Banking with the Poor Newsletters - No. 11

Since mid 1997, a number of countries in East Asia have been hit by a severe economic and financial crisis. This has a number of potential implications for microfinance. Economic recession has led to fewer opportunities for employment in the formal sector of the economy, forcing more and more people into the informal sector. Combined with higher poverty, this has increased the number of potential microfinance borrowers.

At the same time, the profitability of microenterprises has fallen, reflecting increased competition among microentrepreneurs and reduced demand for their output. Recession also means fewer government resources for poverty alleviation programs. Moreover, the crisis largely reflected, and in turn has contributed to, weaknesses in financial institutions and systems. This too has direct and indirect implications for microfinance.

To obtain a better understanding of these and other issues, the BWTP Network instigated a survey of the impact of the crisis on microfinance, covering the nine countries represented in the Network. The survey focused on five main areas: general economic conditions; the demand for microfinance; program operations and sustainability; the availability of resources (which affects the supply of microfinance); and the policy and regulatory environment.

The survey was sent to selected microfinance institutions, commercial banks, national policy institutions and researchers. While the overall number of respondents was quite small (23) they included many of the key players, especially in the four Southeast Asian countries most affected by the crisis. For instance, they included the largest specialist microfinance institution in each of these four countries, as well as a number of commercial banks and national policy institutions with responsibility for microfinance.

The survey was mainly designed to elicit qualitative responses rather than rigorous, quantifiable data. Moreover, the crisis is still unfolding, and many of the effects are yet to emerge. Hence the findings are tentative and preliminary. Nevertheless, they provide an early indication of some of the effects of the crisis, and are likely to be useful to microfinance practitioners, policy-makers and other organisations as they grapple with the crisis and develop responses to it.

Key findings are as follows:

• The countries in Asia with the greatest concentrations of poverty have so far been little affected by the crisis. The two countries with large numbers of people in absolute poverty that have been most affected are Indonesia and the Philippines.

• Programs focusing solely on the poor appear to have withstood the crisis better than programs not specifically targeted to the poor.

• In general, microfinance appears to have suffered most where it is linked into the formal financial system and has therefore been caught up in the crises affecting financial systems. But there are some important exceptions to this.

• There have been a number of policy reactions to the crisis which have had unintended adverse consequences for microfinance and should be reviewed.

2 The Crisis

From the mid 1980s and even earlier, a number of developing countries in East Asia experienced a period of rapid and sustained economic growth that became known in some quarters as the ‘East Asian miracle’.

However, the recent financial crisis has brought this to a halt, at least temporarily. Economic and financial conditions began to deteriorate in Thailand from mid 1996, reflecting a slowdown in export growth and over-borrowing by many business firms. By mid 1997 speculative capital outflows were threatening the convertibility of the Thai baht. It was floated in July 1997 and underwent a large depreciation.

In the third quarter of 1997 financial instability spread rapidly throughout East Asia in what has become known as a ‘contagion’ effect. Stock market indexes fell, and most countries experienced large capital outflows. Currency pegs were placed under a great deal of pressure and were abandoned in a number of countries, giving rise to large depreciations.

The causes of the crisis are complex and differ between countries. However, common factors include overvalued exchange rates, structural weaknesses in the financial sector and excessive short-term borrowing, leading to asset price inflation, speculation and increases in non-performing loans.

The crisis has led to a severe recession in a number of countries in East Asia, with forecast declines in GDP in Thailand and Indonesia and much slower growth in some other countries, sharp increases in unemployment, increased inflation and higher interest rates (see Table 1).

The crisis started in Thailand, and spread quickly to Malaysia and South Korea. Initially Indonesia appeared to have stronger macroeconomic fundamentals than these three countries, but has actually been the hardest hit, with a massive depreciation in the rupiah, sharp increases in inflation and interest rates, and the economy expected to contract by 10 per cent in 1998. Indonesia, Thailand and to a lesser extent Malaysia are not expected to resume rapid growth in the short term. By contrast, the Philippines has weathered the initial shocks reasonably well, and the crisis appears to have had little impact in India and the other South Asian countries.

The crisis is also having serious social impacts. For instance, World Bank assessments suggest that the incidence of poverty in Indonesia, which had fallen to 11 per cent in 1996, could increase to as much as 20 per cent. Declining living standards have led to massive social unrest and to the resignation of President Soeharto after 32 years in power. Estimates from Thailand suggest that as many as 300,000 migrants have returned from the cities to rural areas since the onset of the crisis. And Malaysia has contained increases in poverty by not renewing visas of guest workers from Indonesia, Bangladesh and other countries in the region.

Table 1: Key Economic Data for Selected Asian Countries

(1) Growth in real GDP. Estimates and forecasts by Goldman Sachs (Asia).

(2) Consumer price index. Percentage change in latest three-monthly average on year earlier.

(3) Interbank 1 month interest rate, latest, annualised.

(4) Currency units per $US, spot rate, latest.

Source: Far Eastern Economic Review, May 28, 1998.

3 Indonesia

Demand and outreach

All respondents agreed that the number of people living in poverty has increased substantially, with reduced market opportunities and sharply increased prices, especially for basic foodstuffs. For instance Bina Swadaya, a leading MFI, commented that in three branches for which data are available, 16 per cent of clients have gone bankrupt.

At the same time, there is evidence of a reduction in the outreach of microfinance. In Indonesia, most micro financial services are provided by the unit desa system of Bank Rakyat Indonesia (BRI), a large state-owned commercial bank, and by a myriad of small ‘rural banks’ operating at the local level. Rural banks in Indonesia can establish with a minimum capital requirement of only Rp50 million, and the formal financial system has much greater outreach among the poor than in other countries in Asia. By contrast, there is only a small number of specialist MFIs.

The BRI unit desa appear to have withstood the crisis quite well and even expanded their operations. The number of savers increased sharply from 16.99 million in June 1997 to 19.13 million in March 1998, apparently reflecting a ‘flight to quality’. The rupiah volume of savings increased by 42 per cent over the period. The number of borrowers increased more modestly from 2.55 million to 2.61 million, while the rupiah volume of loans increased by 7 per cent.

On the other hand, it was reported that the rural banks and specialist MFIs have reduced their outreach considerably. Rural banks appear to be facing an extremely difficult situation, as discussed below. One respondent commented that many rural banks will now only provide loans to established customers with good records, and are tightening up on collateral requirements. One rural bank reported issuing only 296 new loans in the March quarter 1998 compared to 477 new loans in the March quarter 1997, even though it experienced an increase in deposits.

Specialist MFIs are also being more cautious in extending loans to new customers. This reduction in outreach, reflecting reduced availability of funds and a desire to maintain portfolio quality, is taking place at the same time as the number of poor people is growing rapidly. One respondent noted that the changes meant that "...the poor will be left behind".

Operations and sustainability

Evidence on the effect of the crisis on repayment rates is mixed:

• Repayment rates for the PHBK program (‘project linking banks and self-help groups’), a major microfinance program operated by Bank Indonesia, have been relatively stable. The monthly on-time repayment rate for January 1998 was 96.6 per cent, slightly higher than the 96.0 per cent recorded in June 1997.
• The BRI unit desa have also managed to maintain a very good repayment rate. The repayment rate was reported at 97.80 per cent in March 1998, compared to 97.82 per cent in June 1997.
• A rural bank reported a decline in repayment performance. The proportion of loans outstanding that were more than 30 days in arrears increased from 14.6 per cent in March 1997 to 18.9 per cent by March 1998.
• Bina Swadaya reported that repayment rates had dropped sharply since the onset of the crisis. In seven of its branches for which data are available, between 20 and 70 per cent of borrowers are in arrears. It has been forced to extend loan repayment terms or reschedule loans, in agreement with borrowers.

Operational and financing costs facing MFIs have also increased significantly. Some, but not all, programs have increased interest rates:

• The BRI unit desa have increased interest rates payable on rural savings by between 4 and 5 percentage points per annum, and have increased interest rates on loans above Rp3 million from 1.5 per cent flat to 2 per cent flat per month. Interest rates on loans up to Rp3 million have remained at 2 per cent flat per month.
• It was reported that most rural banks have not increased their lending rates, which range between 2.5 per cent and 3.5 per cent flat per month. On the other hand, the one rural bank responding to the survey increased interest rates on both deposits and loans by around 1 percentage point per month.
• Bina Swadaya has increased lending rates by between 0.5 and 0.75 percentage points per month.

Resources and policy environment

The crisis has reduced the resources available for microfinance in a number of ways. Most importantly, it has led to a marked decline in public confidence in the banking system in general, and small banks in particular. Moreover, in January 1998 the Government announced that it would provide a full guarantee to all depositors and creditors of both private and state-owned commercial banks for at least two years. This guarantee does not so far extend to the rural banks, which are much more likely than commercial banks to serve poor clients in rural areas.

It was reported that this has encouraged depositors to withdraw their savings from rural banks and deposit them with commercial banks (including BRI unit desa, as noted above). On the other hand, not all rural banks have experienced falling deposits. Somewhat surprisingly, the one rural bank responding to the survey achieved a 30 per cent increase in the number of savings accounts and a 25 per cent increase in the volume of savings over the year to March 1998, possibly reflecting the sound reputation of the particular bank.

Since the onset of the crisis the Government has discouraged the establishment of new banks, and the current economic situation is not conducive to their establishment in any case. The Soeharto Government had also announced a thorough review of central bank and banking laws, to be completed by end September 1998. It is understood that one measure under consideration was to increase the minimum capital requirement for rural banks from Rp50 million to Rp500 million. One respondent noted that such a policy could force the closure or amalgamation of many rural banks serving the general public, including poor clients, in rural areas.

There is also some evidence that banks are less willing to establish linkages with MFIs and self-help groups (SHGs). One respondent suggested that banks are still willing to participate in the PHBK program for linking banks and SHGs, but are giving priority to their internal problems. A leading MFI commented that private banks are less willing to establish linkages with MFIs, but that banks owned by regional governments are still willing to do so.

The Soeharto Government had determined that all programs for poverty alleviation, including government-sponsored microfinance programs, would be coordinated by the Coordinating Minister for Social Welfare. This reflected a desire to improve coordination of programs for poverty alleviation in the face of concerns about the effect of the crisis on poverty.

On the other hand, the crisis has reduced sharply the availability of government funds in general. Some respondents also reported that there had been some change in emphasis at the official level, with microfinance programs based on concessional interest rates being favoured over more market-oriented programs. The trend in Indonesia towards more welfare-oriented microfinance programs, rather than market-oriented ones, has been evident for some time and pre-dates the crisis (See McGuire, Paul B, Conroy, John D & Thapa, Ganesh B, Getting the Framework Right: Policy and regulation for microfinance in Asia, Foundation for Development Cooperation, Brisbane, 1998.)

4 Philippines

Demand and outreach

The microfinance sector in the Philippines is dominated by specialist MFIs, but there are also some MFIs licensed as banks. Respondents indicated that there has been little perceptible change in the degree of poverty in the areas where they are working, but that clients are saying that life is harder because of the rising cost of food and other basic commodities.

TSPI Development Corporation (TSPI), a prominent MFI, commented that it has received enquiries from a few local companies in relation to staff who are being retrenched, and also more than the usual number of enquiries from individuals. Most of these relate to their small business programs rather than their microfinance program. The number of new clients in the small business programs was substantially higher in the March quarter 1998 than a year earlier, whereas the number of new clients in the microfinance program was lower.

At the same time, there has been an increase in the number of borrowers dropping out or not taking repeat loans. Reasons include increased interest rates, reduced business profitability and opportunities, and economic uncertainty. Again, these have affected small business borrowers more than microfinance borrowers.

The People’s Finance and Credit Corporation (PCFC), a second tier institution which on-lends to retail MFIs, commented that its disbursements have decreased since the crisis. Some retail MFIs have got behind in their repayments to PCFC and have been suspended from the program. Others, particularly rural banks, have adopted a more cautious approach to lending because they are concerned about runs by depositors. Hence MFIs are tending to reduce their outreach, even though the number of potential clients is increasing.

Interestingly, PCFC has found that those retail MFIs using the Grameen methodology have been able to keep their operations going much better than other MFIs. It suggested that the poorest clients serviced by the Grameen replicators have maintained their demand for credit, while the small business borrowers served by the other MFIs have reduced their demand. This is consistent with the experience of TSPI noted above.

Operations and sustainability

TSPI commented that there has been a deterioration in repayment rates since the onset of the crisis, but that some of this may reflect factors other than the crisis. It has increased interest rates from 2.5 per cent flat per month to 3.0 per cent per month because of the increased cost of funds, and has tightened up loan monitoring to minimise arrears. TSPI has not yet introduced any new products or services as a result of the crisis. However, there has been increased demand from clients for training and technical assistance in business management.

As noted above PCFC also commented that many retail MFIs have suffered from declining repayment rates. Again, this has been most pronounced among those lending to small business clients, rather than those lending to the poorest clients.

Resources and policy environment

TSPI commented that the cost of borrowing from commercial banks has increased significantly in line with other interest rates. Interest rates on their loans from commercial banks have increased from a pre-crisis average of around 15 per cent to around 27 per cent at present. Commercial banks and government financial institutions have also become stricter in their collateral requirements. Some banks and other financial institutions have reduced their lines of credit, and it is likely to be much more difficult to negotiate new lines of credit.

On the other hand, funds from some official sources have not been reduced and may even have increased. For instance PCFC, which on-lends funds from government and donor agencies to retail MFIs, now has more resources than before. Its supply of funds has been largely unaffected by the crisis, but there has been reduced demand for its funds.

The central bank is currently increasing the minimum capital requirements for establishing banks, with the minimum for most types of banks to increase by around 60 per cent between 24 December 1997 and 31 December 2000. After 31 December 2000:

• The minimum capital requirement for establishing a thrift bank will be P400 million where the head office is in Metro Manila, and P64 million where the head office is outside Metro Manila.
• The minimum capital requirement for establishing a rural bank will vary from P32 million down to P3.2 million, depending on location.

5 Malaysia and Thailand

In Malaysia there is only a handful of institutions involved in microfinance. Of these by far the largest is Amanah Ikhtiar Malaysia (AIM). It has been heavily supported by government and related agencies, reflecting the relative abundance of resources and relatively low incidence of poverty in Malaysia.

AIM has experienced a small reduction in new members since the onset of the crisis. In the March quarter 1998 there were 2,249 new members, 8.3 per cent below the number in the March quarter 1997. Nevertheless, AIM reported that this reflects operational factors, rather than any change in the demand for the program.

It commented that some borrowers have been experiencing difficulties in their businesses since the onset of the crisis. At the same time, the program has become more important to many families. In some cases, the microenterprises operated by women borrowers have moved from being a secondary source of family income to the only source of income, as other family members in wage employment have lost their jobs.

AIM has experienced an increase in defaults since the onset of the crisis with 154 loans in default at the end of March 1998, compared with 77 at the end of March 1997. Nevertheless, repayment rates are still very high, with the on-time repayment rate in March 1998 reported at 99.4 per cent. It was reported that there had been no significant change in operating costs, and while AIM has recently introduced a number of changes including higher interest rates and higher loan sizes, these predated the economic crisis.

Even before the crisis the Government was committed to supporting AIM as an effective tool for poverty reduction. The crisis appears to have increased this commitment. In March 1998 the Government announced that it would allocate an additional RM100 million to AIM, reflecting the need to protect more vulnerable groups from the effects of the economic crisis.

On the other hand, the crisis has made it more difficult for AIM to attract concessional funds from the commercial banks. Prior to the crisis, AIM was negotiating a bank loan of RM20 million at an interest rate of 1 per cent. However, the bank withdrew from these negotiations because of stricter policies adopted as a result of the crisis.

The survey was unable to uncover much information about the impact of the crisis in Thailand, where microfinance is dominated by small community organisations funded under various government programs.

However, Small Enterprise Development Company, a large MFI operating in the rural areas, commented that there are more people wishing to join the program as jobless villagers return from Bangkok. It also reported that the crisis has not affected drop-out rates or repayment rates, but that some clients are asking for larger loans. The volume of savings placed with the program has also declined.

6 South Asia

Respondents from the five countries in South Asia included in the survey reported that the financial crisis in East Asia has not yet had any significant effects on microfinance. No program reported any changes in the demand for microfinance or in program membership as a result of the crisis. Similarly, there have not been any systematic changes in repayment performance, program operations or sustainability, or the availability of resources.

Some of the South Asian countries have been experiencing financial and economic difficulties unrelated to the financial crisis in East Asia. In Bangladesh the banking sector is facing a number of problems, such as high defaults and periodic liquidity crises, but the rate of economic growth has increased slightly.

Nepal has been experiencing slower economic growth since before the East Asian crisis, largely reflecting the over-valued Nepalese rupee. Some microfinance programs have also been disrupted by Maoist insurgents. India and Pakistan experienced slight slowdowns in economic growth in 1997, but at this stage these are expected to be temporary. In Sri Lanka the economy has remained robust.

While all respondents stated that the crisis had not yet had any direct effect on microfinance, a number pointed to potential dangers that could give rise to increased poverty over the medium term.

The large currency depreciations in East Asia are reducing the competitiveness of manufacturing operations in South Asia, such as clothing production in Bangladesh and Nepal. This may further increase the number of people in self-employment in the informal sector. Higher unemployment in East Asia is resulting in the repatriation of guest workers, such as workers from Bangladesh previously employed in Malaysia, giving rise to a reduction in foreign remittances and excess labour supply.

Some commentators also suggested that the crisis was giving rise to a more cautious attitude on the part of bankers and regulators in South Asia. This may further reduce the willingness of banks to establish linkages with MFIs, and of regulators to permit the establishment of small regulated banks (McGuire, Conroy and Thapa (1998) found that none of the countries in South Asia encourage the establishment of small banks, which are much more likely to engage in microfinance than larger banks).

7 Concluding Comments

It is too early to estimate the full effects of the current financial crisis in East Asia on microfinance. The crisis is still unfolding, and many of the effects are yet to be felt. And even where they are already being felt, few hard data are available and much of the evidence is qualitative and impressionistic. Nevertheless, the survey provides a number of tentative conclusions that may be of benefit to practitioners and policy-makers in the region.

One important conclusion is that the countries in Asia with the greatest concentrations of poverty have so far been little affected by the crisis. While the nine countries included in the study had an estimated 495 million people living in absolute poverty in 1995, some 440 million of these were in South Asia, which has been relatively untouched by the crisis.

The five countries most affected by the crisis are Korea, a high income country, and Malaysia, Thailand, Philippines and Indonesia, all middle income countries. Of these, the only two with large numbers of people in absolute poverty are Indonesia (an estimated 22 million people in 1995) and the Philippines (25 million people in 1995). Indonesia is the country that has been most devastated by the crisis, while the Philippines has been the least affected of the five.

Not surprisingly the crisis has caused problems for the microfinance sector, particularly in Indonesia and the Philippines, with declines in the number of clients and repayment rates, and fewer resources available for microfinance.

However, the crisis seems to have had a greater effect on institutions serving small business clients than on specialist MFIs serving the poor. In the Philippines, programs focusing solely on the poor appear to have withstood the crisis better than programs not specifically targeted to the poor, even where such programs are run by the same institution. In Malaysia, AIM has maintained high repayment rates among poor borrowers while other institutions have reportedly experienced increased arrears.

On the other hand, the BRI unit desa in Indonesia, which serve both poor and non-poor clients, have maintained both their numbers and repayment rates in the face of massive economic and social dislocation in that country.

Another more tentative conclusion, is that microfinance appears to have suffered most where it is linked into the formal financial system. This is not surprising as the crisis has been first and foremost a financial one. The rural banks in Indonesia, which are a major supplier of micro financial services, are facing a very difficult situation. MFIs in the Philippines and Malaysia have also found it very difficult to maintain linkages with commercial banks, with increased cost of funds and reduced availability. On the other hand, MFIs which rely on government and donor agencies rather than the formal financial system for resources appear to have fared better.

This does not imply that microfinance should not become more integrated into the formal financial system. Such linkages are critical if microfinance is to reach large numbers of poor people on a sustainable basis. Nevertheless, they may make the microfinance sector more prone to cyclical fluctuations.

The findings also suggest that much greater attitudinal change is necessary within the formal financial system about the scope for commercial engagement with microfinance. It is not the bad debts of the poor that have caused the current financial distress in the region, and it is instructive that the BRI unit desa in Indonesia, which focus on small and micro financial services, have withstood the crisis much better than financial institutions dealing with supposedly less risky clients.

It is also apparent that there have been a number of policy reactions to the crisis which have had unintended adverse consequences for microfinance.

In Indonesia, the Government has guaranteed the deposits of commercial banks but not rural banks, prompting depositors to move their savings from rural to commercial banks. This has reportedly threatened the viability of many rural banks, which are much more likely than commercial banks to provide micro financial services to poor clients.

In the Philippines the Government has announced a timetable for increasing the minimum capital requirements for rural banks and thrift banks, while it is understood that in Indonesia consideration is being given to increasing the minimum capital requirement for rural banks. Indonesia and the Philippines have been unique in Asia in permitting the establishment of small banks in the local level, which are much more likely than larger banks to reach poor clients. Higher minimum capital requirements will make it much harder to establish small banks.

There are some suggestions that in Indonesia, the crisis has led the Government to favour subsidised microfinance programs over more market-oriented ones. While this may be an understandable reaction to increasing poverty levels, it clearly undermines sustainability. With increasing poverty and the need to reach more poor people with fewer resources, sustainability is more important than ever.

Hence in responding to the financial crisis, microfinance has not been a major priority. Policy makers have taken a number of steps that are counter-productive to the establishment of a strong and sustainable microfinance sector. It is therefore important that policy makers pay greater attention to the implications for microfinance when developing policies for financial sector reform and poverty alleviation.