XXIII ENANGRAD. Finanças (FIN) MICROCREDIT IN BRAZIL AND ITS LIMITATIONS AS A CORE POVERTY ALLEVIATION TOOL. Maloe Bosch

Transcription

1 XXIII ENANGRAD Finanças (FIN) MICROCREDIT IN BRAZIL AND ITS LIMITATIONS AS A CORE POVERTY ALLEVIATION TOOL Maloe Bosch Francisco Marcelo Barone Garritano de Nascimento Deborah Moraes Zouain Gustavo de Oliveira Almeida Bento Gonçalves, 2012

2 MICROCREDIT IN BRAZIL AND ITS LIMITATIONS AS A CORE POVERTY ALLEVIATION TOOL FINANÇAS FIN Trabalho convidado Autores: Maloe Bosch, EBAPE-FGV Francisco Marcelo Barone Garritano de Nascimento, UFF Deborah Moraes Zouain, EBAPE-FGV Gustavo de Oliveira Almeida, EBAPE-FGV

3 RESUMO Este artigo estuda o estado atual das microfinanças no Brasil e como as limitações gerais de microfinanças afetam o potencial de microfinanças para a redução do núcleo da pobreza no Brasil especificamente. O artigo considera limitações de microcrédito em alcançar os realmente pobres, o impacto na redução da pobreza e o custo- efetividade. O Brasil não é exceção a limitações gerais do microcrédito; ajuda aos mais pobres é pequeno, o impacto é menor para os mais pobres e com custos operacionais excepcionalmente elevados o custo- benefício no Brasil não é o ideal visando os realmente pobres. Isso deixa uma grande responsabilidade para o governo a prover programas para alivar o tipo de pobreza que o microcrédito dificilmente resolva. A pobreza extrema no Brasil deve ser resolvida atraves de outras privações além da falta de crédito - como a insegurança alimentar estrutural, sensibilidade choque financeiro e falta de educação formal e estas questoes devem ser abordadas em primeiro lugar. Em seguida, o microfinanciamento apresentar resultados apos as questoes iniciais serem tratadas, como um instrumento adequado para combater o nível menos pungente da pobreza de milhões de brasileiros. ABSTRACT This article studies the current state of microfinance in Brazil and how the general limitations of microfinance affect microfinance s potential for core poverty alleviation in Brazil specifically. It considers microcredit s limitations in reaching the core poor, the impact in reducing core poverty and the cost- effectiveness. Brazil is no exception to microcredit s general limitations; outreach to the core poor is small, the impact is the smallest for the poorest and with exceptionally high operational costs the cost- effectiveness in Brazil is not optimal aiming at core poverty. This leaves an important responsibility for the government to initiate programs alleviating the kind of poverty that microfinance is unlikely to solve. If the Brazilian core poverty is to be solved other deprivations than the lack of credit - such as the structural food insecurity, financial shock sensitivity and lack of education - should be tackled first. Then, microfinance can take it on from there, as a suitable tool to fight the less poignant level of poverty of millions of Brazilians. Palavras- chave: Microcrédito, microfinanças, Bancos sociais, Brasil, alcançe de politicas públicas. Keywords: Microcredit, microfinance, social banking, Brazil, outreach.

4 1. Introduction In 2005, the United Nations proclaimed the year of microcredit. The following year, microcredit gained further attention when Yunus and Grameen Bank won the Nobel Peace Prize for their occupation with microfinance for their efforts to create economic and social development from below (Norwegian Nobel Committee Website, 2008). Since then, microfinance has gained a lot of popularity and is generally seen as a tool to empower the poor, fight poverty and change the economic structures that exclude low- income households. According to Microfinance at a Glance, an overview report by the Microfinance Information Exchange (MIX), the worldwide microcredit portfolio is U$ billion (MIX Website, 2010). The enthusiasm of aid donors and policymakers, the amount of funds involved and the seeming success raise the question to what extent microcredit can help the most needy, the ones living in extreme poverty. Microfinance has shown to be an empowering tool for the low income class in general, but it must also keep in mind its objective to serve the most excluded. A country with great microfinance potential is Brazil. It has a great economy with a GDP of trillion US$ and an incredibly large population more than 191 million people (UNdata ). It has a large amount of poverty, constituting a large potential demand for microcredit. Yet, the total amount involved in microfinance in Brazil is remarkably small compared to other Latin American countries with a population and Gross Domestic Product many times inferior. Apparently, microfinance as poverty reduction method has not yet penetrated Brazil like it has penetrated many other developing countries in Latin America, even though the sector is certainly growing nowadays. This paper aims to study the current state of microfinance in Brazil and how the general limitations of microfinance affect microfinance s potential for core poverty alleviation in Brazil. After considering the main problems of microfinance in reducing core poverty it will investigate whether these limitations hold for the current Brazilian situation specifically. 2. Microfinance, Banking the Unbanked Throughout this paper microcredit is defined as small loans offered to people of low- income levels without access to conventional credit of regular banks. Microfinance is defined as a broader package of financial services including not only microcredit but other financial services such as saving accounts, insurance services and money transfers as well. The idea is that microcredit enables the poor to lift themselves out of poverty by financing productive activities (Montgomery & Weiss, 2005, p. 395). Microcredit s methodology is different from that of regular banks in various ways. It targets people with a low- income level who are typically household- based entrepreneurs and self- employed, mostly working in the informal sector. They lack access to regular credit at conventional banks, which generally do not offer small loans and work with requirements these entrepreneurs cannot meet. At microfinance institutions (MFIs), on the other hand, clients start with very small loans. Median loan sizes run from US$ 99 in South Asia till US$1,254 in Eastern Europe and Central Asia (Gonzalez, p.24, 2008). After successfully repaying the first loan, one can opt for a new loan of greater value. This way loan size increases along with the successful repayment record of the client, keeping initial risk at a minimum while allowing the businesses to grow. Time to maturity is shorter than with commercial credit and the repayments are more frequent, usually weekly or biweekly (Westley, 2007). Interests on microloans are

5 usually much higher than on regular credit, due to the high operating costs margins on these customized small loans (Westley, 2007, p.5). Probably the main reason why the clients of microcredit lack access to regular banking services is the fact that commercial banks operate with a traditional collateral requirement, a requirement the poor often cannot meet. Most MFIs lend without collateral or accept nontraditional collateral like household assets. These assets, however, will likely only be registered if the borrower is risking default, since registering and valuing these assets is time- consuming and expensive (Standard & Poor s, 2007, p. 56). In addition to the lack of collateral, traditional credit risk assessments are problematic. Most poor do not have a registered labor record as they work in the informal sector. However, applying for an official loan at a commercial bank often requires an analysis of working history to assess credit worthiness (Standard & Poor s, 2007, p. 55). This creditworthiness assessment is partially passed on to the lenders in the case of group lending. This particular form of small credit is also called solidarity loan. Applying for a group loan clients have to bring together co- lenders whom can be, for example, community members or friends. As a group, which normally consists of three to seven people, they share a joint liability for the loan (Westley, 2004, p.2). In this system of social collateral the informational asymmetries are reduced; community members are much better informed about the financial situation and repayment capacity of a certain person than the bank (Neri, 2008). Another form of microfinance is through community banking, also called village banking. In the case of community banking the group of clients is autonomously responsible for the management of the bookkeeping, distribution and repayment of the funds. They start with a loan from a Community Bank Institution or a Microfinance Institution, but how this fund is distributed among the members is up to the community (Westley, 2004, p. 3). As with group lending, the group bares a joint liability. When a community applies for a loan Community Bank Institutions generally require the members to save a certain percentage of the amount of the loan applied for. This way a collective internal account is created. This serves as collateral, stimulates financial discipline and can be used in case of emergencies once the loan is given out (Westley, 2004, p. 3). Initially microfinance focused on lending solely to groups of women. The Grameen Bank, for example, still defines Grameencredit as targeted to the poor, particularly poor women and in order to obtain a loan a borrower must joint a group of borrowers (Grameen Bank Website, 2010). The preference for lending to women is based on the women s multiplier effect; since they are more likely to reinvest their earnings in their households in comparison to men, women have a multiplied poverty reducing effect (Nader, 2008, p. 645). However, many MFIs lend to men as well. The percentage of women borrowers at the MFIs of all regions reporting to MIX in 2009 ranged from 36% for the 25 th percentile till 77% for the 75 th percentile, with 54.43% being the median. Apparently microfinance in general is no longer solely targeting groups of women. Nor does it focus on group lending or community banking only, since many MFIs offer individual loans today. Sometimes one can apply for an individual loan after successful repayment within a group. Other MFIs simply offer small individual loans directly and accept non- traditional collateral. Requirements to apply for an individual loan are stricter. Individual loans are more common among the upper poor and usually are larger than the loan obtained by an individual applying in a group (Westley, 2004, p.1). A global MIX trendline report of the period showed that MFIs offering both group loans and individual credit are becoming more common (Figure II).

6 Figure II - Number of MFI s selected by the types of microcredit offered Methodology Individual Individual/Solidarity Solidarity Village Banking Total MFIs: 487 Total MFIs: 487 Total MFIs: 487 Note. Source: MIX Market, Trend Lines MFI s Benchmarks., 3. Microfinance in Brazil Compared to other countries in Latin America, the largest country of the continent, Brazil, has a very limitedly developed microfinance market. The Brazilian microfinance sector only started to grow in the nineties when microfinance already was a common practice in some other Latin American countries. However, Brazil s characteristics would suggest a significant market for microfinance. After Chile, the country has the largest GDP per capita of Latin America. The Gini index, measuring the inequality of the distribution of income in a country, is 0,567 for Brazil. This makes it the 10th most unequal country in the world (CIA World Factbook Website). Yet, the total amount of funds involved in microfinance in Brazil is remarkably small compared to other Latin American countries with a population and Gross Domestic Product many times inferior (Figure III). Figure III - Latin America comparisons, data for 2008 Gross Microloan Porfolio (millions US$) Gross Domestic Product (millions US$) Estimated Population in Gross Loan Portfolio as % of Global Gross Loan Portfolio (rounded) Brazil ,595, ,972, % Mexico ,081, ,556, % Bolivia ,701 9,694, % Peru ,933 28,837, % Ecuador ,572 13,481, % Colombia ,745 45,012, % Nicaragua ,961 5,667, % Argentina ,322 39,883, % Chile ,573 16,804, % World %

7 Note. Sources: Gross Loan Portfolio: MIX Market, Gross Domestic Product + Population: UNdata, Although a handful of microcredit initiatives emerged in the states Pernambuco, Bahia, Rio de Janeiro and Rio Grande do Sul in the 70 s and 80 s, significant growth in the microfinance sector started only in the late 90 s (Barone, 2008, p. 52; Soares & Sobrinho, 2008, p.133). Until then, two main factors prevented a real growth in the microcredit sector. Firstly, hyperinflation from 1986 to 1994 causing extremely high interbank rates reduced both the demand and the supply of credit (Nichter, 2002, p. 39). The hyperinflation not only resulted in a credit collapse, but lowered purchasing power of consumers, investment rates and slowed down economic growth (Barone, 2008, p.44). In 1994 the Plano Real, a set of measures to stabilize the Brazilian economy, was successfully introduced after various failed attempts to stabilize the economy between 1986 and 1991 (Barone, 2008, p.45). This plan succeeded in lowering inflation rapidly, through a strict monetary policy of an exchange rate anchor within a fairly rigid band (Schonberger, 2001, p. 2). From then on, inflation has been relatively stable, allowing the Brazilian economy to enter a new phase (Figure IV). The reduced inflation also allowed the official interbank rate (Selic) to gradually come down. In comparison with, for example, the Federal Reserve rate, interbank rates from the 80 s till the mid- 90 s have been relatively high in Brazil (Neri, 2008, p.13) (Figures V). Figure IV - Inflation History Chart, percentage per year Source: Ipeadata Website, database of Research Institute of Applied Economics Figure V- Selic History, monthly averages of Brazil s Central Bank overnight lending rate, percentages

8 Source: Ipeadata Website, database of Research Institute of Applied Economics A second important factor that prevented growth of the microcredit sector has been the lack of adequate legislation regarding microfinance and many regulatory obstacles that were preventing microcredit to be practiced on a growing scale. Under the new and more favorable macro- economic conditions since 1994 the Central Bank of Brazil started to organize debates and seminars involving the main actors from the microfinance sector (Alves& Soares, 2006, p. 27). In the second half of the 90 s this resulted in some policy and regulation changes and a number of important microcredit programs were initiated. One of these new programs was o Programa de Crédito Productivo Popular (Program of Common Productive Credit) of the Banco Nacional de Desenvolvimento Econômico e Social (National Bank for Economic and Social Development), launched in 1996 (SEBRAE Website: Serviço Brasileiro de Apoio às Micro e Pequenas Empresas). Another program called CrediAmigo was started in 1998, after a pilot period of a year, by the public development bank Banco do Nordeste (North- East Development Bank). CrediAmigo is now the second largest microfinance program in Latin America in terms of portfolio size (MIX Publications, Americas: the top 100, 2010). Another example of an attempt to stimulate microfinance in Brazil is a program that was launched in 2001 by SEBRAE, specifically focusing on microcredit (Barone, 2008, p.61). Its objective is to support the microfinance sector and its integration in the national financial system, helping it to become self- sustainable (SEBRAE Website). Other efforts to stimulate the microfinance sector included the creation of two new legal entities; OSCIPs (Organização da Sociedade Civil de Interesse Público Civil Public Interest Society Organizations) and SCMs (Sociedades de Crédito ao Microempreendedor Microentrepreneur Credit Societies) (Barone, 2008, p.55). The first new entity type, an OSCIP, is a non- profit organization serving a social goal and it is monitored by the Ministry of Justice (Kumar, 2005, p.88). Non- governmental organizations (NGOs) can choose to transform into an OSCIP. It can sign cooperation agreements with the government to help it fulfill its social objective and receive public funds to do so. Other types of funds allowed are limited to donor funds and owner funds (Kumar, 2005, p. 87). One of the great advantages of this type of NGO is the fact that OSCIPs are not subject to the Brazilian Usury Law, legislation prohibiting charging more

9 than twice the official interbank rate per annum for organizations not regulated by the Central Bank (Nichter, 2002, p.36). Since the operating expenses of microcredit institutions tend to be a lot higher than regular banks and so do their interest rates to cover these expenses, this exclusion is crucial to the growth and sustainability of MFIs. The other new entity type, SCM, is a for- profit financial institution. It is regulated by the Central Bank and therefore not subject to the Brazilian Usury Law (Barone, 2008, p.56). It is subject to minimum capital and liquidity requirements and restrictions on leverage (Kumar, 2005, p.88). SCMs are permitted to give out loans up to R$ 10,000 per client (approximate US$ 5484 as of June 2010) to individuals and microenterprises for professional, industrial and commercial use. Consumer loans are not allowed. They can not offer securities or collect deposits (Kumar, 2005, p.88). The creation of the new programs and these new institutional forms contributed to the spreading of microfinance in Brazil, even though it started relatively late compared to other Latin American countries. Because of this late start, Brazilian MFIs are still relatively young (Ramírez, 2010, p.8). Another remarkable characteristic of the Brazilian microcredit market is the high concentration of operations in only a few institutions. From a total of 27, the five largest MFIs in terms of clients and portfolio serve 89.2% of all borrowers and hold 89.5% of the microcredit portfolio (MIX Publications, 2010, p.1). These largest five are CrediAmigo, Central Cresol Baser, Cresol Central, Banco Popular do Brasil and Real Microcrédito. 4. Limitations of Microcredit in Poverty Reduction The effectiveness and desirability of microcredit as a policy to alleviate core poverty will be considered on the basis of its ability to reach the core poor, the final impact on their poverty and the cost- effectiveness or financial sustainability (Montgomery & Weiss, 2005, p. 392). To decide on the desirability and effectiveness of microcredit as a core poverty alleviation tool it is important to consider these criteria together even though in practice these criteria often are inevitable tradeoffs The ability to reach the core poor The ability to reach the poor is called outreach and considers the quantity of people served by microcredit. Even though Microfinance institutions (MFIs) are designed to supply credit to the low- income class, the lowest layer in the wealth pyramid consisting of people living of less than a dollar a day is a very limited beneficiary of microcredit (Montgomery & Weiss, 2005, p. 395). Asian MFIs do better than Latin- American MFIs in reaching the poorest with the lowest loan and saving balance per borrower (Montgomery & Weiss, 2005, p. 393). Loan size is taken as a proxy for depth of outreach while it is generally assumed that the poorest take out the smallest loans. Their Microfinance Bulletin data from 2003 shows an average loan balance per borrower of US$ 195 for Asia and US$ 581 for Latin America. One of the main reasons why the supply to the core poor is limited is the relatively high costs in serving the core poor. The poorest generally take out the smallest loans, making the administration and operation costs per loan disproportionately high. This focus on financial sustainability can cause the services to the poorest to reduce or even disappear since these are the least profitable or not profitable at all (Lascelles, 2008, p.4). However, beside the fact that small loans are relatively costlier, other reasons exist that limit the outreach.

10 A lot of the core poor live in rural areas and this contributes to the increased operating cost and risk. Rural loans have higher operating costs, since the operating costs are negatively related to the customer density per square kilometer (Shankar, 2007, p.6). Costs of monitoring and collecting repayments increase in remote areas. Additionally, loans to rural clients have a higher degree of default risk. Participants of rural microcredit programs often take out loans to finance their agricultural or fishing activities. The income gained with these activities can be very seasonally variable (Gaiha, 2001, p. 139). Neri (2008, p.50) states that in order to be sustainable and successful, MFIs should always diversify their portfolio and therefore never solely invest in agricultural areas with one dominant activity. Furthermore, market access is one of the decisive conditions for the microentrepreneur to improve income with the credit obtained (Neri, 2008, p.51). Getting this market access is generally more complicated in rural areas and selling their products in urban areas is difficult. This increases the risk that the rural participants will not be able to produce enough surpluses to make their repayments in time (Bond, 2007, p ). The increased default risk and the lack of portfolio diversification demotivate MFIs to operate in rural areas, in addition to the high operating costs. Normally, in the case of high default risk a loan would still be possible if it is backed up by collateral. However, living in poverty makes traditional collateral requirements impossible to be met (Montgomery & Weiss, 2005, p. 395). One other way to compensate for the high default risk and lack of collateral is to raise exceptionally high interest rates. However, due to the small loan sizes and the labor intensity of banking the poor, the microfinance interest rates generally are much higher than the regular banking rates already. Besides the supply- side limitations, also demand- side factors contribute to microcredit s limited outreach. The collective set- up of the loans is part of the problem of reaching the real poor (Montgomery & Weiss, 2005, p. 396). The group lending mechanism is designed in such a way that when one member defaults, the rest of the group is responsible for this default. The poorest class is perceived to be bad credit- risk, unable to generate enough extra income to repay. Therefore, the fellow- members exclude the core poor from group loans out of fear for their default (Bond, 2007, p. 233; Hashemi & Rosenberg, 2006, p.2). In a review on the Maharashtra Rural Credit Project in India, Gaiha (2001, p. 138) notes that some community members were not allowed to join. Others were pointing to the uncooperative attitude of the village community. Another respondent feared that his efforts to join a credit group might provoke a hostile reaction from village and local authorities (Gaiha, 2001, p. 138). These are examples of how the core poor sometimes exclude themselves from the group lending process. Given their very low and irregular income, they do not consider themselves trustworthy to take out a loan (Hashemi & Rosenberg, 2006, p.2). Taken in combination, these aspects attribute to the limited outreach of microcredit to the core poor. The relatively high cost of serving the poor, the lack of services offered to rural areas because of high costs and risk and the core poor s self- exclusion or exclusion by the group, all contribute to the low extent in which microcredit reaches the core poor Outreach in Brazil As we have seen in Figure III, the total amount of funds involved in microfinance in Brazil is still relatively small. Although this relatively young market is serving a growing

11 number of clients, the total amount of 809,112 active borrowers is moderate in comparison with its population of almost 192 million people (data for 2008). The third line shows the average loan balance per borrower. This measure measures the typical debt burden for the borrower. It takes the amount of US dollars outstanding at a point in time (usually year- end) divided by the number of loans outstanding at that point of time (Schreiner, 2001, p.10-11). Smaller average balances are generally associated with a greater outreach to the poor, since poorer clients typically have a smaller debt burden. Brazil s average loan balance per borrower is significantly smaller than Latin America s average. This suggests that Brazil is reaching poorer clients than the average Latin American MFI. Figure VII: Comparison of Brazilian Microfinance market, data for 2008 Brazil Latin America Global and Caribbean # MFI s ,395 # Active borrowers 809,112 14,100,000 86,200,00 Average Loan Balance per Borrower ,341 1,588* ($) % of population living in households 7.76% 8.22% 25.19% with per capita income of less than US$1.25 a day Note. Source: MIX Website (Brazil overview) and Microfinance at a Glance from MIX Website. Source: PovcalNet, World Bank Development Research Group Website, data for Yet, the size of the average loan balance is not necessarily related to its method of providing loans. Instead, it can also be related to the age of the MFIs. According to the MIX Latin American Microfinance Analysis and Benchmarking Report, the average age of a South American MFI was fourteen years in 2008 (2008, p. 3). However, Brazil s MFIs are far less mature; the average age of a Brazilian MFI is only seven years (MIX: Brazil 2009 Microfinance Benchmarking Analysis and Report, 2010, p. 1). Generally, MFIs that have been operating for a longer period are serving more mature clients. These clients initially started with small loans, but the values of their loans have grown along with their businesses. Accordingly, the high Latin American average loan balance can partially be explained by the long period of functioning of MFIs and does not necessarily show a lack of services offered to core poor. Nor does it indicate that Brazil is extremely dedicated in serving the poorest. (Benchmarking Latin America 2006, MIX, p.4). In the case of Brazil, the lower average loan balance is probably related to the low level of the microfinance market saturation. Thus, Brazil s average loan value being smaller than Latin America s average seems to indicate that Brazil is doing a good job in reaching the poor, but this imperfect measure is not decisive, therefore some other characteristics of the market will be considered as well. In Brazil, unlike in many other countries with high prevalence of poverty, almost seventy percent of the poor live in urban areas (Neri, 2008, p.17). Therefore the Brazilian outreach to the poor is less affected by the lack of rural credit supply, than a country where most of the poverty is located in rural areas. Another remarkable

12 characteristic is the fact that the MFIs working with group loan methodology are the biggest both in sense of portfolio and clients (MIX: Brazil 2009 Microfinance Benchmarking Analysis and Report, 2010, p. 3). Typically, Latin American MFIs focusing on group loans only beat other MFI s in number of clients, not in portfolio size (MIX: Brazil 2009 Microfinance Benchmarking Analysis and Report, 2010, p. 3). While the group loan methodology mostly targets the poorer borrowers, this dominance of a group loan methodology would imply a greater outreach. To consider to what extent the poor are succeeding in entering the loan groups, we take a closer look at the poverty level of the clients of CrediAmigo. CrediAmigo is Brazil s largest MFI serving 49.5% of Brazil s microcredit clients and is often praised for its outreach. It focuses on serving the urban poor (Neri, 2008, p.17). In 2006, 90% of its loans involved solidarity loans in a group (Neri, 2008, p. 41). To obtain a loan the client must be older than 18 years old, have a productive activity and form a group of at least three people who trust and know each other (Neri, 2008, p.201). The only documents needed are an ID, a personal registration number (CPF) and a proof of residency (Neri, 2008, p.210). The proof of residency can also be a telephone or electricity bill, for the people living in unregistered areas such as slums. These requirements try to exclude only the ones who are living without any sense of stability, such as the homeless. Unfortunately, there are still Brazilians without a formal identity and birth certificate. According to an estimate of the Brazilian Institute of Geography and Statistics (Instituto Brasileiro de Geografia e Estatística- IBGE) this number has been decreasing until 8.9% of the Brazilian population in 2008 (Figure IX). These people formally do not exist and will therefore not be able to apply for any sort of social assistance, health care or formal employment, let alone credit. They are usually the poorest, since they do not succeed in obtaining the most basic facilities because of the lack of identification. Even in order to obtain a governmental income transfer called Bolsa Familia (Family Scholarship), directed directly to the core poor in Brazil, people need to show a valid CPF (Ministry of Social Development Website). The far majority of the identity- less people lives in the rural North and North- West of Brazil, in the states of Amazonas, Pará and Maranhão (IBGE Website, Statistics of Civil Registration, 2008). In this sense, the rural population in Brazil is indeed more excluded from the supply of credit. Yet, for the urban poor who do have a formal identity and identification, there exist few supply limitations in areas where CrediAmigo operates, that includes municipalities in the North- East Region, the North of the state of Minas Gerais and Espirito Santo and the cities of Brasília, Belo Horizonte and Rio de Janeiro. For CrediAmigo, the average loan balance per borrower was US$ 405 in 2008 (MIX Website). This is almost half of the national average in figure VII. Even though it is a very crude measure, it suggests that the average CrediAmigo client is poorer than the average client served by microcredit in Brazil. Of CrediAmigo s clients, 58% have a monthly family income of less than R$1,000 which is about US$ (as of June 2010 exchange rate) (Neri, 2008, p.41). This is almost twice the monthly minimum salary of R$510 (Ministry of Work and Employment Website o Ministério do Trabalho e Emprego), However, one has to keep in mind that the first amount refers to family income and the second to an individual income. Almost half of all CrediAmigo s clients, namely 44%, have monthly sales of R$1,000 or less (Neri, 2008, p.208). Finally, Neri (2008, p ) analyses the amount of clients that have crossed the poverty line after participation in the program. This analysis can be used to see the percentage of clients that lived below the poverty line when they entered the program,

13 thereby evaluating the outreach (figure X). Using operational profit and other received funds (such as social government transfers) as a proxy for income, three types of poverty lines were used and compared (Neri, 2008, p.233). The first is half the minimum wage. The second type of poverty line is constructed by Ipea (Instituto de Pesquisa Econômica Aplicada - Institute of Applied Economic Research). Besides the minimum wage this poverty line also takes into account the differing living standards in the states of Brazil, using different poverty lines for different states. The third poverty line is computed by the Getulio Vargas Foundation (Fundação Getulio Vargas - FGV), taking into account not only the differing livings standards in different states but also nutritional needs. Depending on the type of poverty line used, the outreach of credit to the poor living below the poverty line is 32.5%, 29.3% and 14.4%. Thus, only a small quantity of CrediAmigo s clients was living under the poverty line; most clients are upper poor. Figure IX: Clients living above or below povery line when entering CrediAmigo Poverty line 1/2 minimum wage Ipea Fundação Getulio Vargas # living above poverty line % living above poverty 67.5% 70.7% 85.6% line # living below poverty line % living below poverty 32.5% 29.3% 14.4% line Total observations: Note. Source: NERI, M. (2008) p Microcrédito, o mistério nordestino e o Grameen brasileiro: perfil e performance dos clientes do Crediamigo. Rio de Janeiro: Editora FGV. Percentages calculated by the author. Taking all of this into consideration, what can be said about the outreach of microcredit in Brazil? Brazil s average loan balance per borrower is smaller than Latin America s average, suggesting a better outreach to the poor. On the supply side this is mostly related to the dominance of group loan methodology, that targets poorer borrowers. On the demand- side this is mostly related to the abundance of new clients in the relatively young Brazilian microcredit market. Its scale of provision is not as big as in other Latin American countries yet. Nowadays, CrediAmigo plays an important role in the focus on small loans and outreach. This institution probably pulls down Brazil s value of average loan balance per borrower. Yet, even CrediAmigo hardly serves the people living under the poverty line, since the far majority of its clients are upper poor. Although Brazil s outreach is not bad in comparison to its region, general limitations in outreach to the core poor also apply to Brazil The impact in reducing poverty Dozens of studies on the impact of microcredit have been done with quite different results. Many show positive effects of credit on the poverty level of the participants (Khandker, 2005; Nader, 2008). However, these improvements generally show the smallest poverty reduction for the poorest participants. Nader (2008) measured an

14 increase in income after receiving credit, but while the credit was used for consumption smoothing only it did not help to substantially transform the lives of the women living in extreme poverty. Although the idea of microcredit is to productively invest the loan, in practice, the poorest participants often used the loans for non- productive consumption ends. This way they failed to produce enough surpluses. In their poverty- impact overview- study, Montgomery and Weiss (2005) refer to nineteen studies in Asia showing that eight of them showed a positive relation between microfinance and income, four showed no relation and seven showed that microcredit had a bigger impact for the better- off. The majority of the studies showed that the upper poor benefited from microcredit, but the poverty lift was the smallest for the core poor (Weiss & Montgomery, 2005, p. 410). In Latin America Montgomery and Weiss (2005, p. 408) found a more general positive poverty reduction effect. But again, for the core poor microcredit in Latin America showed a weak impact (Weiss & Montgomery, 2005, p. 410). Apparently, the common result among these different studies with different outcomes is the fact that the effect of microcredit is proportional to income, showing the weakest improvements for the poorest (Weiss & Montgomery, 2005, p ). The positive correlation between income and the gains from microcredit makes the poorer borrowers gain less than the relatively richer ones. The likelihood of impact is hugely determined by the initial income of the participant, which is very low in the case of the core poor. Although it can be a very effective poverty alleviation tool for the less severe poverty cases, the likelihood that microcredit will reduce core poverty is a lot smaller. To make microcredit work for the core poor it must at least be supplemented with food aid and training. This is exactly what the Bangladesh Rural Advancement Committee (BRAC) has done with their Income Generation for Vulnerable Group Development (IGVGD) Program (Matin, 2002, p. 2). With a program of food grain safety net, training and credit, the women who enrolled were earning significantly more than they had before enrolling. Their income increase in a year was more than the costs of wheat received. After finishing the IGVGD program 80 % of the participants enrolled in BRAC s regular credit program (Matin, 2002, p. 8). Fighting the food insecurity, the lack of skills and the irregularity of income, the program succeeded lifting the participants out of extreme poverty up until the level at which they could join the regular credit programs. It is an example of a more complex perspective of what contributes to core poverty, taking into account the other structural causes. Other programs exist that have successfully integrated microfinance with non- financial services, improving the performance of the clients. An NGO in Bangladesh called Jogorani Chakra has used a similar model as the IGVGD program and an NGO called CARE Bangladesh has successfully combined microfinance with government- guaranteed employment schemes (CGAP Focus, May 2001, p.11) Impact of Microfinance in Brazil There is no general overview study of the impact of microfinance in Brazil, however, there are some MFI- specific impact studies. Evaluating the impact of an MFI called São Paulo Confia in the state of São Paulo, Monzoni (2008, p.196) found that one extra percentage of credit led to 0.344% more sales and 0.426% more income. His results were robust, even though his sample constituted of only 175 microfinance clients. Monzoni (2008, p. 197) also found that the income impact was proportional to

15 schooling. This confirms the idea that impact is proportional to income, through the link between income and human capital. In his evaluation of the impact of CrediAmigo Neri (2008, p.210) also found that impact was proportional to schooling. Using operational profit as a proxy for income, he found that clients without schooling increased their average operational profit from R$ 654 to R$873; an increase of 33%. For clients that completed primary school the average operational profit increased from R$ 895 to R$1,232; an increase of 38%, and for clients with a form of higher education the increase was from R$1,234 to R$1.944; an increase of 58% (2008, p.211). Neri also computed the percentage of clients that crossed the poverty line after participating in the CrediAmigo program (Figure X). He used the three types of poverty lines that have been introduced earlier (see Outreach in Brazil). The transition matrix in figure XI compares the poverty level of clients when they entered the program to their condition in The percentage of clients that succeeded in escaping from poverty during the program is 48.1%, 50.0% and 60.8% for the poverty lines of half the minimum wage, Ipea or Fundação Getúlio Vargas, respectively. The percentage of clients that lived above the poverty line before participating in the program and ended up living under it after the program was small. This was the case for 4.4%, 3.9% and 1.7% for the respective poverty lines of half the minimum wage, Ipea or Fundação Getulio Vargas. This poverty lifting impact is exceptional keeping in mind that CrediAmigo does not offer any non- financial services along with its credit, such as health, food or education support. However, this minimalistic program would probably succeed in including a lot more clients in this poverty lift, if it would address the more profound causes of chronic poverty. With an eye on financial sustainability, it would probably be the best option for CrediAmigo not to provide non- financial services itself, but to seek a partnership. In the example of the IGVGD program the food safety net was provided by the Bangladeshi government in cooperation with microfinance institution BRAC. Partnerships like these hardly exist in Brazil, although they could greatly improve microfinance s impact on the poorest. A more holistic view including non- financial services would let the core poor, who are struggling with more than just the lack of credit, reap the fruits of microcredit as well. Figure X: Poverty Transition Matrix of clients of CrediAmigo Fundação Getúlio 1/2 minimum wage Ipea Entry Vargas Condition Not Not poor Poor Poor Not poor Poor poor Not poor 95.6% 4.4% 96.1% 3.9% 98.3% 1.7% Poor % 51.9% 50.0% 50.0% 60.8% 39.2% Number of observations: Note. Source NERI, M. (2008) Microcrédito, o mistério nordestino e o Grameen brasileiro: perfil e performance dos clientes do Crediamigo. Rio de Janeiro: Editora FGV, p The cost- effectiveness in comparison with other types of aid

16 As much as the donors, non- governmental institutions and MFIs would like to solve the tremendous amount of poverty, the funds to fight poverty are not infinite. Since non- governmental organizations and even governments have been subsidizing MFIs over the last decades, it is important to question if the benefits created are proportional to the funds dedicated to it. Like mentioned before, according to the MIX the global Gross Microloan Portfolio is at least U$ 44 billion (MIX Website, 2009). It needs to be considered if it has been benefitting the people it was intended to benefit and whether these funds could have been spent more effectively in other ways. Among the MFIs reporting to MIX, 71 % are profitable and do not need any further subsidies. MFIs that are almost reaching profitability account for another 22 percent (CGAP, Focus Note, January 2010, p.5). However, the fact that some MFIs are not financially sustainable is not necessarily a reason for rejection if the subsidy is serving a social goal. Instead, the benefits created should be compared with the benefits created by spending that same subsidy in a different way, serving the same goal. Aiming at hardcore poverty eradication, minimalistic microcredit programs seem to meet their goal to a limited extent. If microcredit shows a poverty lift proportional to income, trying to solve chronic poverty with microcredit will not `deliver the most bang for the bug` (Morduch, 1999, p. 1600). The core poor take out the smallest loans and the smaller the loans, the costlier they are (Tucker, 2001, p. 110). At the same time, due to the proportionality to income, microcredit has the smallest impact on the poorest. A multidimensional program of food, credit and training is generally more costly than a minimalistic microcredit approach, yet the impact is higher. Moreover, after this extensive program they will be prepared to eventually participate in the minimalistic programs. An illustrative example is the 18- months IGVGD program in Bangladesh. Its costs were estimated at about 6,725 takas (approximately US$ 135) per women (CGAP, Focus Note, May 2001, p11). This is more than the average cost per borrower for microcredit in the region of South Asia, which is only US$ 121 (MIX Website). Bangladesh benchmark for the average cost per borrower is even considerably lower than the rest of the region, namely US$ 18 (MIX Website). Comparing these two types of programs, minimalistic microfinance is cheaper than a multidimensional program. Nevertheless, the government and the donors regarded the cost of the IGVGD- program as a small subsidy, since two- thirds of the core poor women participating in the program graduated from a continuous dependence of aid and handouts to self- sustainability after entering the regular microfinance program (CGAP, Focus Note, May 2001, p11). This continuous dependence unlikely could have been solved with the cheaper microcredit. Then why would one spend money meant to solve core poverty on microcredit even though it is relatively cheaper? Thus, aiming at reducing hardcore poverty with a minimalistic microcredit program might not be the most cost- effective policy. Loans to the core poor are the riskiest, the costliest and the least effective in terms of core poverty reduction. For the neediest, other more assistential poverty alleviation programs give a much bigger bang for the buck, even though they may cost more. These could be combined with microcredit eventually, but not before the core poor s issues such as vulnerability and lack of skills and minimal financial base have been tackled. For the upper- poor, on the other hand, microcredit can be a very cost- effective tool to help people to help themselves requiring relatively few funds The cost- effectiveness in Brazil

17 In Brazil the average efficiency level in microcredit provision is not very high. The average level of costs in Brazil is above the benchmarks of its region (Figure XII). These high operating costs cannot be explained by extra non- financial services, since programs that combine microcredit with non- financial assistance hardly exist in Brazil. Figure XI: Operation efficiency in Brazil in comparison with its region Brazil Latin America and Caribbean Cost per borrower* US$ 395 US$ 179 Operating expenses/ Gross loan 33.06% 22.26% portfolio Total expenses/ Assets 38.20% 26.17% Note. * Operating expense/average number of active borrowers Source: MIX Website, Microfinance Benchmarks of MFIs, data for Additionally, Brazil s microcredit market is characterized by high profits, a low dependence on external funds and the fact that most MFIs use their retained earnings and own capital to finance their operations and growth (Ramírez, 2010, p.3). The average return on assets, average return on equity and the average profit margin are at least twice as large for Brazil as the average values for the region of Latin America and Caribbean (Figure XII). Figure XII: Profitability of microfinance in Brazil in comparison with its region Brazil Latin America and Caribbean Return on Assets 3.84% 1.15% Return on Equity 10.46% 4.43% Profit margin 10.75% 4.92% Note. Source: MIX Website, Microfinance Benchmarks of MFIs, data for These two characteristics form a peculiar combination of high profitability with high costs, making the current Brazilian microfinance practice not very cost- effective in core poverty alleviation. However, opportunities lie ahead in this still relatively young market. If these MFIs manage to be profitable despite these high operating costs, the potential gains of improved efficiency can be great. If the efficiency could be increased through innovation, this would lower operational cost and create room for non- financial services. These could be included while still leaving room for enough profitability to be self- sustaining. Competition could drive this innovation. In this situation of lower operational costs, self- sustainability and a more extended poverty approach the cost- effectiveness would be better. However, in reality the operational costs are high and as the market is characterized by a few big providers each operating in different areas of Brazil, the degree of competition is still very low. The self- sustainability is high but the programs are predominantly minimalistic, unlikely impacting a chronic poverty state profoundly. For the massive amount of upper poor microcredit can be extremely useful, but aiming at poverty

18 alleviation for the core poor microcredit might not be the cost- effective policy. Alternatives should be considered. A type of policy that might be more cost- effective is the earlier- mentioned Brazilian income transfer program Bolsa Família. For the extreme poor families, with a per capita family income of below R$ 70, the income transfers are unconditional. For the poor families, with a per capita family income of between R$ 70 and R$ 140 (US$ 38 and US$76, as of June 2010), the transfers are conditional to the children s primary and secondary school attendance and visits to health consults and vaccination programs (Ipea, Millennium Goal Objective Report 2010, p.32). The monthly income transferred per family lies between R$ 22 and R$ 200 (US$ 12 and US$109, as of June 2010), depending on the family income, the amount and the age of the children in the family (Ministry of Social Development Website). Annually, this lies between the R$ 264 and the R$ 2400 per family, which is equivalent to US$ and US$ The poorest receive the greatest amounts in this program and this transfer becomes spendable income directly. With microcredit, on the other hand, the benefits are reversed; the core poor are the least likely to gain. The income generating capabilities through microcredit are the smallest for the poorest and the default risk the highest. In Brazil the average cost of maintaining a borrower is US$ 395 and while incurring these costs, income still has to be generated. In other words, in de case of the deprived core poor, spending US$ 395 on a project with a low probability of return is probably less effective than giving between US$ and US$ of directly spendable income to a whole family. Moreover, in the case of these conditional transfers, education and health are also promoted. This addresses the human capital aspect that greatly determines microcredit s impact. Once the beneficiaries have gotten to the point where credit can unleash an economic potential, microfinance can be an effective and relatively cheap form of aid. 5. Future Challenges of Microcredit in Brazil Brazil should try to facilitate the transformation of microcredit to microfinance, in the sense that it should not solely focus on credit. Changes in the microcredit industry are needed in order let financial micro services grow beyond credit only. For example, neither OSCIPs nor SCMs are allowed to receive deposits of their clients, even though SCMs are regulated by the Brazilian Central Bank (Kumar, 2005, p. 81). This is disadvantageous for both the MFIs and the clients. For the MFIs deposits can be a cheap funding source, lowering the financial expenses. Other advantages of deposit funding for the MFI include wide availability and relative stability (Nichter, 2002, p.37). Most likely, the clients will also benefit from this lower cost of funding, as lowered total expenses will eventually affect interest rates. Moreover, for the clients the deposit option is a way to smoothen consumption and deal with income shocks. Additionally, where savings allow households to smoothen consumption, insurance allows households to manage specific risks by sharing the cost of unlikely events among many poor (CGAP, Focus Note, December 2002, p.5). Including several types of insurance should be given serious thoughts. However, it will require adaptations in the Brazilians law to allow for insurance or even deposits to be provided by non- bank financial institutions like OSCIPs or SCMs. Secondly, MFIs should try to innovate both in the areas of technology and methodology, aiming at lower costs. Some traditional banks successfully saved costs and extended outreach by creative partnerships (Nichter, 2002, p.53), initiatives that can serve as

19 examples for MFIs. For a range of services the clients of the Bradesco Bank can now also be attended at the post offices, gaining service points at once. Likewise, the public bank Caixa Econômica Federal gained service points in a partnership with a federal lottery called Loterias (CGAP, Focus Note, May 2008, p.12). Such creative partnerships could be extremely advantageous for MFIs. Exploring alternative distribution channels can help reach more clients and reduce costs. Therefore, looking for this kind of opportunities should be part of the strategy of Brazilian MFIs. 6. Conclusion This paper has taken a closer look at how the general limitations of microcredit as a core poverty alleviation tool affect microcredit s effectiveness in Brazil. It aimed to study the current state of microcredit in Brazil and how the general limitations of microcredit affect microcredit s potential for core poverty alleviation in Brazil. It considered the ability to reach the core poor, the eventual impact in reducing core poverty and the cost- effectiveness. Outreach in Brazil seems to be deeper than regional benchmarks, as indicated by a smaller average loans balance per borrower. However, the width is smaller; microfinance in Brazil is not yet reaching the amount of clients other Latin American countries are reaching. When it comes to the common difficulties in reaching the core poor Brazil is no exception. Core poor, especially those living in rural areas, are hardly reached. At the same time, the impact for the core poor is limited if programs are consisting of credit only. Unfortunately, it is predominantly this minimalistic type of program that can be found in Brazil. MFIs in Brazil note the same proportionality to income of the poverty- reducing effect of credit, showing the weakest improvements for the poorest. Therefore, taking into account that for the poorest the impact results are the smallest and the costs the highest, cost- effectiveness of microcredit in isolation is not optimal for core poverty. For the core poor on other types of aid should be provided for as long as they do not fit in the high potential microcredit client profile. The exceptional high costs of Brazilian MFIs only reinforce the proposition that funds meant to help the core poor are not most effectively spent on microcredit. Microcredit certainly is a promising and suitable tool to fight the less poignant levels of poverty of millions of Brazilians. However, the belief that microcredit is a cure- all to fight core poverty under- appreciates the heterogeneity of the poor. Brazilian programs aiming to alleviate chronic poverty need to take a more complex perspective of what contributes to chronic poverty. Unfortunately, in this time of a growing focus on financial sustainability in the microcredit sector, microcredit providers are typically moving away from such a perspective. This leaves an important responsibility for the government to initiate programs that aim to alleviate a kind of poverty that microfinance cannot solve. If the Brazilian core poverty is to be solved other core poor deprivations than the lack of credit - such as the structural food insecurity, financial shock sensitivity and lack of education - should be tackled first.

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