social capital in microfinance

8/7/2019 Social capital in microfinance

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Social capital in micronance:Case studies in the Philippines

BENJAMIN R. QUINONES Jr. 1 & HANS DIETER SEIBEL 21Programme Coordinator, Asian and Pacic Development Centre, Kuala Lumpur, Malaysia2 Rura Finance Adviser, International Fund for Agricultural Development, Rome, Italy

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 households

and 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.

Institutional and policy framework

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. The World 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.

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 from

one 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.

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 the World Bank, the Asian Development Bank, Kreditanstalt fu rWiederaufbau, the Development Bank of the Philippines, and the Land Bank of

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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.

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.

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.

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.

Deregulation and the mobilization of positive social capital

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 of the most important instruments has been: the deregulation of interest rates,

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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.

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 the

industry. 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.

Micronance for poverty alleviation: Investing social capital for publicpurposes

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.

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).

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

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

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and to provide greater accessibility of nancial services, lower lending rates,and positive deposit rates to small clients.

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.

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.

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).

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.

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-

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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;

adoption of Grameen's Ten Decisions of personal discipline to be fol-lowed in one's daily life, such as growing fruits and vegetables in thebackyard; abstention from drinking, smoking, and gambling; improvingone's housing; building latrines; safe drinking water for better health;investing in children's education;

intensive training of members and sta to adopt the attitudes, practices,

and underlying norms and values of the Grameen approach.

The rst wave of Grameen replicators in the Philippines were credit NGOs.They operated in an unregulated environment, i.e., there were no prudentialregulations governing NGO credit programs for the poor. (The NGOs mustregister with the Securities and Exchange Commission and are required to leaudited annual nancial statements but are not eectively supervised. As non-stock, non-prot organizations, they can get tax exemption from the Bureau of Internal Revenue. They observe minimum wage legislation and social securitylisting of employees. Foreign grants are reported in the annual nancial state-ments but are not subject to any control or supervision.) The lack of industryperformance standards has created a largely heterogeneous group of creditNGOs with inadequate capitalization, heavy dependence on external funds foroperation and lending, inadequate organizational and operational structures,and weak internal control systems.

The operating procedures of SCOs (Savings and Credit Organizations) arenot tightly prescribed, but some core principles underlie their practices:

selection of members by members; member as a shareholder of the cooperative as well as user of its services; equal shares, equal vote; general membership meeting, generally called at least once a year; authority of general membership to conduct election of ocers; participation of members in the organs of the cooperative; savings-rst program, reliance on internally generated funds; credit linked to savings, equity, and loan history; reliance on individual creditworthiness in managing credit risk; continuous training and education of members; self-governance, in most cases also self-management.

Private rural banks were promoted by the government alongside a cooperativeapex bank in the early 1950s as a means for mobilizing local resources andcreating institutional mechanisms to channel cheap government credit to the

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farmers. Mounting loan arrears overwhelmed the cooperative apex bank andforced it to cease operations in the 1970s. With the demise of the national apexcooperative bank, the district level cooperative rural bank (CRB) emerged asa new institutional form aimed at consolidating the nancial resources of primary cooperatives. The CRB combines the cooperative principles of owner-ship and governance with the prot-oriented individual lending practices of theprivate rural bank.

The social capital of private rural banking is a regulated normative frame-work supervised by the BSP, the central bank. The major regulations aectingthe bank are: minimum capital requirements, deposit taking, interest rates, andloan security. Prior to the policy reforms of 1986, capitalization of private ruralbanks, cooperatives, and cooperative rural banks were quite low and heavily

subsidized by the government. They operated virtually as specialized nancinginstitutions directed by the government through various subsidized credit pro-grams to cater to specic target groups at prescribed rates of interest. In theadvent of the 1986 reforms, renancing facilities for specialized credit programswere discontinued, and rural banks were encouraged to mobilize deposits fromthe public in general. Apart from the standard norms of liquidity, solvency, andprotability vigilantly enforced by the Central Bank to maintain the generalsoundness of the banking system, there are no detailed prescriptions on how arural bank should operate. The basic motivation of people to get together toestablish a rural bank is prot taking, although some might be goaded by agenuine desire to help in the development of local communities.

Like private rural banks, cooperative banks are regulated by the BSP in thesame way as private rural banks, but cooperative banks are dierent fromprivate rural banks in many ways. A cooperative bank is owned by primarycooperatives. The members of its Board are elected by the assembly of cooper-atives that contributed to the capitalization of the bank. Cooperative banking isfounded on the principle of mutual help among the member organizations andaims to maximize socioeconomic benets of the member organizations throughresource pooling and sharing. As a localized apex bank for cooperatives, itengages in wholesale lending to the cooperative organizations. As a ruralbank, it also caters to the nancial needs of individual clients. Owing to itspeculiar makeup, a cooperative bank tries to balance its exposure betweenindirect wholesale lending to member organizations and direct lending toindividual clients. Since member organizations also cater directly to individualclients within the same area of operations as the cooperative bank, the latter

grapples with the ever-present risk of running into conict with the interests of its own member organizations.

In addition, there are two other major providers of nancial services in thecountry: development banks and commercial banks. Development banks in-clude the Land Bank of the Philippines for rural and agricultural credit and thesavings and thrift banks largely for urban small enterprise lending. The devel-opment banks are mainly lending institutions with a pronounced tendencytoward wholesale lending to actual MFIs as well as agricultural cooperatives.

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They do not lend directly to low-income people. Commercial banks with branchnetwork in the provinces mainly collect deposits from big savers in the ruralareas and siphon these o into the metropolitan economy. With the growingcompetition among themselves, commercial banks have extended their savingsfacilities to microsavers, but largely in the urban areas. Their microcredit busi-ness with small farmers and microentrepreneurs is scant or nonexistent. Thatmeans that with regard to micronance, neither development banks nor com-mercial banks act as nancial intermediaries. The former channel credit, muchof it targeted and subsidized, through SCOs and NGOs to end-users; the lattersiphon o scarce resources. From a social capital perspective, each of the twotypes of institutions has its own damaging eect on micronance as a system of nancial intermediation between microsavers and microinvestors. These insti-

tutions are not included in our present analysis.Six case studies of selected micronance institutions in the Philippines arepresented in this report to further demonstrate the impact of PCFC poverty-oriented lending at the MFI institutional level.

Ahon Sa Hirap, Inc. (ASHI)Founded in 1989, ASHI is the rst NGO established primarily to replicate theGrameen approach in the Philippines. The Grameen approach taught ASHIhow to organize poor households into small groups and groups into Centers,how to build up group cohesiveness through weekly Center meetings, and howto make possible uncollateralized cash-ow-based lending to the poor. ASHIcaters exclusively to poor women in the belief that `women are more supportiveof their group members, more patient, trustworthy and giving to their peers,and they have a deeper sense of shame.' The case of ASHI provides evidencethat deregulation of the micronance sector enables an NGO to replicatesuccessfully in one country (i.e., Philippines) a form of social capital accumu-lated among the poor in another country (Bangladesh) and under a repressivepolicy environment that shuns banking for the poor. It shows that deregulationwith a conducive micronance policy enhances the capacity of NGOs like ASHIto increase signicantly their outreach to the poor, and therefore, empower thepoor to ght poverty.

Center for Agriculture and Rural Development (CARD)Established in 1986, CARD started operations as an NGO providing creditto landless peasants. In late 1988, CARD adopted the Grameen approach: it

organized poor women into small groups, enforced compulsory weekly meetings,disbursed loans in small amounts, and collected loans in weekly installments.CARD's case is even more dramatic than that of ASHI: it shows that aliberalized policy environment may allow the transformation of an NGO'sinformal banking system into a formal banking system. CARD virtually re-engineered the traditional framework of the rural bank, which caters to thenonpoor, and transformed it into a formal nancial institution exclusively forthe poor, imbued with the essentials of Grameen banking.

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Inner Wheel Multipurpose Cooperative (IWMC)Registered with the Cooperative Development Authority (CDA) in 1991, theIWMC is a relatively young cooperative with a small outreach ^ totaling1,264 individual clients in 1997- and a small portfolio that expands slowly butis highly protable. The case of IWMC indicates that PCFC's policy of chan-neling low-cost funds mainly to Grameen replicators positively inuences co-operatives to lend to the poorest households, who would hitherto not havequalied as members of the cooperative. But the PCFC renance policy alsohas its downside in that it discourages the cooperative's deposit mobilizationeorts. Here then is a case where public policy meant to encourage reinvest-ment of social capital can actually lead to the consumption of social capital.The policy of providing subsidized funds to replicators of a successful scheme

(i.e., the Grameen approach) has not only undermined savings mobilizationbut also reduced self-help organizations like IWMC into mere conduits of agovernment credit program.

Producers Rural Bank of San Jose City, Inc. (PRBSJCI)Established in August 1995, PRBSJCI began operations a few years before theAsian meltdown reached the Philippine shores. For several reasons, PRBSJCIexpanded its portfolio at an unprecedented pace. But it paid dearly for itswanton outreach expansion as the quality of its loan portfolio soon deterio-rated. Meanwhile, the bank learned about PCFC's renancing program fornancial institutions that would adopt the Grameen approach. The bank lostno time in trying the Grameen approach to maximize loan repayment. This isanother case showing that public policy can inuence substantially the reinvest-ment of social capital. But whether the means (enticing rural banks to adopt theGrameen approach) could bring about the desired results (enhancing the for-mal nancial system's outreach to the poor) is an issue with no clear answers atthis stage. What is apparent is that the objective of PCFC as funding agency(poverty-oriented lending) is not entirely congruent with the objective of PRBas a conduit bank (loss minimization).

Cooperative Rural Bank of Bulacan, Inc. (CRBBI)CRRBI is a cooperative rural bank registered with the Bangko Sentral ngPilipinas (the central bank) and owned by 180 primary organizations. Thebank typies the government-nanced and controlled credit conduit moldedby the past policy of subsidized credit. Although the cooperative framework

enabled the bank to mobilize resources from its members, it did not provideenough room for it to develop into a robust nancial institution. Fortunately,the nancial policy reforms provided the space for the bank's further growth.At once, the bank had the opportunity to break out of membership-basedbanking and the freedom to venture into full-range commercial banking. Atthe same time, the shift to commercial banking poses a greater challenge as thebank now struggles to maintain a balance between the dual roles of a commer-cial banker and an apex bank for cooperatives.

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Sto. Rosario Credit Cooperative, Inc. (SRCCI)SRCCI is a classic product of a policy milieu in the 1960s that fostered self-reliance in the cooperative movement. Even so, the repressive nancial policiesof the past made it generally more attractive for cooperatives to source fundsfrom the government than from the private market. Unlike many other agricul-tural cooperatives, however, SRCCI did not waver from its adherence to thephilosophy of self-reliance and continued to mobilize internally generatedresources through the years. But accumulation of funds was slow and couldnot keep pace with the robust growth of credit demand, often resulting in loanqueues. The nancial policy reforms liberated SRRCI from such a restrictiveenvironment. The reforms provided the cooperative with the capacity to devel-op new nancial products and services and oer them at market rates. The

market-oriented products and services brought new customers to the coopera-tive. SRRCI's loanable funds grew heftily every year. This case indicates thatthe nancial policy reforms could encourage the cooperative to achieve nan-cial self-suciency and therefore enhance further the cooperative's philosophyof self-reliant development.

Summary and conclusions: The need for public incentives for reinvestment of social capital

Formation and reinvestment of social capital is aected by enlarging the politicalor economic resources of poor households and micronance institutions(MFIs) that contribute to social cohesion. In the eld of micronance, theregulatory and supervisory framework as well as the nancial innovations of MFIs have aected poor households' capacity for cooperation and mutualsupport in their ght against poverty.

The impact of nancial repression is to enhance the accumulation of negativesocial capital. It has restrained the growth of the nancial system and has led toseverely restricted and distorted allocations of resources. It has denied the vastmajority of poor households access to bank credit. Instead, it helped createfavored groups of nonpoor who beneted from government rationing of choiceprojects and low-cost funds. At the macroeconomic level, nancial repressionhas led to high ination, high levels of external indebtedness, and low economicgrowth rates.

The removal of restrictive regulation of the formal nancial system reversed

the eects of nancial repression: it contributed to the formation of positivesocial capital. Deregulation increased the level of competition and improvedthe eciency of the banking system. It has enabled pro-reform, pro-poorelements to forge a national micronance strategy in line with the government'smarket-oriented nancial and credit policies. It created a space wherein micro-nance institutions serving the poor have sprouted, enhancing the capacity of poor households for cooperation and mutual support.

Several MFIs in the Philippines have shown that the success and international

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fame of Grameen Bank in Bangladesh can be capitalized to bolster the politicaland economic resources of credit NGOs working with poor households ineconomically depressed communities. The early replicators of the GrameenBank approach in the Philippines, ASHI and CARD ^ two of the case studiesincluded in this report ^ demonstrate how the social capital created byGrameen Bank in Bangladesh can be reinvested in another country and aectthe capacity of poor households in that country for cooperation and mutualhelp. The essentials of Grameen banking include regular attendance at weeklymeetings, punctuality, pledges of good conduct, designated seating arrange-ments, and absolute insistence on on-time repayment.

The case of ASHI shows that, while the Grameen social capital has beenmolded into a highly standardized form and applied under dierent sociocul-

tural conditions in Bangladesh, the creativity of the credit NGO increases thechances for success of replicating it in another country. That creativity is furtherenhanced with the removal of restrictive regulation.

The case of CARD is even more dramatic. CARD's innovative applicationof Grameen progressed from system modication to institutional transformation.The experience of CARD demonstrates how an informal banking system run bya credit NGO can succeed after transformation into a formal banking system.CARD virtually reengineered the traditional framework of the rural bankwhich caters to the nonpoor and transformed it into a formal nancial institu-tion exclusively for the poor, imbued with the essentials of Grameen banking.

The second wave of Grameen replicators in the Philippines were coopera-tives and rural banks, the traditional key players in the nancial market forlow-income groups. A supportive government policy on micronance, whichpaved the way for the Grameen-oriented nancing program of the PCFC,facilitated their entry into the micronance market. Public policy contributedto social capital formation by making use of existing nancial institutions asinstruments for poverty alleviation. By providing renance facility, PCFC hasencouraged rural banks and cooperatives to extend and increase their outreachto poor households, thus empowering the poor to ght poverty.

Among the Grameen second-wave replicators is IWMC, a relatively young,small cooperative impatient to grow. By adopting the Grameen approach,IWMC has learned to organize poor households into small groups and groupsinto Centers, and to build up group cohesion through weekly Center meetingsand associated activities.

But the availability of cheap funds from PCFC discouraged IWMC's deposit

mobilization initiative and therefore weakened the capacity of the cooperativefor nancial self-reliance as well as the capacity of its individual members formutual nancial support. Here, then, is a case where public policy meant toencourage reinvestment of social capital can also lead to its consumption. Thepolicy of providing subsidized funds to MFIs undermines their savings mobi-lization eorts, reduces self-help organizations such as IWMC into mere con-duits of low-cost government funds, and frustrates initiatives towards nancialsustainability.

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Another Grameen second-wave replicator is the PRB, perhaps the fastestgrowing rural bank during the period 1995-1997. Faced with a huge portfoliobuilt over a short per iod of time but fast deteriorating in quality, PRB turned tothe Grameen approach with PCFC funding in the hope that the experience willteach the bank to minimize its growing bad debts. But the partnership betweenPCFC as funding agency and PRB as conduit bank suers from the lack of congruence of goals. PCFC expects the bank to increase its outreach to thepoor, whereas the bank's immediate need is to avail of an approach that canhelp improve the quality of its existing loan portfolio, the bulk of which are notheld by the poor. The greatest challenge in this partnership is the consistentpursuit of a goal that can be commonly shared by the funding agency, the bank,and the clients.

The eects of policy reforms have not been conned to Grameen replicators,however. Deregulation has also enlarged the economic and nancial resourcesof other types of micronance institutions that contribute to social cohesion inrural communities. For example, deregulation has enabled the CRBI to breakout of the constraints of membership-based banking, venture into commercialbanking, and provide a full range of banking services to all types of customers,including rural poor households. Financial liberalization has also allowed theSRCCI to charge market rates of interest for its nancial services, pursue itsorganizational policy of nancial self-reliance, and thereby withstand the Asiannancial crisis with greater resilience.

Acknowledgement

The authors acknowledge the contributions to this study made by Dr. GilbertLlanto particularly on the section on nancial policy reforms.

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