Small is beautiful: The growth of the microfinance segment is continuing unabated

Long a feature of Peru’s financial landscape, microfinance institutions (MFIs) continue to evolve, offering new products and beginning to expand beyond the regions they were initially created to serve. Municipal savings and loan institutions (Caja Municipal de Ahorro y Crédito, CMACs) – a category of MFIs originally serving cities outside Lima – are developing customer bases on a national scale. Commercial banks are also investing heavily in expanding the operations of their microfinance entities as they seek to reach more middle- to lower-income clients.

Unlike the mainstream banking sector, however, the microfinance segment remains much less concentrated, leaving room for mergers and acquisitions, some of which occurred in 2012. Given the current economic climate, the main challenge is likely to be reaching new clients outside the banking system, while striving to improve credit evaluation and keep non-performing loans (NPLs) in check.

Performance

For the fifth year in a row, Peru topped the Economist Intelligence Unit’s 2012 global ranking of microfinance business climates. This comes as little surprise to those aware of the country’s solid microfinance regulatory framework and the current level of competitiveness in the segment.

As of June 2013 MFI credits had grown by 4.8% year-on-year (y-o-y), and MFIs were also effective at capturing client savings, which were up 13.6% over the same period. NPLs increased, however. As of June 2013, the average NPL rate for MFIs was at 6.2% – which represents a 0.6% increase compared to the same month the previous year – and 2.11% for the financial sector as a whole. While it is not uncommon for MFIs to have higher NPLs than large commercial banks, given the credit risks associated with lending to lower-income clients, the recent rise in NPLs may be a sign of overly aggressive efforts by some MFIs to attract clients.

New Clients

Gustavo Morón, business manager of Financiera Edyficar, one of the country’s largest MFIs, told OBG that too many MFIs are demonstrating an “excess appetite for risk” by taking on clients who, far from being new to the banking system, have loans from multiple institutions already.

“There is a lot of space for growth, but if you start lending to the clients of other MFIs it is as if this space does not even exist. This also applies to cases where lenders begin to relax their requirements,” Morón said. “The combination of firms competing for the same clients and relaxing requirements leads to higher NPL rates.” José Beltrán, planning manager at CrediScotia, the microfinance arm of Scotiabank, agreed. “Part of the solution to rising NPL levels will be to look for new clients who are not yet part of the banking system,” he told OBG.

Improving models of risk assessment would also go some way toward addressing the NPL problem. This could include tools such as psychometric testing, which is being pioneered in Peru by the Entrepreneurial Finance Lab, an organisation that works in conjunction with the International Finance Corporation and various private sector partners.

CMAC Expansion

One of the major contributors to the growth in microfinance has been the CMACs. According to the Peruvian Federation of Municipal Savings and Loan Institutions (Federación Peruana de Cajas Municipales de Ahorro y Crédito, FEPCMAC), which represents 13 CMACs, lending by its members increased by 13% in from June 2012 to the same month in 2013. The CMACs serve 1.9m clients and account for around 39% of the total MFI loan portfolio, a larger share than any other MFI association or individual microfinance bank.

CMAC Arequipa is the biggest member of FEPCMAC and the third-largest MFI in the country, after Mibanco and CrediScotia. The savings and loan institution was founded in 1986 with the goal of providing financial services to individuals that had no access to the traditional banking system. At the start, the firm had only one office in Arequipa. Since then, CMAC Arequipa has expanded and today has more than 75 branches and 112 ATMs across Peru.

CRACs

While smaller than the CMACs in terms of their market share, rural savings and loan institutions (Caja Rural de Ahorro y Crédito, CRACs) are also contributing to the development of microfinance.

In June 2012 Financiera Universal, an Ecuadorean MFI with operations in Peru, acquired CRAC Caja Rural Profinanza. The deal tripled the size of Financiera Universal’s assets in Peru and signalled the Ecuadorean outfit’s strong push towards serving rural areas. Beltrán told OBG that this acquisition is part of a trend in which other MFIs, or even large commercial banks, are purchasing CRACs to gain their know-how regarding operations in rural areas. “These acquisitions are not occurring as a result of solvency problems for the CRACs. Rather, a large bank will buy a CRAC to learn more about their operations and how they can be replicated,” said Beltrán.

Big Banks & Microlending

BBVA Continental, Peru’s second-largest bank, followed a similar model when it entered the microfinance segment some years ago. The bank acquired several smaller MFIs over a five-year period, ultimately combining them to form Caja Rural Nuestra Gente. Now the largest rural MFI in the country, Nuestra Gente accounted for 30.81% of the total credit portfolio within the segment as of September 2012.

Two of the country’s largest banks, Banco de Cré dito del Perú and Scotiabank, operate their own microfinance entities. Banco de Crédito del Perú acquired Financiera Edyficar – which is currently the fourth-largest microfinance lender in the country – in 2009. Scotiabank operates the second-largest, CrediScotia, which was formed as a result of the acquisition of Banco del Trabajo in 2009.

Adam Kemmis Betty, the Peru country director at Innovations for Poverty Action, a non-profit organisation that evaluates the impact of development programmes, told OBG that larger banks operating in the microfinance segment could play a distinct role from that of microfinance non-governmental organisations (NGOs), for example. “The larger banks moving into the microfinance segment bring a different pricing and risk management strategy from the kind you might see from most microfinance operators,” he said. Kemmis told OBG that a typical microfinance NGO would utilise a group lending product and work hard to ensure zero default. This practice strictly limits clients’ abilities to take on potentially riskier but higher-reward business activities. Larger commercial banks operating in microfinance also generally offer individualised products, which allow small business owners greater flexibility in exploring opportunities to expand their businesses.

Product Design

While interest rates on microfinance loans have fallen over the years as competition in the segment has increased, Kemmis told OBG that innovative product design can also offer some MFIs a competitive advantage.

For example, offering fixed credit lines to entrepreneurs, rather than regular loans, allows small business owners to limit their liabilities and interest payments by taking out only the amount of credit they need at a given point in time, instead of borrowing larger lump sums out of fear that more capital would not be available later. CrediScotia offers this type of product, a working capital credit line in amounts that range from $200 to $35,000.

Another area that could benefit from product development is agricultural loans. Farmers remain relatively underserved by the banking system due to the high risks associated with agricultural production, including climatic conditions. However, both Financiera Edyficar and CrediScotia have piloted agricultural lending programmes and have expansion plans in this segment. Universal government-sponsored agricultural insurance for small-scale farmers would go a long way towards supporting the development of rural lending products.

Moving Forward

Overall, the microfinance segment is predicted to expand in 2013. Morón told OBG that he anticipates credit growth of 18% and 500,000 additional clients for MFIs. New customers will be attracted to a growing service network, with players like CrediScotia planning to open 15 new branches and Financiera Edyficar in a branch-sharing agreement with Banco de la Nación, the largest state-owned bank in the country.

Going forward, the outlook for interest rates is mixed. While greater competition in the microfinance segment could reduce loan prices, both the central bank and the sector’s regulator have policies in place that are aimed at cooling credit growth (see analysis). This could stabilise or even raise the price of consumer or microbusiness loans.

Regarding market structure, merger and acquisition activity is expected to continue, but leaders from the sector do not anticipate any dramatic form of consolidation. There is still a substantial market, and many players competing to take a share of it.