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Opening Session of European Microfinance Weeks Asks if Financial Inclusion, Stability and Client Protection can Co-Exist Financial Inclusion has long since become the dominant discourse in providing financial services to under-served populations – something which used to be called ‘microfinance’, and before that just plain ‘microcredit’. Inclusion (or ‘Inclusive Finance’, as is voguish) means different things to different stakeholders, but “the provision of quality financial services to those previously excluded from the financial services sector” is probably acceptable to most. But is it costly? Or rather, is the key “quality” element something that is irreconcilable with commercial goals, because of the burdens its provision places on institutions, or the adverse affect it can have on market stability? Put another way, is client protection, in all its forms, in opposition to financial inclusion (in that it prevents vulnerable populations being reached), and can market stability be possible if attention and resources are devoted to client protection at the expense of growth, profitability and scale? “Balancing Financial Inclusion, Market Stability and Client Protection” was the topic for the kick-off plenary at EMW2014. After an introduction by Scott Brown, CEO of Vision Fund and part of the Microfinance CEO Working Group (eight CEOs of international MFIs, covering 45 million clients in 70 countries, and working for advocacy, and industry and institutional strengthening), Antonique Koning from CGAP kicked off a wide-ranging panel debate. Antonique heads up CGAP’s workstream on customer empowerment, balancing, as she put it, “financial inclusion (I), financial stability (S), financial integrity (I), and financial consumer protection (P) (collectively I-SIP)”. Narda Sotomayor represents SBS Peru, the country’s Superintendency – the banking regulator. From a financially excluded background herself, she returned from overseas doctoral study to lead research on changes in regulation, and the impact it has on institutions and clients. Armenuhi Mkrtchyan represents the Armenian Central Bank. As she tells it, for ten years, they set up the infrastructure that could be envisioned to strengthen the supply side of the microfinance market. Credit bureaus, deposit insurance, joint regulatory bodies. “Everything to make investors feel secure”, she says. But in 2006, she and her colleagues realised that this just wasn't enough to achieve “deep inclusion”. Why? Because the customers don’t understand finance, and credit in particular. This meant strengthening the demand side through consumer protection and financial education. Kim Wilson is a Lecturer in International Business and Human Security at the Fletcher School at Tufts University in the US. As a teenager, she says, she was “a child of credit”, working summer holidays for her retailer father to repossess furniture and appliances from defaulting customers. Ten years ago, she found herself as Director of the Global Microfinance Unit at Catholic Relief Services. “We didn’t have any impact assessment or smart understanding of what we were affecting – just lots of hunches, lots of problems among 35 programs, some of which were fully functional but some were plainly non sustainable NGOs. What she came to feel, she says, was that they were clashing against what they were actually supposed to be doing, because it’s difficult to see all the consequences of every action. Microenterprises were serving as fronts for money laundering, for example. So she left that position, “hid” at university, and was approached by Gates Foundation to launch the Fletcher leadership course – two matriculators of which are Armenuhi Mkrtchyan and Narda Sotomayor, alongside her today. So, a central banker, a regulator and a practitioner/academic: a range of experience in how to find the products, mechanisms and regulation to maximise market stability, reach excluded populations, and ensure those clients are adequately protected. What does the audience think, asked Antonique Koning, who moved on to put three statements up for a show of hands and discussion. “There is no trade-off between financial education and financial stability” was the first – with the audience roughly split 50:50. The question is an unusual one – maybe “It is possible to reconcile provision of financial education and market stability” would've yielded richer responses. One audience member argued in favour of the original statement, arguing that investment in education ultimately pays off in stability. The second statement up for discussion was this: “By definition, financial inclusion implies consumer protection”. The trouble here (and the explanation for the audience’s reluctance to commit either way) is that there’s a disconnect between theory and practice. Perhaps most people in the audience agreed with one member, who said that, yes, genuine inclusion needs to incorporate consumer protection, because otherwise all we’re talking about is financial access; inclusion has to mean more. “Financial inclusion means quality financial services, and they cannot be quality if consumers aren’t protected”, goes the argument. But in practice, consumer protection isn’t given the attention it needs in promoting inclusion – although no doubt this is generally improving. The third statement garnered an almost unanimous response, because it’s virtually axiomatic: “Financial education is an essential part of consumer protection”. This is so clear it hardly bears analysis. So, it’s clear that protection, inclusion and stability aren’t ‘zero-sum’. There are synergies to be found. Narda’s focus at SBS Peru is primarily market stability. This means, in practice, “generating the incentives such that financial institutions can develop their own consumer protection initiatives”. Put another way, creating the environment where it’s in the institution’s interest to protect, rather than exploit, the customer. Consumer protection, she says, comes mainly through transparency. A consumer who is well informed about a financial product’s characteristics, including the terms and the risks is in better position to make good decisions, manage risks and understand and meet his or her own obligations. “This is win-win for the client, the institution, and the sector”, she says. For Armenuhi, synergy comes a different route. “In policy, this balance, or synergy, comes about because when people are excluded, this poses threats to financial stability and integrity”. What is financial integrity? Absence of money laundering is one factor, reduced flows in opaque, shadow banking channels. To what extent this is an issue peculiar to certain markets like Armenia, or something that is inherent in all developing markets, was left undiscussed. Caps on interest rates, whether by design or accident, dominated the rest of the session. All the speakers are opposed to caps – as were, from the questions, almost all the audience. After all, when policy makers want to cap rates and do it effectively, they need to have the knowledge of what the caps should be. “Nobody can do this better than the market”, argued Armenuhi. Narla cited her home country of Peru, which went through a well-intentioned experiment in interest rate caps last decade, but with “totally unexpected results”…we ended up damaging those people we wanted to benefit – those in the bottom quartile”. Higher socio-economic segments benefitted, she said, because cheaper credit gives incentives to corruption (and presumably higher socio-economic segments benefit more from corruption). Moreover, market stability mandates sustainability, which means institutions need to be able to cover all their costs. Binding rates are anathema to this. Ultimately, a market with fair competition should take care of it, and push rates down. Kim cited interest rate caps in certain US states, especially on payday lenders. “Credit is heroin”, and people get into a dependency on usurious credit. But she defended caps in this case, because payday lenders (as they do in the UK as well) charge 3 or even 4-digit interest rates – orders of magnitude above their costs, and the caps in place were still high enough that anyone could sustain a business by charging within those limits. Intervening always has its costs. Armenuhi says that in the long term, they’ve found that in Armenia, setting rates is more costly than subsidising vulnerable groups. Narda points to how Peru has now reached its position as the highest rated microfinance market (as recently re-affirmed in the 2014 EIU MicroScope). But policy-makers must remain vigilant. As banks downscale, MFIs are motivated to go and find harder-to-reach markets, and their portfolios change as new, previous excluded people are brought in. A credit portfolio can deteriorate quickly unless the methodology is still appropriate for the new customers, she says. “The process of lending isn't static; it’s very dynamic – and creating a close relationship with demand side is very important.” “Go downmarket, but adapt – or risk destabilising and affecting customers”. Kim finished with a positive story – a morality tale for how to find this elusive balance: “A few years ago, I was in Tajikistan, and kept coming across these ‘ExpressPay” kiosks, where people pay their utility bills and other things. Then, I found out that the network had been closed down. I met the CEO. The regulator had shut him down, but said the following: ‘ if you work with me to meet our requirements, in three months you’ll be licensed, you can re-open, and you’ll even be able to store funds’. True to form, three months later, ExpressPay reopened, fully licensed to take payments and also to hold funds – providing a range of new business opportunities to the company, and services to the customers.” “ExpressPay reopened because there was a great regulator at the Central bank, who understood the key elements of stability, protection and inclusion, and knew that with some adaptation and buy-in from the CEO, all three could be achieved. The lesson is that regulators are human beings too”. author: Sam Mendelson

Q:The theme of this year's conference is, "Developing Better Markets." Why do you believe this is an important topic to highlight? IR:The importance of this year's conference theme of 'developing better markets' is that it comprehensively captures both demand and supply side aspects. It focuses on the 2.5 billion people around the world that lack financial access, takes into account agricultural communities, youth and gender issues and even the very specific challenges associated with former conflict regions. On the supply side, the conference highlights the essential need for ethical values in serving the market responsibly, emphasises customer centricity yet at the same time balances these themes with the constant need for prudent and proficient risk management, which is at the heart of all financial sector activity. Q: Could you tell our readers about WSBI and ESBG and your role within these organizations? IR: WSBI and ESBG are international banking associations. WSBI brings together savings and retail banks from 80 countries representing the interests of approximately 6,200 banks in all continents and focuses on issues of global importance affecting the banking industry, whereas ESBG brings together savings and retail banks of the European Union and European Economic Area that believe in a common identity for European policies. Together, the two organizations agree and promote common positions on relevant matters of a regulatory or supervisory nature, foster the exchange of experience and best practices and support members advancement as sound, well-governed and inclusive financial institutions through delivery of world class training and consultancy services, which are also available to other institutions. I am a Director at WSBI-ESBG, responsible for the group's global training and consultancy activities, with 20 years' experience in leading financial sector programmes and bank reform projects in more than 70 countries worldwide that support international efforts to advance sound, well governed and inclusive financial sectors. I am a Board member and Treasurer of the European Microfinance Platform, and WSBI representative on the Knowledge Committee of the United Nations' managed 'Better than Cash' Alliance. Prior to joining WSBI-ESBG, I worked for National Westminster Bank Plc in the UK and Australia. Q: At the upcoming conference, you will be speaking during a session titled, "Savings for the bottom of the pyramid: Institutional outreach." If you don't mind, please provide us with a preview of some of the points you will be discussing. Could you explain your perspective on the current use of savings in developing countries, and how this tool could be better utilized to promote poverty reduction? IR: Based on experiences developed since 2009 in running a 10 country programme known as the 'WSBI Doubling Savings Accounts' programme, I will plan to the scene for this session from the banking sector's perspective in addressing four challenges: i) how to provide usable savings services for the poor, ii) how to do so at a price that they can afford, iii) how to overcome the challenges of lack of proximity, and iv) finally to address some business case aspects in order that the services may be sustainable. Q: In your opinion, what issue (or issues) must be immediately addressed in order for the microfinance industry to move forward in the coming year? What improvements can European institutions specifically make in regards to this issue? IR: Financial sectors everywhere – including the microfinance industry - are facing a world of disruption from technology, changing customer behaviour and regulation. In the coming years, the delivery of financial services to communities around the world is set to change beyond recognition today. In the new scenarios that are emerging, adaptability and innovation are essential to survival. On the one hand, European institutions can help the developing world through partnership, investment and transfer of know-how; on the other hand, some European players may be surprised at the degree of innovation that is emerging from some developing countries, from which they themselves can learn to the benefit also of European markets. author: Niamh Watters

I’ve been poring over the data collected by the Angelucci, Karlan & Zinman study of Compartamos clients. To recap from my previous blog, with an average monthly loan payment of 2,100 for the loans in the study (and for Mexican MFIs generally), the figure of 1,572 pesos as the average client income poses a seemingly impossible debt-to-income ratio of 130%. The immediate question is whether the income figure is reliable. It does seem extremely low, putting the clients below the 3rd income percentile in the country. Can we get anything more from that data? Here’s the breakdown of the summary data (using the full panel dataset, i.e. households for whom both the baseline and endline surveys are available): [<{"type":"media","view_mode":"media_large","fid":"1181","attributes":{"alt":"","class":"media-image","height":"175","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"480"}}>] At first glance, the data seems even more problematic – the median income per adult is well below the average, at 1,200 pesos/month, meaning that half the clients make even less than that. Our already impossible debt-to-income ratio has now grown to exceed 175% for half of the clients. However, at the household level, total income (which includes job earnings, business activities, remittances and government payments), things don’t look quite so dire – a median of slightly over 4000 / month, or just over 50% ratio. Seems more reasonable, though many (including myself) would view even that ratio as excessive. And for the bottom quartile that earns 2000/month, the ratio remains still very much impossible. Might these incomes be understated? Well, looking at expenses, median food consumption is 750. So the loan payment is nearly three times higher than that. Indeed, loan payment is some 80% higher than the combined expenses for food & other nondurable items (large costs, such as transport, utilities, and housing aren’t included in the dataset). So in principle, the loans look somewhat plausible at the household level. But that’s for one loan – if we accept that many households have 2, 3 or more loans, then the ratio breaks down completely. None of the above figures can support debt repayments above 4200, let alone 6300/month, unless it’s the wealthier households that are borrowing more. As it happens, the survey did capture some information on borrowing, both with Compartamos and with other lenders: [<{"type":"media","view_mode":"media_original","fid":"1184","attributes":{"alt":"","class":"media-image","height":"595","style":"display: block; margin-left: auto; margin-right: auto;","typeof":"foaf:image","width":"972"}}>] Indeed, one can see that borrowing tends to increase together with household incomes. A household earning 8000/month has formal loans totaling nearly 17,000. Then again, we still see plenty of impossible-seeming figures, such as households earning 1000-2000/month carrying debt at over 8,000. We don’t know the repayment figures with these loans, but we do know them for Compartamos, and for these households, the 5,000-peso loans feature a repayment amount of 1600/month – their entire monthly income. That there is a substantial under-reporting of incomes in this survey is inescapable. A substantial number of households (17%) report incomes below 1000 pesos, while showing debt well above average. Some households have business activities that push their incomes into negative territory altogether. It's difficult to conceive that so large a share of borrowers are living on incomes that place them below the 1st income percentile in the country, while borrowing more than households making several times more. Certainly, some of these borrowers may well be struggling financially, but really, no credit bubble can be sustained with so large a number of households so deep in debt that they their repayment requirements literally exceed all of their income. Were that really the case, we would have long ago been hearing of daily tragedies, and seeing a great deal of resentment among borrowers. At least on the the surface, there is not a large number of borrowers in Mexico showing such signs of stress. This survey is among the most detailed recent assessments of the incomes of Mexican microfinance borrowers, yet the numbers still don’t add up. Most microfinance clients continue to be repaying their loans. The question remains – with what? The exploration continues. author: Daniel Rozas

This is part 3 of a 3-part installment from my brief visit to Mexico in October 2014. Read parts one and two. The biggest mystery about Mexico is understanding the numbers. They just don’t quite seem to add up. And that’s what was dogging me throughout the visit, including the two days spent in Mexico City talking to various actors in the sector. I was lucky – it just so happened that ProDesarrollo was releasing its 2013-14 Sector Benchmarking, and I managed to get myself invited to the event. A great opportunity to network with many actors in the sector at once. I also got to see the presentation of the market figures. At the outset of the trip, I laid out several hypotheses. It seems to me that there are really only two that matter more than all the rest: 1) the number of unique clients and number of loans they hold, and 2) the profile of the MFI clients on which the market rests. The question of market size continues to bother me. ProDesarrollo reports roughly 6.5 million active combined clients among its 82 affiliate MFIs. That’s by no means the whole market, but it is the bulk of it. It’s also not hugely different from the 2012 MIX Market figure of 6.0 million clients, so my earlier estimate of some 4 million unique clients is close enough. It’s also something that seemed reasonable by several microfinance practitioners I talked to. Of course, this figure is a guess. Without better data, it will remain that, at least for now. It also remains the case that these clients are poor. How poor? Well, some months ago, I cited the IPA study of Compartamos clients, which pegged the average client’s household income per adult at 1,571 pesos per month ($120) and an average loan amount of 6,462 pesos ($500). Given a loan term of 16 weeks and an average APR of 110%, the weekly loan payment (principal and interest) would be about 480 pesos, or nearly 2,100 / month. So we have a dilemma – the loan repayment is 130% of the client’s income. That’s a seemingly impossible ratio. Were all loans purely business loans, one could rationalize that the increase in business income would offset the repayment requirement (though such an increase wasn’t found in the IPA study). But it’s well known that many loans are taken for consumption-smoothing purposes. And if a family might manage a costly loan to tide over a difficult period (by relying on a spouse’s income, for example), consistent borrowing above one’s income is hardly a sustainable recipe. And that doesn’t even include the problem of multiple borrowing, which could magnify loan repayments by a factor of 2, 3 or more. To complicate matters further, the same study found essentially no change in the client’s financial situation. It’s a dilemma I can’t resolve with the given data. The figures just don’t work. It may well be that the incomes captured by the IPA study are incomplete (and they do seem awfully low, even for poor families in Mexico). Or perhaps multiple borrowers tend to be wealthier. I’ve asked the study’s authors to share additional data they have collected during the study that may shed additional light (or disabuse me of a silly misunderstanding of what that data represents). I will share what I learn in due course. For now, these core questions – who are Mexico’s microfinance clients, how many of them are there, and how much debt do they have? – remain unresolved. These questions shouldn’t be impossible to answer, but until then, Mexico will remain a mystery. But therein lies the key to understanding the problem of overindebtedness in Mexico. author: Daniel Rozas

This is part 2 of a 3-part installment from my brief visit to Mexico in October 2014. See: parts one and three. My first stop in Mexico was a place I first heard about nearly two years ago: Chiapas. The state is in many ways one of the centers of Mexican microfinance. According to ProDesarrollo’s 2013-14 Benchmarking, Chiapas is tied with much larger Veracruz for the largest number of the network’s members (32). The number of MFI branches per population is nearly double the national average. It’s also Mexico’s least developed state. In all, I spent about 22 hours in Chiapas. But even that paltry amount of time can prove revealing. Among the first things I noticed was the degree that credit is embedded in the culture (and apparently, this is nationwide, not just Chiapas). For example, at many retailers the prices quoted are not so much prices as monthly (loan) payments. The price is included, but often in small print. The example here shows a washing machine at a major retailer (Coppel) that’s priced at 6,999 pesos ($520), but the big number you see is 258 pesos ($19) – a fortnightly payment for 18 months. The interest rate is nowhere to be seen, though this one works out to 39% APR. Interestingly, the price of the washing machine is nearly identical to the average microcredit amount in Mexico, which ProDesarrollo reports is now 7,147 pesos ($530). So, at the outset, the interest rate offered by the store is much lower than the MFI rates in Mexico, which often approach (and even exceed) 100% APR.[<{"type":"media","view_mode":"media_large","fid":"1176","attributes":{"alt":"","class":"media-image","height":"480","style":"float: right;","typeof":"foaf:image","width":"360"}}>] The point here isn’t to discuss interest rates. No doubt, the store selling its goods on credit is making quite a markup on the items themselves, so the comparison with loan rates isn’t really appropriate. Moreover, the buyers here are quite likely different – many are probably wealthier than the typical MFI client. Indeed, from my conversations with a handful of borrowers in Tapachula and a nearby village, MFI clients are not big users of store credit – not a single person mentioned buying goods on store credit, though they were quite open discussing their microfinance borrowing. And on that point, I discovered some interesting things. First, of the eight individuals I spoke with at some significant length, there were two types: 1) active microfinance borrowers, each of whom had 2-3 loans, and 2) non-borrowers. I didn’t meet a single individual who had just one loan – for most markets, that’d be very unusual, but it wasn’t unexpected in Mexico. Both groups were largely made up of the same individuals – small vendors in two of the local markets we visited. However, there were also notable differences: all borrowers were women, while the non-borrowers were split roughly evenly between women and men. Half of the non-borrowers also expressed a negative attitude towards microfinance, saying they would never borrow, certainly not at the rates charged by the MFIs. Two were particularly passionate on this point, one saying that the high interest rates amount to “robbery.” Both also said that it was impossible to grow a business relying on such expensive, short-term credit. A couple of the non-borrowers said that the loan officers visiting the market would ignore them – most likely because they didn’t have permanent sales locations, and were selling from boxes or temporary stalls set up outside the market. This differentiating tactic is very common for loan officers in other countries, since such clients can be harder to track down for repayments. The feedback from non-borrowers is important to bear in mind, particularly when seeking to model demand. As is the case in many other places, the target market for MFIs is substantially narrower than just the poor in Mexico. Even among those who work in the informal sector, a substantial proportion will be seen as either too poor (i.e. no permanent place of sale) or simply uninterested in borrowing. Meanwhile, the borrowers all viewed MFIs as generally positive, and all were long-time clients (7+ years). Again, the sample is too small to extrapolate, but it is instructive when juxtaposed with the non-clients. The average years clients have been active in microfinance is something to consider when evaluating capacity for continuing growth, especially in mature areas like Chiapas. What is likewise notable is that at least two borrowers suggested that one of the loans they’d taken were intended not for them, but for someone else, i.e. family or a friend. This appears to be quite a common practice in Mexico, and is well recognized by those working in the sector. Regarding the economic profile of the borrowers: the vendors in the Tapachula markets had permanent stalls in the market area, and sold a mix of goods, from shoes, to poultry, and so on. The borrower in a nearby village was much poorer. Indeed, the village – which had no paved road, a polluted and partly flooding stream, and very basic homes in various states of completion – could be easily compared to poor villages in Cambodia or India. It was a world away from the upper middle income Mexico that one might see in the country’s capital or other developed areas. Such borrowers form a major part of MFI portfolios, so this is consistent with the hypothesis that the sector’s clientele are truly among the poorest in the country. Finally, the question of competition – Tapachula was clearly a competitive market. The borrower in a nearby village could recall six separate MFIs active in there, though each recall was prompted by mentioning a specific MFI. Presumably, there were others that we simply failed to mention. But in light of the fact that Chiapas is the most densely served market in a country that with a uniquely high level of multiple borrowing, the situation on the ground didn’t seem exceptional. I didn’t see multiple competing branches next to each other, as I’ve seen in Lagos, for example. So what to make of this extremely brief visit to Chiapas? First, Mexico’s credit culture arguably creates more credit demand than comparable markets. Second, the target population of MFIs does seem quite narrow, and within that narrow slice, there are many who are not (and are unlikely to become) clients. And finally, the market is clearly competitive, but on the surface, it doesn’t seem to be exceptional. Perhaps the most important thing is what I didn’t find – though some borrowers knew other clients who had defaulted, not a single borrower mentioned overindebtedness as a major issue. More to come. author: Daniel Rozas

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