Community banking, explained beautifully by Charlene Nemson, is supposed to be one of the safest ways to lend money. In Paraguay, where financial inclusion is very uneven, this type of product was only offered by foundations and NGOs until a couple of years ago. As the market is becoming more competitive, the banks and the financial institutions, or financieras, try to innovate to accomplish their goals.
One of the financieras that incorporated this product to their portfolio was Financiera el Comercio. Traditionally, this type of product does not incorporate other types of guarantees, just the joint guarantee from each of the group’s members. Their word is usually enough. However, the alarming growth of the non-performing loan (NPL) ratio in the last couple of months, particularly in the cities, has led to the Financiera’s overhauling of its processes.
This product should teach people to invest and save and become more accurate with finance. The idea is that once people get financial aid, they can develop their business and eventually earn their own personal loans. In the last couple of years, accentuated competition has brought money into communities traditionally excluded from financial services–but the informal economy in Paraguay is very important, and it has proven difficult to create healthy financial literacy around that. As a result, many people have become so comfortable with existing financing mechanisms that they are not changing their bad habits as quickly as we would hope. It doesn’t help that people in the cities know that microfinance institutions do not have a real guarantee or pressure to make them pay, so they get too relaxed about their obligations.
How can the Financiera convince people to repay their loans?
As a result, Financiera el Comercio has promoted the development of a new role: the methodological reviewer. A reviewer, selected from a pool of successful community banking officers, ensures that everyone follows the required steps to secure a loan. Financiera el Comercio developed this methodology, and they are almost certain that, if the methodology is followed, repayment is assured, and I spent the day with one of these reviewers to see if the Financiera was right. After reviewing some operations at the branch, we visited some of the groups in the field that are delaying their payments.
Here’s what I learned from these visits:
- The patience of the officer is crucial, because the group has to make its own decisions. The officer can only advise them.
- In Paraguay, it is culturally difficult to reject somebody who wants to join a group. Therefore, the officer must explain over and over again the risk of having unreliable people in the group.
- If a group does not put enough pressure on its members to comply with their obligations, the contagion risk to other groups increases enormously.
- We forget sometimes that even this type of loan generates risk, so community banking officers need to be well versed in financial risk.
- We should encourage the group to ask its members to agree to a penalty or guarantee in case they don’t meet their obligations, for the sake of the group.
- Officers should encourage their community banking customers to develop good practices in order to earn personal loans, which have better rates and take away group risks.
Microfinance began with the question of how to give financial aid to the unbanked. We are on our way to answering that question, but we still have a lot of problems to solve, and we need to use imaginative tools like this to answer it.