Small Loans, Big Dreams.

After helping hundreds of thousands of small businesses in Bolivia, microcredit is becoming a victim of its own success.

FOR THE LAST THREE YEARS, THE Morales family has been expanding Melanie Export, its clothes-making business near the center of the Bolivian capital, by buying new machines and a car for distribution, hiring several employees and adding new lines of products. A 20-kilometer drive away, in the poor city of El Alto, Petronilla Quentas helps support her large family by manufacturing canvas bags that local women use to carry fruits and vegetables home from market.

These two small-business operators have something in common: both have benefited from microcredit loans of anywhere from a hundred to several thousand dollars. Ladislao and Melania Morales say their loans from microfinance institution Economic Initiative Promotion (FIE) are their only practical option for obtaining credit.

"Banks don't lend to us easily," says Ladislao Morales, whose business operates in the informal economy. "They demand lots of guarantees, paperwork and forms. We can't work with banks." The Morales family has tapped microcredit for five years, building up to its Latest loan of US$3,000.

Twenty years ago, microcredit barely existed. Today, microcredit institutions account for more than 70% of the loans in Bolivia. But microloans have become so prevalent that they're falling victim to their own success.

"Fifteen years ago, none of the poor had access to credit," explains Carmen Velasco, Bolivian executive director for Pro Mujer, a non-governmental organization offering loans to bag maker Quentas and other female microentrepreneurs. "Today, there are so many institutions wanting to give credit that people are overindebted."

In recent years, a slew of companies has appeared offering consumer loans, often to the same clients already carrying production loans. The new companies offering these consumer loans often lack experience in assessing clients' ability to repay, resulting in many clients being overburdened with debt. "[Microcredit] was the least expensive form of generating employment, but now the market is saturating says Microenterprise Vice Minister Luis Felipe Hartmann. "The portfolio [of borrowers] is stagnated."

The microcredit trend began in Bangladesh with the 1976 founding of Grameen Bank, which has become legendary in development circles. In Bolivia, non-governmental organizations began offering microcredit in the late 1980s after economic turmoil, followed by government belt-tightening, caused much of the formal financial sector to collapse. Since then, the microcredit industry has expanded, and today it boasts a portfolio of $383 million and more than 450,000 borrowers served by a variety of microfinance institutions, including one bank, various private financial funds and non-governmental organizations.

The industry was formalized with the passage of a 1995 law that regulated non-governmental organizations and offered them the option of becoming private financial funds authorized to receive deposits and offer other banking services. Although the microcredit industry continues to grow, it faces difficulties from a weak economy, competitors and market saturation. There are also questions about its role in development.

Microcredit surged in Bolivia, perhaps more than in any other Latin American nation, thanks to a combination of circumstances, including the poor condition of the formal financial sector in the '80s, a huge informal economy and steady economic growth through the 1990s. "A great part of the population doesn't have access to formal credit, doesn't have work or documents," says Pilar Ramirez, president of the board of directors of the Economic Initiative Promotion. "So there was a ready population."

Microentrepreneurs had been ignored by established banks, even though their mark on Bolivia's economy is huge: Businesses with between one and four workers provide 65% of Bolivia's jobs. However, the great majority of those businesses operate in the informal economy, meaning that they lack the documents necessary for obtaining conventional bank loans. Microfinance institutions, therefore, had to invent strategies for recruiting clients.

Rather than the borrower approaching the financial institution, the microfinance institutions send representatives to the entrepreneur's business place, which might be a fruit stand, restaurant or textile workshop. The representatives help the business owner calculate income flow and needs and determine what size loan is appropriate.

The microcredit industry has also developed mechanisms for guaranteeing loans, most commonly through solidarity groups--with usually a half-dozen members--which take responsibility for each other's loans. "The only guarantee that we have is the solidarity group," says Judith Trujillo, Pro Mujer's regional director for El Alto. "These people are so poor that they have nothing to offer us."

Because solidarity group members are generally friends and neighbors, social pressure makes repayment rates high, Trujillo explains. "If one fails [to pay], the others immediately go to her house" and ask why.

Microcredit clients have historically been more reliable repayers than their traditional bank counterparts. In 1995, for example, microcredit clients' default rate was 4.1%, versus 6.7% for the banking industry as a whole. However, default rates have risen recently. "Our market segment is perhaps the most vulnerable to crisis," says Marcelo Escobar, La Paz regional manager for Banco Solidario. Nearly all institutions have felt the impact, raising the industry default rate to 11% last year.

Some clients of even the most experienced microcredit providers have also felt the impact. When Adriana Avalos joined Pro Mujer about eight years ago, she operated a small fruit stand. Six loan cycles later, Avalos has a fried-chicken restaurant in her El Alto neighborhood. However, Avalos says she is planning to "take a rest" from Pro Mujer's program. "There's a lot of bad debt," she says. "We, the responsible ones, have to pay."

The scope of the microfinance institutions, including Pro Mujer, goes beyond loans. Some provide business classes and even health courses and checkups. These programs are not completely altruistic: medical emergencies can easily force already poor borrowers to default on their loans.

Sackmaker Quentas says Pro Mujer's business management courses taught her to use her time more efficiently. Before taking the course, Quentas often took the bus to La Paz to sell her bags. Then she realized the cost and time lost in travel made the commute counterproductive. "I didn't know how much I was spending in fares and time," she says. "Now I know how much I should spend sewing, selling."

The microfinance industry has been so profitable that new institutions continue to enter it, although the current economic downturn has slowed its growth considerably. In 1992, one non-governmental organization, the Business Development Program (Prodem), turned itself into Banco Solidario. That transformation may represent the world's only such case. Today, Banco Solidario has 75,000 clients whose average loan level is about $1,000.

Microcredit has turned out to be good business, and its potential as a low-cost way to reduce poverty--while avoiding the paternalistic trappings of charity--has attracted many institutions. "Micro-lending is giving many an opportunity to grow from the bottom up in business and commerce and thereby help their level of life," says Bolivia-born Susan Gonzalez Murillo, vice president of US Bank's Latin American division.

But there are limitations to the microcredit miracle. Not even Pro Mujer's Velasco argues it will wipe out poverty altogether. "[Our clients] have improved their children's educations, their health; they're eating better," she says. "But they're still poor."

In a 1999 study for the World Bank, Paul Mosley, an economics professor at the University of Reading in England, found that microcredit moved many of its borrowers out of poverty and had a broad employment-increasing effect. "In Bolivia, we find it to be an efficient and low-cost method of reducing poverty, but a poor and expensive method of reducing extreme poverty," he wrote.

Others agree that microcredit does not serve the destitute. "Microcredit isn't for the poorest people," explains Micro-enterprise Vice Minister Hartmann. "It's for bankable people."

Microcredit's growth has brought other benefits, including expanded access to financial services, particularly in rural areas. The number of financial institutions opening new offices exploded from five in 1990 to 337 at the end of last year.

Microcredit's success in Bolivia has led to the creation of similar lending institutions in other Latin American nations, including Argentina and Peru. But while microcredit clearly generates jobs--the Morales family employed three people last year when sales were strong--Hartmann questions whether its clients can climb far out of poverty. "There are several studies that demonstrate that microcredit allows you to reduce poverty, but that it doesn't generate wealth [because of annual interest rates of up to 40%]," he says. "No business gives such a return."

Clothes maker Ladislao Morales admits 2.5% monthly interest is a struggle, particularly with weak sales. "The minimum I need to earn is 20% [profit]," he says. "Microcredit is a great help, but you have to know how to work it."

Until recently, businesses--which hold half of microcredit loans--did produce extremely high returns. However, the recent economic slump has hurt many microcredit borrowers. "Micro-credit has suffered a very great blow," Hartmann says. "[Its borrowers] continue being the best repayers, but the bad-loan rate has risen a little."

The Superintendency of Banks and Financial Entities says it is responding by tightening standards for those offering consumer credit. To assist the microcredit industry, Hartmann wants to increase business training, lower interest rates and change laws to make it easier for microentrepreneurs to use their equipment as collateral.

Banks and Financial Entities Superintendent Jacques Trigo predicts that microcredit will continue growing in Bolivia--but more cautiously. "It's better to grow slowly," he says, "but surely."