> Posted by Pablo Antón Díaz, Research Manager, CFI

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Scott Graham, Daniel Rozas, and Pablo Anton-Diaz at the “Preventing Overindebtedness in the Microfinance Sector in Mexico” panel, XV National Microfinance Summit, Mexico City, Mexico, November 2016

For the past decade, in part fueled by regulatory changes in the financial sector, there has been an explosion in the availability of credit to low-income individuals in Mexico. The Mexican microfinance sector has become increasingly concentrated and highly competitive. In 2015, the 10 largest microfinance institutions (MFIs) in the country represented 81 percent of the total market size, with more than 1,500 smaller MFIs sharing the remaining 19 percent.

Data from a study of loan applicants to FINCA Mexico suggests that the vast majority of new loan applicants in Mexico already have active loans and that somewhat less than half of these individuals are already in arrears at their time of application. The growing evidence on overindebtedness and credit bubbles in some regions of the country is an issue that, if left unattended, could trigger severe problems.

The increasingly crowded Mexican microfinance market reflects very deep penetration of a very narrow slice of the population (microentrepreneurs in the lowest two income quintiles) and mounting pressure on new players that need to reach a healthy portfolio size in order to achieve long-term sustainability. To their credit, MFIs have made great efforts to overcome traditional geographical barriers, and the current reach of the microfinance industry covers more than 90 percent of the 2,500 municipalities in the country. Because of the type of customers being sought out by new players, and the already high concentration of competitors in densely populated areas, recent growth in the sector has primarily focused 0n rural areas with low Human Development Index scores. It is therefore not a coincidence that of the five Mexican states with the highest rural populations, four have the highest number of operating MFIs in the country (Chiapas, Veracruz, Estado de México and Oaxaca). Three of these states also have the lowest Human Development Index scores in Mexico (Oaxaca, Veracruz and Chiapas).

Indeed, the number and variety of lenders, along with the total volume of loans in the sector, have increased massively. It is safe to assume that most lenders are profiting under current conditions. What is less understandable is why so many lenders are willing to make loans with apparently little regard for the borrowers’ existing credit statuses. Institutions with proper credit discipline would theoretically avoid making risky loans for fear of write-offs and administration costs. But in Mexico, the current scenario – which includes, among other things, the highest interest rates in the microfinance world – allows some lenders to push the costs of reckless loans onto borrowers. Bad lending seems to be turning into good business in some states in Mexico – with customers paying the price.

A study conducted by the Microfinance CEO Working Group (MCWG) using credit bureau data from FINCA Mexico’s loan applicants in all the main regions of the country is one of just a few studies attempting to gauge the severity of this problem in Mexico. The researchers found that almost 74 percent of new customers applying to FINCA already have loans elsewhere (with 55 percent having one or two, and 19 percent having three or more). Additionally, of the clients with outstanding loans at the moment of application, 44 percent were already in arrears. This incidence of arrears increased with the number of existing credits. For clients with two outstanding loans the incidence of arrears was 58 percent, with the number rising to almost 80 percent for those with four or more sources of credit. If we assume that the results of this study from one large MFI are representative of all microfinance applicants nationwide, it would imply an enormous number of microfinance clients in Mexico with multiple outstanding loans and an also enormous number in arrears.

In Chiapas for example, Mexico’s poorest state (with a population of almost 5 million), there are currently more than 30 registered MFIs in operation. Because of this, multiple borrowing is rampant, with the average urban client in the state carrying four to five loans, according to data analyzed by Daniel Rozas, while clients with as many as seven loans are not unheard of.

In November I had the opportunity to moderate a panel on overindebtedness at the annual “Encuentro Nacional de Microfinanzas” (The National Microfinance Summit) in Mexico, hosted by PRONAFIM, where some of these findings were underscored in front of a larger audience by both Daniel Rozas and Scott Graham, the researchers behind them. After listening intently to both researchers, it was heartening to see how many of the attendees that offered comments were well aware of this silent threat and in some cases had already started to take initiative inside their own institutions to come up with possible solutions to prevent a crisis.

PRONAFIM is a program managed by the Finance Ministry (Sectretaría de Economía) that provides funding for microfinance institutions. The Smart Campaign has worked closely with PRONAFIM to support client protection in the market for over a year. We announced during this panel that as part of the Smart Campaign’s close collaboration with PRONAFIM, we were working with them on how to strengthen their supervisory tools for the specific purpose of – among other things – preventing practices that can lead to the unnecessary overindebtedness of clients. This revamped tool will be launched by PRONAFIM in early 2017 and will be implemented as part of the annual supervisory visits that their compliance teams conduct with the MFI investees in their portfolio. This tool will help PRONAFIM to evaluate these MFIs against minimum industry standards in areas like transparency, prevention of overindebtedness, and responsible pricing practices to identify and correct harmful client protection practices within the institutions they support, and set an example for other competing institutions in the country. This tool is based on the Smart Campaign’s Smart Assessment Tool, which is used worldwide to examine an institution’s implementation of the seven Client Protection Principles.

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