Accepted in Small Enterprise Development. (June-September 2007, Special Issue Agricultural Finance)
Disabling microfinance for agricultural development?
A critical review of CGAP-IDB policies inspired by the Fondo de Desarrollo Local, Nicaragua
J. Bastiaensen & P. Marchetti[1]
Abstract
In 2005, the Fondo de Desarrollo Local gained the international IDB prize for the best non-regulated microfinance institution in Latin America. A year later, in2006, the Central American Bank for Economic Integration (BCIE) selected the FDL from 78 Central American microfinance institutions as the winner of its Award for Excellence in Microfinance Management. Itsleadership in the Latin American Rural Microfinance Association (FOROLAC), its exceptional outreach to rural producers and its development orientation, coupled to entrepreneurial viability and extraordinary sustainability, contributed to these recognitions. Nevertheless, analyzing the incentives and pressures emanating from the current mainstreaming microfinance paradigm, this article expresses deep concerns about the anti-rural and anti-agricultural bias of international microfinance policies and the negative effects that they engender for the further growth of microfinance for a more dynamic and socially inclusive agricultural development in Latin America.
Introduction
This article presents a critical analysis of current, mainstreaming policies in microfinance from the viewpoint of its contribution to rural and agricultural development. It departs from the experiences of the Fondo de Desarrollo Local (FDL) in Nicaragua.The FDL’s mission statement is to promote a more inclusive rural development strategy that reduces the current biases against peasant and small scale productive enterprises. It represents one of the most consolidated rural microfinance institutions of the Latin American continent; internationally heralded with prices of excellence in microfinance from the IADB, the BCIE and the Mixmarket. Despite this international recognition, the FDL experience illustrates that today’s dominant policies constitute rather a threat than a blessing for the kind of development-oriented, agricultural and rural investment finance that is represent. After briefly presenting the FDL, we first diagnose the financial system approach to microfinancein Nicaragua and than analyze its problematic features from an agricultural finance point of view.
1. Some stylized facts about the FDL
The FDL is a non-profit financial NGO with the aim to render financial services to small and medium, rural and urban entrepreneurs allowing them to access investment capital and enhance their living standards. Today, it is the largest, non-regulated microfinance institution of Nicaragua, serving 62,529 clients with a loan portfolio equivalent to US$ 45 million and an average loan of US$ 583 in 2006. In terms of financial performance, it ranks among the best in Nicaragua.Since 2003, Microfinanza Rating has systematically given it the highest possible rating for non-regulated institutions (A+).
What distinguishes the FDL from almost all of other large microfinance institutions is its significant agricultural focus. Operating allover the country, including remote rural areas, about 60% of its portfolio is in agriculture or livestock, with 87% of that in long term financing (more than 1 year). FDL offers avariety of financial products, including loans with tailor-made repayment schemes, combined short and long term loans, flexible credit lines and even experimental micro-leasing (irrigation equipment) and franchising arrangements (for bred cattle). Much of the portfolio finances risky capital investment in technically or commercially innovative activities of small and medium-sized agricultural enterprises. For poor clients, the interest rates applied to such loans are at least 11 percentage points cheaper than the average interest rate of FDL. Following a value chain approach, the FDL also articulates about half of its portfolio to complementary non-financial services through an alliance with its founder NGO Nitlapán as well as other partners, while maintaining full operational independence. More specifically, the FDL facilitates the access of its smaller clients to embedded technical and legal assistance and more interesting marketing outlets such a local supermarkets and export traders serving specific niches. Because of this emphasis on financing risky, investment capital tied to dynamic segments of potential rural growth, the FDL tries to realise a key function of a ‘full bank’. Instead of tying these risky loans mainly to ‘elite clients’ with proven entrepreneurial capacities –as in the case of established commercial banks- it distinguishes itself however by venturing into potential pathways out of poverty for poor clients. Obviously, it is precisely the overall lack of such venture capital for more innovative rural SME development strategies which causes the overall economic model to deepen inequality and exclusion. At present, neither private commercial banking, nor the mainstream of microfinance institutions seems to provide much of this kind of capital.
FDL uses a gamut of repayment strategies, such as joint liability contracts (for poor women), variations of the traditional rural system of co-guarantors (fiadores), as well as more conventional moveable and immovable collateral. The key explanation for its extraordinary repayment performance are the quality and characteristics of its field-level promoters, usually younger men and women from rural communities, with both a good knowledge of the popular economy and an excellent capacity to network with local clients and informants. This local embeddedness reduces the information gap and creates a realm of contract compliance and legitimacy of FDL with clear spill-over effects beyond financial transactions (Bastiaensen, 2000, 2002). All this gradually starts to articulate into a broader process of locally embedded institutional change promoting market integration, personal autonomy and contract culture, as well as better mutual cooperation and trust among peasant as well as non-peasant economic actors.
This strategy reflects the FDL commitment to team up with small agricultural producers in order to promote their participation in dynamichigher value activities which is a precondition for their survival as rural producers. Yet, despite the outstanding repayment rates and high staff productivity (330 clients per promoter in 2006), the FDL’s rural operations remain more costly than its urban ones. This implies that an entrepreneurial strategy exclusively aimed at profit maximization (and not just sustainability) would inevitably entail a significant reduction of the agricultural portfolio. In fact, the FDL has been transferring part of its profits in urban microfinance to its more expensive rural operations in order to guarantee acceptable, but still quite high average real rural interest rates of about 22% per year in the normal portfolios and (an even more subsidized) 14% in the development portfolio.
- The financial systems approach to microfinance in Nicaragua
The new version of CGAP’s so-called ‘pink book’ announces a new paradigm of microfinance: “The new vision recognizes that large-scale sustainable microfinance can be achieved only if financial services for the poor are integrated into overall financial systems.” Today’s perspective emphasizes that microfinance must mainstream, whether through the upgrading of microfinance institutions or the downscaling of commercial banks. Together with this change towards a ‘financial system view’ goes a gradual shift in the understanding of ‘microfinance’ and its role for “the poor”. Whereas the focus initially was on microcredit, today the need for a full range of financial services is emphasized (CGAP, 2004:1). This goes together with an increasing recognition that the impact of microcredit on the poor is much less evident than previously thought (Helms, 2006: 20).
Today’s donor and multilateral institutions strategies in Nicaragua are increasingly informed by the new financial systems paradigm. So does CGAP’s Country-level Effectiveness and Accountability Review (CLEAR) call for a “strategic commitment to financial systems development” by all actors (Flaming, et al, 2005). It diagnoses a vigorous, positive development of the microcredit sector, but criticizes inefficiencies, fragmentation and dispersion. Donors are condemned for financing a variety of earmarked, often agricultural microcredit initiatives (Flaming, et al, 2005:5). The report also denounces excessive concentration on credit. Finally, it is horrified by the possible return of a state-ledagricultural development bank which is much demanded, by producer organizations and politicians alike, given the deficient agricultural credit supply.
In terms of policy recommendations, CGAP calls for a coordinated effort to develop a diversified, more inclusive financial sector composed of regulated institutions offering afull range of financial services. Since there is apparently not much hope that commercial banks will downgrade and despite the recognition of the deficiencies of the current prudential regulation, the key strategy is to support “NGOs in their transformation into regulated financial intermediaries” (Flaming, et al. 2005:8-9). The report also cherishes donors, like the GTZ, the KfW, the IFC and the IADB, for their leadership and vision concerning such NGO transformation –see also below, Procredit bank- (Flaming, et al, 2005:8). Implicitly, this expresses a positive appreciation from the creation, mainstreaming and growth of the now regulated Procredit bank (see below). It also urges donors to stop dedicating earmarked funds for rural and agricultural finance and argues to concentrate international funding efforts into specialized agencies like the IFC and the Multilateral Investment Fund of the IDB (Flaming, et al, 2005:9; 15). This wouldcontribute to the alignment of donor effort with the financial system view and curtailwhat is viewed as uncoordinated and inappropriate initiatives of individual donors.
The application of these policy recommendations has resulted in a considerable flow of multilateral and bilateral public resources to microfinance institutions transforming into regulated for profit banks. An important beneficiary has been the CONFIA-Procredit bank, belonging to the German-European Procredit-network, initiated under the impulse of the German consultancy firm IPC and cooperating with pioneer microfinance organizations in several countries. Anno 2005, the Procredit holding represents 19 ‘microfinance’ banks worldwide, with a total of 213 million Euro loans granted (Procredit, 2006). The Procredit-holding is to a very large extent financed with equity capital from the German, Dutch and Belgian development cooperation budgets (Kfw, FMO, BIO) as well as the World Bank’s International Finance Cooperation (IFC). It has also amply benefited from additional loans at relatively low cost from these same sources. Despite considerable public and NGOownership, the Procredit Bank adopts a decisive for profit approach to microfinance, without however for that reason renouncing to claims of social impact.
Today as before, the Fondo de Desarrollo Local is also a target for the regulation strategy.
As early as 1996, the FDL was offered a cheap credit line of 15 US$ million at 1, 5 % (with a 10 year repayment period) as well as a US$ 2 million ‘encouragement’ grant to become one of the first regularized institutions in the continent, after the Bancosol in Bolivia. (This experience makes us wonder how new the so-called new financial system paradigm actually is.) Disregarding the prescription of its own rural finance strategy paper (IDB, 2001:18-9), IDB apparently did see little need to wait for adjustments to the Nicaragua regulatory framework before pushing the FDL (and others) towards regulation. Also in today’s practice of IDB and CGAP in Nicaragua, we can clearly see the same lack of worry about possible detrimental effects of deficient regulation on rural finance in sharp contrast with the strong concerns voiced in the case of interest rate ceilings intervening with the ‘free’ market (Helms, 2006:84).
- Critical analysis of the paradigm: its options, assumptions and consequences
Many aspects of the current ‘new paradigm’ are irresistible in the beauty of their simplicity. Who would indeed dare to disagree with the statement that we need more services, at a lower cost, for more people? Or, who would think of challenging the need to increase outreach for the poor? Yet, such all too general statements in actual fact hide more than they clarify. In fact, a number of quite debatable, but largely un-debated issues indeed emerge. Many of these issues explain why it would be highly problematic for institutions like the Fondo de Desarrollo Local to respond positively to the incentives for regulation without jeopardizing its social mission.
A full range of financial services
A first problem relates to what is implied with ‘a full range of financial services’. It is quite clear that the argument for a broader range of financial services beyond conventional microcredit does systematically stress financial instruments aimed at managing liquidity and risk. The observed shift away from microcredit also testifies to a discursive shift from a narrative of “the poor” as a group of could-be micro-entrepreneurs towards one where “the poor” are mainly in need of managing liquidity and risk in order to reduce their vulnerability. Gradually, access to financial services becomes attached to a ‘poverty alleviation’ approach, while ceasing to be a contribution to more ‘inclusive economic development’ through the strengthening of micro-, small and medium-sized businesses. Much less attention is therefore dedicated to longer term investment credit and access to risk capital, which is however also largely absent from current microcredit supply and which could allow poor capital-constrained entrepreneurs to engage in more substantial changes in their livelihood strategies. The CGAP country report on Nicaragua concedes that there is a problem with rural finance, particularly with this long-term credit needed to finance investment, but it immediately downplays this admission by adding that “the prevailing bias in favor of credit overwhelms the policy debate” (Flaming, et al, 2005:7) and by criticizing donors for having contributed to a credit-only and rural bias in Nicaragua. This emphasis on non credit services rather than investment related finance is obviously not just a location specific reaction to a typicalNicaraguan obsession with credit, but expresses a general bias of the new microfinance paradigm. This is one of the reasons why the FDL, being among the Latin American microfinance pioneers, has increasing difficulties to visualize its inspiration in the way its success is to become ‘mainstreamed’ and ‘scaled up’.
Impact of microfinance: finance plus
The current downplaying of the formerly heralded, positive impact of microcredit fits into this picture. Of course, the new and more realistic appreciation of the limited development impact of the typical microcredit loan is quite correct in itself. Without the strategic articulation of credit services to promising venues of popular economic development and often with complementary ‘embedded’ non-financial services one cannot expect credit-only to be a miraculous panacea. However, the ensuing conclusion that we should focus on non-credit financial services –besides direct subsidies for the ‘very poor’- is unjustified.We agree with the need for non-credit financial services but find it unacceptable as the only answer to the limitations of the common, short term microcredit loan.Today a significant part of the “rural poor” in Central America remain highly credit constrained (Boucher, et al., 2005:124). They are in need of full banks that are willing to take risks together with them in order to engage in more promising, innovative businesses that would allow them to grasp the opportunities of the global economy and break out of agricultural and rural stagnation. A related flaw of the dominant discourse is that it remains too much a ‘finance-only’ perspective, overlooking the need for a ‘finance plus’ approach that deliberately articulates financial services with complementary enabling development strategies, which are particularly important in the agricultural sector where innovation and market access are key to future perspectives. In particular, Latin American agricultural microfinance is characterized by a lack of coordination between non-financial and financial services, once the portfolio grows beyond one million dollars.
Rural finance and “rural finance”
Further limitations of the dominant market-based paradigm can be illustrated by a brief comparison between Procredit-Financiera Calpía in El Salvador, amply heralded as ‘good practice’ in rural finance (Navajas & Gonzalez-Vega, 2004; Nagarajan & Meyer, 2005), with the FDL. First of all, compared to Nicaragua and many other developing countries, the small and densely populated El Salvador hardly has any ‘real’, more distant rural areas. Even then, the rural portfolio of Calpía never represented more than 30% of the total portfolio(Navajas & Gonzalez-Vega, 2004), whereas in the FDL it reaches over 60%. In terms of financial products, the FDL has a substantial share of credit dedicated to (innovative) agriculture and cattle/dairy activities, whereas most of the Calpía portfolio is geared towards non-agricultural, often petty commercial and service activities. In 1999, the mean income of Calpia’s rural clients consisted of only 28% agricultural income (Jansen, 2004:12). Calpía’s agricultural loans mostly addressed working capital needs, whereas the FDL has a substantial share of longer term investment finance. It is not probable that the indicators of rural and agricultural outreach of Calpía have improved after becoming the regulated institution Procredit.In fact, Gonzalez-Vega, et al. (2004: 112) expressed strong concerns about a “rushed transformation” into a regulated financial institution.
The comparison illustrates that it is crucial to know in what directions, with what kind of perspectives for whom that we want to promote further expansion in financial markets. And, of course, related to that, where do multilateral and bilateral actors put the available public funds to support the desired developments? In the face of these questions, the comparison between FDL and Calpía/Procredit is also quite relevant, since the latter has amply benefited from multilateral and bilateral support in the name of poverty reduction, whereas the FDL for not wanting to transform itself into a regulated financial institution (see below) has benefited much less from access to cheap funds and additional equity capital.This largely undiscussed, implicit anti-rural bias in the policy priorities are of course highly debatable. Not in the least, because this anti-rural discrimination impacts negatively on the average costs of loans for rural and agricultural transformative investments. The lack of cheaper public funds makes itself particularly felt in agricultural finance since, as also stressed by Harper (2005), the existing agricultural investment opportunities generate less spectacular and more slowly maturing, even though –in terms of the formal economy- quite acceptable profits.