8 Causes of a Crash: What happened to Banex?

This is the second of two guest posts by Barbara Magnoni, President of EA Consultants, on what we can learn from Banex and its demise. Banex had been one of the most prominent microfinance institutions in Nicaragua, but as it pushed forward with an aggressive growth strategy, its foundations proved weak.  In early August 2010, Banex (formerly Findesa) entered liquidation. Magnoni gives starting points for understanding how the bubble burst.

While I do not claim to understand the dynamics of Banex’s drastic deterioration, I would propose we examine some possible causes to avoid repeating mistakes in other MFIs and other countries.  Some of the issues to take into account (in no particular order) are:

1) Extremely fast growth and how this may have affected loan analysis (when entering new areas such as livestock, consumer lending and agriculture) as well as hiring practices, training of new staff, and conformity to loan policies and procedures.

2) Incentive schemes. Findesa’s loan officers were known by the rest of the market as “yuppies.” What were their compensation expectations going into their work, how were they compensated and why did ProCredit, the competition, eliminate individual performance incentives in 2008?

3) Consumer finance. According to the Superintendency’s web site, in 2008, only about 50 percent of Findesa’s loan portfolio was in commerce, where most microloans are concentrated.  The remainder was in housing, consumption, livestock and agriculture.  Lending to clients for both business and consumption needs is a great strategy for growing a portfolio and one that many MFIs in Peru have pursued. However, when the economy takes a turn for the worse, the debt burden may be too much for one microentrepreneur or small business to handle.

4) Competition with loan size rather than price or service. While competition can be healthy, it becomes extremely dangerous in a highly saturated credit market. Rather than competing by reducing interest rates, MFIs were forced to show high returns to attract foreign investment. Innovation, mergers and improving efficiencies would have been the answer, yet no significant pressure to reduce rates existed. Instead, MFIs throughout the country were competing by increasing loan sizes. They didn’t do this by improving credit assessment, but by introducing new loans to pile up on top of old ones, for example. Microentrepreneurs were being offered Mother’s Day loans, Christmas loans, loans for the beginning of school, housing loans, home improvement loans, educational loans, motorcycle loans and more by Findesa and others.  This only aggravated the problem of overindebtedness, and eventually, led to even higher interest rates. Why don’t MFIs compete with better quality and lower prices? Are there oligopolistic factors in the sector? I think the case of Mexico, for example, would suggest this is the case in some countries.

5) Focusing on the liabilities side of the balance sheet more than the asset side. Why would an MFI say that its strength is in fundraising rather than loan assessment? This had Findesa competing with the rest of the country’s MFIs for low interest and commercial investment loans.  Did this end up squeezing out some more socially oriented MFIs from low interest rate loans that preferred the better “brand” that Findesa represented?

6) Limited sources of funding. In Nicaragua, second tier funding is relatively scarce and most MFIs (including Findesa through 2007) do not take deposits. This made it an easy place for extra liquid microfinance investment vehicles to place their funds.

7) Corporate governance. This problem has shown itself in a few other instances in the country, including ACODEP (whose CEO ended up in jail last year) as well as Fundacion Nieborowski, another MFI lauded by foreign investors for some time.  Might there be something to being unregulated that makes corporate governance a greater risk? Is there something inherently contradictory when MFIs start showing attractive opportunities for making money that may feed poor corporate governance? Are there enough checks and balances in place that protect the end consumer and the financial system?

8) Politics and economics. While not the cause of the crisis, I think the downturn in the economy and political pressure of the No Payment movement did aggravate an already tense situation. Nicaragua’s government has learned its lesson. Incentivizing people to not pay their loans creates lots of problems for it in the future. The government has now been asked to buy out the bad debt of MFIs that represent loans to No Payment movement members, for example.  But the more interesting bit here is that the argument made to many investors in microfinance that macroeconomics is not correlated with microfinance starts to show some holes in the case of Nicaragua and others as the effects of the financial crisis lead to a downturn in the economies of the countries we work in.