Banks, Mini-Banks and Rural Producers
After the subsidized credit in the 80s and the absence of credit in the 90s, the majority of small-farmer families require savings institutions and adequate credit facilities. Banking laws should be made more flexible so that banks and “mini-banks” can respond to the needs of the Nicaraguan countryside.
A NEW PRIVATE BANK OPENS YEARLY IN NICARAGUA, JUST LIKE IN OTHER COUNTRIES. Financing is a very lucrative sector for those with money to invest. Yet this year and next, state bank branches will be shut down throughout Nicaragua, leaving thousands of rural producers with only their dream of producing, of seeing their farm prosper, of a better future.
The Liberal government insists that its economic development strategy is based on supporting the agricultural sector. Why then is it so difficult for rural families to get credit for their activities in any bank? And why haven't the "mini-banks," the new non-conventional credit institutions—whose numbers are constantly growing—been able to fill the hole left in rural areas by the withdrawal of the National Development Bank? What has been the evolution of the Nicaraguan financial system? Who has it served and for what? How is the future shaping up for small and medium producers in relation to the banks and mini-banks?
Somoza Credit Policy: Only the Large ProducersDuring the Somocista period, the banks joined in a strategic alliance with the state and the productive sectors. In 1952 the sugar producers created the Bank of America and in 1953 coffee and cotton producers created the Nicaraguan Bank. In the 1970s, even though the majority of banks had been created with agroexport funds, the government prioritized urban industry. Two large economic groups formed around the Bank of America and the Nicaraguan Bank, while the businesses belonging to the governing family worked through the Somoza group's Central American Bank.
Only a small portion of bank credits went to agriculture; in 1978-79, the last year of Somocismo, it was as low as 20%, of which 90% was earmarked for large producers and exports. Only 10% went to basic grains production.
In 1959 the Somocista government had launched a financing program for small and medium producers through the National Bank of Nicaragua. The program financed the production of corn, cotton, rice and coffee with interest rates 2% below commercial bank rates. The first savings and credit cooperatives were also promoted in that period. Through AID, the United States promoted a program called INVIERNO in 1975, which distributed credit in kind in the poorest zones, usually also those in which the Sandinista guerrillas were active.
The Somocista government's credit policy clearly favored urban industry and some agroexport. Medium and small agricultural producers were sidelined by the financial system or attended by what today we would call social compensation programs.
Sandinista Policy: The Limits of a ProjectThe Sandinista government promoted a radical reform of the financial sector after it overthrew the Somocista regime, expropriating and then fusing the 17 financial institutions that existed under Somocismo. Four banks emerged from that process, each one dedicated to a specific sector: BANADES to finance agriculture, the Bank of Industry and Commerce, the Housing Bank to concentrate on housing and construction, and the Popular Bank for small urban enterprise.
Through that reform, the revolutionary government sought to link credit policy to national economic policy, making credit an instrument of economic transformation. Credit would promote production, capitalize social sectors favored by the revolution and promote structural changes in the economy: agrarian reform, nationalization of foreign trade and natural resources, new trade policies, etc.
In the revolutionary years this mass of managed credit increased considerably; in real terms it was 3.5 times greater in 1987 than in 1979. The Sandinista state banking system gave abundant credits to all producers—large, medium and small—with low interest rates, easy terms and frequent write-offs. Resources were distributed in rural areas mainly through savings and credit cooperatives, agricultural production cooperatives and enterprises in the "area of peoples' property." Less credit went directly to individual small and medium producers. Basic grains production increased: in 1984-85, corn had increased by 29% over 1977-78 and beans by 51%.
This expansion and redistribution of financial resources reached its limit in 1984 because of serious inefficiencies in credit policy and in the agricultural sector in general. The banks offered concessionary interest rates to rural economic units which, added to inflation—which was also growing because of the war—ended up being negative real rates, with ominous consequences for the entire economy. The banks could not expand more because of structural problems in the rural sector: deficient roads, inefficient technology, low yields, state control of peasant production, plus the war itself. In the end, the banks accumulated bureaucracy and bad services, on top of serving erroneous credit policies.
In 1985, the revolutionary government made new reforms in the financial sector, using various measures to try to regain control over the situation: increased interest rates, a more careful selection of who should get credit—especially long-term credit—and the introduction of bank guarantees. These measures were not enough to substantially improve the situation. With the rising inflation, real interest rates remained negative and, despite the losses suffered by the banks, a more rigorous selection of clients was not established.
Not until 1988, by which time the economy was totally out of balance—rampant inflation, serious trade deficit, price distortions due to production and consumer subsidies—were true adjustments to credit policy made. There was a return to the principles of client selection, such as rationality, productivity and efficiency; supply was reduced to lower inflation; interest rates were unified for all sectors and were indexed annually to the dollar; the amounts loaned were reduced and the exchange rate risk was included in the guarantee.
Chamorro Policy: A Return to Private BankingThe Chamorro government continued the adjustment policy that the Sandinista government had initiated in 1988, and deepened it radically. Credit policy was altered when the state monopoly on financial activities was destroyed. Private banks reappeared in 1991 as a result of financial liberalization and AID support. The passive interest rate—what banks pay on savings accounts—was freed, the Central Bank rediscount program was reduced, the administration of loan ceilings was reduced, and an interbank market regulated by the Central Bank was formed. The Superintendency of Banks was created in 1991 as a regulatory and supervisory body for state and private commercial bank activities.
The state banks played less and less of a role in the new financial scene. Funds for BANADES were cut in 1992, provoking a drastic drop in that bank's activities, though it continued to facilitate credit to large producers. Of the 117 BANADES bank branches, only 71 remained; the rest were closed and hundreds of employees laid off. Each year the Central Bank lessened its participation in financing economic activities, leaving this to the private banks, and limited itself more to being lender of last resort for banks. Active interest rates were freed up, giving banks the freedom to set their own profit margins, although they are obliged to maintain a legal reserve: every bank must maintain 15% of its national currency deposits and 25% of its foreign currency deposits in the Central Bank. This reserve requirement is currently the only mechanism by which the Central Bank can regulate the monetary mass. If the legal reserve is raised, banks have less available liquidity to offer credit.
As is also true in the rest of Latin America, the Chamorro government's financial reform sought to achieve macroeconomic stability while policies to supervise the financial sector sought to guarantee savings security to attract more resources, both of which were demanded by the international financial institutions.
Liberal Policy: Many UnknownsArnoldo Alemán's Liberal government has continued the financial sector reforms with the general objective of promoting exports, stimulating domestic savings and investment, controlling the expansion of liquidity and moving forward with structural changes that give greater participation to the private sector in the country's different economic activities.
The private commercial banks practice aggressive publicity campaigns to attract savings and use them in the most profitable activities: stock and money market speculation, leasing operations and managing billing for businesses. The banks are not interested in small-scale individual credit, particularly in the agricultural sector. High administration costs, climatic risks, the lack of clarity about land ownership and the poor quality of roads and telecommunications are disincentives for the banks to work with these sectors.
Facing this reality, the Liberal government has initiated a Rural Financing Pilot Project with World Bank resources as an alternative source of financing for the rural sector. The funds are channeled through the private banks, which have promised to place one million dollars in nine municipalities of under 15,000 inhabitants up to September 1998. Six branches have been assigned so far; three to Bancentro, which has opened one in San Marcos and one in Nandaime, and three to Bancampo, which opened in Masatepe and Esquipulas. Other banks are also negotiating to benefit from this program.
All of this is taking place while it is still unknown what BANADES' successor will be when this state bank disappears, who will respond to the demand for financing by agricultural production, and whether the proclaimed policy to promote peasant production is genuine. It is also not known whether the private banks that are opening branches in rural zones will finance small producers. So many unknowns, all of them important.
Rural Areas Still Have No CreditThe state banks began reducing their activities in 1990, for political and financial reasons; they dedicated themselves primarily to collecting on the loans already out. The drop in net flow (loans out minus recovered funds) of credit to productive sectors has been constant in the financial system, as indicated in the chart to the left.
According to statistical reports from the Superintendency of Banks, the state bank still supplied 83% of net credit and the private banks 17% in 1992. But by June 1997 this relationship had completely inverted: 14% now comes from state banks and 86% from private banks. Since 1991, Nicaragua has watched a flowering of private banking institutions. Some of them are returning banks that had existed during the Somocista era.
There are currently three state commercial banks and ten private ones in the country. Of these, six of the private ones opened in 1991 or 1992. As a consequence, credit from the banking system to the productive sectors has increased from some 2.3 billion córdobas in 1991 to 4.9 billion in 1996, although there has been a reduction in the growth rate of credit since 1995, and even a real reduction of supply between 1995 and 1996. In addition, beginning in 1994, the Central Bank of Nicaragua stopped providing loans to the financial system.
The bulk of the credit supply comes from savings deposits, either in national currency or in dollars, which according to a CEPAL study represented 74% of credit supply in 1995. The levels of private sector savings in commercial banks increased from US$172.7 million in 1991 to US$633.9 million in 1996. While 83.5% of these savings was in state banks in 1991, by 1996 only 37.5% was in state banks and 62.5% was in private ones.
The reduction in credit supply from state banks, primarily BANADES, has had serious consequences in the rural sector, where credit has been dropping since 1993, as indicated in the chart above. If in 1991 30% of credit went to the agricultural sector, in 1996 it was half that percentage. Although many private banks have branches in the primary departmental capitals, they do not finance family-type agricultural production, which is the most common type in the rural economy. They do not do so for many reasons: lack of knowledge about the sector; deficiencies in the guarantee system, mainly property title problems; high climatic and economic risk; and geographical distance of the clientele.
The drastic change from a subsidized credit policy in the 1980s—in which loans were also often condoned—to an almost total absence of credit in the 1990s has meant that the majority of rural families find it impossible to finance their agricultural cycle, placing them at the heart of the critical economic crisis the country is experiencing.
Projects, Mini-Banks, Usury...An oasis has emerged in this desert: alternative financing sources where state banks have withdrawn and private banks have not stepped in. The waters from these springs vary: some use credit as a tool to confront poverty and exclusion while others only try to do good business.
NGOs, development projects or government social projects themselves are among the former. Some non-profit institutions like CEPAD, Nitlapán, Fondefer or Caruna have created "mini-banks" that have specialized throughout the 1990s in offering credit to small and medium rural economic units, trying not only to offer social compensation, but also to create self-sustainability. The sources of more turbulent waters are enterprises or merchants who, looking for business and profit opportunities, make loans to producers in order to buy their production later or to sell them products. Then there are the usurers who, after being prohibited in the 1980s, have returned with a vengeance in the 1990s.
A credit impact study done by Nitlapán demonstrated that 90% of the small and medium producers in the rural zones had lacked credit in 1991, but that by 1995 that proportion had dropped to 62% as a result of these alternative sources, including usurers.
The National Forum of Rural Finance and Development-Initiative for Nicaragua estimated that in 1996 the most outstanding of the non-profit credit alternatives, the "mini-banks" of FACS, Nitlapán, Caruna, CEPAD and Fondefer, benefited some 58,073 families with US$9.9 million. By comparison, in May of 1997 BANADES had 6,450 clients with a portfolio of US$71 million.
Despite all the advances and achievements, however, the alternative institutions still have not managed to cover all rural credit needs. Only 18% of rural families are covered by these mini-banks and the average amount loaned to each family does not exceed US$170.00.
Control or Flexibility?The Superintendency of Banks (SIB) has attempted to control these new financial mediation institutions, which have also appeared in cities. With this goal, it has established that mini-banks that want to offer savings services to their clients must submit to the same norms as commercial banks. But the pressure is a two-way street: the primary non-conventional institutions have begun to demand that the SIB make its policy more flexible. They would be unable to keep working with small and medium producers under the commercial bank norms because the majority do not fulfill the necessary prerequisites in terms of collateral guarantees.
The rigidity of SIB norms may be one of the primary reasons why private banks have no presence in the rural zones. The Liberal government's Ministry of Agriculture and Livestock is also trying to make the norms more flexible so that private banks will expand their rural activities, offering them subsidies to open branches in rural municipal capitals.
The most recent Central Bank data demonstrate an increase in credit to the agricultural sector. In August 1997, 31% of the commercial banks' credit portfolio went to this sector. One year before, in August 1996, it was only 15.8%. But this advance is occurring within a worrisome framework: BANADES is giving out less than it recovers and is selling its branches to the private banks. Since the latter only finance large producers who can offer guarantees or collateral, financing for the majority of rural economic units is far from being resolved. For example, in its 1997 annual report, UNICAFE notes that the financial sector has only loaned 19% of the credit that national coffee producers require.
Five Types of Credit SourcesGiven all the changes that have taken place in these years, the rural financial markets now include diverse credit sources. The quantity and diversity of the credits vary by region, according to their agro-ecological and socioeconomic characteristics. A 1996 Nitlapán study identified five types of financing sources in Pacific and interior zones:
-The commercial, state and private banks, with a very limited presence.
-The "mini-banks:" unregulated and non-conventional, non-profit financial institutions that are not only present but have demonstrated that small and medium rural enterprises are creditworthy, as long as policies and conditions applied to them are adapted to their production systems.
-International cooperation or state organizations and development projects, which offer credit in cash or kind. They differ from both conventional banks and non-conventional mini-banks in that they do not specialize in financial services. In these projects, credit is one more element to attain development. More than seeking financial sustainability, these organizations use credits to promote gender equity, natural resource conservation, civil society organization, etc.
-Merchants who give loans: commercialization enterprises for agricultural and agroindustrial products which finance selected producers and then buy their harvests. In many cases, these enterprises function as intermediaries between the producers and private banks because banks loan to them more easily. These enterprises charge market interest rates to the producers. Loaning money is not a business for them, but rather a way of guaranteeing a determined production and its later processing and commercialization. The commercial houses also practice a sort of financial service, selling inputs and agricultural tools on credit with up to six-month payment plans.
-Individual lenders or usurers, who lend money without requiring a guarantee. These usurers usually work in the markets and loan to small merchants in their stalls. The law on individual loans puts limits on interest rates according to the official market rate. If the official rate is 18% annually, lenders are not supposed to charge more than 27% annually. The majority of lenders, however, actually charge between 10% and 20% interest monthly!
Who to Go to for a Loan?With so many different sources of financing in the rural sector, the financial markets are characterized by a high level of segmentation, making access to credit more difficult for the majority of economic units. Producers are faced with substantial differences in amounts, terms, forms of payment, guarantees, organization and objectives, so even when they have a profitable and viable investment project, there is no guarantee that they will obtain the most appropriate credit for various reasons. BANADES has no money. Borrowers in private banks have to back any loan with collateral but many thousands of these producers do not yet have property titles. Coffee exporting enterprises only give loans for coffee production. The development projects that come to the community can and want to lend, but only in an amount and time period that inhibits the investment the producer wants. This producer has two options: don't take the money offered by the development project and wait for another opportunity—which?—to make the investment or take it and dedicate it to a less profitable crop or spend it on innumerable necessities.
This segmentation of different credit institutions blocks the transfer of funds among the country's different regions, which is a very important problem for the economic units engaged in trade activities. Particularly in zones in the country's interior, where it is dangerous to travel with cash in one's pocket, many would like to deposit their money in a local bank and withdraw it in the city where they plan to carry out the trade transaction. But they can't.
Are the Interest Rates High?There are those who argue that the high interest rates and lack of credit are responsible for Nicaragua's slow economic growth. Others claim that the limited growth is more a result of the difficult adjustment process the country has been going through for years. The latter complete their argument by pointing out that, while interest rates are high in comparison with the 1980s, with US interest rates and with those of other Central American countries, they are appropriate for a country in the process of structural adjustment. In fact, ever since the 1980 debt crisis and the liberation of the financial markets, interest rates have been climbing throughout Latin America.
According to national bankers, Nicaragua's high interest rates are due to the elimination of controls on capital flow and to the fact that the country must keep its interest rates above the international average in order to attract financial capital and compensate for the high risk and high intermediation costs of capital in Nicaragua. The active interest rate in Nicaragua is calculated based on an international referential equivalent to the level of return on US Treasury bonds—it was 5% in 1995—plus the country's exchange risk (0.4%), plus the credibility rating of government policies (10.7%), plus the intermediation margin (6.2%). Between 1990 and 1994, the risk and credibility rates in Nicaragua dropped because of greater confidence in the economy, while intermediation margins grew, allowing the banks to increase their profits.
The legal reserve in the Central Bank is the lowest in Central America and does not justify the high intermediation levels. Two factors probably explain the high levels of these margins. First, the state banks concentrated for years on making large loans to politicians who did not pay them back; they had to cover those losses by charging higher interest rates. Second, the Nicaraguan banking sector has an almost oligarchic structure, which allows banks to set interest rates together, with agreements made between a few families.
In this situation, captured savings are channeled to activities with higher return rates and less risk, such as commerce. A drop in active interest rates would contribute to more competitive agricultural production at the international level. On the other hand, unregulated financial institutions, the non-conventional "mini-banks," have demonstrated that even at high market interest rates, financing of small and medium rural enterprises can be viable for both the institution and the beneficiaries.
The success of the institutions that have chosen this option rests in the way they give out loans and their knowledge of the agricultural sector. Decisions about whom to finance, for what amounts and under what conditions are based on knowing the local situation and the production systems of the financed economic units. Based on this, they finance the totality of activities carried out by the peasant family and not a specific crop, as do commercial banks. By working this way, they reduce the risk of losing the loan if the financed crop is lost.
High Transaction CostsThe transaction costs that economic units in rural areas pay to obtain resources (in addition to the interest rates) vary according to the source giving the credit and to their location. Bank offices are located only in the departmental capitals, far away from many zones, and transport to seek loans is expensive.
The mini-banks and the development organizations generally establish themselves closer to their potential clients. They also respond more rapidly to producers' demands. In local banks promoted by Nitlapán, for example, producers requesting their first loan wait an average 30 days for a response. Commercial banks and commercial lenders take more like 45 days. Processing a loan in a commercial bank takes a producer five days, while local mini-banks take no more than two.
In addition to charging relatively high interest rates, the conventional financial intermediaries charge legal fees and supervision costs, making the effective cost of credit even higher, which is more significant when dealing with small loans. And, finally, for the great majority of producers who do not yet have their property titles in hand, the collateral requirement makes it impossible for them to obtain loans from banking institutions.
Where to Keep Savings?It is often heard in Nicaraguan that there is no culture of saving and that people have no confidence in the banking system. Central Bank statistics contradict these statements: they demonstrate a constant growth in savings volume captured in commercial banks since 1990. But these are urban statistics. In the rural areas only a few better-off families have savings in commercial banks. The majority of rural economic units "save" in other ways: cattle, fixed capital, labor capital such as inputs for agriculture, lumber for artisans, etc.
The low levels of "institutional savings" in rural zones have two causes. The first is historical: many of those who saved in the 1980s lost all their savings because of inflation and the huge 1988 devaluation resulting from the money change; they now mistrust banks totally. Second cause: the banks' savings policies do not offer incentives to the majority of low-income rural families to open an account. The transaction costs are too high—the families withdraw small amounts, the process is slow, transport is expensive—and so it ends up more favorable to keep the savings at home, where it can be lost, spent without control, or devalued. It would be safer in a bank, would maintain its value and would earn something. It would be a small insurance for emergencies. Having a savings account would give many rural families the opportunity to accumulate a certain amount in a safe place with earnings, which would facilitate investment planning. Why don't they do it? They lack the main motivation to save in a bank: access to future credit. There is a firmly established idea in rural areas that "I borrow from those who lend to me, and if they stop lending to me, I stop borrowing from them."
Legislation Should Be More FlexibleThe mini-banks that offer credit to rural families could easily capture savings but cannot do so for legal reasons. Nicaraguan banking legislation is too conservative.
Naturally, banking authorities in every country have to monitor the security of savings that the population deposits in banks in order to avoid a financial and even political crisis, as recently demonstrated in Albania's pyramid savings, where a mafia of ex-politicians deceived thousands and thousands of people by offering them attractive interest rates to capture their savings, then disappeared with the money.
But Nicaragua could be more flexible. The new unregulated financial institutions—"mini-banks"—want to capture local savings in order to become self-sustainable, independent of foreign cooperation resources, and to be able to function as true financial intermediaries between those with surplus money to save and those who have a deficit of money to produce. That's why these institutions have begun negotiating with the SIB and have received a positive initial response; the new 1997 banking law includes an article authorizing the "mini-banks" to constitute themselves as "non-profit financial institutions."
There is still a need to draw up regulations and special norms for these kinds of institutions, at which point the banking authorities could commit the error of wanting to control the mini-banks—a sector they are not familiar with—with rules resembling those controlling commercial banks. The mini-banks deserve flexibility: they work not only "for no profit" but also with high-risk economic sectors, often in zones of difficult access involving a high level of personal risk.
Almost all are "Category C"The primary problem of rural economic units today is the lack of property titles, which makes it impossible for them to present the collateral demanded by the SIB to obtain loans of a certain amount to finance their productive activities.
Another problem is the prudent norms designed by the SIB for commercial banks, aimed at minimizing instability risks in the financial system. These norms force the banks to maintain determined reserves over credits according to their risk level. For example, if the norms determine that a producer is in Category C (30-80% risk), the institution loaning to him/her is obligated to maintain 50% of the loan in a doubtful collection provision to cover the risks. Because of their capital and the guarantees they present, the majority of Nicaraguan rural families find themselves in Category C. What can be done with them? Nitlapán came to the conclusion that its local banks could not continue serving those they currently serve if they had to operate under SIB norms. But if the norms were made more flexible and adapted to the real conditions of rural Nicaragua, everything would change and even private banks would dare to lend to these small rural producers, even if most of them are labeled as Category C.
Why not take this Step?The disappearance of BANADES now challenges banking authorities to seek a way to allow the country and its rural citizens to emerge from prolonged stagnation. Banking laws and norms must be adapted to the agricultural sector's reality. The government speaks of creating an Institute of Peasant Welfare to inject liquid resources into the rural zones. Why not take better advantage of the existing skills and accumulated experiences of so many non-profit financial institutions, drawing up regulations and norms that allow these mini-banks to become financial intermediaries? The private banks could invest part of their portfolio in the mini-banks without greater risks or more spending. Maybe this would be a strategic step toward rural development in a Nicaragua that, although it dreams of globalizing, is still rural.