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This is part 1 of a 3-part installment from my brief visit to Mexico in October 2014. See: parts two and three. I’m on my way to Mexico, for what I hope to be the start of a deeper exploration of overindebtedness in the country. Data analysis an ocean away can be revealing, but there’s nothing like seeing the numbers come alive when visiting the field. First stop: Tapachula, Chiapas. Every analyst has his or her own approach. For me, I find it best to come with a number of hypotheses and then see to what extent reality reflects those initial preconceptions. I like to keep an open mind and am always willing to change my view. Still, having a pre-existing framework in mind helps structure field observations, especially when time is short. I’ve already shared my thoughts on multiple borrowing and overindebtedness in Mexico, but those go back a couple of months. Since then, I’ve spent a fair bit of time digging deeper into the data and comparing Mexico to what I’ve seen elsewhere (including finalizing a study of Moroccan MFIs during 2008-13, including how they dealt with substantial multiple borrowing during 2009). Based on this and earlier work, I’m putting down some of my hypotheses below. Hypothesis 1: The Mexican microfinance market reflects very deep penetration of a narrow slice of the population Some numbers: MIX Market has about 6.1 million active borrowers for Mexico in 2012. Adjusting for the multiple borrowing rates in the Finca study, this implies 2.2 million unique borrowers. Of those, about 75% are women. However, the MIX market doesn’t include several large MFIs (such as Banco Azteca) and even an even greater number of [<{"type":"media","view_mode":"media_large","fid":"1139","attributes":{"alt":"","class":"media-image","height":"351","style":"float: right; padding: 5px 0 5px 12px;","typeof":"foaf:image","width":"480"}}>]small ones. Then again, the Finca study probably excluded many of those small MFIs, because they don’t report to the credit bureau. So there is an undercount – I have no idea how large. Perhaps a factor of 2, perhaps less, probably not more. So I’ll go with 2, and assume there are 4.4 million unique borrowers, of whom 3.2 million are women. Those women are from among the poorest segments of Mexican society. After all, in Mexico where the average per capita income is over $10,000, a $400 loan just isn’t very much. Seems unlikely that anyone other than somebody very poor would bother with groups and all the baggage that comes with them, just to borrow $400 for 4 months, at a rate of some 100%. And indeed, from the World Bank Findex microdata (available as a Stata download here), we see an anomaly: 9% of women in the bottom quintile are borrowers, which is nearly double the level of women in the quintile directly above theirs, which in turn is higher than the middle quintile. This is in fact very unusual -- the trend in nearly all other countries is the opposite, with wealthier individuals consistently borrowing more than poorer ones. The average per capita income level in the bottom quintile in Mexico is $173, which is well above the finding from the Angelucci/Karlan study, which cites household income per adult at 1,571 pesos/month ($112). So I think we’re on reasonably firm ground in describing the population of Mexican microfinance clients as being women in the bottom income quintile (though really, this depends on how widely client incomes vary). And how large is that? Well, the bottom quintile would have 24 million people, of whom about 65% are ages 15-64. So about 16 million people, or 8 million women. From the analysis above, we have roughly 3.2 million unique women borrowers, or 40% of the target population. That’s drastically different from the 9% cited in Findex – a discrepancy that remains to be explained. But it does seem that the segment of microfinance borrowers is narrow indeed. What other signals might confirm if this hypothesis is true? There are a couple of signs to look for. One is particularly strong geographic concentration in poor regions. Hence the focus on Chiapas, the country’s poorest state. By extension, microfinance penetration in wealthier regions should be smaller. Another sign would be the diversity of products (i.e. how much above the $400 average?) offered by Mexican MFIs and also the diversity of incomes among the clients. If the dispersion of both figures is narrow, it would support the hypothesis. These are the data I’ll be looking into. Hypothesis 2: Overlending in Mexico can be sustained for a long time [<{"type":"media","view_mode":"media_large","fid":"1141","attributes":{"alt":"","class":"media-image","height":"242","style":"float: left; padding: 5px 12px 5px 0;","typeof":"foaf:image","width":"480"}}>]One of the key misunderstandings of bubbles is that they must pop relatively soon. In fact, they can last years. Let’s go back to that FINCA study. One interesting addition to its multiple borrowing figures was the addition of default rates for each category of borrower (Figure 2). The figures are so high as to be unbelievable. So, nearly 9 out of 10 borrowers holding 6+ loans are delinquent? And even 34% of borrowers holding just one loan are likewise delinquent? Were these figures truly reflective of the market in Mexico, we wouldn’t be talking about a credit bubble – this would already be a full-blown crisis. Indeed, the study itself questions the reliability these delinquency figures. As it happens, there’s a simple test for this. Consider the one-loan borrowers. They fall delinquent at a rate of almost exactly 1/3rd. If one were to throw a simple die, the chance of rolling a 5 or 6 would essentially be equivalent to the delinquency rate of these single-loan borrowers. So what would happen if one were to throw that die two times? Three times? Well, as it happens, figure 2 shows the odds of throwing a 5 or 6 at least once for each of the number of times the die is rolled. If you replace the die roll with the number of multiple loans held by the borrower, you could likewise compute the probability of default at each of the levels of multiple borrowing. It turns out that the probability of borrowers holding 2, 3 or more loans falling delinquent is essentially identical to the delinquency levels reported in the credit bureau data. The implication is that these delinquency figures have nothing at all to do with the added stress of holding multiple loans. Instead, it likely reflects a problem in how delinquency is reported to the credit bureau in the first place. This is a serious problem for the credit bureau and for Mexican MFIs, but it says little about overindebtedness. [<{"type":"media","view_mode":"media_large","fid":"1142","attributes":{"alt":"","class":"media-image","height":"252","style":"float: right; padding: 5px 0 5px 12px;","typeof":"foaf:image","width":"480"}}>]So it seems that multiple borrowers in Mexico aren’t really defaulting at a rate that’s any different from other borrowers. This is exactly as it should be. It’s what I found in the credit bureau data of Moroccan MFIs just before and after the 2009 crisis holds (IFC publication forthcoming). Simply put, even heavily indebted borrowers may perform at essentially “normal” levels – at least until the crisis hits. However, when the crisis comes, the whole edifice breaks down – in Morocco in 2009, multiple borrowers defaulted at levels far above those of single-loan borrowers, while borrowers holding 4+ loans defaulted at the rate of 60%. We saw the very same pattern in Bosnia, and for that matter, with US subprime borrowers. At heart, it is the bubble itself that sustains multiple borrowers. When stressed, they simply borrow more. In some cases they will default, and those defaults essentially serve as the escape valve for deeply overindebted clients. The steadily rising write-off rates in Mexico are likely signaling this very mechanism. These write-offs can be a way out for the most distressed borrowers, but at the broader level, they are the very process that allows the bubble to grow ever larger. Like a volcano, whose mini eruptions precede the big one, these are warning signs that one ignores at one’s own peril. [<{"type":"media","view_mode":"media_large","fid":"1150","attributes":{"alt":"","class":"media-image","height":"329","style":"float: left; padding: 5px 12px 5px 0;","typeof":"foaf:image","width":"480"}}>]So what other signs of a building bubble might one look for? The clearest would be a steadily growing loan/income ratio. Loans that steadily consume ever rising incomes is a telltale sign of a developing bubble. Finding such a trend would largely support my argument that loan amounts in Mexico are not too small for borrowers, though the thoughtful comments to the contrary are serious and should be considered. Unfortunately, this trend may not be so easy to capture. Another option is to look at trends in multiple borrowing itself. If my arguments on loan size were incorrect, what the data should show is a relatively clear dispersion, with some borrowers maintaining relatively large number of loans over time, while others hold a smaller number, reflecting their individual funding needs. One should also see changes in multiple borrowing that go both ways – sometimes borrowers would increase the number of outstanding loans, other times they would decrease. On the other hand, a steady increase in multiple borrowing across the board would be a sign of a growing bubble. Hypothesis 3: A strong shift in the perception of debt among individuals It’s very common for bubbles to build among people who are relatively new to debt, and social norms governing debt begin to loosen. There has been ample experience with this – in Ireland and Spain, the housing bubble featured a notable shift in home buying patterns. The ready availability of credit encouraged people to buy with far greater leverage and much less saving than had been the case with earlier generations. The same can be seen in the credit card bubble in Korea, which followed a sudden departure from earlier cultural norms that had eschewed borrowing. It is telling that one of the key warning signs in Bangladesh, where the 4 leading MFIs seemed to have successfully averted a crisis in 2007-08, was the fact that the MFIs were finding clients to be resistant to more loans. These were after all 2nd and 3rd generation clients, who had grown up with essentially the same microcredit products households and were well familiar with both their advantages and their risks. In Mexico, there’s no such historical depth with microcredit. An interesting indication would thus be to look for differences in how credit is perceived by older generations, and how they view the borrowing of their children and grandchildren. Hypothesis 4: Competition trumps coordination among MFIs A key lesson from the Morocco crisis was the rapid reaction of the leading MFIs, who worked together to address common issues, particularly with respect to sharing client data. This was a massive change for a market that featured very aggressive competition, with the two leading MFIs both vying to top the other in outreach and size. In Mexico, there is a credit bureau, but it isn’t required for many market participants, including some very large ones, like Micronegocio Azteca. It’s also critical that the coordination that does happen be more than just words, as was the case with Indian MFIs in the leadup to the crisis, when the newly-created MFIN was promoting the quite sensible Code of Conduct, while the leading MFIs, including SKS, were focused entirely on pursuing their IPOs. In the process, the focus on growth pushed aside any commitments to avoid client overindebtedness. The important question in Mexico today is whether the concerns about overindebtedness and long-term market sustainability go beyond words, and whether real, coordinated action among market leaders is taking place. By the same token, if aggressive competition and growth continues to be their primary driver, it would suggest that the sector is likely heading down the same path as the MFIs in India, Bosnia, Nicaragua, and elsewhere. Hypothesis 5: Regulators are “solving” problems by ignoring them In most microfinance crises, the response of the regulators came after the crisis had already manifested itself. The sole exception might be Morocco, where the regulators were already becoming involved in the sector for unrelated reasons, with supervisory visits starting to take place about a year prior to the crisis. This is one reasons why the Moroccan crisis was both less intense and shorter than any of the others. By contrast, the Reserve Bank of India was quite actively seeking to avoid any real supervision of Indian MFIs until their hand had been forced by the state government of Andhra Pradesh, whose actions had essentially stopped all microfinance activity in the state. For that matter, the subprime crisis in the US also followed a period of light regulation, with Alan Greenspan refusing to take any action to regulate the mortgage sector. If the regulators in Mexico start actively addressing the serious risks in the microfinance sector in the country, for example, by raising minimum capital requirements, expanding credit bureau reporting to all significant MFIs, conducting supervisory visits to the sector’s largest MFIs, and generally start looking seriously at a sector that affects Mexico’s poorest citizens, then that’d be a sign that the crisis may be avoided. If, on the other hand, they continue to deal with the problem by ignoring it, this will be yet another signal that the market is heading towards disaster. Setting the stage These five hypotheses form the core of my concerns over Mexico. Did I miss anything here? Certainly – this is hardly an exhaustive list. However, this is a way for me to set down a set of expectations in advance. I’ve also tried to highlight the types of factors that might suggest that the microfinance sector in Mexico isn’t overheated or is likely to achieve a “soft landing.” I will keep you posted. author: Daniel Rozas

author: Daniel Rozas

My latest post on the credit bubble in Mexico had one especially interesting comment. Jose Manuel asked to consider the loan sizes in the country as a factor that might explain the prevalence of multiple borrowing. The comment is highly relevant. What Jose Manuel suggests is that loans in Mexico are unusually small. And in a way, he is right. On a per capita GNI basis, Mexico's loans are smaller than in any other country. By contrast, India's loans are nearly three times larger.<1> This has two potential implications: first, small microfinance loans put less of a burden on Mexican borrower incomes, and second, their inadequate size encourages clients to borrow from multiple lenders in order to meet their requirements. And yet, I find that both implications are incorrect and that multiple borrowing levels in Mexico continue to point to a very large bubble. Multiple borrowing as sign of success It has been often noted by practitioners that microfinance loans are by design insufficient to meet the needs of some microentepreneurs. Indeed, SKS founder Vikram Akula argued this very point in his letter to the Wall Street Journal in August 2009 – a year before the Andhra Pradesh crisis. In addition to this well-accepted fact, Akula also cited a study conducted in Andhra Pradesh in 2007 that found clients with multiple loans having better repayment rates. Here is how I described this study, when warning of an oncoming crisis in Andhra Pradesh five years ago: The Krishnaswamy study found that multiple borrowers, representing 7-10% of clients in his sample, consisted primarily of highly motivated entrepreneurs seeking to raise more capital than what was offered by any one MFI. This is unsurprising – due to the nature of their cycle-based lending model, MFIs knowingly underfund their borrowers, thus assembling funds from multiple MFIs is a logical strategy that Krishnaswamy suggests is simply a replacement for the informal funding sources the individuals would have tapped otherwise. This is also consistent with the money management practices documented by Collins et. al. in Portfolios of the Poor. However, as the market heats up and multiple borrowing becomes increasingly widespread, the number of multiple borrowers grows beyond these stand-out individuals… On this point, I haven't changed my mind – it isn't multiple borrowing itself that concerns me, but rather, the channel through which it occurs. There is a subtle, yet enormous difference between a motivated entrepreneur seeking out additional capital for her business by soliciting multiple MFIs, and a borrower who takes on another loan that's actively – or even aggressively – pushed by a loan officer looking to meet his monthly bonus quota. In Mexico, I suspect there is a lot more of the latter than of the former. Market equilibrium So what about the loan size in Mexico? Recall that main reason why microfinance loans are often too small is that loan size is used as a way of establishing repayment history for clients who don't already have one. With each loan repaid on time, clients become eligible for a larger loan amount. But that figure doesn't increase forever – once credit history is established, repayment capacity becomes the limiting factor, and not necessarily how many prior loans the borrower may have had. This suggests that, as microfinance markets mature, the mechanism for setting loan amounts begins to look more like traditional retail lending. And so, driven by the laws of supply and demand, the loan size in established microfinance markets should arrive at an equilibrium. On the supply side, lenders would prefer to lend as much as their clients need, but not more than they are able to repay. After all, it takes roughly the same amount of effort to evaluate a client for a smaller loan as for a larger one, so larger loans should increase profits. For lenders, purposefully lending less than is tantamount to leaving free money on the table – an unlikely outcome for profit-driven institutions. On the demand side, borrowers face a similar dynamic. Each loan application and repayment process consumes time, expense, or both (e.g. sitting in group meetings, traveling to a branch), which normally borrowers would prefer to minimize. All else equal, borrowers would thus prefer fewer loans. The intersection of these two drivers – lenders seeking to maximize profits and borrowers seeking to minimize costs – would set the equilibrium loan size. Of course, microfinance isn't quite so simple. To this basic model, one should add a few adjustments. For some larger amounts, lenders may find funding the full amount to be excessively risky, even if the borrower's repayment capacity is not in doubt. In such cases, the lender may well expect the borrower to supplement the offered loan with loans from competing MFIs. On the borrower side, the inflexibility of microfinance disbursement and repayment cycles may lead clients to seek additional loans on top of their existing ones. And of course, there are the exceptional clients whose risk tolerance and business acumen prompts them to seek out funds than MFIs would normally be unwilling to provide. In short, some level of multiple borrowing is a natural feature in microfinance markets. The question is how much? It is here that comparisons to other markets are useful. After all, are Mexican borrowers so much more business-savvy or have so much more volatile incomes that they require a larger number of multiple loans to manage their funding needs? Likewise, are Mexican lenders really so extraordinarily risk averse that they make it standard practice to give away the extra profit they could receive by lending larger amounts, and instead expect their clients to go borrow more from competing MFIs? Indeed, what reason is there to think that the market equilibrium for loan sizes in Mexico is governed by rules that are so vastly divergent from everywhere else? So why are loans in Mexico small? If the above theory is right, the answer should be that Mexican loans aren't big or small – they're exactly right for their market. So why do they seem small? Consider first the per capita GDP ratio (or its close cousin, GNI, preferred by MIX Market). At first glance, it seems a reasonable proxy for comparing the levels of client indebtedness. But it's not. First, the per capita GNI comparison is normally used as an indicator for depth of outreach – how poor are the clients of the MFI? By that argument, the figures in Mexico imply that the country's MFIs serve clients who are substantially poorer than the average Mexican. As it happens, there is some data that helps to get a sense of comparison. According to the Banerjee/Duflo study in Andhra Pradesh, the average household income consumption for MFI clients in 2010 was 11,497 Rs/month, which translates to 68% of India's per capita GNI that year. Meanwhile, the Angelucci/Karlan study of Compartamos cites household income per adult at 1,571 pesos/month, which translates to 17% of Mexico's per capita GNI.<2> Thus, in the relative terms of per capita GNI, the typical microfinance borrower in Mexico is four times poorer than her counterpart in Andhra Pradesh. Clearly, using per capita GDP (or GNI) as a proxy for loan size relative to borrower incomes vastly overstates the incomes of typical microfinance clients in Mexico. Interest rates, again… The other major reason why Mexican loans may seem small is that what's being measured is the loan amount, which is not at all the same as the total obligation undertaken by the borrower. With an average portfolio yield of 82.3%, Mexican loans are unusually expensive – more than three times the average yield of 26.6% for MFIs worldwide in 2012 or the yields in India and Bosnia during their market peaks (25% and 24%, respectively).<3> The impact of such differences on client cash flows is quite dramatic – a client holding 4 loans with an 80% interest rate faces a total payment obligation that's nearly the same as a client with 6 loans at 25% interest. The stress on borrower cash flows in Mexico is thus much larger than the loan amount alone would indicate. Back to the bubble Thus far, the high prevalence of multiple loans in Mexico has been my primary indicator of a microfinance bubble in Mexico. I recognize that for any single client, multiple loans are a poor indicator of repayment capacity – exceptional entrepreneurs or individuals with particularly volatile incomes may well need multiple loans to meet their needs. The question is not whether any one client has multiple loans, but whether their overall prevalence in the market indicates overheating. I've tried to show that the size of the loans in Mexico does not imply less financial stress on borrowers or a higher propensity to take on multiple loans. Ultimately, their size is governed by the same laws of supply and demand, whose equilibrium is unlikely to differ much from other markets. If we accept that the figures for multiple borrowing at market peaks in Bosnia and Andhra Pradesh reflect the limits of those markets' credit capacity, and we observe that multiple lending in Mexico is far above those levels, then we should also recognize that Mexican microfinance has likewise exceeded its credit capacity, and what we're in fact seeing is a very large bubble. <1> Weighted average loan size = 3.9% of per capita GNI in Mexico, and 11.0% in India. For each MFI, loans weighted by number of active borrowers. Source: MIX Market 2012 data. <2> For India, average number of adults in survey household was 4, so assuming that all income is consumed, per adult income is calculated at 2,874 Rs/month. GNI per capita is expressed in current USD (Atlas method), i.e. not adjusted for purchasing power parity, so as to be consistent with loan sizes, which likewise aren't adjusted by PPP. There may be some differences in foreign exchange rates used to express loan size in USD (Oanda.com, 12/31/2010 for both countries), which may not fully correspond to the World Bank Atlas method. The samples in the Hyderabad and Compartamos studies should not be taken as representative of microfinance clients in either country (for example, Hyderabad is relatively wealthy, as are the areas surveyed in Mexico); however, the data is sufficient to demonstrate that Mexican client incomes are substantially smaller than the country's per capita GNI than is the case for Indian clients. <3> MIX Market 2012 author: Daniel Rozas

Last week, as its football team was preparing for its match with the Netherlands, Mexico hosted the International Forum for Financial Inclusion. It was an important event, opened by the President of Mexico, Enrique Peña Nieto, and attended by such notables as Christine Lagarde. By all accounts, it was an excellent meeting where representatives of financial regulators from around the world shared their experiences and strategies to promote financial inclusion in their countries. But one thing stood out. During his speech, Jaime González Aguade, President of the Comisión Nacional Bancaria y de Valores (agency in charge of regulating Mexico's financial sector) stated: #Mexico's emergence as global leader in #financialinclusion evident: http://t.co/C5rA5qMQXt @GonzalezAguade @cnbvmx pic.twitter.com/IOuGnxJXrV — AFI (@NewsAFI) July 2, 2014 I have no reason to dispute his assertion. But one has to wonder — how should this leadership be reconciled with the high rates of overindebtedness among the country's microfinance clients? And when the bubble bursts, might it not undermine the very efforts to expand financial inclusion that Mexico is promoting? author: Daniel Rozas

Last week, MFIN, received official recognition from the Reserve Bank of India as a Self-Regulatory Organization in charge of regulating the activities of its members. This is the first time a financial organization received such official recognition in the country. Indeed, I'm not aware of any other countries that have a similar arrangement, so this may well be a global milestone as well. This is a big deal that bodes well for the future development of the Indian microfinance sector. It also reminded me of an article co-authored by M-CRIL's Sanjay Sinha and myself back in January 2010, nearly a year before the onslought of the Andhra Pradesh crisis. MFIN had been formed just months before, and had developed a Code of Conduct that included many important features, including strong limits to multiple lending - a maximum of 3 concurrent loans or combined amount of 50,000 rupees (~€750 at the time). However, we felt that as a purely self-regulatory institution, MFIN lacked the teeth to effectively monitor its members, and we made the case for a system quite similar to the one that's just been implemented in India. I look forward to seeing it thrive and set an example for others. Here's an excerpt from the original article: We welcome the efforts of the leading MFIs and hope the overlending limits they will be implemented quickly. However, we are somewhat concerned about the long-term viability of the framework that is being set up. Self-regulation is notoriously difficult and fickle. Current market conditions certainly create incentives for leading MFIs to comply with MFIN’s standards, but situations change quickly and memories fade fast, while the business imperatives to maintain or grow market share never let up. How will MFIN monitor its members? What enforcement mechanisms will it have to insure adherence, and will these include exposing offenders – a threat that is essential for compliance? And what happens when outside actors, not bound by its rules, begin to chomp at MFIN members’ market shares? It may seem an unreasonable concern, as MFIN currently represents the overwhelming majority of the microfinance market in India, but that may not be the case for very long. Let’s remember that it was the growing market share of new actors in the US mortgage market – Bear Stearns, Lehman Brothers and others – that undermined long-established industry underwriting practices, causing a downward market shift that helped feed the housing bubble. These are questions not unique to MFIN, but that apply to any self-regulatory body where the nature of regulation comes into direct conflict with near-term business imperatives. As a rule, such structures can easily lose their teeth once clearly visible risks sink back under the surface. Moreover, what makes MFIN’s work particularly difficult is that its present objective – to prevent overlending – is a long-term one. Much like the assets and liabilities of MFIs, the impetus and purpose of self-regulation must also be matched; otherwise enforcement can prove especially difficult. That is the reason why most financial regulation is after all done by government. Certainly, we don’t want to suggest that MFIN’s efforts should be supplanted by the Reserve Bank of India (RBI) or another government entity, as it would effectively slow the necessary learning and innovation needed to implement such regulation. However, there is a middle ground – RBI, which already oversees the NBFC MFIs that comprise MFIN, could promulgate general objectives (such as limiting overlending) and delegate to MFIN the formulation and implementation of the regulatory policies required to meet them, reserving the right to withdraw this delegation if it deems necessary. By doing so, it would retain the critically important threat of government action, thus giving lasting teeth to the self-regulatory body. At the same time, it would foster more rapid development, better innovation and ultimately more effective regulations than it could develop on its own. Moreover, with such official imprimatur, MFIN’s standards could also become legitimate requirements for all MFIs, not just its members or other NBFCs. We recognize that this would represent a significant departure from the normal regulatory practices of RBI, but microfinance is not a normal financial market, and is very much in need of effective, innovative regulations that at present only the market participants themselves could devise and implement quickly enough to avoid the pitfalls of further overlending. author: Daniel Rozas

Or the more things change, the more they stay the same... Sometimes it seems as though there is no shortage of proverbs when it comes to looking at the seemingly inevitable credit business cycle. In my last blog I took a look at the unprecedented stability of the US banking sector during the 50 years following the Great Depression. Recent news from Mexico – in the form of a study by the Microfinance CEO Working Group – shows just how far away we're from that world. There's much to say about that study, and also the Working Group itself, which deserves credit for the willingness to publicly share the data, no matter how distressing the findings might be. And yes, they are distressing. If there's one thing to take away from the study, it's this chart: [<{"type":"media","view_mode":"media_large","fid":"980","attributes":{"alt":"","class":"media-image","height":"248","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"480"}}>] What this shows is that a large majority (74%) of applicants for a microfinance loan have at least one loan already outstanding. Put another way, if this group of loan applicants is representative of microfinance clients in Mexico, that means 45% of all microfinance clients have 3 or more loans – a figure that is without precedent in the microfinance sector. Consider the below comparison: [<{"type":"media","view_mode":"media_large","fid":"981","attributes":{"alt":"","class":"media-image","height":"239","typeof":"foaf:image","width":"480"}}>] Sources: Mexico; Bosnia: EFSE; AP: Rozas/Krishnaswamy; Cambodia The distribution of multiple loans above includes figures just prior or during major repayment crises in Andhra Pradesh and Bosnia, respectively. By comparison, Cambodia was a market where three microfinance investment managers (Incofin, BlueOrchard and Oikocredit) were sufficiently concerned about the risks of overindebtedness that they conducted a detailed borrower survey. Next to these three markets, Mexico is in a league of its own. The number of clients holding 5+ loans is double that of Bosnia. The numbers are also consistent with observations from the ground (see here, for example). For reasons I reviewed already a year ago, Mexico worries me deeply. Its potential to damage the reputation of the microfinance sector is greater than that of Andhra Pradesh. The fact that little seems to have been done since then worries me even more. Set aside for the moment the finding about arrears, which are so extraordinarily high as to be essentially unbelievable. In effect, they imply that 59% of existing microfinance clients in Mexico have at least one loan in arrears. Were this in any way comparable to traditional PAR30 figures, this would already constitute a repayment crisis. The rest of the data in Mexico suggest that they're probably not true, and the authors do raise serious questions about the reliability of repayment data in the study. But there's no reason to believe the data on multiple borrowing to be faulty, in which case microfinance lenders in Mexico (along with the many competing consumer lenders and others) are literally on the brink. When will the sector collapse? I don't know. One never can say for sure. There's even a chance it might not collapse. But maintaining the status quo, let alone continuing to grow the sector in this situation, is tantamount to sitting in a boat half-filled with water. It may float for now, but even a minor wave will capsize it. The Microfinance CEO Working Group has correctly called upon the regulators in Mexico to take charge. They are absolutely correct in doing so, and I cannot stress enough the urgency of the situation. Every passing month not only increases the chance of crisis, it also reinforces complacency. After all – doesn't the fact that the boat is floating prove its seaworthiness? Maybe things aren't so serious after all? Nothing could be more foolhardy. We've seen this movie many times before. Remember 2006? Persons no less esteemed than Alan Greenspan argued then that the mortgage bubble in the US either did not exist or at least did not pose a serious problem. Didn’t we see this in Iceland, Ireland, Spain? In 2009, a year before the crisis in Andhra Pradesh, Indian MFIs were more aware, at least publicly so. The then-formed Indian MFI association MFIN had put forth a Code of Conduct to limit overlending, and also embarked on an effort to create a credit bureau. Though some certainly meant it seriously, for too many, the effort was but an exercise in PR. Just months after SKS, the leading MFI in the country and the largest member of MFIN, had signed on to the Code of Conduct, it rolled out an incentives scheme (literally called "Incentives Galore"!), under which one loan officer signed up 273 new groups in a single month – 1365 new clients. Anyone with the most passing knowledge of microfinance would find that number appaling. It is. It also demonstrates how efforts to avoid a crisis through self-policing can't work in competitive markets that are already oversaturated. Mexico is no exception. There is only one case I know where such efforts have succeeded – in Bangladesh, where the 4 leading MFIs seemed to have successfully averted a crisis in 2007-08. However, the characteristics of the market in Mexico make such an outcome not only unlikely, but downright impossible. Certainly not with its very high interest rates, a highly diverse market of thousands of MFIs and consumer lenders, a microfinance sector with no prior experience in crisis management, and borrowers who are relatively new to microfinance (certainly compared to Bangladesh, where MFIs are now serving their 3rd generation of clients). Speedy and effective action by the regulator is an absolute necessity. Should it fail, the industry – and most importantly, the clients – will suffer greatly. But at this stage, the onus will fall on the public authorities that stood by and watched it all happen. They have been forewarned. author: Daniel Rozas

Recently, I was reading the Economist and came across Charles Keating's obituary. That name means little to most readers outside the US, but for me it reminded of an idea that's been percolating in my mind for quite some time now: while rich countries offer valuable lessons for microfinance regulation, those lessons alone won't be enough. You see, Charles Keating was the poster-child of the Savings & Loan Crisis during the late-1980s, which saw the collapse of many of these small banks across the US, ending an unprecedented 50-year period of stability in the US banking sector. From today's vantage point, that period is also difficult to understand. After all, it took less than 20 years to go from the S&L crisis to the much larger collapse in 2008 (don't let the graph mislead – S&Ls were typically small banks, so while the failures were many, their impact on the broader economy was far smaller). What was behind this period of stability? It wasn't the economy, which though growing nicely, still saw plenty of recessions, including some serious ones in the mid-70s and early 80s. It wasn't the Bretton Woods system, which was abandoned more than 15 years earlier. There is however, one factor that almost perfectly parallels this 50-year period: banking regulation. The banking regulations in place as late as 1980 had not changed much since the 1933 Banking Act, which itself was introduced in response to a catastrophic bank failure during the Great Depression. Banks were constrained in both the type of loans they could make and the type of deposits they could offer. The system came to be encapsulated in the so-called 3-6-3 rule of banking: borrow at 3%, lend at 6%, be at the golf course by 3pm. As all jokes go, it's a gross oversimplification, but it's also a reflection of reality. After all, such a description would make no sense at all in today's banking system. Starting in 1980, a series of laws started significantly eroding that process. These included loosening restrictions on the types of assets S&Ls could invest in. The resulting plunge into high-risk assets (real estate, junk bonds, and other mostly commercial investments) took only a few years to lead to a full-blown collapse of the industry. So how is this historical episode relevant to microfinance? On the positive side, it demonstrates that despite recent experience, banking regulation can work. Because bank runs had been eliminated by the introduction of deposit guarantees, since 1933, there was really one way for banks to fail en masse: by making bad investments. In the S&L crisis these tended towards the commercial side, but in 2008, the fault lay very much with bad loans to consumers, particularly mortgages. And bad loans to consumers hurt the borrowers as much or more than the banks. So the regulations in place during the 50-year period of stability largely meant that people also weren't being overindebted through excessive lending by banks. But there is a catch. The regulation in place at the time was highly repressive, offering little room for innovation in banking services. In the developed economy of the US, where access to finance was not a high concern, having a static banking sector was almost certainly a price worth paying in return for stability (needless to say, the economy certainly didn't suffer!). But for developing countries, where access to finance is low, that tradeoff is much less clear. Repressive regulations in such a context might bring stability, but it would also maintain a status quo where the majority of the population continue to be excluded. That means continuing use of informal services that cost more and offer less, especially with respect to security. Shady operators and scammers offering "investments" or "deposits" will continue to bilk the most vulnerable out of their hard-earned money. So where does that leave microfinance? Must we accept a volatile sector and the risk of overindebtedness as an unavoidable cost of greater financial inclusion? I don't believe so. The key lies in being able to recognize overheating markets and cool them before they crash. Over the past year, I've become convinced that this could be done with a tool like MIMOSA, which highlights markets that show signs of excessive credit and overheating. Its standardized system of scoring makes it more difficult to explain away signs of overheating, and make it easier for regulators to put in place controls to slow down the sector. And for that reason, my collaborators and I have been working hard to take MIMOSA to the next level, making it sufficiently reliable that it could become the technical guide for strategic decisions on a country's financial system. Armed with such a tool, no longer would we have to choose between stability and financial inclusion. I hope we can get there. author: Daniel Rozas

A recent article by the Economist hails a study in Bangladesh by Shahidur Khandker as "the biggest study so far finds that microcredit helps the poor after all." Within the sector, the article has been widely circulated as proof that, indeed, microfinance does work. Rupert Scofield, CEO of FINCA, found vindication that this study finally resolved the problems of earlier randomized control trial (RCT) studies, which had found that microloans had zero impact on clients: The recent short-term studies were undertaken in highly saturated markets and focused on clients who diverted some or even all of their loans into consumption. Microcredit works best when the client uses it to fund a business. But there's the danger of jumping to early conclusions. Before considering the Khandker study, it's worth addressing the way Scofield seeks to explain away the RCTs by referring to "highly saturated markets" and "clients who divert loans to consumption." First, Scofield errs by suggesting that the RCTs (assuming here he means the Banerjee/Duflo 2009 study in Hyderabad and others) were undertaken in highly saturated markets, thus implying that Bangladesh is somehow less saturated. On the contrary, Bangladesh is the most saturated market of all. Even the Khandker study repeatedly discusses widespread multiple borrowing among the surveyed households. While we all have the image of the microfinance bubble in Andhra Pradesh in 2010, it's worth remembering that at the time of Duflo's study, during 2006-08, it was significantly less saturated, probably less than Bangladesh anytime in the past decade. And Duflo's study is by no means the only one. I am sure that Scofield would not suggest that Karlan's RCT study in Manila in 2006-08 (which found much the same thing as Duflo) was conducted in a market more saturated than Bangladesh. As for the diversion of loans to consumption, is there anything in Khandker's study to suggest that the households he surveyed did NOT divert their funds to consumption? Why would we assume that these clients are any different from those in India or Philippines? I find no basis for this. Scofield does have a point about the relatively short timeframe of the RCTs, though I don't find them quite so short, given that they spanned one full loan cycle or more. So what about the Khandker study itself? Here, I must once again go to the authority, David Roodman: The article appears to commit what Dierdre McCloskey and Stephen Ziliak dub the “standard error of regressions,” which is to confuse statistical significance with real-world significance. Statistical significance, as meant here, is the certainty that the impact of microcredit is not zero. Real-world significance is whether the effect is big enough to matter. “A 10% increase in men’s borrowing raises household spending by 0.04%….Borrowing by women pushes up household spending by one and a half times as much.” Let’s see…because of compounding, seven 10% increases would about suffice to about double borrowing. So doubling female borrowing will lift household spending by 7 * 0.04% * 1.5 = 0.42%. To me, that seems small—about a sixth of the impact found in the first study of these families. Indeed, 0.42%. That's what's being hailed here as proof of success. Let's put this in perspective. Let's say you are a middle-class family earning €50,000/year. Would you want to double your debt in return for an extra €210? No, probably not. Neither would Scofield. In the two client examples he gives, we don't see a benefit of 0.42%. Both are standout clients. One has actually gone on to build a million-dollar business. They are the equivalent of those two kids you knew in high school, one of whom went on to become a successful lawyer and another a billionaire hedge fund manager. And as with the high school curricula, I doubt that FINCA's lending programs are oriented to those two success stories. No, they quite rightly aim to serve the average person, which is what microfinance should be all about. The need for quality financial services – savings, credit, insurance – is enormous. And so far, we've barely made a dent. I reject microfinance as the story of rags to riches. As financial providers, we're in no position to be selling tickets out of poverty. Rather, we should focus on providing everyday people who are excluded from the financial system with the products they need, and doing so responsibly. When some clients do extraordinarily well, we should celebrate them, not us. When others make mistakes or suffer bad luck, we should try to mitigate their situations as best we can. But above all, we should focus on those in the middle, and try to make their lives just a tad easier and help them lay the foundation for the next generation. That should be the measure of success. author: Daniel Rozas

As the microfinance industry has grown, there has been an increasing focus on the non-financial impacts that microfinance institutions (MFIs) can have. While the industry developed to tackle socio-economic issues through providing access to finance, its impressive growth led to increasing evaluation of MFIs potential social and environmental impacts. As a result, MFIs are increasingly expected to consider a broader spectrum of issues in their operations. As important organisations at the forefront of business within many emerging economies, MFIs can be important catalysts for environmentally and socially sustainable growth. Despite the small size of many MFIs, their capacity for direct impact on local environmental and social issues can be significant. However it must also be recognized that pursuing initiatives that are not 'core business' is likely to be a challenge given MFIs often-limited resources. The development of appropriate mechanisms that encourage MFIs, and more broadly, SMEs (Small & Medium Enterprises) in emerging economies to adopt improved environmental and social practices is important. In light of this, we are excited to be working with the European Microfinance Platform to develop the evaluation metrics for the upcoming European Microfinance Award: Microfinance and Environment.<1> This work has allowed us to explore the role of MFIs in positively considering and addressing environmental issues, both through direct-targeted initiatives as well as in their everyday business activities, including environmental governance and credit assessment. We have also considered the types of programs and products an MFI could develop to positively influence the environment and their bottom line. Some environmental issues in emerging economies are also business opportunities, e.g. development of business linked to providing access to safe drinking water and energy. On the flipside, a lack of capacity, poor last mile logistics and limited access to appropriate financing mechanisms are often constraints to tackling pressing environmental issues impacting local livelihoods. MFIs are well placed to facilitate solutions to these issues. There is also a growing interest amongst MFI professionals to incorporate environmental governance alongside social impacts.<2> This is understandable, given the pressing nature of environmental concerns in many emerging countries. Consideration of environmental issues within emerging market businesses can present opportunities to build a company with a license to operate that goes above and beyond the norm, resulting in strong consumer loyalty and word-of-mouth marketing. In emerging economies, access to affordable renewable energy, safe water and agricultural inputs can be particularly valuable due to a lack of infrastructure. The story about a village that had no access to electricity until it was connected to solar power has been told before, but there are other opportunities to invest in leapfrogging. Some examples include certified agricultural and forestry products, water storage systems, rainwater harvesting systems, drip irrigation, high-quality & certified agricultural inputs and solar energy. Environmental aspects should also play a key role, especially in the case of MFIs, in the assessment of credit and operational risks. Environmental events, accentuated by climate change, may create opportunities but also disrupt business activities, and their influence must be considered in business models. MFIs can play a leading role in identifying and tackling these issues, after all, it is not the first time the industry has broken new ground and fostered high impact growth. Yet, as MFIs are often small institutions, sometimes in remote areas, with limited resources and capacity, they are likely to struggle. These challenges are often somewhat erroneously used to justify why large-scale multi-national companies do not take appropriate action on environmental issues – however these difficulties may in fact pose a legitimate challenge for MFIs. Nevertheless we see this new and growing field as interesting, and one of many opportunities that can catalyze better economic growth in emerging markets. In consideration of this, the European Microfinance Award is an important opportunity for leading MFIs within this space to be showcased and rewarded, providing inspiration to other organisations and individuals around the world. We are therefore thrilled to help support and promote the European Microfinance Platform's important work, and particularly to work with them on designing this year's Award. We look forward to seeing applications from a wide variety of MFIs that demonstrate the emerging frontiers of sustainable business. Applications close on June 15th 2014. For more information please check http://www.e-mfp.eu/news-and-events/5th-european-microfinance-award. This post was originally published on Clarmondial Blog _______________________________ <1> The European Microfinance Award was launched in October 2005 by the Luxembourg Ministry of Foreign and European Affairs – Directorate for Development Cooperation and Humanitarian Affairs, to support innovative thinking in the microfinance sector. This year's edition aims to highlight opportunities for microfinance to improve environmental issues in the South and encourage the industry to find innovative solutions for global environmental concerns. <2> See for example, Green Microfinance. Characteristics of microfinance institutions involved in environmental management by Marion Allet and Marek Hudon. Available under https://dipot.ulb.ac.be/dspace/bitstream/2013/138434/1/wp13005.pdf author: Clarmondial

For years, credit was the driving force behind microfinance. But times have changed. Instead of credit, we now speak of financial inclusion and expanding access to savings stands as one of the topmost objectives for the sector. We also live in the age where it's no longer acceptable to claim success without reliable metrics to back it. And on that front, the metrics applied to savings are woefully inadequate. According to a paper recently published by e-MFP, 50-75% of the savings accounts reported by MFIs stand empty. Like shadows cast by an evening light, the majority of savings clients are but illusions that obscure the real savers. We are thus doubly tricked – led to believe that more clients are saving than is the case, and that the clients who save are poorer than they really are. This is both a problem and a symptom of a larger challenge. The problem is simply that we know surprisingly little about real savings outreach. Reporting the gross number of bank accounts and total deposits, whether for a single institution or an entire market, is a poor reflection of reality. As Elizabeth Rhyne put it succinctly: "possession of a bank account ... should not be confused with genuine inclusion." Yet that assumption lies behind most of the metrics used to report savings outreach. In 2008, the microfinance sector in Bolivia, one of the case studies in our paper, reported 1.4 million savings accounts, with an average balance of $309. Bolivia is often regarded as one of the most mature microfinance markets, and the success of its savings outreach is one of the reasons why. However, our analysis shows that after excluding empty accounts, the actual outreach drops to some 366,000 active savers, with an average balance of $1,225. Instead of reaching millions of poor savers, Bolivian MFIs are serving a substantially smaller number of individuals, many of whom probably earn more than the MFIs' traditional clients. Similar patterns show up at banks and credit unions. That's the problematic outcome of how savings outreach is currently reported. The large number of empty savings accounts is a symptom of the substantial challenges of serving poor savers. The past few months have seen a spate of publications examining the challenges – and successes – of serving poor savers. Accion recently shared findings from its affiliates that demonstrate how empty accounts reflect regional and institutional differences in microsavings. As with our findings in Bolivia and elsewhere, Accion's Latin America partners' apparently high savings outreach is a quirk of arithmetic: in half of the institutions, over 70% of accounts are dormant. This is in part because savings are considered unprofitable, while clients do not perceive MFIs as the right place to save. However, not all savings products for the poor result in high dormancy rates. By explicitly focusing on serving the needs of poor savers, Finamerica, Accion's partner in Colombia, rolled out a product whose dormancy rate of 33% is less than half of its traditional products. Examples of this abound elsewhere: Grameen Foundation's Microsavings Initiative at Cashpor, India achieved a dormancy rate of 28% compared to average dormancy rates of over 80% among financial institutions in India. Similarly at CARD Bank in the Philippines, the Grameen Foundation collaborated with the behavioral economists from ideas42 to increase transaction frequency by 73% and raise account balances by 37%. The efforts aren't limited to microfinance institutions. Working with five large commercial banks around the world, the Gateway to Financial Innovations for Savings (GAFIS) seeks to promote the development of appropriate savings products directed at low income people. Mirroring Accion's experience in Latin America, its recent report highlights that traditional low-balance accounts are not profitable. However, GAFIS identifies three patterns for savings behavior (spend down slowly, accumulate, preserve) and demonstrates how a robust agent channel with flexible products tailored to client behaviors can help increase savings activity. These efforts suggest that an explicit focus on serving savers, as opposed to raising deposits or simply opening accounts, can have a material effect on client savings activity. At the same time, it's worth recognizing that empty or even dormant savings accounts are not necessarily a problem in itself. Clients may use accounts as a means to receive payments rather than as vehicles for saving – an important financial service in its own right. In other cases, such accounts may facilitate transactions between the institution and the client. And finally, keeping inactive accounts open may help maintain a customer relationship that could be reactivated at a later time. All of these are useful and legitimate objectives, as are efforts to reduce dormancy rates. Yet, it is impossible to monitor such efforts by looking at the number of accounts and total deposits. All of the above projects included a deeper examination of both account activity and account balances, including separating out empty or dormant accounts. A similar approach should be applied more broadly. Reporting on savings, whether by MFIs, country associations, investors, and others should move to a new set of standards. As an initial recommendation, we suggest the following: * Reporting of stratified balances, including explicit separation of empty and nearly empty accounts (e.g. <$ 1 or <0.001 GNI per capita). * Reporting of accounts stratified by transaction frequency. This should include essentially inactive accounts (for example, 0 transactions over past 6 months), as well as a few levels of stratification by level of activity (<1 transaction, 1-2 transactions, 3+ transactions per month). * Reporting of number of total transactions per period, stratified by transaction size (<$10, $10-50, etc.). Such additional reporting may incur marginally higher costs and administrative burdens. However, such reporting is essential for MFIs that want to strengthen their client relationships, especially when targeting the poor or financially excluded. If we as a sector are to reach the objectives we set out for financial inclusion, we must abandon the illusory shadows of traditional savings reporting, and face the full complexity of real savings outreach. author: e-MFP

Every November, the European Microfinance Week (EMW) brings together a high-level group of decision-makers, opinion-leaders and practitioners from the microfinance industry to discuss the state of the sector and the way ahead in the coming years. This past November, the e-MFP team went one step further, and conducted a poll of attendees on the key trends affecting the sector and its level of preparedness to address them. Modeled on the survey conducted by the SEEP Network (Keeping an Edge: What Will It Take in the Current Microfinance Context), which polled leaders of 39 Microfinance Associations (MFAs) around the world, the e-MFP survey was sent to EMW delegates before and during the Week. The preliminary results were presented at the final plenary of the conference, along with the SEEP survey, thus allowing attendees to compare and contrast the results between the two perspectives, and build upon three days of discussion on the challenges and opportunities ahead. The respondents were required to rate five trends across two dimensions: TRENDSDIMENSIONS Clients’ increasingly diverse needs Emergence of new technologies Evolving profile of funding available for microfinance Changes in financial regulation Decreasing market share Relevance: Will this trend challenge MFIs’ ability to remain relevant, given their current business model and capacity level? Preparedness: How prepared are MFIs to adapt to this trend? Respondents had to rate each of the trends 1-5 in terms of relevance (not likely to very likely) and preparedness (poorly prepared to very prepared). The prime focus was looking at gaps – the differences between the challenge each trend posed to MFI ability to remain relevant on the one hand, and MFIs’ preparedness to deal with it on the other. In other words, the larger the perceived ‘gap’, the greater the challenge will be to the industry, according to the respondents. The results paint a picture of what a broad cross-section of the microfinance industry sees as the emerging trends, or to paraphrase Harvard Professor Michael Chu in the Conference’s opening session, how the industry avoids ‘being Kodak’. “We’re at the next wave of disruption” he claimed, “Microfinance was the disruption of finance; and now it will be disrupted itself”. The ‘gaps’ presented in the EMW survey perhaps foreshadow from where this disruption will come. Results The survey achieved a remarkable response rate well over 50%. As shown in figure 1, overall, respondents saw the largest gaps in diverse client needs, technology and decreasing market share. The latter also shows a clear difference from the original SEEP survey, which found no significant relevance-preparedness gap for ‘decreasing market share’. While the survey showed some variation among different types of e-MFP delegates, those who identified themselves as representing MFIs or other direct service providers reported the narrowest gap across all categories, both less concerned about the relevance of different trends and also more optimistic about MFIs' ability to meet them. [<{"type":"media","view_mode":"media_large","fid":"761","attributes":{"alt":"","class":"media-image","height":"257","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"480"}}>] Within each Figure, the percentage scores are the numbers of respondents who rated the trend 3, 4 or 5 on a 1-5 scale across the five trends, in terms of its Relevance (5 being very likely), and Preparedness (5 being very prepared) Client increasingly diverse needs Clients have increased demand for a wider range of financial services, many of which are not currently provided by the majority of existing MFIs. Broken down by trend, ‘Clients’ increasingly diverse needs’ revealed a 19% gap between the relevance of the trend and MFIs' preparedness to address it. But breaking the responses down by individual score reveals yet more: only 14% rated MFIs’ preparedness as high or very high, while 60% respondents rated the trend as relevant or highly relevant (see Figure 3). [<{"type":"media","view_mode":"media_original","fid":"762","attributes":{"alt":"","class":"media-image","height":"244","style":"vertical-align: middle; margin-left: auto; margin-right: auto; display: block;","typeof":"foaf:image","width":"229"}}>] Broken down by respondent type, the challenge for MFIs to remain relevant to meeting client needs is relatively consistent among respondent segments. Their level of preparedness was more varied, with 57% of NGO delegates rating MFIs as slightly or poorly prepared, compared to 40% overall. Meanwhile, MFIs and other direct service providers saw the trend posing less threat to MFIs' future relevance (48%), and also least concerned about their ability to meet the challenge (28%) including the only respondents who rated MFI preparedness for this challenge as very high. [<{"type":"media","view_mode":"media_large","fid":"763","attributes":{"alt":"","class":"media-image","height":"257","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"480"}}>] Emergence of new technologies New technology is affecting how products are delivered and banking is done. These include mobile payments, biometric identification devices, new IT platforms etc. With respect to ‘Emergence of new technologies’, 51% of respondents rated it likely or very likely to challenge MFIs relevance, and 22% said MFIs were prepared or very prepared to deal with it – a 29% gap. [<{"type":"media","view_mode":"media_original","fid":"764","attributes":{"alt":"","class":"media-image","height":"244","style":"margin-right: 15px;","typeof":"foaf:image","width":"229"}}>] Broken down by respondent type, Fund Managers/Investors saw the trend as likely to challenge MFIs' relevance (75%), while rating MFIs’ preparedness among the lowest (44% – see Figure 6). Meanwhile, for MFIs, the relevance-preparedness gap was essentially non-existent (3%). [<{"type":"media","view_mode":"media_large","fid":"765","attributes":{"alt":"","class":"media-image","height":"257","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"480"}}>] The evolving profile of microfinance funding MFI funding sources and type of available funding are changing. Debt and equity funding still available, however generally in lower amounts for MFIs Overall, the challenge of ‘Evolving profile of microfinance funding’ produced a 28% gap between relevance and preparedness: 48% saw this trend as likely or very likely to challenge MFIs relevance, while only,20% thought MFIs are prepared or very prepared to deal with it (Figure 7). [<{"type":"media","view_mode":"media_original","fid":"766","attributes":{"alt":"","class":"media-image","height":"244","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"229"}}>] Interestingly, both investors and MFIs were most concerned about shifts in funding as likely or very likely to challenge MFIs’ relevance (56%). However, investors were notably more concerned, with none rating MFIs as being highly prepared, compared to 11% of MFI respondents. Changes in financial regulation Changes in regulation and industry infrastructure are affecting how MFIs operate ‘Changes in financial regulation’ produced the smallest relevance-preparadness gap in both surveys. Nevertheless, only 2.1% in the EMW survey said MFIs were well prepared while close to half rated the trend as likely or very likely to challenge MFIs' relevance. [<{"type":"media","view_mode":"media_original","fid":"767","attributes":{"alt":"","class":"media-image","height":"244","style":"margin-right: auto; display: block; margin-left: auto;","typeof":"foaf:image","width":"229"}}>] NGOs saw regulation as the most significant trend to challenge MFIs’ relevance (see Figure 9) and were the most pessimistic about MFIs’ preparedness to deal with it. Moreover, a surprising 38% of Fund Managers/Investors rated this 5 out of 5 in terms of relevance – the highest level of concern recorded by any group in any trend category. Meanwhile, not a single DFI, Fund Manager or Support Organization respondent rated MFIs as very prepared to deal with this. [<{"type":"media","view_mode":"media_large","fid":"768","attributes":{"alt":"","class":"media-image","height":"257","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"480"}}>] Decreasing Market share New entrants seeking large scale deployment are providing financial services to a rapidly increasing number of clients, making significant gains in market share The trend of ‘Decreasing market share’, defined as the competitive threat from new providers and platforms, diverged the most from the SEEP survey results – the only trend really to do so. While Microfinance Country Associations responding to the SEEP survey found a negligible 2% gap between relevance and preparedness, for EMW respondents, the gap was highest among the five trends – close to 40%. Nearly 60% of respondents rated the trend as likely or very likely to challenge MFIs’ relevance, whereas only 20% said MFIs were prepared or very prepared to deal with it. 77% of DFI respondents saw this trend as likely or very likely to challenge MFIs' relevance, and over a quarter of NGOs rated its relevance as 5 out of 5. Meanwhile, over half of NGOs and Investors said that MFIs were slightly or poorly prepared to deal with this challenge. As with other trends, MFI representatives were the least concerned, with a greater number (45%) reporting the MFIs as being prepared to deal with the trend than those who saw the trend as significant in the first place (35%). In this respect, they most closely reflected the responses of Microfinance Country Associations pooled in the SEEP survey.[<{"type":"media","view_mode":"media_original","fid":"769","attributes":{"alt":"","class":"media-image","height":"256","style":"margin-right: auto; display: block; margin-left: auto;","typeof":"foaf:image","width":"242"}}>] Conclusion Both the e-MFP and the SEEP survey seek to paint a picture of what two overlapping respondent groups (Microfinance Country Associations and EMW delegates, respectively) consider to be the key disruptive trends to microfinance, and to what extent MFIs are generally prepared to meet those trends head on. There is great value in asking these questions – especially before and during a conference that seeks to identify and prepare for these trends before they can adversely disrupt the industry. Clearly, the most challenging trends for MFIs – given the gaps between the perceived challenge to their relevance and their preparedness to address it – are the reduction of market share that comes from new market entrants (such as mobile network operators) and the diversification of client needs - away from inflexible microcredit, to a complex array of services appropriate for the particular needs of certain segments. Respondents were clear on what is coming, but less optimistic with respect to how prepared MFIs are to deal with them. Perhaps this is a pessimism that stems from lack of familiarity – relatively few respondents at EMW were practitioners themselves. Those that were, proved to be the most optimistic in terms of their own perceived preparedness. Perhaps there is reassurance to be drawn from this – they know what they're doing. Or perhaps this a real cause for concern – MFIs are complacent (even ignorant) about what needs to be done in order to adapt. After all, with the exception of changes to the funding landscape, MFIs tended to consider the trends less challenging than respondents as a whole. Perhaps the most interesting ‘gap’ the survey has revealed is not the ‘preparedness gap’ per se, but the gap between practitioners and everyone else. author: e-MFP

See part-one of the blog here. In our previous post, we addressed our first two findings: 1) over-indebtedness stems not only from aggressive microcredit policies but also from global trends of financialisation, and 2) over-indebtedness should be understood as a process of economic and social impoverishment through debt that can develop in mutual contradiction. We continue our summary with two other findings that look at the issue of local decision frameworks and juggling practices, and the ambiguous role of microcredit. 1) Local decision frameworks and juggling practices Financial illiteracy is a commonly – and wrongly – attributed a cause of over-indebtedness. This stereotype reflects profound ignorance of the complexity of local financial reasoning and decision frameworks. Our case studies highlight the subtleties of budget management and debt behaviour. Over-indebtedness is caused not by financial illiteracy but rather, is shaped by, and reinforces, pre-existing inequalities in gender, caste, ethnicity and religion. We argue that borrowers and lenders resort to specific decision frameworks – reasoning tools that are available to individuals in specific situations to appreciate risk, take financial decisions and choose among various financial tools. Decision frameworks have socio-cultural, legal and normative components and are not necessarily sophisticated or formal. They stem from social interactions and are thus embedded in individuals’ social positions, particularly in terms of class, caste, gender and ethnicity. Financial decisions serve multiple – and often conflicting – purposes, whether making ends meet, respecting social structures, positioning oneself in local social networks and hierarchies, or asserting one’s individuality. Throughout the book, we highlight specific decision frameworks which people resort to when dealing with money and debt, along with the prevalence and sophistication of ‘juggling’ practices. To keep multiple objects in the air simultaneously, a juggler must be continuously throwing and catching, which demands not only speed and dexterity, but also risk-taking. The same is true for financial practices: people combine multiple financial tools to support ongoing borrowing, repayment and reborrowing (one borrows from one place to repay elsewhere). Individuals swap roles between debtor and creditor, and even the poorest people are also likely to be creditors. Certainly, juggling debt can help substitute cheap debts for expensive ones and facilitate managing different repayment time scales imposed by lenders. But social motivations also count. Juggling practices often reflect deliberate strategies to multiply or diversify social relationships, and strengthening or weakening the burden of dependency ties. Our various case studies highlight the multiple meanings of lending and borrowing, which are constantly negotiated to serve individual purposes, while remaining inseparable from local culture and structural constraints. The subtle and complex trade-offs involved leads to a plethora of complementary and often incommensurable, non-substitutable financial practices. We also find that no pure market price can reflect relative demand and supply. Financial practices are instead regulated through a web of social institutions. The terms and conditions of debt reflect micro-politics and the history of relative statuses. Debt practices are fragmented and hierarchical, as is illustrated in this book by cases in multiple geographies and contexts, be it Dalits and lower castes in India, indigenous communities in Mexico, Hispanic migrants in the United States, lower classes in Madagascar and in France, as well as women in a range of environments. 2) Paradoxes and ambiguities of microcredit These considerations have many implications for current microfinance practices, which have become a necessary component of the economy of the poor. On the one hand, we note the poor’s considerable capacity to appropriate finance and microfinance in a variety of sometimes surprising ways. Clients do not passively consume microcredit services, but translate and interpret them according to their own frames of reference, adjusting and adapting them, and often bypassing the rules to do so. Diverting loans for so-called “social purposes” (i.e. non-income generating), which is discouraged by many MFIs, is the rule rather than the exception, as is recycling microloans into informal loans. This either takes the form of on-lending microcredit to others, or borrowing informal loans to repay microcredits. Clients often decry solidarity groups, despite the fact that they are officially praised for their effectiveness in enforcing repayments and social cohesion. And yet, in some cases groups tend to replicate and reinforce rather than abolish pre-existing social hierarchies and divisions. Manipulating and misappropriating microcredit funds is not limited to borrowers. When repayments lag in highly competitive environments, MFI staff use increasingly aggressive techniques to enforce repayments. In some cases, borrowers, who are mostly women, can become sucked into intricate spirals of debt where they have no choice but to reborrow, even if they no longer want microcredit, since this is the only way to preserve their creditworthiness. Microfinance alone is rarely the sole cause of household over-indebtedness. However, microcredit can catalyze pre-existing imbalances and accelerate declines. Conversely, when supply matches the diversity of local needs in contexts with potential for economic development, microfinance can play a positive role, as the Malagasy case study illustrates. Throughout the book, different cases highlight the tension at the core of the paradoxes and ambiguities of microcredit. Microcredit is a desirable form of credit for borrowers because it appears to be a way out of oppressive debt traps. It is a promise of an egalitarian relationship contracted outside local circles of social hierarchies. Unfortunately this hope for freedom often proves illusory. The lives of the poor are precarious. Sometimes it may take only a single unexpected shock – a health emergency, a sudden loss of income, or any one of the multitude of disasters that continuously threaten the lives of families living on the edge. And with formal social protection often non-existent or ineffective, people desperately turn to protective debt, as oppressive as it might be. The terms and conditions themselves are relatively impoverishing and any substantive equality would require extricating a household from its subordinate status in a number of cross-cutting exchange relations. Such radical changes in social relations coming from outside as well as inside the economy, are beyond individual households’ control. In other words, while microfinance may improve households’ cash flow and management, it can also lead to financial vulnerability, credit addiction and debt traps. These policies can do more harm than good, not only because of commercial aggressiveness and competition, but also because microfinance promoters lack a proper vision of local socioeconomic dynamics and financial needs. author: Solene Morvant-Roux