Since they were first created during the 1970s, microcredit institutions have shown themselves to be an efficient tool for combating social and economic exclusion. Nevertheless, as the World Bank has indicated, the current global financial crisis will create 53 million more poor people, which will put the microfinance sector to a test. Prospéritas, a microfinance institution whose goal is to offer small loans to the low-income population of Colombia, emerged in this context, and it won first prize in the IE Business School’s 2008 entrepreneurship competition.
At the moment, there are more than 5.3 million micro-enterprises in Colombia. The potential market for microfinance is served by only 16 institutions that address 17.9% of the total demand. Prospéritas estimates that the business opportunity is as much as US$5.4 billion. Universia-Knowledge@Wharton spoke with two members of the Prospéritas team — Marcela Torres of Colombia and Tomás Baylac of Argentina — about the birth of the company and how microfinance is faring in these difficult times.
Universia-Knowledge@Wharton: What is the current condition of the microfinance sector at this time? Do you believe that the increase in poverty will provide incentives for creating institutions and organizations dedicated to granting microcredit?
Marcela Torres: The crisis will not have a significant effect on the industry in terms of demand for microcredit. On the one hand, our clients, who mostly belong to the informal economy, are less sensitive to economic cycles. They cannot remain quiet while waiting for the situation to improve. In their case, it’s about survival, and if they don’t work for a week, they will suffer the next week when it comes to eating. That is why the informal economy remains very active.
On the other hand, microcredit could be considered an ‘inferior good’ – one whose consumption increases whenever income drops. In this sense, the sector will bring in clients affected by the crisis in the financial system. I would hope that demand increases or at least maintains itself at the same level. So long as there is demand, the existing micro-financing infrastructure will be utilized.
Tomás Baylac: It’s on the supply side that there is going to be a problem. There are problems with liquidity in the world, and it is not so easy to get financing. This may affect the NGOs [non-government organizations] more than anyone else. That is to say, the ways for acquiring money and the business model are behind the times. If there is a business that can become a profitable enterprise, theoretically it is not going to have financing problems. When you have a good [business] model, you can get funding.
UK@W: The microfinance sector is incapable of reaching large portions of the population that are excluded from financing. In what areas is it failing?
M.T.: The sector does not reach the poorest people because of the legal structure, and the vision of microfinance institutions. This is creating a phenomenon of ‘upscaling,’ in which microfinance institutions tend to the upper part of the pyramid of micro-enterprises, or the ‘development segment,’ as I understand it. This segment is comprised of micro-enterprises that have real collateral for guaranteeing their loans so they are considered the most profitable. Thus, commercial banks that want to develop microcredit programs also reach out first to the development segment. This concentration of the industry makes this segment over-indebted, and it has not enabled the funding to reach those who are poorest.
The NGOs that traditionally deal with the poorest people are also suffering from problems of access to sources of financing, so their options are limited. Until there is a mature capital market in this sector, we will continue to see this phenomenon.
T.B.: The market for potential clients of microcredit is divided into the lower, subsistence stratum, the simple accumulation level, and the development level. It is very difficult for microfinance institutions to reach the first sector because this segment needs financing more than ever. This makes it unprofitable to deal with any concept that is profitable. Government assistance is required if we are going to provide more funding to these people. We also need foundations that can easily provide funds. Those people who belong to the ‘simple accumulation’ sector also need this kind of microcredit in order to expand their businesses — in order to produce. The system itself and the use of that money facilitate the payment of that microcredit. And the development sector is covered by commercial banks.
UK@W: What kinds of institutions and organizations provide microcredit to the segment of the population that has fewest resources? And what are the main advantages and disadvantages of these various sources of financing?
M.T.: There are three big groups of institutions that offer microcredit: The NGOs, the non-banking financial institutions, and the banks. The NGOs have the potential to achieve the highest impact because they generally deal with the poorest people, and they also offer non-financial services such as training, marketing and health care. As I said earlier, they have limitations when it comes to accessing sources of financing because they depend on donations.
On the other extreme are the banks, which have credit infrastructure and methodologies that do a better job of adapting to the poorest of the poor, the smallest segment in the universe of the micro-enterprises. The advantage the banks have is their ability to reach a lot of people.
And the non-banking financial institutions are in a transitional phase from being NGOs to becoming banks. They are self-sufficient in their financing (as are the banks), but they don’t have the vision that they had as NGOs because they have a mandate for profitability.
In addition to those three ways of financing, there are informal ways such as the drop-by-drop loans offered by usurers who can charge interest rates of more than 10% a day. Other methods widely used are ‘chains of saving,’ second-hand stores, and pawnshops. Chains of saving are an informal agreement within a group of people who commit themselves to contribute a certain amount of money periodically (usually, every month). The members of the group take turns taking the complete sum contributed in a particular period. For example, if the group consists of 10 people who contribute 20 euros a month, a different person takes the 200 euros each month. The ideal thing would be to have a profitable institution that does not abandon its mission to reach the poorest people.
T.B.: If there is a positive aspect of an institution [like ours], it is that it is a for-profit organization. That makes this business profitable, and makes it possible to attract more financing and give loans. It would be nice to count on unlimited funding to pursue social goals, but these funds are restricted. You can get sources of financing and become profitable, and this makes it possible for you to get funding. It is a source of controversy that an institution of this sort is for-profit, and there is lot of rumbling about that fact. We defend ourselves for being a for-profit institution by noting that we manage ourselves as a business in terms of operational efficiency, and we respond to investors, and so forth, obviously within limits, without asking for too much profitability.
In some countries, the interest rates charged to people are regulated by law, but there are other countries that are more flexible and permit higher rates. Microcredit makes it possible to loan more money to the people who need it by charging them interest. Without charging interest, it would not be possible for them to get money and they would have to resort to usurers. On the other hand, donations are limited.
UK@W: How and why did the idea for Prospéritas emerge? Why in Colombia? What type of business model have you created for granting microcredit?
M.T.: The idea of creating Prospéritas was hatched by three Colombians: Marcela Torres, Francisco Noguera and Santiago Alvarez. The three of us were working in a consulting firm in Bogotá, and we shared the uneasiness of trying to combine the business world with the goal of providing some relief for the needs that existed in the region. We were inspired by Muhammad Yunus’ book, Banker to the Poor, so we decided to use microfinancing as a vehicle for contributing to the economic and social development of low-income micro-enterprises and their communities.
Following an exhaustive investigation of the microfinance industry in the region, we began operations with Dalila, our first client. She dreamed of having her own hot dog stand, which required the equivalent of 60 euros. With the good use of that first microloan, Dalila doubled her revenues in only two months. Motivated by those positive results, we set out to acquire a second client, Samuel, who rented out washing machines by the hour in his neighborhood. Along with Dalila and Samuel, many others came along because the fund that we created managed to finance about 100 micro-enterprises in three low-income areas around Bogotá. This pilot project became the seed of what is today known as Prospéritas — a micro-financing institution that offers microloans and training to low-income businesspeople in emerging economies.
Once we were at the IE Business School, we had the opportunity to form an excellent team composed of Jennifer Guintu (California), Jaime Carvajal (Colombia), Tomás Baylac (Argentina), Ricardo Valencia (Colombia) and our professor, Tomás Gutiérrez (Spain). Gutiérrez, a professor at the IE business school, decided to take a year-long sabbatical to dedicate himself to Prospéritas.
Microloans make sense in countries that have high rates of poverty and low penetration of the formal financial system. So Colombia and, generally speaking, the other countries of Latin America, are a good place for this industry. We chose Colombia for our connection and interest in this market, and because of the great potential that it has.
UK@W: What have been the main obstacles that you have found for developing this project?
M.T.: I would say that the main obstacle is managing to break the common conception that the microenterprise segment is highly risky. On the contrary, this has shown that the rate of arrears in the industry is about 3%, which is far below that of the traditional financial system.
T.B.: It is hard to get financing these days, but if you propose a business plan that makes sense, it is possible. We need $1.25 million dollars to launch a project, which is not much, relatively speaking. Once the project is under way, it becomes profitable with 2,000 micro-loans. At an average of $500 per micro-loan, that means you need financing of a million dollars. As a result of a good screening process, the rates of non-payment are low in this industry, about 2% to 3%. With such a low rate, your investment can generate a very stable cash flow in a market that is not very affected by economic cycles. There are technical methods for mitigating risks and diversifying a [loan] portfolio that you can use as a justification for any investors in such projects.
UK@W: What will be the main challenges when Prospéritas goes into operation in June? Is this model exportable to other countries in the region?
M.T.: Our main challenge when we begin operations will be to maintain steady growth. We are confident that there will be enough demand, so it is important to align our growth with our operational capacity. Another challenge will be to achieve the necessary investments in technology that we’ll need for maintaining our operational costs at a low level from the outset.
T.B: This model is exportable to countries with similar characteristics from a legal and cultural viewpoint. From a cultural viewpoint, you have to take into account the country’s traditional ways for making payments, as well as how much trust there is in the society. For example, in Bangladesh they work with group loan models in which the group becomes responsible [for the debt] of all of its members. In Latin America, it is very hard for that to happen. The group does not want to make itself responsible for other people; so individual loans are what works there. In deciding whether the model is exportable [to a particular country], the way a particular society functions has a great deal of influence. From the legal point of view, not every country is the same. In Argentina, for example, the law is less developed than in Colombia.
UK@W: What are the different stages and the process for obtaining a micro-loan?
M.T: To obtain a micro-loan, a business person must undergo basic training about the meaning of a loan: how long it lasts; how much it is; interest rates, renewals, requirements, etc. Later, you must arrange for a visit in which our analyst collects information [about the borrower], visits the business, and helps him fill out a credit application. That application is evaluated by a loan committee. The businessperson is then notified about the decision. If the application is approved, the loan is formalized and disbursed. This process could take three days.
The analyst’s visit is very important in the process because the analyst is the person who evaluates the capacity and willingness of the micro-entrepreneur to repay the loan. Equally critical is the periodical procedure for the [continued] development of micro-entrepreneurs and for [managing] the behavior of the portfolio. Throughout the process, there are training courses in business areas that we believe are vital for achieving our mission.
The average micro-loan in Colombia has grown in recent years, and is now about $1,000. Prospéritas hopes to have an average of $500 for primary loans.
UK@W: What sort of impact do you believe Prospéritas and other projects of this sort will have on the population and economy of Colombia?
M.T: If we manage to strengthen micro-enterprises, it will unleash a phenomenon that is very positive in several ways. From an entrepreneurial viewpoint, it will stimulate self-employment and generate new jobs. Micro-enterprises will grow, become formal, and wind up accessing other sorts of funding and services from which they had previously been excluded.
As for families, they will manage to have more funds available for nutrition, education and healthcare. From the viewpoint of the community, this strengthens the exchange of goods and services. It also formalizes [business] activities, which permits micro-enterprises to enter into the economic dynamics of the country.