The overall perspective is that after several decades, the Microfinance industry still remains at 18% penetration of the total market, which means it has not budged an inch since it began; this was the sad conclusion of the ADB report last year.
To make matters worse, there is now an appalling level of overlapping in Microfinance service, what we call multiple loans. This was a major issue in India years back when poor borrowers were forced to get more than one loan driving them to indentured slavery. Because of many Microfinance malpractices like this, many countries with large MFI (MicroFinance Institutions) services are now legislating anti-MFI laws, to tax MFIs for example.
Although the total penetration is still very low, one can no longer find a place in the Philippines where a borrower has only one loan. Usually, the borrower will have multiple loans. One safeguard that is becoming an SOP in Microfinance now is to ask how many loans the borrower has before a loan can be approved.
It is even more out of control now as large players from overseas have invaded the country with easier to obtain loans. They don’t require a group fellowship of at least 30 borrowers to be formed anymore. A single individual borrower will do. This is sad because community organizing has been proven by many scholarly studies to have the most beneficial effect on the community and the MFIs are no longer doing it. it is also during fellowships that the gospel can be preached.
The large players have lots of money and using leverage and statistics, they can quickly demolish competition. The usual ratio is a default of 3% among poor borrowers and with a large portfolio, that can easily be achieved. A smaller portfolio will suffer a bigger loss ratio.
The large players as a result no longer does credit investigation, almost no forms to be filled up and the loans are released almost immediately. The group guarantee is dispensed with. The small players who still believe in the beneficial effects of community organizing resulting from group guarantee and fellowship formation, are at a loss because many of the borrowers have in a way “wizened up” and they tell us they don’t want group guarantee, “why should they pay for the default of others, it is every man for himself now.” This is sad when the community is fragmented and becomes very individualistic.
There is a great need to expand the scope or area of operation of MFI but then, the reason for the overlapping of loans is because the MFI is very dependent on logistics and geography. The area representative, the one dispensing the loans, has to walk an average of ten kilometres just to do his job, or walk ten hours a day. It is impossible to operate the MFI over a large territory without establishing branches but then branches are expensive and results in bigger overhead costs. that is why many MFis are operating in the same place and not venturing out to areas with no MFI.
On the front line, the MFIs are now facing the battle of its life.
The internal revenue office is running after MFIs and throwing the book at them. There is now a pending lawsuit in the tax court against the biggest MFIs, totaling about a billion pesos for deficiency income and value added taxes. It is likely the MFI will win the battle over income tax but the value added tax (12% vat of gross receipts) will be difficult.
The central bank is also at the heels of MFIs. Starting this year, the laws applied to banks and non-bank financial institutions like pawnshops and lending investors, were applied to MFIs. The two laws are 1. On the disclosure of all charges and interest, or simply, disclosing the real effective interest rates imposed. 2. The central bank also wants that the interests are computed on a diminishing rate basis. The MFIs up to now still computes by the fixed rate basis, meaning, even if part or most of the loan has been paid off, the interest is still applied to the original total loan undiminished by payments already made.
actually the DBP (Development Bank of the Philippines) is mandated to do this. if the DBP will only do its job there would be no need for MFIs. but the DBP’s money is mostly lent to big businesses even though its charter says it should cater to the poor. if the central bank does not mind that DBP is not doing its job then it should not lean on the MFIs so much.
We know that the real effective interest of MFIs is not the advertised 3% monthly. It is about 5% if we include the surcharges, membership fees, shareholding contributions, service charge, etc. (all hidden costs); this is about 60% annually. The pawnshops advertised as required by law an effective interest of 5% with collateral. MFIs have no collateral.
However, most MFIs have not factored in taxes and others costs. If we factor in the 12% vat which in this case will be the total 12% undiminished by input vat since most MFIs do not have input vats with which to reduced their output vats, then we add 12% to the 60% already charged, for a total of 72%!
If we lose in the income tax also, it will be higher.
If we want to recover what we will lose from the diminishing rate computation which is being implemented already January 2013 by the central bank, we will have to add another 10% which would make the total interest rate imposed to 82%. One of the executive directors of the biggest Christian MFI said, when that happens, they will just close shop.
Many of the MFIs also collect what is called CBUs (Capital BuildUp), or capital build up or savings. The central bank many years ago allowed MFIs for altruistic reasons to collect CBUs and not require them to get a permit to operate as a bank on the premise that the poor borrowers once they have accumulated enough savings or CBUs can now become independent of MFIs and borrow from their own savings. This exemption is not even allowed by law, but is only a concession given by the central bank for MFIs. Only a law can repeal or modify a law. The law is clear that when one gets deposits from a certain number of people, it becomes a bank or needs to get a bank license.
This idea of a CBU was theoretically correct only. The mfis have used over decades, large amounts of these CBUs to lend back to the savers with interest! While the savers or owners of the CBUs only earned nominal interests on their savings, the mfis lent to them their own money at the usual high rates.
The central bank may thus revoke this special privilege since it has been largely abused to the detriment of the poor borrowers. The only solution to this is to make the borrower form their own cooperatives and make them independent. The opposite though has happened; it is the mfis that have grown bigger.
So, if the CBUs are dismantled, the 82% could even go up some more!
What if the mfis formed and established more cooperatives? Each barangay would have its own and they could be federated also to make them the most profitable cooperatives in the country, with a great leverage.
85% of the existing cooperatives registered with the Cooperative Development Authority are now bankrupt or not operating. The main reason is weak business management capacity.
The mfis can help a lot in this matter. They can be the nursery for these cooperatives. The MFIs have so much power. With their loan portfolio, they can easily compel the poor to save. This is a miracle really. With their expertise in loans and savings management, the MFIs can manage the cooperatives until they mature. MFIs can collect their CBUs until it reaches 200,000 pesos, enough for a group of 20 borrowers, the usual size fellowship. Then register them as a cooperative with 20 members.
The MFIs will then be hired as management consultant to operate the cooperative. What the MFIs will charge will no longer be interests but consultancy fees or management fees, all of which are outside of the jurisdiction of the central bank. With that set up, the whole MFI will get out of the jurisdiction of the central bank entirely; they can charge as much interest as they like, even use the fixed rate for computing interests.
They will also not be taxable either for income tax or vat. Although when the cooperative’s capital has exceeded 10 million pesos they will be taxable already but that is too far away in the future yet. Also, if the cooperative lends to non-members, then it is also taxable, although, many have an escape hatch for this, by making non-members into associate members without shares.
The beneficial effect of community organizing is also put in place again when cooperatives are formed. This is the self-help principle that is so valuable in community development, which is set against top down programs, which are not empowering nor participatory in their decision making. For years, the major criticism against MFIs has been that it is the mfis that have grown and grown wealthier while the poor borrowers have become nothing but perpetual borrowers.
There is justification though for the high or excessive interest being charged by MFIs. If we compare their rates with the so-called “bombays” or 5-6 (get 5, return 6), it is still a lot cheaper. Also, when compared with the bank loans, MFI services are still more accessible. Most poor borrowers are informal businesses and will not be able to submit the papers required for formal bank loans.
Of course, eventually, MFIs will want to bring the borrowers to that stage. If we define the indices for measuring success of MFIs, it will include that. Although most MFIs only count as index of success the repayment rate and nothing more. The other indices are:
- The poor borrower grows from micro to small and to medium, eventually to become large enterprise. This is the model used by the government for measuring the success of their poverty alleviation programs. We need to help the micro to become bigger, more stable and more successful. We have a lot at stake in this since the SME or small medium enterprises provide 70% of the jobs in the country, more than the biggest top ten corporations of the Philippines do. Most of the SMEs are micro enterprises with a lifespan of less than a year.
- The micro enterprise should eventually enter the formal business sector, register its business and issue receipts, submit financial statements and keep books. There is a law for marginalized businesses, which gives the micro enterprise the privilege of registering without need of paying the registration fee nor paying taxes, until it is able to grow and reach the minimum gross sales for taxability. This is a good index of success, that the micro has become a formal business.
- Most borrowers from the poor also cannot open a bank account and the mfis serves that purpose for the meantime. Their savings in the form of CBUs are deposited with the mfis. Once they have reached the 200,000 pesos minimum capital requirement, they should be moved to a regular bank in the name of the cooperative.
- Eventually, the borrower should be able to borrow from the bank which charges less than the mfis. The mfis should help the new cooperative access bank loans by arming it with three years of audited financial statements which is the minimum requirement banks ask for when a business loan is requested.
- Another good index of success is that as the micro grows, it generates employment, and it always happens.
- Also, the business should begin to pay taxes as it grows. One expert on micro finance said, the Philippine mfi industry is the second best in world but it is not impacting the economy. It is still underground as a business. It is largely untapped and not part of the normal flow of commerce. The poor have according to Dr. Sotto, nobel laureate from peru, so much assets outside of the commercial system, and these should be included in the formal sector and market. They should be given titles to their assets, and a bank account they can leverage and be tapped for business. It is also true that for the most part, it is the mfis that are benefitting from the microfinance and the poor actually do not in the end, after several years, do not improve or prosper. The fact is that, worldwide, the percentage of success in business has always been very small. Only less than 10% of the borrowers survive after ten years, the rest closes down and goes bankrupt.
But that 10% is a healthy percentage and is true worldwide. Also meantime, while under the care of the mfis, the borrower’s family is able to eat and all their kids are able to go to school. So it is still what we call a necessary evil. But mfis when they finally realize that the borrowers should be made independent and formed into their own cooperatives owned by the borrowers themselves, the mfis will be in the crucial role in the whole strategy of developing the country’s SMEs. The mfis can mobilize savings, mobilize capital for loan portfolios, train in enterprise development, form and manage cooperatives, and create the most stable and prosperous foundation for the Philippine economy.
MFIs have a real niche. Regular banks cannot go there because it is just too much hassle. Quedancor tried this a few years ago and lost ten billion, and the criminal cases filed are still being up to now. as a result, Malacanang has prohibited all government agencies from engaging in micro finance which obviously is outside the government’s competence. Compare for example the tellers in the regular bank and in the mfi. A teller in a regular bank works inside an air-conditioned office, with a maximum clientele of about roughly 200. She also gets more than minimum wage salary with great benefits. While in the mfis, the area representative needs to raise up a MINIMUM of 400 borrowers before she can get her salary, usually less than minimum wage, with hardly any benefits.
She has to work outside, exposed to the elements, to robbers and epidemics. She has to walk several miles a day to see clients in their homes or stores. The ratio of loans also allows very little profit. Lending ten million pesos to two or three borrowers is a lot safer than lending it to one thousand borrowers in small amounts. Mfis are too labor intensive to become truly profitable. With the harsh competition from the big players, mfis seem on the verge of seeing their final demise.
I have also been part of the group that helped our mfis, a network, to become a party list, to be a member of congress representing the poor borrowers. This is another role the mfis can take advantage of to further promote the development of the micro enterprises. Most of the country’s laws on business are directed towards large businesses, big businesses. It is almost as if the micro enterprises do not exists even though all big things must begin with small things. The whole philosophy of the world’s business is that big businesses alone beget new businesses, promoting monopolies. The Philippine laws for example, prohibit the creation of new banks, one can only have a bank by buying an existing bank. It was a miracle when the mfis were allowed to open a microfinance bank, a new window in the central bank territory.
Laws should be made to address the fact that many micro enterprises cannot open their own bank account and are informal. Safety nets should also be created to ensure that micro enterprises grow, such as provisions for health care, insurance, scholarships for their dependents, etc.
Today, some of the biggest MFI players are generating more profits from micro insurance than from their loans business. If congress can work on this to make the micro insurance grow and benefit the micro enterprises, it would be amazing. I was part of the team that developed the package for the best micro insurance in the market, which is a lot cheaper than the government PhilHealth but with five times more benefits.
If you go to the slums today to peddle your micro finance, the first thing the mothers will ask you is if you have micro insurance. They will buy from your mfi only if you have micro insurance. This is really a revolution. It was unheard of a few years ago. None of the poor cared about insurance, it was just so esoteric for them, so out of this world. But after so much floods, fires, and motorcycle accidents, the poor are now very aware of their need for micro insurance. It is also a market niche that is barely visited by existing businesses. The law must encourage the growth of this sector, promote more competition to even lower some more the premiums for these micro insurance.
A final item to discuss are start-ups, hardly anyone mentions this group. MFIs don’t go to start-ups, they only lend to existing businesses. In other words, the MFIs do not lend to the poorest of the poor, they can’t. If they do their defaults will rise to the impossible level. 90% of start-ups fail according to global statistics. But without start-ups, there can be no micro enterprises also.
Someone has to do it, invest and lose money in start-ups. If 10% are able to move up, to become micro enterprises, then it is already a big achievement. Once it becomes micro-enterprises, the MFIs can now take care of it.
I am sure many more people are more well-versed in this topic and I certainly have no monopoly of this topic and I would really enjoy getting comments and inputs on this to make this a more accurate and impactful paper, to help the MFI industry to grow.