NB Financial Health
Trouble Brewing in Microfinance?: Peru and Mexico’s microcredit sectors appear to be in danger of collapsing – and the market-driven model is to blame
The fatal limitations and market-driven disasters associated with the microcredit model have been increasingly aired these last few years, including on this site.
Nonetheless, support for the microcredit model has remained very high. Not unlike the “efficient markets hypothesis” developed by U.S. economist Eugene Fama, an always controversial idea that was then comprehensively debunked by the 2008 global financial crisis, the market-driven microcredit model has similarly been exposed in practice as a failed financial model. Yet it remains a revered concept in the eyes of many academic economists (especially in the U.S.), and in big business, the banking sector, the international development community and the political establishment.
The reason for this is that the microcredit model supposedly gives real-life meaning to so much of neoclassical economic theory and neoliberal ideology – for example, that free markets always produce the best outcome for society, that the poor can easily pull themselves up by their own bootstraps if they want to, that commercial incentives are always good, and that business is best suited to resolving poverty. That these ideologically-driven pro-market insights all generally fail the test of history is considered to be of little importance compared to the felt need to unswervingly defend the theories and ideologies that most benefit business and political elites.
Soon, however, all the false positivity surrounding microcredit might just disappear for good. This is because microcredit meltdowns appear to be approaching in Peru and Mexico, two of the biggest and most universally celebrated market-driven microcredit sectors in the world. If these meltdowns occur, they would become the latest in a series of crises that struck first in Bolivia in 1999, and then continued across the globe after 2008 – in Morocco, Bosnia, Pakistan and Nicaragua – before culminating in the worst meltdown to date in the Indian state of Andhra Pradesh in 2010. In response to that crisis, some microcredit advocates blamed political interference rather than the greedy CEOs that brought on the crash. But if Mexico and Peru’s microcredit markets suffer similar fates, it will be nearly impossible for the global microcredit industry and its supporters to yet again incorrectly blame the government for what are clearly market-driven disasters.
The microcredit sector in Mexico is very big, probably significantly upwards of $US 5 billion, and it is widely agreed in the microcredit industry that it has been very well regulated (ie: minimally regulated) by the Mexican government. Mexico is also the location of one of the most famous “best practice” microfinance banks of all – Banco Compartamos. Yet as microcredit supporter Daniel Rozas points out, the sheer extent of microcredit saturation in Mexico now appears to presage a coming meltdown of quite major proportions. Already some regions, notably Chiapas, are so over-indebted that it is almost impossible to find any new clients not already in possession of a handful of microloans that they are already finding it difficult to repay.
Of course, the microcredit industry in Mexico has been very keen to locate some – any – positive impact evidence to put forward as a rebuttal to the manifest problems caused by the growing over-indebtedness of the poor. Yet in my view, even long-time microcredit supporters have struggled to do so. For instance, Yale University Economist Dean Karlan and his colleagues, undertaking an impact evaluation of Banco Compartamos (on behalf of Banco Compartamos*), found miniscule positive impact – while conveniently avoiding any exploration of some of the principal downsides that lie at the heart of microcredit.
However, Peru’s problems are probably causing even more worry to the global microcredit industry than the problems in Mexico. Peru is by far the world’s largest microcredit market (at more than $US 11 billion), and in 2013, the Economist Intelligence Unit yet again declared this market to be the world’s best example of an efficiently regulated microcredit market.
Yet today, Peru’s microcredit market is disturbingly close to a meltdown, one that could see its market and institutions shrink considerably, and possibly uncontrollably. Among other indicators of mounting problems, after experiencing a very rapid decline in the number of borrowers and in the number of loans outstanding, and after having to write off significant amounts in both 2011 ($US 76 million) and 2012 ($US 78 million), Peru’s largest microfinance bank – MiBanco – was sold off to a competitor.
Part of the obvious reason for the massive but quite unsustainable growth in Mexico’s and Peru’s microcredit sectors, as the International Financial Corporation in a round-about way now somewhat belatedly accepts (with regard to Mexico), is the essentially ideologically-rooted decision in the 1980s to structure the emerging global microcredit sector around supposedly efficient Wall Street-style operating methodologies and market-driven incentive systems.
This move had a very important, but ultimately disastrous, effect. In order to maximize their own incomes, profits and bonuses, too many microcredit institutions (and their loan officers) chose to push out far more of the “product” than was genuinely needed and/or could be productively used. And, even worse, it very often went both to the wrong people (the most vulnerable) and/or was used for simple consumption spending needs. The not-unexpected result now emerging in both Mexico and Peru, is the very same end game that we saw on Wall Street in 2008 – that is, a market-driven calamity.
The market-driven, commercially oriented microcredit model was a creature of its (neoliberal) time, and its time has now passed. Policymakers urgently need to move to support a new generation of community-owned and controlled financial institutions, those institutions that economic history conclusively shows to be up to the task of meeting the real needs of the poor and of wider society – instead of merely satisfying the greed of the financial sector.
* Note: Additional sponsorship was provided by the Bill & Melinda Gates Foundation and the National Science Foundation.
Milford Bateman is a freelance consultant on local economic development and, since 2005, Visiting Professor of Economics at Juraj Dobrila Pula University in Croatia.
- Impact Assessment