Memo to the President Elect: End the Credit Squeeze on Latin America's Poor
by María Otero
America's Quarterly, November 6, 2008
Over the past two decades, democracy has taken hold in the vast majority of Latin American countries. Notwithstanding an anti-market backlash led by Venezuela, the region as a whole has benefited from stable economic policies and improved growth rates. Yet these gains remain imperiled by persistent poverty and income inequality.
According to a May 2008 report from the Council on Foreign Relations (CFR) Task Force on U.S.-Latin American relations, to which I contributed as the president and CEO of ACCION International, economic growth in Latin America has lagged behind that of other developing regions. The CFR report, citing figures provided by the World Bank and World Economic Forum, noted that Latin America’s combined economies grew a scant 2.1 percent between 1995 and 2005. The regional poverty rate, now 37 percent, has barely budged in a quarter century. Indeed, the number of poor has risen from 136 million in 1980 to nearly 200 million today.
The United States plainly has a vital interest in reversing these bleak statistics. Failure to increase wealth more quickly and to reduce income inequality undermines support for democracy. A survey of 19,000 people across Latin America by the polling firm Latinobarómetro found that the percentage that preferred democracy to all other forms of government dropped from 63 percent to 54 percent between 1997 and 2007.
By working with Latin American governments to reduce poverty and inequality throughout the hemisphere, the incoming administration can also ease immigration pressure on the United States. Indeed, an enlightened immigration policy would aim not only to provide decent options for guest workers in the U.S., but also to help Latin American nationals who work in the U.S. put their earnings to productive use back home. An important means to that end is microfinance—the provision of small business loans (and, increasingly, other financial services) to the self-employed poor.
Lack of access to core financial services—credit, savings, insurance, pensions, electronic payments—is a major impediment to upward mobility for Latin America’s poor. Throughout the region, according to a 2006 Inter-American Development Bank report, just 10 percent of the population has access to credit accounts, and total lending to the private sector is just 25 per cent of GDP, compared to 76 percent in developed countries.
The new president should therefore boost U.S. support for the growing microfinance movement. Microfinance in the region began in Brazil in 1973 and has since developed a strong footprint throughout Latin America. In 2006, the top 10 microfinance institutions in the region increased their lending by 36 percent, according to MicroCapital Monitor.
To date, approximately 10 percent of the region’s estimated 50 million micro-entrepreneurs have received at least one micro-loan. That’s a significant start, but a tenth is just a tenth. And micro-lending is just one step.
What’s required is an active effort by the new administration to support the spread throughout the region of truly inclusive finance. That means access not just to credit but also to savings accounts, checking and electronic payment services and insurance. Without financial services, life is a precarious, day-to-day enterprise, in which a fire, a poor growing season or an illness can cripple a family’s fortunes and stunt its children’s future prospects.
Over the past 30 years, pioneering microfinance institutions (MFIs) have proved that the poor are "bankable," and that providing access to credit and other financial services increases the ability of the self-employed poor to boost their income, mitigate the risks that accompany poverty and improve their living conditions. Well-targeted and responsibly delivered micro-loans, in concert with financial education, can increase the earning power of self-employed Latin Americans.
While government should support efforts to scale up provision of financial services to the poor, the job belongs primarily to the private sector. In recent years, the microfinance industry has been growing at what the Financial Times calls a "dizzying pace."
Between 2004 and 2006, according to the Consultative Group to Assist the Poor, housed at the World Bank, outside investment in MFIs rose from $1.7 billion to $6.7 billion worldwide. Private-sector investment is driving innovation that is reducing the high costs of lending to the poor, leveraging technology and ever-more efficient business processes.
U.S. encouragement of this trend could make a real difference, however. Indeed, the kind of U.S. engagement that can effectively foster inclusive finance is well-suited to the kind of light-touch influence the U.S. should seek to exercise in an era in which most Latin American governments are democratically elected, stable, increasingly assertive, and sensitive to perceptions of heavy-handed intervention from their giant neighbor to the north.
Acknowledging this political reality, the CFR recommended that Washington work largely through multilateral organizations, civil society organizations and domestic and international businesses in their efforts to help Latin American governments create inclusive finance sectors.
That’s sound advice, and a firm policy directive from the new U.S. president will ensure that it is taken. The multilaterals have the skills and experience to promote financial inclusion. The U.S. should seek to expand their capacity to offer technical assistance on regulatory frameworks and credit reference systems that are necessary for private banks to enter these markets. The new administration should make it clear to the multilaterals that helping to develop the right financial and regulatory infrastructure in target countries is a U.S. policy priority.
As the market develops, competitors multiply and lower-income Latin Americans find their options for credit and other financial services expanding, the multilaterals should also seek to support financial literacy programs to help ensure that the newly banked do not become over-indebted or purchase services ill-suited to their needs.
The U.S. should also use its diplomatic influence and aid resources to promote the development of regulatory climates in Latin America that are conducive to the growth of competitive financial services markets. Some of the most formidable obstacles to the growth of the microfinance industry are caused by governments that both over- and under-regulate—sometimes simultaneously. Ways in which national governments can choke off growth of an inclusive financial industry include imposing interest rate ceilings, launching government microfinance banks, and bringing bank supervision into the orbit of political leadership. Governments also often make it too difficult for lending institutions to accept deposits, a major engine of growth for the banks, as well as of wealth accumulation for the populace. Sadly, U.S. antiterrorism zeal has had a negative effect on this front. The U.S. has promoted "know your customer" rules that make documentation for opening accounts excessively burdensome. The U.S. can restore balance by raising "know your customer" requirements proportionately for higher-balance accounts.
Working through multilateral agencies, the U.S. should encourage Latin American governments to view themselves as facilitators, but not participants, in the financial sector. The principle that credit decisions must be made without political interference is fundamental. Governments should refrain from using the financial sector as a means of financing their own spending. The legal framework must recognize property rights, and court systems must uphold secured transactions. Most important, broad access to financial services should be a core goal of financial sector policy.
Targeted multilateral aid to MFIs in countries with favorable regulatory environments can help move policy in the right direction. In many cases, the multilaterals can strengthen the market by working with the private sector in countries where the regulatory environment allows it. The new administration should encourage Congress to simplify the procurement process for programs such as USAID, freeing the agencies to work directly with NGOs and financial service providers located in the recipient countries. USAID programs should empower these local organizations to design and implement programs that provide financial services to the poor.
Market research shows that most Latin American immigrants come to the U.S. with specific financial goals and the intention to return home. In fact, there is a natural relation between microfinance and guest workers engaging in such circular migration, and ACCION is already working in Honduras on just such an initiative.
Support for inclusive finance can stimulate this virtuous cycle at various entry points. First, facilitating the efficient transfer of remittances creates the opportunity for financial institutions to help steer funds sent home into productive use. At present, according to ACCION’s internal research, only 27 per cent of Latin American recipients of remittances are bank customers. Latin American MFIs and banks should be encouraged to offer savings accounts with low minimum balances as well as microenterprise or home loans backed by the income provided by remittances. Prepaid cards can reduce the trouble and cost of sending money home and provide an entry point for bank outreach to relatives of workers in the U.S. The U.S. can smooth the way to broader financial access, again, by easing its enforcement of stringent "know-your-customer" rules—as well as by simply advocating savings-friendly regulations.
Inclusive finance programs should also focus on guest workers or long-term migrants to the U.S. who return to their countries. USAID and multilateral/institutional technical assistance and capacity-building programs should encourage MFIs and other financial institutions to target the returnees, who have often developed significant financial and personal resources, equipping them to start businesses or invest in their home countries.
In the twenty-first-century struggle to rapidly reduce and ultimately eliminate poverty, inclusive finance is emerging as more than just another arrow in the quiver. Creating conditions under which the poor can profit from the financial sector and be trained to make prudent and productive use of financial services is one of the fundamental challenges of poverty alleviation. Those challenges should serve as a linchpin of U.S. policy.