International Executive Master in Development Studies (IMAS) 2010-2011 Title of the dissertation to obtain the Master of Advanced Studies (MAS): Overindebtedness in microfinance. Case-study of the clientele of Financiera CREAR in Los Olivos, Lima Norte, Peru Author: Cosmin Olteanu Supervisor: Jean-Michel Servet Date: Geneva, 18th of March 2011 GRADUATE INSTITUTE OF INTERNATIONAL AND DEVELOPMENT STUDIES INSTITUT DE HAUTES ÉTUDES INTERNATIONALES ET DU DÉVELOPPEMENT Rue de Lausanne 132 - CP 136 - 1211 Geneva 21 - CH - P +41 22 908 57 00 - http://graduateinstitute.ch II Acknowledgements This thesis would not have been possible without the help and support of numerous persons whom I keep a warm memory of. I want to thank Dr. Felipe Portocarrero who made my adventure in Peru possible and accompanied my discovery of the fascinating Peruvian microfinance sector. As every academic work has an origin, it is to Jean‐Michel Servet that I have to thank for what I achieved. He was the one that trusted me and guided my first steps in the research process. With infinite kindness he supported me during the sometimes difficult process, always giving me useful advice and encouragements. A special thank is for all those who accepted to talk to me and share their opinions, namely Luis Guerra, Ramón Flores, Jorge Bustamante, Marcos Corrales, Cesar Gordillo and Luz Valdez. I am particularly thankful to the clients who allowed me to enter their homes and discussed with me very personal and delicate issues. The support of my host institution, Financiera CREAR S.A., was invaluable, and I am grateful to all the managers and employees who welcomed me and went to great lengths to support me during my field study. This research was done during a sabbatical year from my job, and I have to thank Dr. Bernd Zattler and Dan Balke for their support and understanding. Finally and above all I want to thank my wife Yasmin for always being there when I needed her. Her insightful remarks and thoughtful advice made this paper what it is now. It goes without saying that any errors or mistakes in this work are entirely my responsibility. III Abstract Originally celebrated as a poverty alleviation tool which is financially sustainable, microfinance is experiencing worrying developments, such as deterioration of loan portfolios, growing commercialization and increasing public criticism due to exaggerated profits. Overindebtedness is one of the most worrying trends, as it has negative effects on the loan beneficiaries and in the same time it threatens the very existence of the sector. This field research analyses from an empirical perspective the causes and effects of overindebtedness in the specific case of the clientele of Financiera CREAR Arequipa S.A. in Lima Norte, Peru. It was found that overindebtedness is generated by a mix of causes related to the increased competition between microfinance institutions and to the specific behaviours of clients confronted with an abundant credit offer. This produces a series of effects at institutional and client levels, which can be described as institutional cannibalization, client forced‐feeding, desperate borrowing and loan bicycling. Key words: microfinance, overindebtedness, cross indebtedness, commercialization, Peru Célébrée à l'origine comme un outil de lutte contre la pauvreté qui est financièrement viable, la microfinance connaît des évolutions inquiétantes, comme la détérioration des portefeuilles de prêts, la commercialisation croissante et l'augmentation de la critique publique en raison de profits exagérés. Le surendettement est l'une des tendances les plus inquiétantes, car celui a des effets négatifs sur les bénéficiaires de prêts et dans le même temps menace l'existence même du secteur. Cette recherche de champ analyse d'un point de vue empirique les causes et les effets du surendettement dans le cas spécifique de la clientèle de la Financiera CREAR Arequipa S.A. à Lima Norte, Pérou. Il a été constaté que le surendettement est généré par une combinaison de causes liées à la concurrence accrue entre les institutions de microfinance et les comportements spécifiques des clients confrontés à une offre de crédit abondante. Il en résulte une série d'effets au niveau institutionnel et du client, qui peuvent être décrites comme cannibalisation institutionnelle, alimentation forcée du client, emprunt désespéré et faire la bicyclette de prêts. Mots clés: microfinance, surendettement, endettement croisé, commercialisation, Pérou Celebrada originalmente como una herramienta de reducción de la pobreza que es financieramente sostenible, la microfinanza se encuentra en un contexto preocupante, caracterizado por el deterioro de las carteras de préstamos, la creciente comercialización y la crítica de la opinión pública en relación a sus utilidades exageradas. El sobreendeudamiento es una de las tendencias más alarmantes, ya que tiene efectos negativos sobre los beneficiarios de préstamos y al mismo tiempo amenaza la existencia misma del sector. Este estudio de campo analiza desde una perspectiva empírica las causas y los efectos del sobreendeudamiento en el caso específico de los clientes de la Financiera CREAR Arequipa S.A. en Lima Norte, Perú. Se encontró que el sobreendeudamiento esta generado por una combinación de causas relacionadas con la alta competencia entre las instituciones de microfinanzas y con los comportamientos específicos de los clientes frente a una abundante oferta de crédito. Esto produce una serie de efectos a nivel institucional y del cliente, que pueden ser descritos como canibalización institucional, alimentación forzada de cliente, prestar desesperadamente y hacer ruleta de préstamos. Palabras clave: microfinanzas, sobreendeudamiento, endeudamiento cruzado, comercialización, Perú IV Chapters Chapter I: Introduction Chapter II: Microfinance, from village to Wall Street Chapter III: Microfinance at a crossroads Chapter IV: Overindebtedness, a growing concern Chapter V: The context of the study and the research method Chapter VI: Data presentation and analysis V List of figures, tables, text boxes and photos Figure 1: The wealth pyramid .............................................................................................................. 18 Figure 2: The spectrum of Financial Services Providers ........................................................................ 26 Figure 3: The critical triangle of microfinance ...................................................................................... 36 Figure 4: The causes of overindebtedness according to Schicks .......................................................... 49 Figure 5: Location of Los Olivos in Lima and in Peru............................................................................. 61 Figure 6: Financing structure of CREAR as of September 2010 ............................................................ 63 Figure 7: The chain of overindebtedness .............................................................................................. 83 Table 1: Comparison between individual lending and group lending methodologies ......................... 24 Table 2: The “microfinance schism” ..................................................................................................... 31 Table 3: Levels of cross indebtedness around the world ...................................................................... 54 Table 4: Levels of cross indebtedness in Peru ...................................................................................... 54 Table 5: Overindebtedness early warning sign index ........................................................................... 55 Table 6: The Peruvian microfinance institutions at a glance ................................................................ 59 Table 7: CREAR at a glance .................................................................................................................... 63 Text box 1: Advent of microcredit in Peru ............................................................................................ 12 Text box 2: Microfinance at a crossroads ............................................................................................. 16 Text box 3: The entrepreneurial spirit of the poor ............................................................................... 20 Text box 4: BANEX Nicaragua................................................................................................................ 45 Photo 1: CREAR Agency in Los Olivos.................................................................................................... 62 Photo 2: CREAR mission, vision and values .......................................................................................... 64 Photo 3: The Wall Street of Los Olivos .................................................................................................. 71 VI List of Acronyms ACP Acción Comunitaria del Perú ASOMIF Asociación de Instituciones de Microfinanzas del Perú BID Banco Interamericano de Desarrollo BRI Bank Rakyat Indonesia CAC Cooperativa de Ahorro y Crédito CAF Corporación Andina de Fomento CARE Cooperative for American Relief to Everywhere CGAP Consultative Group to Assist the Poor CMAC Caja Municipal de Ahorro y Crédito COFIDE Corporación Financiera de Desarrollo COPEME Consorcio de Organizaciones Privadas de Promoción al Desarrollo de la Micro y Pequeña Empresa CRAC Caja Rural de Ahorro y Crédito EDPYME Entidad de Desarrollo para la Pequeña y Micro Empresa FEPCMAC Federación