MICROFINANCE MATTERS - Innovations and the Future of Microfinance in Latin America

By Alejandro Soriano S., Senior Executive, the Andean Development Corporation (CAF)

2005 is definitely a landmark year for microfinance around the world. The United Nations has boldly taken up the baton on the subject at a world-wide level and stakeholders, governments, financiers and microentrepreneurs are working towards generating a positive outcome in several aspects of human development.

In Latin America, microfinance has been an important component of the consolidation of financial sectors by massively extending the benefits of financial services to traditionally disadvantaged clients under difficult service delivery conditions. In general, in lower income countries with deficient institutional infrastructures, microfinance has been an important development tool by expanding both the depth and the breadth of the coverage of the supply of financial services in populations traditionally excluded from access. In addition, in some countries, microfinance is the forerunner of the evolution of these nations' financial systems; the microfinance sector has developed new financial technologies and learnt how to manage credit portfolios and other financial transactions by no longer relying on traditional guarantees based on real estate or other tangible forms of wealth, which will continue to lose relative importance with the evolution towards modern economies.

If future economies are going to depend fundamentally on human capital, know-how, information, innovation capacity, positioning in global markets through communications technologies, and the value of one's reputation - indispensable to participating in repeated transactions with multiple counterparts - then wealth and income generation are going to increasingly come from these intangible assets. Microfinance carries an edge in the development of financial technologies which are based on the valuation and accumulation of intangible assets.[1]

Likewise, the continuous development of microfinance, resulting from the correct application of the aforementioned knowledge, will be based on markets where the rules of the game are clearly established, the actors are innovating, the investors and risk rating companies understand the business and a great commitment to undertake such a venture exists. Otherwise, microfinance will cease to provide genuine support to that disadvantaged segment of society, and specialized financial institutions, often equipped with a lack of suitable knowledge, will tend to migrate to other market niches in an attempt to survive, thus abandoning the microbusiness sector.

In Latin America during the last decade, the microfinance sector has shown surprising growth in spite of the macroeconomic crises that some countries have experienced. If what is sought is to multiply the fruits of this expansion, the process of transformation of the sector that has accompanied this growth must continue and become even more consolidated. Simultaneously, the sector must learn to face new challenges successfully and to expand the range of services offered, both to the segments of the population currently reached as well as to new segments.

The Andean Development Corporation (CAF) has contributed to this process by supporting the consolidation of a range of specialized financial intermediaries which use technology to manage credit portfolios and strengthen capacity to attract deposits, while simultaneously offering other financial services in a permanent and sustainable way. CAF has also supported this process through initiatives aimed at strengthening the regulatory and supervisory framework of the microfinance sector and other legal reforms that promote competition and the incorporation of regulated financial intermediaries into these segments of the market.

Considering the success attained by the microfinance sector and analyzing the challenges it faces to ensure sustainable development and high impact in the future, CAF feels that rural development will be one of the fundamental bases to generate new markets, while others will be innovation in financial institutions and the creation of a climate favourable to the entrepreneurial spirit. This sector of the economy, which is virtually ignored in most Latin American countries, could quickly become the engine of economic and social development in our countries.

On the other hand, at the level of financial institutions, these must become much more creative. Alternative credit and service products must not be the only priority; the structure of their liabilities must also be given due consideration. In this sense, CAF considers it important to develop Latin American security markets through issuing bonds and shares with the participation of microfinance institutions (MFIs). This will diversify these institutions' sources of financing, thus allowing them to opt for new and creative alternatives

In order to achieve this, the active participation of risk rating companies is needed. These companies have reached the conclusion that in some countries microfinance organizations better administer risks than the traditional banking sector. There may be two explanations for this: first, these institutions have developed good systems of evaluation, supervision, administration and recovery of credits, and second, the clients have developed an appropriate financial culture. In addition, suitable regulatory frameworks, in which ideologies are not a priority and no political interference exists will be the basis of the evolution of the microfinance sector.

In the future, MFIs, organized into specialized associations and supported by international organisms, must optimize the use of their comparative advantages and the amazing process of innovation and transformation taking place in Latin American financial systems must continue to benefit their customers.[2] Though much has been achieved over the last thirty years in the microfinance field, there still remains much more to be done to improve the quality of life of most Latin Americans.

(1) Claudio González-Vega, "Microfinanzas, Desarrollo Económico y Mercados", Caracas, CAF, 24th February, 2005.

(2) Claudio González-Vega, Seminar "Innovaciones en microfinanzas: Alcances y Desafíos" Caracas, CAF, 24th February, 2005.