UNITED NATIONS CAPITAL DEVELOPMENT FUND    Microfinance

Issue 10 / March 2005

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Past Issues

By Francisco Jose Abate-Frajul[1], Policy Change Coordinator, Women's World Banking

Introduction

Colombia has a de facto interest rate ceiling which stems from the usury rate established in two different sets of legislation. This ceiling has always been seen as an obstacle to the development of Colombia's financial sector and, in particular, of its microfinance sector, but given Colombia's social and economic context, it has been impossible for the government to tackle this problem. During the latter part of the 1990s, however, changes in the calculations of the usury rate posed a particular challenge to the microfinance sector which required immediate action if the industry was to survive. This article describes how these changes affected Women's World Banking's (WWB) five Colombian affiliates and the Colombian microfinance industry, and the process used to achieve concrete policy change to remedy the situation.

Macroeconomics

Clients of Corporación Mundial de la Mujer

In the mid-1990s, facing excessively high public expenditures, financed increasingly through high debt, the Board of Directors of Banco de la República de Colombia (the Central Bank) decided to radically reduce the amount of currency in circulation and imposed an exchange rate band in order to avoid a precipitous rise in an already high inflation rate. This reduction of currency caused a sharp deceleration of economic growth, which translated into high levels of unemployment and a drastic reduction in internal consumption. The combination of all these factors triggered a deep economic recession during 1998-1999, which resulted in a profound crisis in the financial sector.

It should be noted that during the 1998-1999 crisis, the WWB affiliates' portfolios maintained their growth, quality and profitability. In addition, the affiliates renewed their commitment to low-income households by expanding into a lower income market niche. This was evidenced in the significant reduction of the average loan amount during this period.

Government Policies: Practical Consequences

The Colombia Central Bank de-facto interest rate limit derives from the usury rate established in two sets of Colombian law: Criminal and Commercial. Until 1999, this situation did not pose a serious obstacle for the Colombian microfinance sector. In 1999 however, when the government decided to change these definitions, it inadvertently endangered the microfinance industry. The Commercial Code (la tasa de interés bancario corriente (TIBCO)) defined the usury limit as 1.5 times the weighted average interest rate on commercial short term loans (short term defined as terms of one year or less). The Criminal Code (la tasa de Libre Asignación de los Bancos (TICOLA)) established the crime of usury as charging an interest rate higher than 1.5 times the weighted average interest rates on commercial short term loans and credit cards. In April 1999, preferred loans were added to the definition of the TICOLA while the TIBCO was placed within a band.

The practical implications of these changes were that the TIBCO went from 42.4% at the end of 1998 to 17.45% at the beginning of 2000, and the TICOLA similarly dropped from 50% to 18% during the same period. This drop had an obvious negative effect on the income of financial institutions, which placed the entire microfinance sector in a tremendously precarious position. For instance, in 1999 the Fundación WWB-Colombia, possibly the most prominent MFI on the continent, had administrative expenses of 13.9%[2], provisions of 2.9% and interest expense of 10.6% of the average gross portfolio, meaning that in 1999 its cost of disbursing a dollar equaled 28 cents. That year the arbitrary governmental change in the TICOLA calculation method reduced the interest rate from 22% to 17%, below the 28% cost. This situation was not sustainable from a financial point of view for the microfinance sector.

The Strategy and the Process

Given this state of affairs, the WWB affiliates, other MFIs in the system, formal financial intermediaries, WWB itself and other international networks played an essential role in the search for a policy solution that would make microfinance commercially viable once more. The solution agreed upon was the addition of administrative fees not included in the calculation of the interest rate for purposes of the application of the usury limit. This decision came about through a measure of the Governmental Microenterprise Council in 2001, which was the result of extensive policy advocacy.

Consensus, a Seat at the Table, and a Message

The affiliates of WWB first decided to generate consensus among the players in the microfinance sector regarding a solution that was both technically sound and politically viable. For this purpose a number of meetings were held including domestic and international players.

With a mutually agreed solution in hand, and backed by the institutional credibility of WWB, the affiliate leaders sought concrete links with the government that would ensure a seat at the negotiating table. This would, at least, guarantee that those making decisions would hear the opinions of the industry. And in this context, they initiated a high level dialogue with the government that continues to this day. It included the interaction of these leaders with government representatives, including the Vice-Minister of Finance, the Minister of Development, and the Chairman of the Instituto de Fomento Industrial (IFI) [Institute of Industrial Development]. A crucial point in this dialogue was the meeting between the WWB Global President with the economic advisor of then-President Andrés Pastrana, in Cali, Colombia. In addition, WWB sponsored, at the request of the affiliates, several forums and roundtables with the Colombian government. Finally the government agreed to hire international experts to study the problem and give their opinion on the sector's needs, the real costs of microlending and the best supervisory and regulatory practices for microfinance.

Achievements and Lessons Learned

A number of concrete achievements emerged from this process, including Law 590 of 2000 or MIPYME [micro, small and medium-sized businesses] and Law 795 of 2003. Law 590 defined microbusiness and microlending, established the Microbusiness Council and created the space to charge fees and commissions to cover microlending transaction costs, in accordance with the limits later set by the Microbusiness Board. Law 795 established the difference between microcredit and consumer credit.

In addition, in 2001, the Microbusiness Council issued a regulation which set the conditions for fees, and established 7.5% per annum as the limit for microlending.

What have we learned from this process?

• That microfinance institutions have a role to play - and a responsibility to fulfill - in defining the government and state policies that affect them.
• That the process begins by creating consensus within the industry about what is technically most appropriate for the sector and why.
• That all channels of communication within the Government structure that are available should be used, always attempting to develop key relationships that will later keep this dialogue open.
• Finally, that contact with the government must be used to educate its representatives on the technical changes needed, so that the regulations issued are applied but are not used to constrain either the microfinance sector or its ultimate objective: developing financial systems that work for the majority.