How Government Regulations Affect Microfinance in Brazil - Essay Example

Microfinance - How government regulations affect microfinance in Brazil Contents Contents 2 Literature Review 3 References 9 Literature Review Microfinance is a form of credit in which short term loans, especially working capital loans are provided to the entrepreneurs who have a micro or small scale business. These kinds of source of credit for the small sized industries in the developing countries have been instrumental in the reduction of the level of poverty in the countries. The main source of this kind of financing is generally the non profit organisations that provide credit at a very subsidized rate. The governments of the nations have a crucial role to play from the regulatory and financing points of view. A lot of measures are required to make this form of financing a sustainable one. This requires the scope of the microfinance schemes to be further widened. There are several challenges that the governments of the countries opting for these kinds of schemes face. There is lack of mobility in the credit and a lot of reliance on the government as the source of the funds. The competitive environment of the microfinance sector is a lot biased towards the public sector organisations. Therefore the government needs to ensure all forms of transparency in the way the markets and the competitive forces work. Several works have been conducted over the years on various aspects of microfinance. A review of the literature would provide an insight into the microfinance sector and the regulatory framework within which the Brazilian microfinance companies work. Microfinance companies are considered to be feasible alternatives for banks as well as informal sources of credit. Collaterals are used to ensure the timely repayment of the funds. The specific feature of microfinance is that instead of an individual liability toward the lending institution, there is a cooperative liability towards the lender. This method guarantees that the funds are repaid on time or the payments are paid at regular intervals. If the individuals repay the loans on time, they get incentive to get loans of higher amount the next time which makes the borrowers credit worthy. The individuals opting for these kinds of schemes are forced to save for themselves so that the there is enough collateral for the amount of loan that they have taken. Due to the joint liability feature of the microcredit the risk of default is less because the people of a particular locality know each other well and they can estimate the repayment capacity and the chances of default of their co-borrowers. Along with this each of the parties in the loan can monitor each other. Therefore the basic economic problems like moral hazard or adverse selection can be removed through this feature of microfinance institutions in Brazil (Morduch, 1999, p. 1569). Though chiefly deployed by the NGOs of Brazil, the government is equally active in the developing nations in the promotion of the microfinance institutions and setting up of a stringent regulatory framework for the proper functioning of the industry. The government also has a significant role in granting credit of lump-sum amounts to the microfinance institutions. The study of various situations where the system of microcredit has been implemented has been conducted by the researchers. The results have shown that the schemes have positively affected the economies in which they were being implemented. The repayment rates had been quite high in those countries. This has been possible because of the structure of the model which entails extreme scrutiny of the borrowers of the funds. The capital that is provided as the loan is also used effectively which necessitated the repayment on time. About 15 million households represent the informal sector in the Brazilian Economy. However, the microfinance institutions have been able to bring less than three hundred thousand under its purview. This means that apart from 2.5% of the prospective market, the remaining has remained untapped. There have been several attempts on part of the government to stimulate the sector since the inception of the scheme in Brazil in 1972. The slow growth for 2 consecutive decades has been followed by a surge in the growth of the sector. Four types of MFI are found in Brazil which includes the Public Interest Civil Society, the Microenterprise Credit Society, Commercial Banks and the State Owned development banks. Thus microcredit during the start of the new millennium was considered to be the central reason for the development of the underdeveloped societies. However, a noticeable point in this regard is that although the number of involvement in these funds were increasing over time the amount of money that came into the market was comparatively less. The interest charged by the microfinance organisations was also very high. Thus they were mostly interested in providing the corpus funds as consumer loans rather than micro credits for welfare and developmental activities (Otero and Rhyne, 2001, p. 49). The activities of these MFIs shifted to the allied activities rather than remaining focused to the main motive of providing credit to the poor. Thus the government of Brazil was forced to make necessary amendments in the regulatory environment of the microcredit market and was forced to bring the commercial banks into the scene. The years 1999-2000 witnessed several changes in the laws that governed the market. This guaranteed increased penetration and access to the potential customers belonging to the groups with lower income. The banks got permission to send their representatives in these areas and spread the awareness of the scheme. With the introduction of commercial banks into this sector the government took a prudent step in widening the net over a greater number of populations in Brazil. Several policies implemented by the government have questioned the relevance of the microfinance institutions in the present day. The state run banks took the initiative in extending the credit for longer terms to the economic groups in order to promote the economic activities that would contribute to the development process. The rate of interest offered in such kind of loans has been comparatively low. The schemes that the MFIs provided could not match up to the schemes provided by the government. However, the potential customers that these banks targeted could not actually be brought under the scope of these banks. The funds provided by the banks did not reach the small and medium sized entrepreneurs. Any application for funds in the banks also required a lot of paperwork to be done on part of the borrowers which negatively affected the demand for these loans. The interest rates of these loans were also very less and sometimes negatives which induced the borrowers not to repay the loans. The legal framework that governs the microfinance institutions in Brazil is not conducive to the expansion because of the escalating operational costs. The microfinance institutions are neither allowed to start savings schemes or insurance policies which constitute major financial services even to the lower sections of the society. These limiting regulations on part of the government have restricted the source of funds for the MFIs and question the sustainability of these entities in the long run. However some of the scholars have argued that the regulatory bindings on the ability to collect credit are not as constricting as it seems because the Inter-American Development Bank or the National Development Bank along with the state and the municipal governments act as good source of credit for these institutions. However these sources cannot be relied upon on a long term basis. A microfinance institution would be able to sustain in the long run only if along with providing small size loans it accepts deposits from the people. However, the collecting investment schemes can also pose a problem on the savers if they become bankrupt. The complication in the regulatory framework in Brazil also discourages the foreign investors to provide corpus funds to the MFIs. The process of registration and the various restrictions on the use of currency acts as a turn off to these foreign investors. The reporting and regulatory requirements in case of Brazil are more stringent compared to the other countries that have adopted this kind of model for financing. Clubbed with this the legal structure of the country is such that the rights of the labourers and the consumers are protected well. As a result of this the operation costs have gone up. Before the mid 1990s, the economy of Brazil faced a macroeconomic instability. The banking sector of the country was characterised by hyperinflation where the main source of funds were the investments and the nominal fee from the banking services. Loans and advances did not have much significance especially because of the high rates of interest. Therefore the commercial banks made a huge amount of profit by investing in the bonds issued by the governments (Nagarajan and Meyer, 2005, p.5). Luis Ignacio Lula da Silva was the president of Brazil who was famous for the changes he made in the policies that would change the social welfare scenario of the country. The policies that were brought into action by the previous president failed to address the problems of the poor. The present president posited that easy access to credit by the poor would act as a major solution to the economic problems of Brazil. A host of policies were included in the economic policy of Brazil. A proper planning for the development of the microfinance sector was carried out along with the variety of goals that were considered as part of the agenda of the country. The potential customers were identified by the government along with the problems that were associated with each of the segments. The issues included the constraints on the rules that guided the operation of the cooperative credit facilitators. The commercial banks also had very little interest to reach to the people of the lower income groups. The concentration of the existing MFIs was also in the bigger cities which were properly connected rather than the villages in the interiors of the country (Lapenu, 2002, p. 297). On the issues being identified the next positive step on part of the government was to look for proper channels to access the target population as well as to reduce the rate of interest that are being imposed on the loans. The agenda of the government included the expansion of various schemes that reached the poorest regions of the country. Loans at subsidized interest rates were provided to the needy farmers as per their eligibility based on the level of income or the sector they served. A large number of agents were also involved in the process of expansion. Along with this, new financial products like hassle free savings account and insurance plans with the lowest premiums were also included. The main motive behind this was to reduce the operation cost for those who had very little to save out of their meagre income. There were several other alterations of the legal and regulatory framework with an expansionary motive. The creation of cooperative societies was also a step forward towards the progress of the microfinance sector. The previous regulation of restricting these societies to the specific profession was removed. The liberalised regulation encouraged the municipalities of Brazil to come forward and form cooperatives for providing credit. The incorporation of the new model permitted the expansion of the cooperatives to the various categories of the professionals. In the previous schemes the acceptance of deposits was not permissible by the MFI which changed with the new regulations being implemented in 2004. This rural savings scheme provided with another source of fund for the MFIs which were beneficial to the growth of the sector. The government also made several tax exemptions on the companies that provided funds for financing the schemes that provided social security. However, the cooperatives did not get the benefit of tax exemption. The system of quota introduced on the equity of the shareholders also provided the borrowers access to greater amount of credit. This encouraged the borrowers to have more amount of share in the equity holdings. However, several loopholes were also noticed in the schemes. The subsidised rates at which microfinance were provided encouraged the borrowers to default. Along with that a clear line was not drawn between microcredit and microfinance. References Morduch, J., 1999. The microfinance promise. Journal of Economic Literature. Vol XXXVII. Nagarajan, G. and Meyer, R. L., 2005. Rural finance: recent advances and emerging lessons, debates, and opportunities. Columbus: The Ohio State University. Otero, M. and Rhyne, E., 2001. The new world of microenterprise finance: building healthy financial institutions. West Hartford: Kumarian Press. Lapenu, C., 2002. The triangle of microfinance: financial sustainability, outreach, and impact. Baltimore: Johns Hopkins University Press. Read More