Social capital in microfinance: Case studies in the Philippines

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<ul><li><p>Social capital in micronance:Case studies in the Philippines</p><p>BENJAMIN R. QUINONES Jr.1 &amp; HANS DIETER SEIBEL21Programme Coordinator, Asian and Pacic Development Centre, Kuala Lumpur, Malaysia2Rura Finance Adviser, International Fund for Agricultural Development, Rome, Italy</p><p>Abstract. The present study examines how formation of social capital in the micronance sector isaected by enlarging the political or economic resources of the informal groups of poor householdsand micronance institutions (MFIs) that contribute to social cohesion. In particular, this chapterattempts to show how the regulatory and supervisory framework as well as the nancial innova-tions of micronance institutions have aected poor households' capacity for cooperation andmutual support in their ght against poverty.</p><p>Institutional and policy framework</p><p>A fundamental form of social capital in micronance is the institutional andpolicy framework, the set of formal rules and norms (constitution, laws, regu-lations, policies) that regulate public life in a society. TheWorld Bank calls this`macro-level social capital.' Financial regulations may form the legal basis forcontractual arrangements and interactions between entities from dierent sectors,such as the terms and conditions of nancial contracts between cooperatives orbanks and individuals. They represent a resource that facilitates coordinatedaction by citizens, and as shown in this study, they can also inuence theformation of social capital among poor households.</p><p>There may be a hierarchy of three or more levels of regulation pertinent tothe micronance sector: governmental regulation, e.g., by the legislature (policy-making) and by the central bank or bank superintendency as a rst-tier regu-latory authority (bank supervision); nongovernmental regulation as delegatedto a second-tier regulatory authority such as an auditing federation of a net-work of nancial institutions; and self-regulation of micronance programs ormicrocredit outlets by formal or informal nancial institutions through theirown rules and regulations, which in the absence of standards may vary fromone organization to another. Ideally, all three levels are integrated through aneective management information and reporting system. The micronancesituation in the Philippines is quite far from the ideal.</p><p>The obvious need is for capital transfer from rich to poor countries and thedisbursement of cheap credit to the poor. Special development nance institu-tions were created at international, bilateral, and national levels to channel thecredit, such as theWorld Bank, the Asian Development Bank, Kreditanstalt fu rWiederaufbau, the Development Bank of the Philippines, and the Land Bank of</p><p>195</p><p>[421]Policy Sciences 33: 421^433, 2000. 2001Kluwer Academic Publishers. Printed in the Netherlands.</p></li><li><p>the Philippines. In the process, national governments took upon themselves thecombined roles of planner, banker, supplier, marketing agency, producer, andwelfare provider. Among their main nancial instruments were interest rateceilings and subsidies, credit targeting, credit rationing, and agricultural pricecontrols. Subsidizing interest rates on loans and directing subsidized credit topriority crops and borrowers became major development strategies, with agri-cultural production, rather than rural development, the objective.</p><p>Institutions were instrumentalized as conduits of government funds, ham-pering the growth ^ at times even the emergence ^ of self-reliant local nancialintermediaries. As credit was only available for government-directed purposes,farmers tended to take advantage of the fungibility of money, diverting it toother purposes and subverting project additionality. Due to resource scarcity,subsidized lending projects were narrow in scope and void of dynamic growth.Given a wide discrepancy between credit supply and demand, credit rationingbecame a principal strategy. Administered credit showed a persistent tendencyof reaching the wrong recipients in wrong quantities at the wrong time forwrong objectives.</p><p>The policy of nancial repression helped create favored groups of nonpoorpeople who beneted from government rationing of choice projects and low-cost funds. In turn, the favored groups ensured economic support to those inpower and abetted rampant political interference in economic and lendingdecisions. Government ocials and experts substituted their own rationalityand decisions for those of the farmers and the market. It might also be notedthat the absence of democratic control over political and economic processescontributed to the rise of the Marcos dictatorship.</p><p>Ceilings on interest rates prevented nancial institutions from signicantlyexpanding outreach to poor households. As transaction costs tend to be con-stant per loan independent of loan size, interest rate ceilings and credit subsi-dies led to concentrations in the loan portfolio, allocating relatively large loansto a few big farmers, neglecting the small and the poor. Banks shifted trans-action costs to borrowers, including legal and illegal charges, making cheapcredit expensive to the end-user. As banks acted as conduits for governmentfunds, rather than applying credit policies of their own, subsidized creditcreated its own high risks and associated default rates.</p><p>Deregulation and the mobilization of positive social capital</p><p>Since the 1980s, the assumption that the poor cannot save and that poorcountries cannot mobilize nancial resources domestically has been graduallydropped. The poor do save, their marginal propensity to save being usuallymuch higher than that of the nonpoor. With appropriate strategies, instru-ments, and products to mobilize domestic resources, many governments havemoved from a policy of nancial repression to a policy of deregulation. One ofthe most important instruments has been: the deregulation of interest rates,</p><p>196</p><p>[422]</p></li><li><p>permitting nancial institutions to oer attractive savings products with pos-itive real returns and to charge interest rates on loans which cover their costsand risks and allow for a prot margin exchange rate deregulation to ease thefree ow of private capital. Also important has been the deregulation of bankentry and branching, including the provision of legal forms for local bankswith lower equity requirements, accompanied by a deregulation of the traderegime.</p><p>In the mid-1980s, the Philippine government took bold steps toward nan-cial liberalization; and as the 1990s came to a close, it opened the bankingindustry to greater competition from ten new foreign banks. The BangkoSentral ng Pilipinas (BSP), the central bank, abandoned its restrictive bankentry and branching policies and encouraged the entry of new players in theindustry. The BSP removed all restrictions on the opening of branches in therural areas in 1989 and lifted the moratorium on the entry of new banks in 1990.To further liberalize branch banking, BSP in 1991 auctioned o franchises toestablish branches and allowed banks to put up branches nationwide. In 1992,BSP gave branching privileges in rst-class cities or municipalities, an incentivethat has particularly encouraged branching in low-income municipalities.Branch banking was fully liberalized in 1993, subject to capital adequacy,liquidity, protability, and quality of management criteria.</p><p>Micronance for poverty alleviation: Investing social capital for publicpurposes</p><p>Deregulation enabled pro-reform, pro-poor elements to forge a national micro-nance strategy in line with the government's market-oriented nancial andcredit policies.</p><p>The vision is to have a viable and sustainable private (micro) nancialmarket with the government providing a supportive and appropriate policyenvironment and institutional framework to that market. This will beachieved in a liberalized and market-oriented economy where the privatesector plays a major role and the government provides the enabling environ-ment for the ecient functioning of markets and the participation of theprivate sector (Llanto, 1986).</p><p>The strategy recognizes the unsustainability of directed credit programs, whichhave a negative impact on the eort of micronance institutions to engage innancial intermediation. Instead of mobilizing deposits, the line of least resist-ance is to depend on government funds for relending to target clientele</p><p>On the other hand, the strategy stresses the importance of private sectorinitiative in the micronance sector. Underpinning it is a market-based incen-tive structure that motivates greater private eort; spurs greater competition;and uses a modicum of public resources to reach small depositors and borrowers</p><p>197</p><p>[423]</p></li><li><p>and to provide greater accessibility of nancial services, lower lending rates,and positive deposit rates to small clients.</p><p>To make the strategy operational, pro-reform groups in the government andcivil society sectors rallied behind three strategic measures the governmenteventually created: the National Credit Council (NCC) to rationalize govern-ment-supported credit programs; the People's Credit and Finance Corporation(PCFC) to channel government funds to poverty-oriented credit programs; anda People's Trust and Development Fund (PTDF) to nance capability buildingof MFIs. These measures were meant to reduce the negative social capitalembedded in directed credit programs and to help build the technical capabilityof MFIs, which have cost and informational advantages in small clientelemarkets.</p><p>The NCC devoted its eorts in phasing out subsidized credit and enjoinedthe governmental Agricultural Credit Policy Council (ACPC) to undertake avigorous campaign against directed agricultural credit programs. The govern-ment terminated as many as 42 directed credit programs in the agriculturesector and advised nonnancial government agencies not to implement creditprograms.</p><p>Despite the strong stance against directed credit by ACPC, however, tradi-tional politicians (called `TRAPOS' by the local press which means `mop' inFilipino), who beneted from subsidized credit programs, continued to imple-ment them and therefore undermined the eectiveness of the government'spolicy reforms. Between 1994 and 1996, as many as 86 directed credit programswere found to be administered by various government nancial and nonnan-cial institutions, clearly pointing to a policy reversal (Llanto et al., 1997).</p><p>The stubborn refusal of TRAPOS to terminate directed credit programs hashad several root causes: the expediency with which politicians can buy votes byproviding cheap credit to their constituencies (as illustrated by PRB, one of thecases included in this study, whose loan portfolio balooned from a few millionto over a hundred million pesos over a period of three years, in the face of afailed land reform); the rent-seeking behavior of those who directly benetfrom preferential credit disbursement in various legal and nonlegal ways; thesheltering of disbursement agencies against competition; and, last but notleast, the vested interest in the continued supply of easy money among thosewho hold positions in national and international disbursement agencies.</p><p>The present government of President Estrada, which came into power in1998 on a pro-poor platform, appears responsive to the demands of the MFIs.It dismantled the 86 directed credit programs and held the view of havingprivate nancial institutions provide credit to the countryside and a broad-based clientele in general. The agriculture sector has also taken fresh steps tophase out of directed credit programs under a new law, the Act to ModernizeAgriculture, passed in December 1997, which stipulates a market-orientedcredit policy and greater private sector participation. A related piece of legis-lation is the Poverty Alleviation Act, also passed in December 1997. The lattercreated the People's Development and Trust Fund (PTDF) to provide capability-</p><p>198</p><p>[424]</p></li><li><p>building support to micronance institutions, but the Fund has not yet beenimplemented as of the writing of this report.</p><p>Grameen banking</p><p>The biggest challenge in the micronance market is overcoming the nancialconstraint faced by organized groups of poor people while fully utilizing thesocial capital generated by informal peer groups to ensure the success of non-collateralized lending. A monumental breakthrough occurred when ProfessorMuhammad Yunus founded Grameen Bank in Bangladesh and went on toprove that a bank catering solely to the poor can become a signicant player inthe nancial market. Having originated as a nongovernmental organizationproviding credit to the poor and later on classied by authorities in Bangladeshas a specialized bank for the poor, the Grameen Bank has become a model forcredit NGOs working with the poor in developing countries.</p><p>Formally launched in June 1979, Grameen Bank (GB) is widely consideredone of the world's most successful nancial institutions that caters exclusivelyto the poor. On its website, the Bank reports as of 31 December 1995 anoutreach to 2.06 million `member/borrowers,' 94 percent of them poor women,in 36,142 villages of Bangladesh, reached through 1,068 branches. Cumulativeloan disbursements are given as US$1.84b; loans outstanding, according to thebalance sheet, amount to $298.8m, total assets $474.5m, and `deposits andother funds' $127.47m. Many have been deeply impressed by these guresand GB's publicity, particularly since the Microcredit Summit of February1997 in Washington. Grameen's success is explained by a self-regulated nor-mative framework not supervised by any authorized agency, which prescribesits operations in detail (CARD, 1998):</p><p> a focus on poor women, gathering detailed target group information andusing rigid selection criteria to bar the nonpoor from access to its services</p><p> organizing prospective borrowers in groups of ve and centers of aboutsix groups each which in turn come under a Grameen branch;</p><p> a credit-rst program design, initially nanced with donor or governmentfunds;</p><p> internal resource mobilization through a compulsory savings component,supplemented by external donor or commercial resources;</p><p> reliance on peer pressure and joint liability of solidarity groups as aspecial type of risk management, which allows Grameen to lend withoutcollateral;</p><p> strict credit discipline with absolute insistence on timely repayment (exceptduring natural disasters);</p><p> weekly center meetings with compulsory punctual attendance, where apledge is sung and payments are transacted with a Grameen branchocer in the presence of all members;</p><p>199</p><p>[425]</p></li><li><p> special nancial contracts, comprising a series of one-year repeat loans toindividual borrowers at market rates of interest, starting small (around$50) and, contingent upon the group members' repayment performance,growing bigger in predetermined steps and amounts, repayable in weeklyinstalments, with a ve percent up-front deduction to be paid into thegroup's emergency loan fund;</p><p> adoption of Grameen's Ten Decisions of personal discipline to be fol-lowed in one's daily life, such as growing fruits and...</p></li></ul>


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