5.8% at 90 days) despite this purging of the bad loans. So far, according to the Mix data, there have not been any write-offs in 2013, but these are quarterly accounts, we should wait for the annual accounts to verify this. Do not underestimate how serious this is. Later on in the report the amounts are published: MiBanco wrote-off $76 million in 2011 and an additional $78 million in 2012. Write-offs therefore cost the bank of the same order of magnitude as its staff costs. This is chronic. And do not forget that each of these written-off clients represents a poor Peruvian who was unable to repay a loan, essentially went bankrupt, and will have presumably been reported to the credit bureau and is now black-listed. These are not merely numbers but people. All too easily we forget this, particularly from the lovely, air-conditioned head office!
  • The impairment loss allowance for 2013 is $117 million. Again, a significant amount.
  • Total liabilities over the period increased by 14.5% from 2011 to 2012, as MiBanco took on more debt ($143,617,700 more to be precise). But liabilities actually declined marginally (by 1.5%) in 2013. However, currently liabilities are $1.9 billion. Think about this for a moment – MiBanco owes more money than its entire loan portfolio is worth. Does that sound healthy? Admittedly the majority of this is the deposit balances of the clients, but “borrowing”, which I assume is external debt, is a whopping $382 million ($13 million more than in 2012). With this structure of the balance sheet, and the increased leverage mentioned previously, one wonders if MiBanco can easily raise additional borrowings currently. And indeed, what happens when lenders start refusing to roll-over or make new loans, as BlueOrchard did? Things could get uncomfortable for MiBanco – the most obvious way it can repay this debt is by winding down its portfolio, i.e. shrinking, which is what we have seen quite obviously in 2013. Thus as ACP flogs its assets to pay its loans, is MiBanco essentially doing the same? If MiBanco refuses to extend loans to well-repaying clients, they will simply leave and take their savings with them, further worsening the problem. It is a slippery slope.
  • And then we have the all-important equity, the single item that keeps the shareholders excited. This fell by $17.4 million in 2013, or 6.9%. Although this is unlikely to please the shareholders, MiBanco does still retain a healthy equity cushion of $234 million, so collapse is not imminent. But the board of directors, and the shareholders, will presumably want a decent explanation of why senior management wiped off nearly 7% of the equity in a single year in a country that is apparently the best in the world for microfinance.
  • Fees and interest paid by the clients amounted to $380 million in 2011, and rose to just below $400 million by 2012. Unfortunately 2013 data is not reported. Although the portfolio declined substantially in 2013, the average portfolio in 2013 was not significantly different to the average in 2012, so gross income could be of a similar order of magnitude. We await the annual accounts to verify this. While this may sound like a lot of money extracted from the pockets of poor Peruvians, it is not all profit, as the lion’s share goes to covering the operating expenses ($205 million in 2012, a 23% increase from 2011, 2013 not reported yet). But MiBanco also pays interest, and in 2012 its own financing expenses rose to over $80 million, to both depositors (who earn interest) and to external lenders such as the microfinance funds. But, to present a single rather worrying trend, net operating income in 2011 was $48,471,636. This fell an impressive 82% to a mere $8,620,165 a year later, and things appear to have worsened since.
  • Alas the lack of complete 2013 data makes more observations impossible. The rest of the data presented is of mild interest. From zero female members on their board this fortunately increased to 1 in 2012 (with 11 men). Women account for a little over one third of managers and staff, and marginally over half the clients. Call me biased, but perhaps a few more women running this bank not be a bad idea!

Conclusion

While it is true to say that the current problem was sparked not by MiBanco but by its main shareholder, who is clearly not doing very well, MiBanco is far from healthy. Would you buy shares in this company? Would you lend them money? Would you entrust your savings to them? This is not a backward country without regulations run by cowboys, this is the best country on Earth for microfinance according to the Economist Intelligence Unit. This is not some struggling NGO with a few thousand clients – this is one of the largest MFIs on Earth. Problems with the portfolio are not minor – it wrote-off 1 in 20 loans in both 2011 and 2012, before the current problems emerged. 140,000 active borrowers left the bank in 2013 alone, and even more than this if you consider number of loans rather than number of people. By the end of 2013 1 in every 13 clients was in default over 30 days. 1 in 17 hadn’t made a payment for three months. This is a terrible situation.

The only thing I can suggest here is a change of management. This is not a game – if MiBanco goes down, it will take a lot of people down with it, most of whom are largely innocent. The main shareholder is sufficiently reckless to land itself in default on a senior bond, so there is not much hope there. This is not a country such as Greece suffering major structural problems, Peru grew 6.3% in 2012. Triodos and the IFC may be slightly more prudent, but they have minority stakes. In my personal opinion Grupo ACP has a lot of answering to do, and flogging a few marginal assets in Bolivia or El Salvador to keep its bondholders happy is not enough to resolve the underlying problem.

As we have seen in the recent financial crisis, mis-management in large financial institutions can have a catastrophic impact on entire societies, and I must beg to disagree with the Economist Intelligence Unit that Peru is a well-regulated country. Any regulator that allowed the current situation to arise under its watch should be questioned. MiBanco, the largest MFI in Peru, and its main shareholder, are dangerously close to requiring a bail-out. How can that possibly be considered good governance? It may have been good for investors for a few years, but a regulator has a slightly broader gambit than protecting return on equity for investors. Where was the client protection in all this? What is a multilateral such as the IFC doing investing in such a shoddy institution with tax-payer funding? Who is going to pick up the pieces if MiBanco collapses? What is going to happen to the entire Peruvian microfinance sector (which extends into the mainstream commercial banking sector) if there is a crisis such as Pakistan, Nicaragua, Bolivia, Morocco, Andhra Pradesh, Bosnia etc? What is going to happen to the genuine entrepreneurs who rely on capital to run their businesses?

This looks like gross incompetence to me. And while I’m ranting about the regulator’s deficiencies, the Economist specifically praised it for not using interest-rate caps (i.e. regulating against usury) – MiBanco doesn’t charge very high interest rates, but some MFIs in Peru are charging rates over 200%. What on Earth inspired the regulator to think that was going to help Peruvians grow their businesses? These people are on a different planet.

And are we to believe that MiBanco is the only bank in trouble?

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What are Some of the Signs of a Looming Microfinance Crisis?

I have received a few questions on whether I am suggesting this is the beginning of an actual Peruvian microfinance meltdown, and should clarify my stance on this.

Basically, I don’t know.

The signals are inconclusive. But when we look at previous crises (Bolivia, Morocco, Nicaragua, Andhra Pradesh, Pakistan, Bosnia etc.) there are certain triggers, or catalysts, that seemed to push a serious situation over the edge. They differ from country to country, and people have criticised my Peru piece on the basis that “Peru is not Nicaragua”. I totally agree with such critics, Peru is most certainly not Nicaragua, but that does not imply that there is nothing to learn from the Nicaraguan crisis, or any of the others. Obviously if many of the similarities in previous crises emerge in Peru, this would be cause for concern. So, what are some of these alarm bells, and do they apply in Peru?

Andhra Pradesh is perhaps the most publicised microfinance crisis to date. The broad accusation was that loan officers applied extreme pressure on defaulting clients that forced some clients to suicide. Whether or not these claims are valid, there is no evidence (that I am aware of) that this is occurring in Peru. The principal threat to non-repaying clients appears to be black-listing on the credit bureau and an inability to obtain more credit.

If anyone knows of cases of violence or humiliation used by banks against Peruvians, please send me the evidence.

All crises have over-indebtedness in common, and there is certainly sufficient evidence already to suggest this could be a problem in Peru. I have spoken to some funders over the last days, and opinions are mixed. As a broad rule, those with more money invested in Peru believe this is less of a problem, perhaps unexpectedly. I cited two reports in the original post supporting the fears of over-indebtedness. These are both somewhat out-of-date (the situation has likely worsened since they were written) and exclude the endless other sources of debt, formal or otherwise: cars bought on credit, those store cards you can get in Lima shopping centres in about 5 minutes, credit cards etc.

There are various definitions of over-indebtedness, and prior to the Nicaraguan crisis there was no clear consensus. I remember, I was there. But why is delinquency rising in Peru? Why have professional and experienced banks such as MiBanco been unable to control this? Why did they lose 100.000 clients last year? Why is this delinquency happening across the entire country rather than just at one or two troubled banks? We are fast approaching a situation when 1 in 10 Peruvians with loans are unable to meet their monthly repayments – think about that for a moment. No one wants to default on a loan, these people are cutting back their expenses, economising where possible, working harder, draining their savings, perhaps selling personal possessions, and are simply unable to meet their monthly loan repayments. Suggesting that this is not a cause for concern simply because the entire sector hasn’t yet collapsed seems a naïve stance to me.

Some Peruvians are in dire trouble, and we need to limit the extent to which this happens rather than suggest that it is not yet occurring to enough people to cause a systemic crisis.

Nicaragua was triggered by civil unrest. So far there has been no animosity against the banks, but there have been protests against the mining companies. This triggered the “no pago” movement in Nicaragua, as banks over-charged clients and tried to imprison non-repaying clients, which naturally irritated their families. There is no evidence of such behaviour so far in Peru, but it is not inconceivable. However, look at the interest rates some of them are coughing up, this could easily cause poor clients to rise up against their so-called benefactors. The 3 highest I have found so far, according to page 52 of the December 2012 COPEME report, are:

  • CMAC Del Santa 203.11%
  • CRAC Sipan 157.26%
  • Edpyme Inv. La Cruz 233.48%

Another potential trigger is the withdrawal of investors. We have seen this with BlueOrchard, and I have spoken to one fund who makes a similar claim but has been unable (or unwilling) to provide me with tangible evidence that it has reduced its exposure to Peru. Perhaps in a later blog I will examine the individual portfolios of a few funds to see if this is the case, but most funds are extremely non-transparent in revealing where they have invested, so this is not so easy.

An additional alarm bell would be depositors withdrawing their savings from the banks as they lose faith in them as guardians of their scarce savings. The evidence in the case of MiBanco is mixed. It actually has increased the number of depositors, but each depositor now holds a reduced balance. The overall effect in 2013 was a 1.7% decline in the total deposits held at MiBanco, which is not indicative of a run on the bank. But then again, the bank was only recently put up for sale, so it will be interesting to see the latest data to confirm if this remains the case.

Another alarm bell would be disconcerting action taken by the regulator. If investors perceive the regulator as making adverse moves that could harm their earnings, this could prompt investors to leave. If the regulator does nothing the situation is unlikely to improve. If the regulator offers overly-generous client protection (in the eyes of the banks and their investors) this could also trigger the departure of investors. What about an interest-rate cap? The Economist Intelligence Unit specifically praises Peru for NOT having such a cap (“The lack of an interest-rate cap, reasonable capital requirements and the availability of various legal structures create low barriers to entry” – register for free to download report). Most MFIs charge relatively reasonable rates, but even preventing interest rates of over 100% might be a wise move, as such loans inevitably lead to strife. And if either the investors or the general public perceive that the regulator is worried about the situation, this could trigger an investor exodus or a run on the banks as clients attempt to rescue their savings in the expectation of a possible crisis – also not ideal.

So actions of the regulator are also indicative of the likelihood of a crisis, but could themselves trigger a crisis, it’s a fine line. And Peru’s regulator is not in an easy position currently (although one could argue that it was the same regulator who allowed this current situation to arise).

Obviously the collapse of a major bank would be a serious alarm bell. The cajas are in trouble, MiBanco is in trouble, ACP Is in trouble – this is not entirely inconceivable. Collapses of institutions are often euphemistically described as “consolidation”, but is the collapse of a major MFI in Peru really that unlikely?

And of course, there are many other signs of a crisis looming. This is a brief blog post. Do we see these in Peru? Yes, some of them, to some extent. Does that mean a crisis is imminent? No, but it does mean we should keep our eyes peeled for more signs, and make concerted efforts to avoid a crisis, rather than keep going along the same trajectory with our eyes closed. Let’s learn from previous mistakes.

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Update on the Unfolding “Problems” in Peru, Friday February 7th

I have received endless calls, emails and messages about my recent post, almost unexpectedly, so I feel obliged to keep my loyal readers up to date on the unfolding problems in Peru. I have therefore diligently prepared three new posts (I will assume that readers of these posts have read the original):

  • An update on recent events (below)
  • A brief description of some of the warning signs of a microfinance crisis
  • A brief analysis of the financials of MiBanco up to Dec 2013 based on MixMarket data

First, Credicorp posted some disappointing results. Earnings are down 28.1% in 2013 due to “extraordinary expenses” in their investment bank and insurance areas. So, does this increase or decrease their chances of buying a defunct and large Peruvian bank such as MiBanco? There’s no comment so far.

But in a comic twist, following the rather unexpected sale by Grupo ACP of a 12% holding in BancoSol in Bolivia (they still hold a 6% stake after the sale), the CEO of BancoSol made a most extraordinary statement. I shall use Google Translate in order not to be accused of unfair translation:

“As part of its investment policy worldwide, and on the understanding that [Grupo ACP’s] mission to establish strong microfinance institutions that empower microentrepreneurs in several countries has been met in Bolivia, ACP decided to transfer part of their participation in a group three European banks through the advice of the prestigious Responsibility Investments AG of Switzerland.”

So, according to this interpretation, Grupo ACP decided to sell simply because it had already achieved such stellar performance in Bolivia that it would flog the shares to the Europeans. No mention of the fact that Grupo ACP is in technical default on its senior bond, presumably facing a rather dire cash crunch, and looking to sell whatever it could to avoid a full-blown default on the bond prompting Fitch to cut the rating to junk status. Are we to believe this was a pure coincidence of timing? And with their clear mission to “empower microentrepreneurs”, there was no mention either of the fact that MiBanco, ACP’s main asset, empowered nearly 100.000 fewer this year.

And what exactly is ACPs current “investment policy worldwide”? I suspect if could be “flog anything you can and use the funds to pay interest on that pesky bond that we should never has issued in the first place” – hardly a sophisticated strategy.

My question is simply, what gets flogged next? Banco Forjadores in Mexico? Apoyo Integral in El Salvador? Emprenda in Argentina?

But my questions don’t end there. How much did ACP get for the sale? I imagine the “prestigious” responsAbility made a tidy buck on that one. Someone in Switzerland will get a nice bonus this year. Such prices are rarely disclosed, and given the political and regulatory risk in Bolivia right now it is hardly a risk-free investment.

The million dollar question, obviously, is whether Credicorp (or anyone, for that matter) has agreed to buy MiBanco. If they decline the price will plummet. It’s one thing to offer a widget for sale at $10, it’s another thing to wonder around seeing if anyone will buy your widget in a hurry despite others having announced in the national press that they aren’t interested. The longer they wait the lower the price, and the greater the stress to ACP and speculation in the market. Maybe they could post it on eBay?

“Peruvian bank for immediate sale, any offer accepted, cash only, vendor assumes no responsibility for the quality of the portfolio or for the cost of a major restructuring involving substantial redundancy payments, buyer will have to share ownership with some pretty irate Dutch investors, the vilified microfinance fund Accion, and the IFC. See other items for sale by this vendor”.

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Trouble Brewing in Peru? MiBanco in Dire Straits

I was surprised more fuss wasn’t made of Fitch’s October 2013 downgrade of Grupo ACP – the main shareholder of Peru’s flagship microfinance institution (MFI): MiBanco.

“The downgrade [] is driven by ACP’s losses (mainly due to foreign exchange volatility during 2Q13 in Peru and the region) and the weakness of its dividend revenues caused by the performance of its main operating subsidiary and revenue generator, Mibanco… Mibanco’s performance deteriorated in 1H2013, as credit costs (loan loss provisions) increased significantly and, along with lower operating revenues, drove profitability down to 0.74% (ROAA)…, recovery is not expected to be swift… At end 2Q13, ACP breached the indebtedness covenant of its 10- year, US$85 million corporate bond due on 2021.”

The article goes on to explain how Grupo ACP negotiated a waiver of its loan covenants until June 2014 – not long now. S&P subsequently issued a warning about the Peruvian microfinance market. Peruvian banks saw profits slow in 2013, profit at Edpymes (small private MFIs) fell by 13%, while the cajas saw profits plunge 90%.

MiBanco is one of the biggest MFIs on the planet and it doesn’t seem to be doing that well. Dividends and profitability are down; portfolio quality is deteriorating; its main shareholder, Grupo ACP, is breaching its covenants; and the rating outlook is negative. Sounds pretty serious to me.

MixMarket data confirms this. MiBanco’s return on assets (ROA) fell from 1.91% in 2011 to -0.10% a year later, while return on equity (ROE) fell from 20.47% to -0.89%. The more reliable COPEME reports support these results.

Furthermore, the ominous warning about deteriorating portfolio quality is confirmed by the available data. In November 2012 MiBanco had a reported overall PAR30 (proportion of outstanding loans delinquent over 30 days) of 7.3% – fairly high by international standards, particularly for a large commercial MFI, and compares unfavourably with other Peruvian MFIs. PAR30 reached 9.1% for loans specifically to small companies. The MixMarket reports an overall PAR30 of 8.14% by mid-2013, and over 12% in 2012 (while ACP claim it was only 4.5% on page 39 of their 2012 annual report).

From December 2012 to September 2013 MiBanco’s portfolio declined from $1.9 billion to $1.7 billion, while client numbers fell by nearly 100.000. Even more worryingly for such a large MFI, 61% of its clients have loans elsewhere (the second highest bracket in the COPEME report), hinting that over-indebtedness could be an issue in Peru. This is not the first time over-indebtedness concerns have been raised in Peru: see a June 2012 article; or a March 2013 Planet Finance report which summarised succinctly: “obvious – and high – degree of multiple borrowing in Peru”.

According to the Economist Peru is the best country in the world for microfinance, and MiBanco is the largest MFI in the country. But something is going wrong. This is interesting firstly because there are already murmurs in the sector that Peru could be about to face a serious crisis fuelled by chronic over-indebtedness. Secondly, MiBanco boasts an important set of investors, including Accion – a key global player in microfinance. In part for their profiteering performance regarding Banco Compartamos in Mexico, Accion inspire polarized opinions regarding the benefit, or curse, of commercial microfinance. It will be interesting to see how Accion’s pet project for sector-wide self-regulation, the inappropriately-named Smart Campaign, will respond to mounting evidence of a crisis in Peru. I imagine with utter silence, as their salaries depend to some extent on the profitability of their investments. They claim to be the self-regulator or watchdog of the sector, the fair trade label of microfinance. But Accion holds some uncomfortable investments.

But perhaps even more intriguingly, according to the April 2013 Investor Update of Swiss investment fund BlueOrchard, their total microfinance portfolio was $270m, but by May it had fallen by $15m to $255m. What accounted for this dramatic decline of nearly 5% of the fund value in a single month? In the April report the single largest loan of the fund was to MiBanco, representing 6.47% of the entire fund (about $17.5m). Peru was the single largest recipient of funding with approximately 9.5% of the entire fund, i.e. BlueOrchard had other Peruvian investments of approximately 3% of the portfolio.

By May, Peru had fallen to 12th place and represented only 3% of the portfolio. In light of the downgrade it appears that BlueOrchard may have been fortuitous to get out of MiBanco when they could. They mention the departure of MiBanco explicitly, but without mentioning the MFIs performance:

“[T]he allocation to Peru decreased considerably as a result of the timely repayment of an outstanding loan to Mibanco. Changes in the Peruvian regulatory framework require a 36-month minimum duration for new loans to microfinance institutions that can currently or in the near future capture deposits (financieras and banks). This translates into a minimum life of 41 months, whereas the prospectus guidelines of the BlueOrchard Microfinance Fund limit the loan tenor to a maximum of 3 years. With an increasing number of institutions graduating to the status of financieras, this regulatory constraint will result in a reduced country allocation to Peru and further diversification within South and Central America.”

Did Blue Orchard re-lend this capital to other institutions, if not in Peru perhaps in South and Central America, as stated? It appears not – by August the portfolio had fallen a further $2m, to just under $253m. Meanwhile Peru fell to 17th place in BlueOrchard’s portfolio by November, just above Cameroon.

BlueOrchard Peru ranking

Is Blue Orchard’s justification for not rolling over the MiBanco loan valid? It could be a convenient excuse for getting out of an over-heated country without stating so explicitly. The new CEO is no fool, but nor will he wish to irritate the funding sector by pointing out what many already fear. It was either lucky or intelligent – well done either way.

Blue Orchard’s main rival, responsAbility, has a staggering $110m invested in the Peruvian financial sector (see page 13 of their 2012 annual review), including $6m to MiBanco  – they must be sweating currently. And let’s not underestimate the size of the Peruvian microfinance sector – according to the MixMarket (the best data available, alas) Peru represents nearly one third of all lending in Latin America and the Caribbean. At $10.7bn, Peru is 12% of all microfinance lending on Earth ($90bn). It’s 25% more than Africa and the Middle East combined. South Asia, including the markets of India and Bangladesh, accounts for only $8.2 billion. To conclude that Peru is therefore over-saturated would require a more detailed analysis of populations and penetration levels, but in short – microfinance in Peru is big business. Only the microfinance sectors of Indonesia and China exceed that of Peru, but with populations of 240m and 1.4bn respectively, versus Peru’s rather modest 30 million. Mexico, Bolivia and Ecuador, all of which have faced concerns over over-indebtedness, have a combined population of nearly 150 million, and yet their combined microfinance sectors are smaller than Peru (approximately $10 billion). While such comparisons may not be entirely valid, it goes without saying that a collapse of Peru’s microfinance sector would have catastrophic implications for the entire microfinance sector.

To put this over-indebtedness into perspective, there are approximately 4 million microfinance clients in the Peruvian microfinance sector, of which a quarter are shared with other banks (i.e. double counting due to multiple lending, according to COPEME), for a total of approximately 3 million unique clients. The average client therefore has an outstanding microfinance loan of approximately $3,500, excluding store cards, mortgages etc. Interest rates are typically of the order of 35% per year, suggesting the average client is paying about $1,200 per year in interest alone. For a country with a GDP per capita of $6,500, it seems worrying that a fifth of this is directed merely to interest payments on loans.

According to the MixMarket the following are also “funders” of MiBanco: AECID (Spain); Bamboo Finance (spin-off from BlueOrchard, Switzerland); the IFC (multilateral); Incofin (Belgium); Triodos (Holland); and Profund (Costa Rica). In addition MiBanco posts its shareholders on its website:

  • Grupo ACP hold 60.7%
  • The IFC has 6.5%
  • Accion has 15.69% (via the Cayman islands, of course)
  • Triodos has 11.82%
  • Other minor investors account for 5.92%

Those listed on the MixMarket but not on MiBanco’s website are either out of date (not the first time the Mix has deviated from reality); debt-only providers (e.g. responsAbility); or included within “other investors” (Bamboo Finance lists MiBanco as an investment on its website, so it is presumably one of the smaller investors).

The rating downgrade makes another ominous claim: “ACP’s management reports advanced negotiations to capitalize the group. However, if the capitalization is delayed or reduced, ACP would have limited cash flow to fulfill its financial commitments, hence the Negative Rating outlook”. Who would invest in ACP right now? Its international portfolio consists of marginal institutions, the only jewel in the crown is MiBanco, and recovery there is unlikely. A 21% reduction in return on equity in a single year combined with a breach of covenant is hardly attractive, and profits in 2013 halved. The larger microfinance funds such as responAbility or DWM could be interested, or even an existing investor such as Bamboo Finance. Beyond that, the mainstream private equity investors are unlikely to take such a gamble while the legal status of ACP is still unclear – it is currently an NGO. However, a vulture fund focussed on acquiring distressed assets could seek to buy MiBanco at a low price, strip it and get out quickly, helping Grupo ACP to limp on another day. But the redundancy costs involved would be huge.

Rumours have surfaced that Credicorp (main shareholder of Banco de Crédito de Perú – BCP) may be sniffing around MiBanco as a potential acquirer. Everything depends on price – Barings Bank was in dire trouble in 1995 and yet ING bought the bank for £1. To buy a clearly struggling, massive bank in a country that most sane insiders suspect is significantly over-heated and enjoys rampant over-indebtedness is a bold move. But, as decades of microfinance history has shown, the sector is littered with fools willing to ignore facts and take reckless gambles for the sake of a quick buck at the expense of the poor. The management of Credicorp will no doubt get a bonus for pulling of an acquisition, and do we really believe they will put the long term interests of the Peruvian poor above a nice bonus and a quick buck for their shareholders? Perhaps Credicorp’s board may wise up to this. I hope so, as this could be an expensive mistake. They are in safe hands, however – the advisors to the transaction are none other than those of Banco Compartamos, so they are familiar with vulture capital(ists).

As if evidence of strife at ACP was not yet clear, on February 4th this year (i.e. this week), they flogged a 12% stake in Bolivia’s BancoSol to prop up their balance sheet. Desperate times call for desperate measures.

Peru image

But letNicaragua image’s not exclude the broader situation in Peru. Economic growth is forecast to slow in 2014, while inflation is rising. Investors are broadly pulling out of developing countries. Civil unrest aimed against the some of the large mines has already caused riots, eerily reminiscent of the Nicaraguan “no pago” crisis. Mining revenues are declining, as is tax income. With growing over-indebtedness it is not inconceivable that more militant factions of this somewhat socialist country could trigger a similar meltdown. The images above are from a recent uprising in Peru, and the Nicaragua “no-pago” crisis. Can you spot which is which? With so many deposit-taking institutions, a run on the banks is possible were Peruvians to begin questioning the safety of their deposits.

A final observation is that people in the sector have been very unwilling to discuss this. For the magnitude of the implications it received remarkably little attention. microDINERO was the only news agency to translate the Fitch downgrade report to Spanish. Even Peru’s leading financial newspaper, Gestion, failed to mention it.

However, there is no way the sector would allow a collapse of either an MFI of this size, or of the Peruvian microfinance sector more broadly. They are simply “too big to fail”. The implications of a Peruvian collapse would be catastrophic, and almost every microfinance fund would lose significant sums, if not collapse entirely. No, this has to be bailed out, and if not by BCP or a vulture fund, then a state-funded bail-out, or some soft-financing from the IFC or some such body would be required. The sector is groaning after five years of criticism and scandal, this could be the hair that breaks the camel’s back. Even if the neo-liberals have to dig deep into their own pockets they are not yet ready to throw in the towel on their beloved scheme to indebt poor people. Peru may be their current, and perhaps greatest challenge to date.

So, what can we conclude from this brief analysis? I would suggest the following:

  • Regardless of what the Economist says, I wouldn’t invest a dime in Peruvian microfinance right now. Over-indebtedness is mounting, the pre-cursor to previous crises; the flagship MFI is in trouble; and the first investors are withdrawing.
  • This will be the acid-test for the Peruvian regulator, whom the Economist praises so lavishly. Can it avert a crisis without over-regulating the sector? We are about to find out, but let’s not forget that India was thus praised prior to the Andhra Pradesh crisis, as was its leading MFI – SKS – prior to the 90% collapse in its share price. Pride comes before a fall. And whose interests will be protected – those of investors, or the poor?
  • MiBanco is likely to re-focus its portfolio in the sectors where it performs best:
    • Housing loans earn a small gross margin and are a relatively minor share of the portfolio, so unlikely to be the source of the turnaround.
    • Consumption loans have healthy returns but are also a relatively small share of the portfolio.
    • Microfinance loans are their core market, have reasonable returns, and MiBanco maintains an acceptable risk level in this segment (PAR30 of 4.7% for microloans according to COPEME).
    • … But this does not necessarily bode well for other Peruvian MFIs. If MiBanco re-focuses on microfinance and consumption loans (often interchangeable), this will further direct funding to these already over-indebted niches.
    • Fitch’s downgrade was strongly worded, with a negative outlook, and explicitly states that improvement is far from imminent – there has been none to date.
    • Blue Orchard were wise to get out when they did – a fund attempting to avoid any scandals or collapses following the mass exodus of its own investors over the last couple of years. Once bitten twice shy – they were bitten in Nicaragua and presumably don’t want a repeat.
    • Triodos are likely rather nervous and watching the Peruvian market closely, but as equity investors there is little they can do other than ride it out. However, they may be sitting on a sufficiently large capital gain that a fire sale exit may be under consideration. I generally like Triodos, and blogged about them previously. MiBanco was always an outlier within their portfolio.
    • Accion – they’re sitting on such a pile of cash from their investment in Compartamos that I can’t feel too worried for them. If anything disastrous does occur in the Peruvian microfinance sector it might make the Smart Campaign look even more ridiculous than it already does, but does anyone take Smart seriously anyway? As one commentator suggested wittily, “The SMART Campaign is actually misnamed—CRAFTY would be more appropriate.” Preventing over-indebtedness is apparently one of their key goals, and at least two of Accion’s investments are major contributors to the problem.
    • I am keeping my eyes peeled for any signs of civil unrest, animosity towards banks, bank activities that could be viewed as aggressive (confiscating assets etc.) which typically spark (not cause) a national revolt, as happened suddenly and violently in Nicaragua and India.
    • If fair-weather investors discreetly start to reduce exposure to Peru, or there are signs of Peruvians withdrawing savings as they fear for the integrity of some institutions, this may accelerate such a collapse.
    • Keep your eyes open for soft funding to prop up either ACP/MiBanco or an acquirer. If BCP/Credicorp pulls out of the acquisition, hold your breath.

Microfinance crises are obvious with hindsight, but difficult to predict as their causes are often hidden by the MFIs and their investors, and begin with a small spark. See Nicaragua or Andhra Pradesh if in doubt. The first warning signs are generally ignored. Is this a Peruvian red flag? I don’t know, but it certainly makes me nervous.

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Microfinance Warnings from South Africa

It’s not every day I read a post or article on microfinance that nearly knocks me off my chair. This article is one of them. Read it. It’s short and surprisingly frank. The opening reference to Yunus is tangential. The article is mainly about an investment fund that pulled out of the sector: Futuregrowth Asset Management. If I may just quote three particularly poingnant comments:

“The industry seems to be pumping debt down peoples’ throats. It is no longer socially responsible and does not belong in developmental funds.”

“The fundamentals are blown and the business model is unsustainable; 70% to 80% of ‘new business’ is to existing clients. So the trick is to keep them on an indefinite treadmill, always reoffering them a new loan, or reschedule but by lengthening the term to reduce the instalment”

Prof Yunus, who spoke at the Gordon Institute of Business Science, said: “We don’t lend money for consumption. Your consumption should come from income. When you create a consumption loan, there’s no end to it.” Instead, Grameen focused on lending money to people who would use it to generate income.

The poor on treadmills? The image that occurred to me was of a hamster happily spinning round his wheel, hooked up to a mini-generator to provide a drip-feed of electricity to the owner!

And once again that awkward mention of consumption lending – sooner or later people might realise that they are mostly not financing entrepreneurial activities at all, but new TV purchases.

This is dangerous for the microfinance sector for at least three reasons. Firstly, the article makes reference to yet another microfinance bubble, and it is questionable how the sector would survive such a scandal, still reeling from the Andhra Pradesh crisis, with Mexico and Peru suffering chronic over-indebtedness. Bad news from the microfinance sector of Ghana is an almost daily event. Secondly, this is another departure of an investment fund from the sector, and these are the jokers who provide the fuel for the fire. Take them away and the fire might go out. Sure, there are other ways capital enters the sector (governments, P2Ps etc), but this doesn’t bode well. The die-hard microfinance funds will continue assuring us that this is the miracle cure for poverty if only we’d hand over our dollars to them to invest on our behalf and take a nice management fee in the process, but when this class of investor starts pulling out, images of decks of cards spring to mind. If the funds don’t refinance the MFIs, the MFIs can’t refinance the clients. If clients don’t expect to be able to get additional loans from an MFI, there is a strong(er) incentive to not repay the current loan. If default rates rise and more investors are scared away, this can become a self-fulfilling prophecy.

Thirdly, the microfinance sector is furiously trying to re-brand itself, and launch all manner of initiatives to perk up its ailing reputation (largely window-dressing, see Truelift). If such measures fail to persuade the professional investment funds, for how long will the general public remain convinced? Sure, this is not a large, global microfinance fund, but watch this space.

Meanwhile Blue Orchard continues to decline. From $268m in January the August report suggests the fund is now hovering at just below $253m.

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Exploitation Declines, a bit

I had a go at Opportunity International in November 2012 over their extortionate interest rates. I thought I’d update the findings, as new data has emerged on Chuck Waterfield’s excellent website www.mftransparency.org. The results were interesting:

The poor Kenyans saw the total APR on the most expensive loans increase by 1%, but they are unlikely to notice this in the repayment amount given it increased from 134% to 135%. Hardly a bargain, but neither is this the highest rate Opportunity charge, unfortunately.

The lucky Ghanaians are receiving a positive bargain from Opportunity. From an eye-watering 161.4%, the most expensive loan is now “only” 124.1%.

Alas Malawi did not benefit from such generosity, as it’s most expensive loan now costs 144.5%, up from 128.3% previously.

Mozambicans pay the same – 152.7% – also not the cheapest source of capital on the planet. I am not sure if this is because the rate didn’t change, or new pricing data wasn’t provided.

The Ugandans also benefitted, with a full 2% slashed from the overall APR, to a mere 103.1%. if this reduction in interest continues they could be paying double-digit interest-rates in a few years.

Rwanda also saw a substantial reduction, from 107.5% to 76.8%.

Last, but by no means least, Tanzania’s 92.1% is a relative bonanza compared to the previous rate of 109%.

Imagine if your mortgage company told you the interest rate was declining by 10% – you’d be over the moon! But spare a thought for those poor Malawians who saw rates increase by nearly this amount. I can’t be bothered to work out the weighted average etc., other than to say that on average it looks like Opportunity are slightly reducing their maximum rates. Still, triple digits always concern me, and one wonders how this will impact their bottom line – most of these MFIs were loss-making already.

The comments on the previous blog tended to focus on the irony of such interest rates being charged by a nominally Christian institution. I think the irony remains. The company’s FAQ section is still equally nebulous about the interest rates charged. It’s pure speculation, but I imagine they have no desire for all those generous donors to actually find out the rates they are fleecing from the poor Africans, and are probably not entirely happy with MFTransparency publishing the rates nor me writing about them, but this is publicly available information.

Do not understimate how powerful Chuck Waterfield’s site is: you can see precisely who is exploiting who, to one decimal place, and download the actual repayment schedules.

Long live transparency (and regulation)

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Disguised Mediocrity – the quest for POSITIVE impact results at Compartamos

[This is a detailed review of an academic paper. For a summary of this blog-post, click here].

A recent paper has attracted attention, likely to garner support from microcredit supporters. Firstly, it was written by prestigious academics from well-known institutions (Yale, Dartmouth, Innovations for Poverty, thanking many of the industry heavyweights in the process – Banerjee, Duflo, Adams, Roodman etc). Secondly, it focuses on a polarizing institution – Mexico’s Banco Compartamos. The bank caused uproar in 2007 for an extremely profitable IPO, charging the poor high interest rates (up to 195% by some measures), and for huge payouts to certain individuals. This prompted some to wonder if profit had become detrimentally dominant in the sector. “They’re absolutely on the wrong track,” said Muhammad Yunus. “Their priorities are screwed up.” Thirdly, and perhaps most critically, the results seem superficially positive – microcredit is helping the poor after all, even at Compartamos.

However, upon closer scrutiny, the results are surprisingly pessimistic. The paper is complex and I struggled to understand all the econometrics involved. In some regards this resembles the famous Pitt and Khandker 1998 paper: it appears to support the core premise of microfinance, but as one digs deeper such conclusions are a little more “fragile” than one might suspect. For example, David Roodman discovered that by removing 16 outlying observations (of a total of 5,218) in the P&K sample the positive impact of microfinance vanishes. Hardly reassuring. Further doubts of P&Ks findings were published by Duvendack and Palmer-Jones (2012). Debate ensued perhaps because the paper had been so influential in justifying microfinance.

I will describe the current paper in layman terms and share some thoughts on it. My conclusion is simple – this is a rigorous paper that extracted every positive element possible from the dataset, and should be read with interest and caution in equal measure.

The paper

The authors use a randomized control trial (RCT) methodology. This is widely considered to be a valid experimental technique for such investigations, although it does have critics (amongst them, Angus Deaton of Harvard). In essence, the method splits the sample into those who receive a loan and those who don’t (similar to a “control group” in medical experiments), and looks at the differences between the two. In reality it is a little more complex. The subtleties of possible flaws in the methodology is not my prime concern here – what worries me are the results presented.

The authors worked alongside Compartamos in the northern Mexican state of Sonora state, ranked 9th of 31 states with a GDP per head of $10.336 in 2007. They made loans to some of these clients, exclusively to women, at APRs of roughly 110% APR. The market interest rate is apparently 100% (page 2 – the authors cite no source for this claim). Quite whether this APR includes the cost of VAT and forced savings is unclear. David Roodman analysed the interest rates charged by Compartamos (see his table below) and demonstrated succinctly how an uncompounded annual interest rate of 79.13% increased to 87.03% when forced savings were considered. When the cost of VAT is included the rate increases to 101.1%. Considering the effect of compounding increases the APR to 195%. There is no mention in the paper of either forced savings or VAT, so I have no idea exactly what this stated APR of 110% refers to. The Compartamos website suggests the rate APR is 77.6% excluding VAT, with no mention of forced savings. Finally, clients repay loans at a bank or convenience store (page 6) and there is no mention whether this is at the expense of Compartamos or the client. Bank transfers are relatively expensive in Mexico, and this could increase the total cost of loans yet further.

Their findings are mixed but the overall conclusion is positive. The paper is fairly balanced, and while the impression I get is that the authors extract every ounce of positivity they can from the frankly mediocre findings, they do state that there is simply very little evidence of much impact on a number of key variables. The glass is half full.

“Some good and little harm” (abstract & page 3).

“There is evidence of both increased investment and improved consumption smoothing” (page 3).

“Happiness, trust in others, and female intra-household decision power also increase” (page 3).

“Overall we do not find strong evidence that the credit expansion creates large numbers of ‘losers’ as well as winners” (page 4).

The dangers of over-indebtedness and a lack of positive impact upon poverty are mentioned as the potential pitfalls of microfinance. This is a narrow view of the potential harm that microfinance could conceivably have. Readers of Bateman will be familiar with his criticisms that microfinance trivializes the industrial base of countries and limits the formation of small and medium enterprises. Capital used to finance microfinance portfolios, including mobilized savings, could have been deployed in other developmentally focussed ways with a greater impact on the long-term health of the industrial base of a nation and create meaningful jobs. Such funds are instead deployed creating hordes of trinket-vendors. Such arguments are hotly debated, but make no appearance in this paper.

Microfinance sceptics have suggested that crowding out, or employment displacement, or as the authors of the paper label the phenomenon – “business stealing” (page 1), is a serious risk, and yet the paper barely discusses the phenomenon. They claim on page 3 that their analysis measures the total impact on the community, and not just of their subjects, and yet I was not convinced this was the case. Entire neighbourhoods are flooded with loans, and yet not a single incumbent entrepreneur was driven out of business by this influx of capital? There is no mention of such adverse effects. Instead they simply state that “Our estimated effects on the treatment group, relative to control, are net of any within-treatment group spillovers from borrowers to non-borrowers”. Er, please explain. This seems like quite a major claim (or assumption).

Then we come across an interesting reference which touches on one of the central myths of microfinance: loans to the working poor. Microfinance finances entrepreneurs, we are generally led to believe. Compartamos’s own mission statement defines microfinance as “financial services that offer productive people at the base of the pyramid, access to loans, savings accounts, insurance and other services that help develop their businesses and families”. The emphasis is upon creating or building businesses. This is the mantra of microfinance. And yet the paper clearly states that Compartamos “targets working-age women who operate a business or are interested in starting one”. They don’t actually need to be either working (merely old enough to do so), or have a business (merely curious to start one).

The authors expand on this point on page 4: “100% of borrowers are women but we estimate that only about 51% are ‘microentrepreneurs’.” Page 5 elucidates further regarding the underlying activities of the clients: “business activities (or plans to start one) are not verified [by Compartamos]”. Whether the client is engaged in any activity at all appears of such little interest to Compartamos that they don’t even verify the existence of such activities. Nor does it appear of much interest to the authors of this paper. To be included in the study the client had to answer yes to any of the following questions: do you have a business, do you want to start a business, or do you just want a loan?

Many people mistakenly believe that microfinance is used predominantly (if not exclusively) to finance businesses – respect to the authors here – they clearly state that much of this capital is not used for entrepreneurial activities at all – a vital message that the mainstream media and general public usually ignore.

However, this lack of interest in the underlying activities of clients is not to suggest that Compartamos doesn’t have a formal mechanism of carrots and sticks to ensure clients repay loans. Group pressure is the principle means (joint liability). But intriguingly the authors explain on page 5 that the credit bureaus are useful: “Compartamos does pull a credit report for each individual and automatically rejects anyone with a history of fraud. Beyond that, loan officers do not use the credit bureau information to reject clients”. However, on page 6 the authors state that “Compartamos also reports individual repayment history for each borrower to the Mexican Official Credit Bureau”. So, the credit history of the client is irrelevant in the loan application process, but if they fail to repay a loan they are reported to the credit bureau and their credit rating, and thus ability to access other services, is threatened. There is nothing inherently wrong with this, but it sheds some light on the priorities of Compartamos and their strategy: we don’t care about your other borrowings, but beware of non-repayment! The credit bureau is useful to them, but as a threat.

Apparently 9.8% of groups in general are delinquent for more than 90-days (page 6) and are therefore reported not only to the credit bureau but are sent to a collection agency, but the overall default rate is only 1%. Let’s not overlook this fact – 1 in 10 groups struggle to successfully repay a loan. Delinquent members suffer a credit bureau downgrade of some sort – is this a sign of the great success of microfinance? Maybe Compartamos manages to eventually recover 99% of all loans, that’s great for the bank and its shareholders, but 1 in 10 groups have missed a payment by over 90 days – something is clearly not going that well for a significant number of people.

And strangely in this paper, there is very little discussion of default or PAR. Indeed, if measuring the impact of a loan upon clients, including such esoteric measures as “life and harmony index”, surely two potentially negative and easily measured impacts are “client didn’t repay loan” and “client reported to credit bureau”. These were not measured for some reason. We hear plenty about female empowerment in decision making, but if a woman is no longer able to get a phone contract because she’s blacklisted at the credit bureau for missing a repayment to Compartamos, this is a worrying secondary effect ignored in this paper.

Then, on page 2, a stunning statistic emerges. Only 18.9% of those offered loans actually take one. Put it another way – 81.1% are not interested in taking out a loan. In the panel sample it is even lower, at a mere 11.9% (page 10, i.e. 88.1% not interested).  And yet we are told on the same page that “returns to capital in Mexico are about 200% for microentrepreneurs”. Hang on, there’s something wrong here. The experiment is conducted in a region where Compartamos was not previously operating, the authors demonstrate that over-borrowing is not a problem in the region (average number of loans per client in entire sample: <1), the poor face 200% returns on capital, and yet over 4 in 5 can’t be bothered to take out a loan even when someone comes knocking on their door offering one – is that normal? This is hardly supporting evidence of the “absurd gap” between the limited supply of credit and the huge pent-up demand.

Research Design, Implementation, and Data

It transpires that only the clients in the outlying areas of Nogales are included in both the baseline and follow-up surveys, so I wonder how representative this is of the entire region. I am relatively unfamiliar with the complexities of RCTs, but I thought the idea was to mix clients up randomly so they are spread out over the entire region, to exclude any effects that may be specific to one region.

They basically did two surveys – a baseline to 2.912 respondents, and an endline to 16.560 respondents. Combining these two led to the panel sample of 1.823. But this means that 1.089 of the baseline respondents were not included in the endline survey. Why not? Did they drop-out between the two surveys (hardly encouraging)? Or maybe they all were surveyed, but for some reason rejected from the actual panel survey. I couldn’t find any explanation of this.

The only other point which jumped out at me in this section was on page 10: “70% of borrowers in the treatment group borrowed more than once”. Given that the project spanned only 2 years or so, and loans are for only 16 weeks, certainly for the 30% who borrowed only once in this period it is hardly surprising that the authors didn’t find much impact. How much impact can a 16-week, $600 loan have on a client, who probably doesn’t even have any sort of micro-enterprise, over a 2 year period?

Identification and Estimation Strategies

This is the technical part of the paper, I’ll skip over this. Only one aspect of this section seemed noteworthy (and I understood!). While discussing the approach for detecting winners and losers (the title of the paper), the authors kindly warn the reader: “recall, however, that [we] have panel data on only about 11% of our sample and for a subset of outcomes” (page 12). Why was 89% of the sample ignored? Because 89% of clients offered a loan didn’t want one. It would be nice to see some additional discussion on this rather awkward point. It appears to have been rather delicately brushed under the carpet.

Results

This is the most interesting section. It roughly follows the order of the data tables provided at the end of the paper:

Tables 1 and 2

These present the base data. Most of the statistics quoted are self-explanatory. “[O]ur survey respondents are observably similar across treatment and control clusters” (page 8) – this is true with regards most variables. However, it was interesting to see that 24.4% of the 16.560 endline sample were prior businesses owners, while 48.8% of the panel sample had prior businesses (see columns 1 and 4 in table 1 for “prior business owner” row). Those in the panel sample were exactly twice as likely to be “entrepreneurs” – quite a major difference in my opinion. Perhaps not surprisingly, those who were previous business owners were approximately 10% more likely to take up a loan than those who were not. Also, it appears that three quarters of respondents had never been a member of a savings group.

Table 3

They find evidence of crowding-in of loans, i.e. those that take loans from Compartamos (average size is $645) tend to increase their total borrowings by $1.248. The authors interpret this in a vaguely positive manner: “these results suggest that there was little substitution of Compartamos loans for other debt”, i.e. it was not the case that clients who borrowed from Compartamos reduced their borrowings elsewhere. This may be a relief to other lenders in the region, but it does raise some questions about over-indebtedness. But other items in Table 1 are interesting:

  • There is no significant decline in the amount clients borrow from moneylenders. I thought microfinance replaced the evil moneylender? Shouldn’t we expect those so blessed with loans from Compartamos to borrow less from moneylenders? If the moneylenders charge such incredibly high interest rates as often claimed, presumably flooding the market with comparatively cheap (110% APR) Compartamos loans would reduce borrowings from moneylenders. Perhaps the moneylender rates are therefore not materially different to those of Compartamos? Yunus “never imagined that one day microcredit would give rise to its own breed of loan sharks” – is Compartamos therefore a loan shark? The authors challenge the common (and convenient) misconception that microfinance is a substitute for the moneylender.
  • They measure satisfaction with access to financial services (column 8) and find no significant change. This is hardly reassuring. Those who got a loan are no more impressed with the whole banking model as those who did not.
  • Obtaining a loan has a significant, but negative impact on the tendency to join an informal savings group. Compartamos loans displace savings groups. Is that good or bad? It depends on the terms of the savings group I suppose.
  • A mysterious line in the table which recurs in most tables is labelled “number missing”, referring to the number of clients excluded from the sample for some (usually unstated) reason. These are not trivial numbers: 9 respondents were missing from the question regarding savings group membership, but 2.484 (15%) were missing from the question about whether formal credit would be their first port of call if they needed a loan. I found no explanation of why the response rates varied so widely.

Table 4

This is one of the most interesting tables to see what the authors do and do not discover. For example, whether the client has a business or not has almost no impact on the outcome of the loan. Their claim that these loans helped businesses to grow originates in the third column: “a 0.8 percentage point increase on using loan proceeds to grow a business”. Did I read that correctly? 0.8% means only an additional 8 in every 1.000 clients used the loan to grow a business? Sure, it’s better than zero, but not a lot. The average for the sample (not explicitly mentioned, but visible in the table, column 3) is that 95% did NOT use the loan to grow a business – a disappointing result, and the fact that this got marginally better is hardly cause for celebration. Is this really one of the key findings of how beneficial microfinance is? And growing a business does not necessarily imply the business benefitted anyone, particularly if net profit declines, or if there is a negative impact upon non-borrowing vendors in the region.

Taking a loan had almost no impact on number of employees, i.e. zero employment creation. Taking a loan increased revenues, but also increased expenses by a comparable amount. The overall impact on profit was slightly negative, and not statistically significant. Hardly cause for celebration. Work harder, but make no additional profit. Or rather, work harder and any incremental profit vanishes via interest paid to Compartamos?

The final two columns in this table assess the impact of loans upon household business income and the likelihood of having suffered a financial problem in the last year. Neither are statistically significant, but the authors explicitly point out that the coefficient for the latter was positive: “an increase of 0.7 percentage points in the likelihood that the business did not experience financial problems in the past year” – again, hardly cause for celebration.

I’m not sure what conclusions one can come to other than the impact of the loans was minimal. No evidence of harm is not the typical claim made by the mainstream microfinance sector. This is a very worrying set of statistics in my opinion. I find it unusual that the final paragraph of this section suggests “in all, the results on business outcomes suggest that expanded credit access increased the size of some existing businesses”. Glass half full once again?

Those celebrating the wonders of microcredit should take note of the findings of this paper.

Table 5

The authors concede that they found no impact on business profits or total income as a result of loans, but remind the reader of the rather modest increase in the number of clients that used a loan to expand their business (an additional 8 for every 1.000 clients). The major claim in table 5 is that 20% fewer clients had to sell assets in order to repay a loan (page 16). This 20% reduction, described as “striking”, is in fact a decline from 5% of clients having to forcibly sell assets to 4%. Although technically true I am not sure the word “striking” would have been my first choice. Worded as “the rate of firesales declined by 1 case for every 100 clients” doesn’t sound quite so dramatic.

Such descriptions leave me wondering, not for the first time, if the authors are a little too anxious to extract any positive news where possible. They discover no evidence of loans used to buy assets (in fact this is a statistically insignificant but negative factor, what happened to the proverbial sewing machine or goat that microentrepreneurs supposedly buy?). Nor do they find treatment clients buy more groceries or spend more money on family events, both of which decline but are not statistically significant. One might have thought, a priori, that clients with loans might purchase the occasional asset, particularly given the rhetoric about microfinance helping the poor to grow businesses. Think again.

Increases in school and medical expenses were not statistically significant. In fact, the only other statistically significant result in table 5 is that clients with loans bought slightly fewer temptation goods, defined as cigarettes, sweets and soda. I suppose this could be considered a good thing, but in Mexico of all countries, would it not have been wise to add junk food to the list of temptation goods? Mexico scores surprisingly highly on most measures of body mass index or obesity. But it’s a minor point.

Table 6

This table is, frankly, disappointing. There is not a statistically significant result in it. The authors’ frustration is palpable. “We do not find significant effects on any of the five measures” they openly confess. No impact on income – we already saw profit actually went down. Surely this is catastrophically disappointing: hundreds of loan officers traipsing around in the blistering heat of northern Mexico for two years lending millions of dollars to armies of poor Mexicans apparently to use to good effect in the quest to eradicate poverty, and income didn’t change. Can we finally dispose of the “poverty alleviation” claim of microfinance once and for all? Instead we have to scrape around digging up marginal impacts on secondary or tertiary factors to justify the practice at all. To put this simply – what is the point? One can imagine the authors must have been rather frustrated by this point. Endless tables and calculations, 16.560 interviews, and barely a sign of any positive impact on those that receive loans. We have the income smoothening argument as a last resort – although the evidence in favour of this is minimal.

And thus we arrive at table 7, where at last something positive is extracted from the data.

Table 7

Factor tested

Statistically significant

Positive or negative

Depression

Yes

Positive

Job stress

No

Negative

Locus of control

No

Unclear

Trust in institutions

No

Negative

Trust in people

Yes

Positive

Life and harmony index

No

Positive

Economic satisfaction

No

Negative

Good health

No

Positive

Child labour

No

Positive

Participates in financial decisions

Yes

Positive

# of household decision has say in

Yes

Positive

# of household issues with conflicts

No

Negative

The only factors that are statistically significant are also beneficial to the clients. However, before cracking open the champagne, let’s put these in context:

  • The majority of tests discover no statistically significant impact. Observe the red sections in the table above: negative impacts on job stress, trust in institutions, economic satisfaction and domestic conflicts. None of these should be taken too seriously as they are not statistically significant, but they are of the wrong, or rather unfortunate, sign.
  • Trust in people apparently improves, but one wonders how accurate a measure this is, and how it squares with the decline is participation in savings groups. Also, given that for a significant number of clients (76% in fact) this is their first experience with group loans, it is hardly surprising that their trust in other people increased marginally. It’s comparable to discovering that people’s trust in parachutes increases after their first skydive. And let’s not exaggerate the impact – it grew marginally.
  • The measure “participates in financial decisions” is a mysterious one. It went up, but this is hardly surprising – the clients took out loans. That’s at least one financial decision they participated in. Footnote 29 clarifies: “the dependent variable… is a binary variable equal to one if the respondent participates in at least one of the household financial decisions…”
  • Much is made of the increase in the proportion of women who participated in a financial decision. The index grows from 97.5% to 98.3%. Great, it’s in the right direction. They rephrase the improvement as the number of people who have no say in financial decisions fell from 2.5% to 1.7%, which is technically true – it fell by a third. It just smells ever so slightly of trying to extract something positive out of the results. If none of the clients had ever won the national lottery before the RCT, and one client won the lottery during the trial, would that be described as an “infinite percent increase”?

Nonetheless, the conclusion to this sub-section entitled welfare is that “the results… paint a generally positive picture of the average impacts of expanded credit” (page 18). I would add “but they are generally pretty minimal and the typical client faces neither benefit nor loss, and the entire microfinance exercise appears to impact only a very small sub-set of clients, sometimes marginally positively, sometimes marginally negatively”. They wrap up this entire part of the paper on a positive note (page 18):

“Increasing access to microcredit increases borrowing” – Increasing access to cigarettes increases smoking.

“[But this increase] does not crowd-out other loans” – in fact it increases overall borrowing. First-time heroin users report similar findings. Over-indebtedness is already a serious potential problem in Mexico.

“Loans seem to be used both for investment – in particular for expanding previously existing businesses – and for risk management” – but relatively few of the clients had an existing business, the increase in asset purchases is minimal, income and expenses both increase while profit decreases. Risk management and income smoothing are often cited as benefits of microfinance, but forgive me if I am missing something here – where is the actual evidence of such benefits?

“there is evidence of positive average impacts on business size, avoiding fire sales, lack of depression, trust, and female decision making” – but all these results are generally marginal, and there are also a number of negative impacts, while the majority of tests (and who knows how many were performed but not published?) showed no impact either way.

“There is little evidence of negative average impacts” – this is probably the least biased conclusion one can arrive at. Microfinance doesn’t do much good, nor does it do much bad.

This latter point is really the crux of this case. I wonder if it would not simply have been easier to enrol the entire group in a lottery. A few decent winners funded by a large number of people who are unlikely to really notice the loss of $1. Some good and little harm, and a whole load easier than setting up a microfinance bank. Imagine an advertisement for a new (medicinal) drug: “mostly ineffective, helps a slim minority, kills very few”.

The final section of the paper…

…Adds little to the main findings, examining the variability of outcomes (outliers basically). I found only two interesting revelations.

“The results suggest that non-business owners use the loans to pay off more expensive debt, work less, and are happier for it” (page 23).

“The main takeaway is some, albeit far from overwhelming, evidence that some people fare worse when faced with expanded access to credit. Several of the sub-groups have more negative treatment effects than positive ones, with the patterns of results for those who are poorer or without prior use of formal credit access perhaps the most eye-opening” (page 27).

Yes – read that sentence again – it’s the most vulnerable people who seem to be the most likely to suffer. I thought those were the ones we were meant to be helping? And bear in mind that Compartamos doesn’t generally lend to the very poor, i.e. this sub-set is quite small for Compartamos compared to some other institutions. And then we have their overall conclusion: despite all this evidence, “our study adds to the mounting evidence that microcredit is generally beneficial on average, but not necessarily transformative in the ways often advertised by practitioners, policymakers and donors”.

This final statement is awesome. I disagree with the first part of it – where is this mounting evidence that microcredit is generally beneficial? Perhaps, debatably, if microsavings and microinsurance are included, we could possibly say there is some evidence that microfinance is generally beneficial, at a push, but microcredit? No, I cannot agree with the authors, either in general terms, or based on the findings they themselves present. “Mediocre at best” is a fairer generalisation. But they poignantly observe that the sector is hyped – that those behind the phenomenon of microcredit have falsely advertised it. This is a finding I wholeheartedly agree with.

Who are the real beneficiaries?

According to the MixMarket data for Compartamos for the years 2011 and 2012 gross loan portfolio grew from $840m to $1.1bn, as client numbers increased from 2.234.440 to 2.495.028. Stated yield on portfolio (excluding impact of forced savings and VAT) declined marginally from 73.11% to 71.38%. Net profit after taxes also declined from $167m to $156m. This equates to a net profit of $65 per client over the year based on the average number of clients. To put this in context, this equates to a little over $1m in profit per year for Compartamos and its investors simply from the sample of clients used in this study (16.560).

PAR30, the standard industry measure for portfolio quality, worsened from 3.86% to 4.44% (an increase of 15% in one year). However, the PAR90 (loans delinquent over 90 days) increased from 2.48% to 2.64% – these are the clients who are reported to the credit bureau and handed over to a debt collection agency. This is lower than the numbers suggested in the paper, but we must also consider written-off portfolio. In 2011 Compartamos wrote-off 2.91% of its portfolio, increasing to 4.19% by 2012 (an increase of 44%, equivalent to 1 in every 24 clients).

The return on equity also declined from 33.62% to 30.5%. However, as Chuck Waterfield explains in wonderful detail, this is historically low for Compartamos. The 10-year average ROE was 53%. “Compartamos investors made a 300-to-1 return on their 7 year the day of the 2007 IPO”. Waterfield proposes an ROE in excess of 25% is in the “red-zone”. Compartamos is well within this red-zone. Shareholders certainly benefit from these activities. According to Dan Rozas, “the profits of Mexican MFIs are among the highest anywhere. This is particularly highlighted by Compartamos, which has held the title of the single most profitable large commercial MFI in the world for five of the past six years.  At nearly $100 million, its annual dividend payment to investors is larger than the balance sheets of most MFIs.” And let’s not forget the $2m total package to the CEO of Accion at the time of the IPO – Maria Otero, before she shuffled through that most magnificent of revolving doors straight into the White House.

In a nutshell: investors in Compartamos make very substantial profit. Finding any benefit accruing to Compartamos clients is like finding a needle in a haystack, and as this paper demonstrates, it is possibly easier to focus on the lack of harm to clients rather than search desperately for any trivial benefit they may enjoy. Once again, the rich enjoy a feast while the poor scrape around for the crumbs under the table. Welcome to Compartamos.

Conclusion

This is an important, well-written paper. Despite every effort to paint a positive picture, the results of microcredit’s impact on poverty are a little disappointing. It would be interesting to repeat the analysis in a country such as Ecuador where interest rates are capped at 30.5%. Presumably this might leave a little more profit in the hands of the poor rather than the banks and their shareholders, and lead to some more positive results.

The paper is powerful and thought-provoking, but one must read it thoroughly and not be convinced by the upbeat abstract. I didn’t expect many positive results from Compartamos, but the lack of substantial harm is good news, as more ethical institutions could actually be doing some mild good. But is +/- 2 years really enough to capture the actual impact of microcredit upon the poor, either positively or negatively? And one must acknowledge that the design of the RCT (reasonably) obliged the authors to examine a relative un-saturated region of Mexico, where the detrimental impact of over-indebtedness is perhaps less prevalent. Had the authors examined Chiapas the results may have been radically different. See the quote below from Dan Rozas’s excellent paper on a potential looming crisis in Chiapas, at the extreme other end of the country to that studied by Karlan et al.

“In Chiapas, Mexico’s poorest state of 5 million, there are some 40 MFIs operating. Multiple borrowing is rampant, with the average urban client in the state carrying 4-5 loans, while clients with as many as 7 loans are not unheard of… The average microfinance loan size is 3.2% of per-capita GNI, but in impoverished Chiapas, that’s 8.0% of the state’s per capita income. Very roughly speaking, that translates to liabilities of at least 32% of a theoretical client’s annual income owed in short-term loans… By comparison, loan sizes in Andhra Pradesh in 2010 were 11.5% of per capita GNI, while the rate of multiple borrowing in Chiapas is as bad or worse than was the case in Andhra Pradesh. Moreover, prevailing interest rates in Mexico are some 2-3 times higher than in India, which puts far greater stress on the clients’ repayment capacity for the same amount of debt. Put together, these figures imply that the bubble in Chiapas is worse than was the case in Andhra Pradesh on the eve of the crisis.”

So, I have one niggling question about this paper. Despite the evidence presented being so mediocre in terms of the impact of microcredit, why is there an on-going positive spin throughout? The two seem at odds with one another. Naturally no explanation for this is to be found in the paper, but Reuters may provide the answer. In an article by Paige Gance, Karlan (the key author) is quoted as saying:

“Investors should be quite happy and sleep better at night knowing they’re making money and making the world a better place”.

I am not sure if I, as an investor in microfinance, would be particularly happy with these results. Some investors in Compartamos certainly made a lot of money, but does this paper describe a better world? But here, perhaps, lies the clue – the Holy Grail of the microfinance community is not necessarily to have a transformative impact on the lives of the poor, but to keep the investment dollars rolling in and to protect the (increasingly frail) reputation of microcredit. An entire industry has been created around the concept, and that encompasses not simply banks, but academics, rating agencies, investment management funds, consultants etc. Industry creation was the final justification for the existence of the microfinance sector in David Roodman’s book.

The moment the investors throw in the towel the whole pack of cards collapses. Perhaps this is why there are so many positive references to the impact of microfinance when the evidence suggests otherwise? Motivation is impossible to prove, but I ask any reader of the original paper two simple questions:

  1. “Don’t you just get this weird feeling that the authors are desperately trying to present the case for microfinance in any way possible?”
  2. “Are you convinced that indebting poor people at 110% APRs is making the world a better place?”

 

“Win Some Lose Some? Evidence from a Randomized Microcredit Program Placement Experiement by Compartamos Banco” by Manuela Angelucci, Dean Karlan & Jonathan Zinman, May 2013

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Disguised Mediocrity – the quest for POSITIVE impact results at Compartamos (summary)

[For the full review of this paper, click here]

An important recent paper written by distinguished academics examines the impact of loans upon a range of variables. The authors use a sophisticated Randomized Control Trial (RCT) methodology and data from the controversial Mexican Bank, Compartamos. This bank is (in)famous for high interest rates, an extremely profitable IPO in 2007, and high salaries and payouts to certain individuals.

The results are surprisingly gloomy. Despite every effort to paint a positive picture, perhaps their best summary is simply “some good and little harm”.

The analysis takes place over approximately 2 years, thus it is not clear that the long-term impact of indebting poor people (either positive or negative) will be visible over such a short time-span. I have a few questions about the details of the experiment, particularly regarding spill-over effects from borrowers to non-borrowers, and the absence of much discussion on client desertion and delinquency. However, the paper is certainly worth studying in detail, and the results are intriguing. I will summarise a selection here:

  • Interest rates charged are 110% APR, for 16 weeks, for an average loan of about $650.
  • Most clients are not to microentrepreneurs. The minimum requirement is simply that the client would like a loan.
  • Compartamos does not consider over-indebtedness data from the credit bureau important in the loan application process, but does report non-repaying clients to the bureau.
  • Apparently returns on micro enterprises are 200%, and yet when offered loans door-to-door, less than 1 in 5 clients took a loan from Compartamos. 30% of these did not take a repeat loan.
  • Taking a loan from Compartamos does not reduce loans taken from other sources, but quite the contrary – it encourages clients to take more loans from other institutions.
  • Taking a loan from Compartamos does not have any impact on loans taken from moneylenders, shedding doubt on the myth that microfinance replaces borrowings from moneylenders.
  • Borrowers’ satisfaction with access to financial services does not change following a loan with Compartamos, although they are less likely to join informal savings groups.
  • There is no notable difference in impact upon those with or without a business.
  • Loans did encourage clients to grow their businesses (when they had one), but the increase was marginal.
  • Loans did not prompt any job creation. They increased business revenues, but also expenses. The net impact on profit was actually negative. There is a very slight improvement in the likelihood of a borrower facing a financial problem (in support of the income smoothing debate for microcredit), but it is not statistically significant.
  • A few clients demonstrated a reduced tendency to have to sell assets to repay a loan. But equally they found no evidence that clients used loans to buy assets, thus the iconic use of a microfinance loan to acquire a goat or sewing machine seems challenged.
  • There is no evidence that consumption of household groceries or expenses on family events increases as a result of borrowing. There is a minor increase in school and medical expenses, but they are not statistically significant. Borrowers spent less on “temptation” goods, but these excluded junk food despite the obesity crisis in Mexico.
  • They examine the impact on various “soft” variables, such as happiness, stress, health, trust in institutions etc. Most results are not significant. Of those that are, there is evidence that credit reduces depression, increases trust in people (but not in institutions), and improves participation in decision-making.

The authors optimistically interpret this in a positive fashion, suggesting that microcredit leads to “some good and little harm” (abstract & page 3). “There is evidence of both increased investment and improved consumption smoothing” (page 3). “Happiness, trust in others, and female intra-household decision power also increase” (page 3). “Overall we do not find strong evidence that the credit expansion creates large numbers of ‘losers’ as well as winners” (page 29).

My principal criticism of this otherwise decent paper is that I was left with an overwhelming suspicion that every effort was made to extract something positive from the data, while brushing over the rather disturbing negative impacts. “Mediocre”, or “disappointing” would be the adjectives I would use to describe their findings. However much lipstick one applies to a pig, it is still a pig. However, towards the end of the paper the authors announce that:

“The main takeaway is some, albeit far from overwhelming, evidence that some people fare worse when faced with expanded access to credit. Several of the sub-groups have more negative treatment effects than positive ones, with the patterns of results for those who are poorer or without prior use of formal credit access perhaps the most eye-opening”. (page 27)

Thus it appears the most vulnerable are the most likely to suffer.

I then place the analysis in context, first by examining the astonishing profitability of Compartamos, identifying the real beneficiaries of the operation (certain individuals and the shareholders, thanks to the high interest rates charged), and reviewing some of the criticism of MFIs charging these rates at such levels of profitability. I then wonder how the results may differ were the analysis carried out in a country where such interest rates are considered exploitative, or were the analysis performed for a longer time-period. Finally, I refer to Dan Rozas’s excellent work on a looming crisis in Chiapas, at the extreme other end of Mexico. It appears the authors of the main paper have selected one of the comparatively more wealthy regions of Mexico suffering the least from over-indebtedness, and in fact the problem may be far worse in other regions.

I end the paper with a quote from one of the authors that may shed light on why such mediocre evidence is interspersed with such positive dialogue:

“Investors should be quite happy and sleep better at night knowing they’re making money and making the world a better place”.

A constant stream of (profitable) poor people is guaranteed for many years, the bottleneck in microfinance is the flow of investors. I speculate that this may be the motivation for the (at times almost desperate) attempt to extract anything positive from this dataset.

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(Critical) Microfinance Book Reviews

Introduction

A reading list produced by the Center for Financial Inclusion (aka Accion) was recently re-Tweeted. It is boldly entitled “5 Great Books About Microfinance and How the Poor Use Money”. The list is bizarre to anyone with a remote interest in actual microfinance research. It lists generally promotional, one-sided books preaching the miraculous benefits of indebting poor people. In no way does it represent a balanced reading list. It does, however, exclude some of the traditional “microfinance hype” books, such as those by Yunus, Counts, Robinson and Harris. Elizabeth Rhyne’s 2001 book is, of course, mentioned, and they kindly provide a photo and link to purchase this particular manifesto. It is presumably coincidence that Rhyne works at Accion. The list also excludes an industry-standard text: Portfolios of the Poor.

Acknowledging that some people may appreciate a more balanced view of microfinance, I have compiled a list of 13 books challenging the wisdom of microfinance. Ten of these were published since 2010, but I include three definitive texts prior to this period, demonstrating that concerns regarding microfinance had emerged as early as 2001.

I have followed the example of Accion and made no attempt to provide a balanced reading list, but I state so explicitly. However, in order to be as un-opinionated as possible, I list these in publication date order (newest first) and provide the Amazon.com book description, date, price (as of July 30th 2013) and the number of reviews. Where I know of other reviews I provide a link to these also.

I trust this will serve as a counter-balance to the hype that typifies the microfinance sector, and will empower people to discover the other side of the debate: microfinance is not a panacea, and by learning where we have failed we may have an opportunity to learn from prior mistakes and better serve the poor. Finally, I would ask readers of this list to provide comments, particularly if they are aware of other relevant books, reviews to the books listed, or merely to share their opinions of these texts.

Reviews

Governance across Borders – Transnational Fields and Transversal Themes

Philip Mader, Leonhard Dobusch & Sigrid Quack, April 2013, $5.82 (Kindle only)

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