Costa-Rican economist and lawyer, with a Masters from London School of Economics and a PhD from Stanford University. Professor Emeritus and Director of the Rural Finance Program at Ohio State University. Trustee of the BBVA Microfinance Foundation. Consultant for international agencies and for financial authorities and governments in several countries. Lecturer at the Boulder Institute Microfinance Training Programme and at the Universidad Autónoma de Madrid Microfinance Masters Course. Over three decades’ experience researching microfinance, he has authored numerous books and papers on economic development, poverty, international trade, rural finance and microfinance.
1. You became interested in rural finance from a young age. Was this for personal reasons?
It had to do with my upbringing. I lived in Costa Rica at a time when banking was run by the State. In 1948, the Costa Rican banks were nationalised, on the grounds that this was necessary to encourage more democratic lending. So, throughout my youth, I had to put up with all the inconvenience of inefficient, bureaucratic banks.
While still a university student in Costa Rica, I wrote a paper where I identified the enormous concentration of the system’s credit portfolio. At that time, just 10% of the borrowers from the supposedly democratizing State-owned banks held 85% of the country’s outstanding credit. I was amazed by the contradiction between intentions and reality. There might have been a political will to democratize access to loans, but lending was enormously concentrated in surprisingly few hands. My undergrad paper measured borrowing in the country and found it was more concentrated than land ownership or the income distribution. And I learned my first key lesson, which laid the foundations of my professional career: Good intentions are not enough.
The concentration was especially marked in agricultural borrowing, while I had been interested in the issue of poverty from very young, especially in the rural areas, where poverty tends to concentrate. Of all the portfolios, it was lending to farmers that showed the highest concentration. That was when my interest in the impact of policies on rural finance was born.
2. How is rural microfinance different from other kinds? What are the main problems? What do you think of farmers insurance?
There are two dimensions to this. There is a territorial dimension. Rural living means long distances from urban centres where people are concentrated and there is sufficient market size. It means low population density and high population dispersion. But there is also a sectorial dimension. Farming and activities related to the use of natural resources in general are enormously important in rural life.
These two characteristics set up barriers. First, distance is a tremendous barrier, pushing up transaction costs and making it hard to reach your customers. It is hard to get to know them and it becomes difficult to separate them according to their risk profile and demands. Distance pushes up the cost of monitoring, makes it expensive to visit the clients and to check out the results of their projects.
Second, rural populations are more heterogeneous than other populations. One plastics factory is very much like any other. One farmer and another, even at two-hundred meters distance, are tremendously different… You just have to go round the curve in the road and things change. The farmer on the other side of the hill cannot grow flowers because the sun does not hit his land in the same direction. So information, which is a key determinant of financial transactions, becomes a more significant problem in the case of rural finance.
Third, being dependent on agriculture means that farmers depend a lot on things beyond their control: weather, nature, plagues, natural disasters… And these events tend to be systemic. They affect all the farmers in the same area at the same time, creating high covariance. This is the biggest problem for a financial institution wanting to work in rural areas. If something goes wrong, it is going to go wrong for all your customers at the same time. You can’t diversify.
So you have to find a tool to tackle this systemic risk. The only tool we have discovered so far has been insurance against catastrophic events. But developing such financial tools is an area still very much in its infancy. Little experimentation has been undertaken to learn what might be done. Once this type of insurance exists, rural finance will have made real progress.
3. What do you consider to be the causes behind inequality increasing, even as GDP rises in Latin-American countries?
This is a tremendously complex issue, which possibly varies from one country to the next. But I can imagine two key determining factors, among many:
– The declining quality in education, as it lags behind advances in technology and the information economy, while more complex processes of value generation require human capital with high-level specialisation. The holders of this human capital (engineers, system designers, software and robotics producers, etc.) can use it to earn high incomes. However, less qualified workers, with less such human capital, are held back by the shortcomings in education systems that have not kept up with the times and do not enable them to improve their productivity or their wages. So the incomes of the highly educated continue to go up while the low-skilled workers, without much education, are stuck where they were. And the gap widens, even among people who depend solely on their work to generate income.
– At the same time, in some countries there are high legal, regulatory and bureaucratic barriers to moving from the informal economy to the formal economy. This is an issue that could be of great interest for your journal. How much does it cost to get a licence to operate? How much does it cost to get through the red tape? What are the asymmetries between being regulated or unregulated, in the formal or the informal economy, when you factor in taxes, requirements and other charges? All this leaves a lot of people trapped in the low-productivity informal economy. And these barriers prevent small family businesses becoming small firms that might employ say ten to fifteen workers, simply because it would require them to jump through so many hoops that doing so becomes horrendously expensive. It stops them before they start.
4. How do you see the medium-term future of the industry? What role will commercial banks and microfinance institutions play? Do you think the growth of this sector will slow down?
It is now fashionable to talk about financial inclusion. I think we should recognise various things here:
First, microfinance is an innovation for producing specific types of financial services, essentially for self-employed workers, family firms, small businesses, etc. It is one way of achieving financial inclusion, but not the only way.
A second observation is about a major paradox. On the one hand, mainly in a large metropolis such as Lima, Bogota or Quito, financial inclusion is substantial and even certain segments of population are over-indebted. On the other hand, in the same countries there are regions where the population is essentially excluded. This coexistence is a very typical phenomenon in developing countries. You have over-borrowing for some and a total absence of institutional access to borrowing for others.
The future is to be found by resolving this paradox. This will entail discovering institutional, regulatory and technological mechanisms to reduce the incidence of over-indebtedness. And, at the same time, there must be a new wave of innovations, to enable us to reach out to where there is no institutional supply of financial services at all yet. Where there is nothing, there will be enormous opportunities for growth.
Perhaps the saddest thing is when the job is botched, when the credit decision is low quality and people are given more credit than they can afford. All they get is an ephemeral, transitory and fragile inclusion. Then, when it ends, they fall into a black hole, even harder to get out from than where they were to start with. They are penalized in credit bureaus, lose their reputation and are unlikely to be granted any further loans.
Who could do what is needed? A diverse range of entities; there is room for different kinds of players: banks, non-bank microfinance institutions, even some NGOs highly specialized in certain segments of the population. Each of them could operate alongside the rest, because they would have competitive advantages operating in some market segments and not in others, and vice versa.
However, we could imagine that commercial banking will continue to have a corporate emphasis, and it will take advantage of new information and communication technologies to develop transactional services, above all payments systems, money transfers, public utility payments, etc. The people who are currently customers of microfinance entities will also have access to these services. Nonetheless, at the end of the day, the banks that are newly trying to enter the microfinance sector with credit services are going to lose the game against the entities that started up doing microfinance, which will have already developed strong relationships with their customers.
Because history matters. Arriving ten years earlier means ten more years of learning, ten more years of getting to know your customers and developing loyalties. You can’t reproduce that from one day to the next. Moreover, the banks’ corporate culture doesn’t allow them to have the patience to enter into this segment for ten years just to see if it might work out. Either they get an immediate payback when they try it or else, as soon as they don’t do so well, they will leave. So I think that for the segment we are talking about (household-businesses, small self-owned firms, production-oriented microenterprises, etc.), the entities that have a microfinance focus and a microfinance technology, those that have cultivated direct relationships with their clients, are the ones that will survive in this segment of the market.
We are clearly entering a new stage in microfinance. There has been a structural discontinuity in what we could call the natural rate of growth in this sector. The first stage was about filling the void, at a time when one could grow very fast. But in any area of life (in physics, biology, markets, etc.) never-ending exponential growth is impossible. In the places where they have been operating (the others are still empty), these entities face a new era of slower growth, which we hope will be more prudent. For the larger entities, with a larger scope of operation, growth opportunities will be in new regions, new kinds of customers, new kinds of products, in a greater range of circumstances, rather than in doing more of the same in the same places that are already saturated.
5. Do you think that microfinance institutions should gain scale through consolidation? If so, where especially?
Scale matters a lot, because scale is the source of all kinds of economies. It enables you to dilute overheads, diversify and attempt different kinds of outreach, because you can operate in different locations and avoid the vulnerability of working in places of limited scope. Very local entities are tremendously vulnerable when something goes wrong. Say they are coffee producers in Oaxaca and there is a natural disaster or maybe international coffee prices fall. A cooperative there which only has coffee producers on its books cannot survive.
So, volume of transactions matters, to generate economies of scale. And geographic outreach matters, to reduce covariance. And portfolio size matters, to diversify over different sectors and diversify across the size of your customers. Scale allows you to bring down costs and reduce risks; and that is good for everyone. Because if having some medium-sized customers in the portfolio enables you to dilute overhead and other fixed costs better, then interest rates can be lower not just for the medium-sized but also for the small customers. Yet, you couldn’t have brought down interest rates if your only customers were small customers.
How do you get scale? There are many ways. It could be through mergers. I am slightly fearful about that. Putting two poorly performing small entities together to make a larger one does not necessarily make for a good entity. So mergers for the sake of mergers cannot be a panacea. But it is possible for an entity with sufficient capacity and clout to transform entities whose weaknesses have more to do with their size and limited capacity to raise debt, so what they are lacking is capital. There, in a takeover, merger or suchlike tone may take advantage of assets such as the local knowledge or the social and human capital that the weaker entity might have. Because, although it is possible that a given entity might enter into the business on its own, simply because it is bigger and has sufficient capitalisation to do so, in practice local human capital and knowledge are difficult assets to reproduce immediately. So you can go down different routes. It depends on the country, on the entities and on the market structure.
There are two issues that we should perhaps mention. What is this market consolidation going to be like? Well, that depends on the regulatory framework: the rules for getting a license to operate or for exiting, the requirements the entities must comply with. What should really happen is that the prudential regulator says, “Here is the market structure I want to have within five years or ten years.” First you have to visualise what you want. “I want to have a financial system with robust, low-cost entities that offer access to different customer profiles, etc.” Then you must ask “What regulatory framework must I adopt to reach this ideal structure I am proposing?” It is not a matter of creating ad hoc rules and putting out fires. The regulator must have a long-term view.
One of the things that the Peruvian regulator mentioned in Iquitos and I mentioned in my talk in Madrid is that “entities are lacking a long-term vision.” But the regulator must also have a long-term vision. Indeed, it must have a longer-term vision, given that the regulator has to understand how the whole system needs to evolve over time. I think that in this long-term vision, it is more useful to society if a structure is developed with a reasonably small number of robust entities than with a multitude of fragile, perishable ones. The “reasonably small number” does not worry me in terms of competition, because I have learnt, above all in the financial market, that competition is more ferocious when it is between four or five giants than when it is between two-hundred midgets. What you need is a competition-friendly environment.
6. You know the Bolivian microfinance system very well. What are its specific traits?
Bolivia is the clearest example of how microfinance can become a substantial component in the financial system and a driving force of financial development in a low-income country with incomplete institutions. Too often we think of microfinance just as a tool for alleviating poverty or some such thing. But Bolivia is an example of how microfinance can also be important for the financial development of a country, for the evolution of the entire financial system.
Nowadays the loan portfolio of the microfinance institutions is substantially more than one third of total lending in the entire Bolivian financial system. Three quarters, nearly four fifths of the customers of any type of institution (banks, mutuals, cooperatives, etc) are customers of a microfinance institution. The microfinance institutions are close to accounting for 20% of the total Bolivian Domestic Product. These data show how much microfinance matters as finance, and how important it can be in the evolution of the financial system.
This was reached by a felicitous convergence of three sets of circumstances:
– A tremendously innovative environment with market freedom and a great diversity of entities (individual credit, solidarity group loans, village banking) with different orientations but an enormous emphasis on innovation, where the quality of the customer relationship is at a premium as the central focus of innovation.
– A particularly well-suited specialized regulatory environment, which emerged from a continuing conversation and a dialectic process between the regulator and the market operators where, for example, Bancosol proposed doing something different, and the regulator said, “OK, let’s see what happens.” That way, the regulator learned and then formalised the new way of doing things, and thus the conversation unfolded. While reality was one step ahead, it was followed closely by the regulator, refining procedures and interacting with the players in the market.
– A non-opportunistic governance structure where, unlike banks and State-run financial institutions, the microfinance entities did not expect the government to do them any favours. They had no expectations of being bailed out if things went bad. And as there was no possibility of a bail-out, they were responsible, prudent. They took care and did not behave opportunistically (like the banks did, leading to the world-wide crisis). They did not expect anything from the government, and the government did not get involved either (not until last year). So there has been a process in which the microfinance institutions blossomed into the dominant sector of the financial system, thanks to the State refraining from imposing guidelines of one kind or another, capping interest rates or requiring portfolio quotas, and thanks to an environment of ultra-low inflation and reasonable economic growth.
Perhaps I should add something else. Why is Bolivia different from other microfinance experiments? Because, right from the outset, Bolivia was an enormous laboratory. There was nobody saying “Microfinance can only be done Grameen style or else it’s not microfinance.” No. There were credit institutions lending to individuals, there were group-credit institutions with joint liability contracts, village-banking institutions… All of them, right from the start, were trying to find solutions from their very different perspectives and with connections to very diverse international groups.
Bolivia was the arena on which the battle to discover best practices was fought. So, Accion International (the godmother to Bancosol) said, “No, what really works is solidarity groups.” And IPC from Germany, with Andes Procredit, said, “No, what you have to do is individual loans”. And Pro Mujer said, “No, let’s do village banking.” And, there in Bolivia, all these visions went into battle to see which one could outsmart the others. And, in this process, they made an all-out effort to do things well, but also learned from their peers. There were tremendous externalities, collective learning. Employees from one institution went to work at another. Know-how was spread around and mixed between them and a kind of cross-fertilisation took place that was enormously beneficial. In the end, the best versions of each model developed in Bolivia, with individual lenders, such as FIE, and village-banking lenders, such as CRECER, both of which have won several international awards for being the best in their class.
7. What are the main points that microfinance legislation should cover for sustainable development of the sector?
The regulator must understand that microfinance is different. But the difference that matters from the regulatory viewpoint is not that of good intentions. It is not that a different regulation is needed because the customers are poor or because they are women. Rather, it needs a different kind of regulation because the risk profile is different and because the credit methodology used to analyse this risk profile is different from the one that traditional banking applies. It the regulator does not realise that it is different, and tries to apply the same rules to both traditional banking and microfinance, as if they were the same thing, this will never be efficient. So that’s where it has to start.
Second, the regulator needs to recognise that the costs of reaching the previously unbanked population are higher and behave differently from the costs of commercial banking. Consequently, it should not interfere in price-formation policies, because these must reflect the cost differences and make sure the institutions are sustainable. And also, when distinguishing between risks, the regulator must clearly understand that consumer loans for wage-earners have a completely different risk profile from credit for self-employed customers working in a productive activity rather than drawing a wage. It you treat consumer lending the same way as microfinance, you kill microfinance.
There is definitely a lot of debate right now about the need to protect customers. It is obvious that if microfinance is a more customer-oriented business, on the grounds of minimal respect, there must be transparency and fair play towards the customers.
8. What role do you think multilateral entities and social-responsibility funds should play?
A negative role and a positive role… or what we could call a do-nothing role. Perhaps what is most important is to ensure an even playing field. Allowing a donor or an organisation to come along and give a million dollars to an NGO and say “Here’s your million dollars to give credit at 2% interest rates, and if people can’t pay, it doesn’t matter if you don’t recover the loan and everything else”, and then allowing the NGO to survive and expand in a market where it is going to destroy the culture of repayment, where it is going to distort notions of contract, alter price structures, etc. well, that is destroying the even playing field. That kind of intervention is harmful to the ones that are doing things properly, who are really working well. It creates unfair competition, which is tremendously damaging to the sector. Many donors, many governments have these outdated notions, this kind of paternalism that makes them fund entities that are not going to survive.
Part of the consolidation process we were talking about before has to do with the need for an exit mechanism, so that entities that aren’t doing their job properly and are doing damage can disappear.
On the positive side, there are two things the donors and funding agencies can do. One is to contribute to the creation of public goods and, very fundamentally, to the formation of human capital for the sector: grants, courses, internships, exchanges, etc. And contribute to the development of new technology, promoting pilot projects, the design of new products in their experimental stages and suchlike, to promote technological change in the sector. In the case of the investment funds, their role is to complement the entity’s resources with funding in a responsible manner. And that means not just putting up money, but really taking responsibility for the entity’s decisions and performance; behaving like a real owner. You can’t just let someone put money into the fund for reasons of social responsibility or whatever, and then not oversee the entity or contribute to its management. You have to bring in know-how, new ways of seeing things, other ideas, professional management, along with the funds.
9. How important is corporate governance for the sector’s transparency and restructuring?
An entity’s performance, how much outreach they have, who they service, the quality of their services, how efficient they are, will very much depend on the decisions taken by all the stakeholders: credit officers, branch managers, regional directors, the risk unit, etc. And these decisions are not taken in a vacuum. Rather, they will be a response to the incentives structure, which says what consequences there will be for me, for the others, for our mission, if I behave in one way or another.
The key role of corporate governance is to appropriately and clearly define the incentives, reward structure. Some rewards will be monetary and others not, such as the possibility to grow professionally, job stability, being given tasks that you find stimulating, and suchlike. A structure where doing things well is rewarded and doing things badly is punished one way or another. But what is to be done must be clearly understood. Designing this kind of incentives structure is not a trivial endeavour, because you need insight into what drives people, what motivates them to do things well.
10. As a trustee in our Foundation, and someone who knows the microfinance institutions making up our group, what do you think is the hallmark Grupo Microfinanzas BBVA? What makes us different from the rest of the microfinance institutions or groups currently operating in this world?
I think two inputs into the process make us different and, as a consequence, the results we get. One is the quality of the Foundation staff, both in the Madrid Foundation and in each of the entities. I go to the Dominican Republic; I go to Colombia; I go to Peru; I go to Chile… and wherever I go I am amazed at how special the people there are. They have a real integrity, real quality as human beings. I am not only impressed by their professional skills and abilities, but by their commitment, their charisma. You really feel that charisma throughout the Foundation.
The second difference is having found a formula to combine local knowledge, experience and reputation in one particular field with things that are harder to acquire without scale: systems, control mechanisms, tools, etc, coming from the expertise in the headquarters. Despite all the tremendous difficulties involved, the Foundation has managed to bring together both these facets.
The consequence of this has been rapid expansion, prestigious award-winning operations and being able to offer customers quality service with an eye to the future, a notion that coming into a relationship with our entities is not a one-off exercise but something that looks ahead to the longer term. It is a bit giving our customers a sound view of their future with the Foundation institutions. Other entities have this to different degrees, but all in all, with our operation in Latin America, this is the group that has it the most at present.
11. You have published masses of papers, reports and books. What would you like to write now?
There is a subject that is definitely applicable to finance, but applies to economic policy in general and even to people’s lives, and that is the importance of history. And how, although it is important, we find it so hard to learn from it, and so repeatedly commit the same mistakes.
Latin-American governments had capped interest rates, imposed portfolios quotas, engaged in inflationary policies and other forms of financial repression, at least until the end of the Seventies. The consequences were disastrous and reform was inevitable. The stranglehold was loosened, allowing the market to breathe. But now, three decades later, the world has forgotten the lessons it had learnt and is trying to do the same as it used to do, using repression again. Why do they never learn? Especially the policy makers, why can’t they learn the lessons of history? I would like to illustrate this with some examples from finance and microfinance.
12. What is the most pleasant moment in your day?
The sunset. There are two dimensions to this. I love dusk, when a palette of colours is combined with a feeling of peace and serenity. It is a moment each day when one says, “How marvellous, another day gone by in which I have done things, embraced someone, stretched out my hand…”
13. Tell us something that you really like, apart from research and writing.
I like a whole bunch of things, but there are two things I am especially passionate about. I love Nature, and when I have the time and the opportunity I go out hiking in the mountains or along the beach, just to walk and observe Nature. But I am also passionate about art. I love all kinds of music, visiting museums, and am a movie-addict.
14. Do you get on well with lawyers? Any stories you could tell us?
I have a surprise for you: I am a lawyer! My grandfather and my father were lawyers before me. Even as a child, my father used to sit me down next to him and discuss his cases, telling me about the litigation he had underway, the contracts he had drawn up… From very young, I helped him with documents, you know, like writing up deeds in a protocol or whatever.
I studied law and when I graduated, I got a British Council scholarship to go to London to do my Master’s degree. After that I never went back to practice law professionally. But my legal training has been enormously useful for learning how to debate, how to organise arguments, how to think about things within a logical structure… So I am very happy to be a non-practicing lawyer with a legal training.
15. If you hadn’t been a teacher, researcher and writer, what would you have liked to be?
I would have liked to be everything, but if I had to choose just one: then an architect. I would have liked to be an architect who would have been especially skilled in finding equilibria between what comes from Nature and what is human, able to design spaces where Nature and our humanity could meet in harmony.
16. A final confession: tell us something you have not yet done and would like to do.
Write a novel that had nothing to do with economics. A novel on the multiplicity and complexity of human relations; a novel in which the characters have more than one relationship and all of them are highly complex.
17. What character from history would you like to have known?
I could think of three, for different reasons and at different levels:
– Jesus. Regardless of his divinity, because he was the human being who most transformed the way human beings see others.
– Leonardo da Vinci. Because of his tremendous imagination, his capacity to imagine multiple worlds.
– Nelson Mandela. He is a recent, contemporary example of the power of forgiveness
