microcredit in mexico as a policy measure for development

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Microcredit in Mexico as a Policy Measure for Development

Zaira GonzalezAGIN 5312


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The birth of the Nobel Peace Prize-winning Grameen Bank, Bank for the Poor in 1983

started a wave of microfinance programs all over the world, especially in developing countries

which have a high percentage of population living in rural, agricultural areas. Mexico was not

the exception in adopting this poverty alleviation policy. With 3,171,774 beneficiaries, Mexicos

microcredit programs reach the biggest number of people in Latin America. The goal of these

credits is to enable low income entrepreneurs to invest in a small business, and thus help them

improve their income. This paper explains the rationale behind credit lending, the history and

description of credit in Mexico, the criticisms behind microcredit programs in Mexico, as well as

providing some recommendations on how to improve these programs.

Overview of Microcredit

There are three main characteristics that differentiate microcredit from commercial credit:

the size of the loan is relatively small, the beneficiaries are people from low income levels and

lack collateral, and the beneficiaries do not have proof of income or credit history. Microcredit

programs aim at alleviating poverty by helping finance low income people small businesses,

serving as generators of income and thus helping families escape poverty. Spillover effects are

also important, since an increase of income for families can also translate in an increase of

income for the community where the families live. Microcredits also allow individuals to keep a

constant consumption level in the event of an income shock such as disease, unemployment, or

weather changes (particularly relevant for agriculture related activities).

An important principle often introduced to advocate for micro entrepreneurs access to

credit is that of capital diminishing returns. This principles assumes that the production function

that businesses face is concave (fig. 1), and as such each additional unit of capital will generate


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smaller growth in revenues. The implication of this assertion is that investment in low income

individuals microbusinesses, which operate with little capital, should have a better performance

than businesses that operate with a lot of capital.

In spite of the substantial positive welfare benefits and profitability that financing

projects from low income families can bring to financial institutions, there are important

constrains that micro entrepreneurs face to access traditional credit markets, turning it into an

inefficient market. These constrains can be summarized in three categories: asymmetric

information,borrowers characteristics, and incentive problems.

The asymmetric information challenge refers to banks inability to monitor a loan

disbursement. This issue can be divided in two phases, ex ante and ex post loan disbursement.

Ex ante, banks do not have the capacity to observe all the relevant characteristics of credit

requests. Being unable to discriminate risky from safe investment credit applications, banks

must charge a high interest rate on credit, which discourages entrepreneurs with safe investments

from taking loans. Thus, at a high interest rate of credit, the bank will observe an adverse

selection of applicants, since only risky investors will apply for a loan. Ex post disbursing the

loans, banks do not have information on how resources will be used, how much effort borrowers

will put to their investments, or if borrowers will change their initial project. Due to the small

size of the loans, monitoring microcredit beneficiaries to obtain this information would result in

a loss for the bank.

The cost inefficiency of monitoring loans is only one of the many disincentive traditional

banks have to lend to low income people from developing countries. Although as previously

mentioned, investment in low income individuals microbusinesses has a better performance than

businesses that operate with a lot of capital, the risk of financing a micro business is higher than


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the risk associated with investment on a big corporation. In addition, developing countries often

lack adequate property rights (like ejido and communal land which cannot be sold or put as

collateral), and do not have strong legal contract enforcement tools, resulting in a revenue loss

for banks in the case of default.

The third and final reason why low income individuals are unable to borrow from

commercial banking institutions are the characteristics intrinsic to their poverty levels, such as a

lack of collateral, unstable employment and income, and lack of credit history. Thus, it is

evident that the relationship between poverty and credit access results in a poverty trap: to escape

poverty individuals can use credit to invest in a small business, but they have no access to credit

because they are poor.

The result of these three obstacles to credit is an inefficient credit market, where the law

of demand and supply does not apply: there are people who want and can pay the interest rate at

which credits are provided, but there is no access to these funds. However, in the past three

decades microcredit programs in the developing world have filled the gap left by traditional

financial institutions, with Mexico leading the way among Latin American countries.

Microcredit in Mexico

Until recently, Mexico had been a rural country, with most of its population living in

communities of 2,500 people or less. Thus, the history of microcredit in Mexico has deep links

to agricultural development in the country: after the Mexican Revolution of 1910, the path was

cleared for the socialist agrarian reforms of the 1930sthat were accompanied by the creation of

the Banco Nacional de Crdito Ejidal in 1935, among other minor agricultural banks. However,

it was not until 1976 that the government decided to merge all these minor banks into a single


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bank named BANRURAL, indicating the start of a concise state-led approach to rural (micro)

finance. The country wanted to reach the highest level of self-sufficiency possible, and

BANRURAL became a tool to improve the agricultural productivity of the ejido sector through

the use of microcredit and support price, guaranteeing farmers a minimum price for their crops.

However, the use of microcredit for agricultural development experienced a strong

contraction with the adoption of neoliberal policies in the 1990s. The adoption of NAFTA in

1994 became the symbol of this liberalization period, where the state now focused on open and

market oriented policies, which benefited large, commercial farmers. With the arrival of this

liberalization period the number of BANRURAL beneficiaries shrank to 25%: from 800,000 to

224,000. Figure two shows the dramatic fall in the volume of agricultural credit in 1994 by both

development and commercial banks. The Post-liberalization period that started in 2000

continued to decrease the governmental intervention in the agricultural market. Figure 2 shows

the significant fall in the volume of government agricultural credit starting in 2002, being

replaced by commercial banks.

The decline in the use of microcredit for agricultural development happened at the same

time as the country became more urbanized. Thus, the use of microcredit as a development

policy was not exclusive of agriculture and rural areas any longer. Among all the countries in

Latin America, Mexico currently has the biggest amount of beneficiaries (although it also awards

the smallest credits on average348 USD) (table 1), and is the 6th

most microfinance business

friendly in the region (figure 4). Microcredit also serves as a women economic empowerment

tool: 88.0% of borrowers in Mexico are women, a figure relatively higher than the rest of the

continent, where it drops to 59.8%. Nevertheless, figure 5 shows how credit is still relevant to

the development of Mexican agriculture, having a significant impact on the total production


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value, average output, average surface irrigation, and percentage of units in a production

organization per municipality.

Although the role of microcredit in Mexicos economic development is evident, these

programs have two important flaws: high interest rates and cost inefficiency. Table 2 shows how

Mexicos microfinance rate of 72,2% is by far the highest in the continent, which in turn

averages 30,7%. The problem of inefficiency is equally alarming: the expenditure in both

personnel and administrative costs as a percentage of total assets in microfinance programs is

twice as big as the rest of Latin America (table 3).

Conclusion and Recommendations

Although Mexicos microcredit programs have a lot of room for improvement, they

have undoubtedly been key players in the policy alleviation strategy of the Mexican government

since the 1930s. The changes that these programs operations have experienced throughout the

years have corresponded to the different social and economic realities that the country has

undergone. In addition to addressing the issues of high interests and inefficiencies mentioned

above, microcredit programs in Mexico must improve their evaluation information, since I was

unable to find data on the impact that microcredit programs have had on the standard of living of

borrowers at a country level. The different microcredit programs run by the government should

also become more centralized and coordinated in order to avoid competing against each other. If

the programs are able to address these weaknesses, their impact on poverty will become

substantially greater.


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Appendix

Figure 1. Capital Diminishing Returns

Figure 2. Volume of Agricultural Credit Lent by Banking Sector


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Figure 4. Countries by microfinance business friendly environment score

Figure 5. Performance comparison of production units Credit vs No Credit


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Table 1. Microcredits by Country


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Table 2. Interest rates from microfinance institutions and banks in Latin America and the

Caribbean

Table 3. Efficiency Indicators of Microfinance Programs in Mexico and Latin America

Latin America and the

Caribbean

Mexico

Personnel Expenditure/TotalAssets

9.2% 21.2%

Administrative Costs/Total

Assets

7.1% 13.2%


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microcredit in mexico as a policy measure for development

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