With Western sanctions putting a squeeze on the Russian financial system, the Kremlin is willing to consider innovative new economic ideas. One of them is microfinance.
It remains to be seen if microfinance will help Russia to keep its finance system afloat. Photo: RIA Novosti
The complexity of the current situation in external economic relations and, particularly, the Western-led sanctions put additional pressure on Russia's financial system. Most notably, sanctions are restricting the supply of funds in the financial system, stimulating the need for a new approach to raising capital and maintaining liquidity. At the same time, these shifts in the environment are leading to calls for the development of an internal market to meet both supply and demand. Economic development needs to be financed, sometimes at a higher level of risk. A very fine balance of policies is required from the financial regulators and other involved authorities.
That's why Russia's authorities pin hopes on microfinance as a way of stimulating small private business, as indicated from the recent “Russia Calling!” forum hosted by VTB Bank in early October.
Until now, the discourse on microcredit in Russia was more likely to revolve around the topics of “profiteering,” social risks and rogue collection practices – quite far from the ideas of financial inclusion and building opportunities through microenterprise that are prominent elsewhere in the world. The legal definition of “microcredit” varies internationally: The upper limit may be not so “micro” – 25,000 euro in the EU, about 1 million rubles (nearly $21,000) in Russia. “Microcredit” is generally recognized to play a formative role in the stimulation of small private enterprise with many associated economic benefits.
There are essentially three perspectives on the issue: social policy and ethics, enterprise and economic development, and the place of microcredit in the overall architecture of the financial system of the country. Effective policymaking within Russia would require considering all those angles, since any single dimensional approach is likely to be destructive for the ecosystem of entrepreneurship.
What is the current situation with microfinance in Russia?
The part of the market that is represented by officially registered microfinance organizations (MFOs) and “credit cooperatives” grew by a factor of 11 (in nominal ruble terms) between 2004 and 2014. Currently, the portfolio of official microcredits is valued at 68 billion rubles (about $1.4 billion). This may seem impressive until we check it against the dynamics of lending by the mainstream banks. Their portfolio of consumer loans grew in the same period by 33 times and stands at almost 10 trillion rubles ($212 billion). Moreover, their loans to small and medium enterprises are valued at 7.7 trillion rubles ($164 billion ). So the message of the underdevelopment of the “micro” part of the market is right to the point – microfinance is tiny compared to the share of regulated banks and, moreover, its relative weight is shrinking.
According to the data of the National Partnership of Microfinance Market Players (NAUMIR), the microcredit industrial association, 15 percent of the outstanding portfolio comes from payday loans (Very short-term – up to 30 days – loans with very high annualized interest rate); nearly 50 percent consists of loans to business; and the balance is longer-term consumer loans. Estimates of the number of clients range from nearly 300,000 to over 6 million. The figure of the World Bank – 1.8 million – seems to be closest to being right.
We should note that some regulated banks come in fact very close to microloans in both the procedures of approval and the interest rates of the so-called “quick non-collateralized consumer loans.” Some peculiarities of the Russian market even encourage small entrepreneurs to borrow from the banks as physical persons, declaring consumption as the purpose and then using the money to finance their enterprises.
For a small businessman, actually there is little meaningful distinction between “personal” and “business” loans – if you repair a Citroen Berlingo which is employed for all possible purposes, how to account for the expense? The value of the portfolio of “micro” loans of the mainstream banks can be estimated at 300 – 450 billion rubles (about $6.3-9.5 billion), some 5-6 times higher than the portfolio of official microcredits.
Thus, overall some 3 to 5 million Russians currently have one or more loans that can be classified within the “microcredit” paradigm. Probably 30-40 percent of them are using them for business purposes, and the average loan size tends to be not that “micro” – approximately 100,000 rubles (about $2,000).
Using Latin America as a benchmark for Russia makes sense
Russia’s level of microcredit lending is more in line with the practices of Latin American countries than with the South Asian markets, where the sums tend to be really small. South Asia accounts for almost 60 percent of global microfinance customers, but it holds only 12 percent of the total loan portfolio. In contrast, Latin America accounts only for 16 percent of borrowers and for 33 percent of the total portfolio. The average loan size here is in the range of $1,000-$5,000, which is quite close to levels in Russia.
Latin American countries, too, are rather close to the Russian level of population income. The GDP per capita in Chile or Argentina is more or less on par with Russia, and Brazil is some 50 percent lower (while India is lower by almost 4 times). The Latin American countries are also recognized to have high quality of regulation of the microcredit segment with priorities on development and access. While recognizing microloans as an important market instrument for the development of enterprise, this regulation also pays substantial attention to the issues of transparency and fairness of deals and protection of the borrowers’ rights.
The institutional practices vary from country to country. Brazil relies more on the specialized programs of regulated banks, and a special law requires the banks to use not less than 2 percent of their deposits for the task of crediting the low-income population. This results in programs like CrediAmigo from Banco de Nordeste with some 1.7 million clients, a program that is widely acclaimed as an important factor in the growth of small business in the country’s less developed region. A somewhat different legal landscape is represented by Mexico, with official separation of business and personal loans, the former provided through specialized banks while the latter are reserved for “multi-purpose microcredit non-regulated organizations.”
This division by purpose rather than by size of the loan makes sense for creating a task-centric financial architecture for credit in a country. Banks inevitably play a key role in any credit system, just because of their size, resources and competencies that are beyond the possibilities of smaller specialized microcredit organizations. Yet, because of the stability imperative, they are over-conservative when it comes to the issues of development, and their quest for operational effectiveness usually excludes the possibility of “hands on” handling of grassroots deals. A two-tiered system with a role for both banks and MFOs could be an effective step forward: the former employing their resources and the latter providing the “last mile” of decision making.
Now is the time for Russia to develop its microcredit sector
The flexibility of microcredit lending in individual cases is especially important for Russia with its high regional diversity. The distribution of gross regional product per capita in Russia is a continuum spanning the range from the level of the leading EU economies (in Moscow or Tyumen) down to figures comparable to Bolivia or India in the cases of Tyva or Kabardino-Balkaria. The top-tier regions are getting most of the attention from national banks, and are used for calibration of the scoring systems and processes. The task of financial inclusion is bringing development to the regions, towns and villages which need it most.
The conventional wisdom is that the growth of small enterprise is very much a story about income growth, employment, and social stability. What is sometimes forgotten is that it is a market in its own right, a key generator of demand for cars, telecommunication services, IT hardware and software, energy, and innumerable other products and services.
Microcredit can also be an important player in international trade, especially in non-resource exports. Currently in Russia just 0.2 percent of small businesses are exporters, while the EU average is 3 percent. Yet, Russia has one of the lowest levels of entrepreneurial intentions in the world (according to the Global Entrepreneurship Monitor). Just 2 percent of the adult population has an idea of starting his or her own business – compared to 27 percent in Brazil, 14 percent in China, 22 percent in India and the EU average of 13 percent. The availability of financing is a crucial factor in such intentions and microcredit has consistently demonstrated the capacity to drive small business growth across the globe.
Now may come an important moment for small enterprise in Russia. The nation’s largest businesses, especially the state-run corporations, are grappling with international sanctions. Corporations within Russia are also starting to struggle with the issue of reduced demand for their products and the need to focus on operational effectiveness.
Against this background, small business can be a leading driver of effective, sustainable and self-reliant economic growth. Microfinance will not do the entire job of this development, it is just an instrument, just as no axe is capable of building a house on its own. Yet, building a house with bare hands is also highly problematic. It is very encouraging that the issue of microfinance has finally attracted the attention of Russia’s top policymakers. A balanced, informed and task-centric policymaking process should follow.