Microfinance industry could face flat interest cap on loans

- Tuesday, June 28, 2011

Microfinance industry could face flat interest cap on loans

El Salvador's fast-growing microfinance sector is facing a bill that would set a flat interest rate on loans.

The proposal has been put forward by the ruling leftist FMLN party and counts on majority support in the country's parliament.

The calculation mechanism remains under discussion, with the current proposal looking to cap the interest rate at 5-6% above LIBOR, according to Francisco Zablah, a member of the Salvadorian parliament's financial committee.

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The proposal makes El Salvador the latest Central American country to attempt to regulate the rapidly expanding microfinance sector in response to accusations of abuse and profiteering.

"This bill would help us get rid of the abuses and usury that pervade in our country - all the way from international banks to informal loan sharks," Zablah said.

"We don't want to reinvent the wheel; we simply want to adapt to our needs the anti-usury laws that are in place across the world from Uruguay to Spain."

COVERAGE RISK

The microfinance industry rejects this proposal, arguing that the bill would damage the poorest sections of society who have no access to the formal financial system.

"This proposal simply does not take into account that our cost structure is totally different from banks," said Jorge Peña, president of national microfinance association ASOMI.

"The methodology employed by microfinance institutions is much more cost intensive - we have to go visit the client, organize communal meetings, personally collect the interest, etc," he noted.

"Therefore we work with higher interest rates. It's a risk premium for working with people who don't have tangible collateral."

LESSONS FROM NICARAGUA?

Peña believes the bill would make El Salvador repeat the mistakes of neighboring Nicaragua. In 2009, Nicaragua's leftist government openly supported a voluntary loan default movement - called "No pago," or "I won't pay" - that seriously crippled the country's microfinance industry.

"But even Nicaragua has now made a U-turn. A new law has been passed this year that liberalized the interest rates once again," Peña said. "The government of Nicaragua understood that it was damaging the poorest sections of the population."

Zablah said that to avoid these mistakes, the finance committee has invited experts to study where Nicaragua went wrong in implementing its former anti-usury policies.

ASOMI opposes the regulation of interest rates in principal. But if the interest cap is to go ahead, the trade group proposes to differentiate ceilings by segments depending on the loan products and the size of the loans.

"Every segment has its own credit practices, risk profiles and funding costs," Peña said. "We can't have a single tax rate because the market is heterogeneous."

According to the latest figures from ASOMI, El Salvador's microcredit portfolio reached nearly US$1.2bn by 2009, or about one-eighth of the total banking system. ASOMI's members, mostly NGOs, represent about 12% of the country's microcredit portfolio.