Four years ago, the Dutch bank ABN AMRO commissioned a report from CGD on what makes some microfinance institutions succeed as businesses. I wrote it with Uzma Qureshi. We began the project by networking, looking for good people to talk to and good institutions to learn from. Perhaps it was Beth Rhyne who pointed us to Gabriel Solorzano, the founding head of FINDESA in Nicaragua. We called him.
As you can tell from the number of times we cite him in our report, he is a great interview. Gabriel told us that FINDESA, a regulated financial institution, was born out of the non-profit INDE, which had been created, or at least assisted, by the German aid agency GTZ in its early years. Gabriel's goal was to make FINDESA a "world-class institution." He said he was applying the Japanese model to microfinance. In part, this meant observing examples around the world and copying what worked. He studied the regulatory system in Peru, the survivors of an early bubble in Bolivia, the fast-growing Compartamos in Mexico. He studied at Harvard too. But the Japanese model was also for him a philosophy of learning. Learning came in three stages, he told us: schooling, on-the-job training, and "self-illumination."
Gabriel said FINDESA had grown 70--80%/year for four years, which stressed the organization. He described the mechanisms in place to achieve "safe growth." There was a four-level hierarchy of loan review committees, the largest loans going highest. Employees received bonuses when arrears among their clients were below 2%. If a branch's arrears were high, all its officers lost bonuses.
FINDESA made not "Asset-Based Credit" (ABC, loans backed by collateral) but "Integrity-Based Credit" (IBC). To judge integrity, loans officers used subtle techniques. They would check with neighbors about drinking and gambling problems. They knew every financial statement they received was fake, at least to the extent of leaving out the salary of owner. So to judge that "shadow salary," they looked at whether the applicant had kids in school, a new car, a big or small home. Officers would show up unannounced at the applicant's store at 5pm to compare cash register contents to claims on the application.
FINDESA took pride in its independence from microfinance network organizations such as Accion International and Women's World Banking.
In October 2008, FINDESA obtained a banking license---permission to take savings---and became BANEX. But by then its situation was already coming unglued. Years of rapid growth in the Nicaraguan microfinance industry collided with shock waves from the financial crisis in the United States. A populist movimiento no pago (no-payment movement) caught fire; the debtors' revolt won backing from President Daniel Ortega. Microfinance institutions and their foreign investors fought back in the media and presumably behind the scenes. (Ironically, at same time, the Royal Bank of Scotland nearly collapsed after recognizing huge losses on its take-over of ABN AMRO.)
Last week, BANEX entered liquidation. Since Microcredit Portfolios Are Sand Castles, in financial value terms, the overseer won't find much more than a pile of sand (or should I say scattered ashes?).
Some in the microfinance movement will be tempted to blame the Nicaraguan crisis entirely on movimiento no pago. I believe that would be a mistake. The best analysis I have seen so far is that of Greg Chen, Stephen Rasmussen, and Xavier Reille at CGAP. Generalizing about Nicaragua and three other nations with bubble troubles, they write:
These local events influenced the crises and the public dialogue about the crises, but they were symptoms of underlying vulnerabilities within the microfinance industry itself and not root causes of the crises.
Among the root causes: rapid lending growth, inadequate internal controls, multiple borrowing on the part of clients, and reviews from rating agencies that failed to spot problems.
The CGAP trio wrote that the delinquency crisis hit all 22 Nicaraguan microcreditors. Perhaps foreign network groups will rescue some of their Nicaraguan affiliates. Perhaps, that is, BANEX's independence from such groups was another factor in its demise.
To the list of afflictions for the industry as a whole, I would add: the large flow of money from foreign investors, which inflated the bubble. The fault, dear Brutus, is not in our stars, but in ourselves, and all that. According to figures I blogged before, the largest investor in the top five Nicaraguan microfinance institutions was Blue Orchard, with $46 million at end-2008. The Central American Bank for Economic Integration (CABEI) had $33 million; ProCredit Holding, $28 million; Financiera Nicaragüense de Inversiones, a (defunct?) Nicaraguan government using money from Germany's KfW, had $27 million; and responsAbility, $15 million.
All of this money came from public and private organizations with "social" missions. I wonder: are the recent bubbles in microcredit the first in history to have been fueled by generosity rather than greed? I suppose the universal ingredient is hype.
BANEX was a young microfinance institution. By all appearances, it had a bright future ahead of it. It died too young. What should the microfinance industry do to prevent a repetition of this tragedy? Here's one partial answer.