This is my paper published in the latest "EMN Magazine", June 2010
Another new law in France on credit in May 2010 is published: primarily on the control of consumer credit.And by the way, the government exerts pressure on banks so they get directly involved in professional microcredit. But is this a profitable business for banks? Surely not if they also provide counselling to microentrepreneurs, which is essential Hence the questions about the coordination between microfinance networks and banks.
__ 1 – Business creation in France deeply moved by recent reforms.__
Microcredits continue to grow in France despite the economic crisis. This is probably explained since 2007 by a specific effect: the threat to salaried employment contributes to the creation of new businesses by the unemployed, but also by deeper movement. In 2003 and 2005, the Dutreil Laws simplified many procedures in business creation and then, in 2009, the “self-entrepreneur” status (autoentrepreneur) dramatically changed the landscape of business creation in France. Indeed, in France, new businesses increased from 215,000 in 2001 to over 300,000 in 2008, mostly very small businesses. In 2009, more than 580 000 new businesses were registered (+75% in one year) which are mainly attributable to the new status of self-entrepreneur because other categories of businesses declined.
The profiles of these newcomers are not very different from those of traditional businesses; yet it is a radical innovation. The formalities for starting a business are reduced to little things (you can register online in 10 minutes and start invoicing) and business rules are minimal provided that the activity is very modest: maximum turnover of €32,000 per year for a service activity (€80,000 for a commercial activity). Even though data are not yet reliable, the magnitude of the movement is indeed still modest, as only one quarter of self-entrepreneurs has a real activity; and an even smaller part of them gets an income that is comparable to the minimum wage.
__ 2 - Microcredit in France: the figures.__
France is the most active Western Europe country for professional microcredit. This is due to the overwhelming success of Adie, which has been giving media coverage to microcredit for over 20 years, and to the more discreet and stubborn field work of France Initiative. Both microfinance networks are very different in their structures, their philosophies and their targets, even if they have the common feature of being not-for-profit associations.
In 2009, some 40,000 new business creations were financed out of the banking networks. The large majority is divided into two roughly equal parts between Adie, with average loans of €2,800 for small projects presented by persons in difficulty, and the local platforms of France Initiative, with average loans of €7,800 for larger projects. Other practitioners, such as the France Active Network and some regional networks, have lower trading volumes.
It is likely that there is a much higher latent demand, estimated by studies (Adie in 2008, the EIF in 2009) to be 100,000 loans per year. This is significant, as consistent estimates show that only 15 to 30% of entrepreneurs consider getting into debt to start their business. The remaining ones are reluctant to take such risks, or feel they do not need a loan.
But this demand is only expressed in terms of the supply. Much of the success of Adie is linked to this phenomenon: for a long time, people having problems did not consider setting up a business for many reasons, one being that these people had assimilated the fact that a bank would never trust them and lend them the necessary money. It is thus a supply policy that has proved, over the last 20 years, that many people have both the will and capacity "to start their own business" and to develop sustainable projects, even when they have no choice but to live on minimum social benefits.
3 – Two types of cooperation with banks
Two other developments are changing the landscape. On the one hand, banks no longer content themselves with leaving microcredit networks to do what they do not want and cannot or do not know how to do directly, that is to say small business loans. On the other hand, the combined pressure of French government and European authorities led the banks to get involved directly in this universe that they are largely unaware of.
Traditionally, for over 20 years, banks in France have been outsourcing small business loans to microcredit networks. With Adie, the agreement in principle was clear. Adie was the one doing all the upstream work (candidate selection, project validation and various aids to entrepreneurs) and the downstream work (double tracking of the customers: follow up of the reimbursements and follow up of the business management), the loan being implemented by the bank. Then recently, Adie changed its policy to master its own loan production from its own funds. For the local platforms of France Initiative, the pattern is different and remains unchanged. The 500 local committees (the ones taking lending decisions) are composed partly of local bankers. Hence, the unsecured loans are decided in an informal arrangement with the banks, making it easier for entrepreneurs to access additional loans from one of the mainstream local banks.
Thus, a dual system was established, highly effective for both partners:
• The bank avoids the costs of production it considers disproportionate to the amount of the loans and its standards of production. It leaves this work to the associations, which receive grants to do it, but then picks up good quality customers.
• The associations, Adie and France Initiative, show the government (which today remains their main provider of subsidies ) that they contribute to the creation of many healthy businesses capable of development, while the banks show that they are unable to do this work alone.
The policies of these banks have been more or less explicit over the last twenty years. Some prefer to adopt the attitude of sponsors (BNP Paribas), whereas others, such as Crédit Coopératif, and more widely the Popular Banks (Banques Populaires) that federate decentralised banks, have built real professional partnerships close to the SME world that are strongly involved in supporting microfinance. They have long supported the Adie initiatives, and are heavily involved in the loan production of the France Initiative platforms.
4 – Two very different types of microcredit
Adie and France Initiative do not differ only in their targets and the amounts of their loans. These two networks base their action on very different philosophical grounds. Adie addresses people in difficulty who have a micro project. Its main loan is the Solidarity Credit (Crédit Solidaire): it is a loan of an average of €2,800, a term of 18 months, with an overall interest rate between 10 and 12%; and Adie asks its customers for a guarantee for half of the loan amount. The France Initiative loan is aimed at people who are not particularly socially excluded, but who cannot, alone, have their projects financed directly by a bank. The average loan amount is much higher (€7,800) and funds projects much larger than those of Adie’s clients. The France Initiative loan is an unsecured loan: that is to say without guarantee or collateral (the borrower agrees to repay “on his/her honour”). In addition, it is a free loan, without interest. Its main attribute is to increase significantly the business creator’s capacity for additional indebtedness, since this unsecured loan would be the last one to be reimbursed in case of a problem.
The question arises whether this unsecured loan is within the definition of microcredit. Indeed, Adie's goal is to achieve financial balance by covering its costs and risks from the profitability of its loans: it is a goal consistent with the vast majority of microfinance institutions, even though studies show that this balance is unlikely in Western Europe (Evers & Young). France Initiative depends entirely on grants and patronage, as its operation is, by definition, in deficit and will remain that way. In addition, France Initiative funds projects that may be considered too large to match the definition of microcredit. According to the EU definition, confirmed in 2007, this would be business loans of a maximum of €25,000: this is the case for the unsecured loans of France Initiative, but their considerable leverage effect on the entrepreneur’s additional bank debt leaves this open for debate.
__5 – The attitude of banks: disappointing from a strategic point of view __
Since the recent financial crisis, banks in France, under government pressure, have made commitments towards the VSE (Very Small Enterprises) in order to support them in a difficult situation. The banks had announced, at the request of the government, their level of commitment in 2007. Within the category of "VSE of less than 5 years", we cannot distinguish those that would be considered as microcredit. But we can notice that of the €400 billion of outstanding loans granted to SMEs-VSEs, the outstanding loans related to VSEs (turnover less than €1.5 million) of less than 5 years, among which are the business creators, amounted to €78 billion at the end of 2007. Following the reduction in credits due to the depression of 2008 - 2009, the Government obtained formal commitments from the five major banking groups to increase their commitments in 2010. But it is likely that this increase will benefit mainly the well-established clients of the banks, and not primarily the microentrepreneurs.
Banks have two traditional arguments to explain the weakness of their direct engagements. On the one hand, entrepreneurs are inherently risky customers because "one out of two fails," according to the traditional affirmations. In fact, recent studies (INSEE - APCE, Agency for entrepreneurship) show that the rate of "failure" is much lower(almost half of this group stops voluntarily)
On the other hand, banks have long advanced another argument; that of the disproportionate production costs of small business loans. If it takes the same time to lend €5,000 as €50,000, the explanation is simple. But it also shows that, beyond their traditional clientele of retailers and artisans, banks have invested little in getting to know entrepreneurs. The argument of "asymmetries of information" is weak, especially because lately they have had the ability to adjust credit interest rates, following the recent removal of usury rules in France. It does not seem that the opportunity to charge higher interest rates has changed their production methods.
6 – Review the terms of coordination: amounts and profitability; risks of competition
Thus, the situation in France is now unstable. For over 20 years, the two main networks, Adie and France Initiative, have been giving convincing evidence of their effectiveness, each network according to its model. But they can only develop themselves by obtaining the cooperation of banks. The discussion is about the fact that the ceiling of €25,000 is not a good definition. Indeed, the implicit consequence would be to free banks from their direct responsibilities towards the majority of small start-ups, that would be left to the microfinance networks. So the discussion is about the amount. Banks should commit themselves to implementing loans they could grant directly from €10,000 upwards while microfinance networks would focus on microcredit loans under €10,000.
Is this division sustainable? Some bankers specialized in VSE are willing to make efforts to improve productivity and thus lower the minimum amount of their loans. But they add that if Adie, in particular, increases the average amount of its loans, they become very close to some regular loans from the bank to its own customers, artisans or retailers. In this case, the support that the bank grants to Adie is less justified: both practitioners are potentially in competition, while Adie is subsidized to implement its loans. And Adie would possibly be in trouble as it cannot offer the additional services offered by the bank (current account, financial services, overdrafts, credit cards ...). The debate is open today, concerning a still small part of Adie’s "best" customers.
Ideally, the collaboration between banks and microfinance networks develops through mutual learning. Banks learn under what conditions some network customers could become profitable customers for them, and microcredit networks learn from banks about the technology they need (computer systems, scoring, recovery techniques ...). But the limit appears quickly, if one or the other has the feeling that customers are being taken from them!
7 –Two risks for the future: to abandon the logic of the professional loan; and thetrend towards the dematerialisation of the relationships between lenders and borrowers
The limits of cooperation between banks and microfinance networks are also defined by other external pressures. The pressure on the profitability of banks' equity capital, strengthened by the Basel Agrements: small business loans are undoubtedly the least profitable loans for banks. Also the competition between banks and specialised financial institutions, which changes the nature of business loans.
By definition, business loans are based on a strong relationship between lender and borrower, the one needing to "understand" the plan of the other. So this requires a dialogue which implies high production costs. Whereas the techniques of personal loans (consumer loans, revolving credit, etc..) come down to a very quick benchmark between a personal profile and a database: this allows specialised financial institutions to make revolving credit loans of very small amounts, up to €100 or €200, which are very profitable.
So the temptation is great to go from one technique to the other, especially as, in the case of micro projects, the boundaries are blurred between the person of the borrower and his/her project. This is what has happened in some Latin American countries since the late 90s. The banks have built a range of personal loans in direct competition with that of microcredit NGOs who offered professional microcredit, often in peer groups. The result is an oversupply and severe indebtedness phenomena previously unknown . This is a risk already present in some European countries, especially in the East, and which questions the very logic of microcredit. There are no more physical meetings to discuss the project, no more dialogue or assessment; whereas, by definition, clients are people who need advice and counselling. Besides, the fact that microcredit is accompanied by advice and counselling is also part of the European definition.
This "debt by a click" trend converges with another trend towards the dematerialisation of business creation procedures. In France, since 2010, just 10 minutes of Internet procedures are needed to become a self-entrepreneur and start one’s activity. So there is no longer any physical encounter, either with a lender, or with a counsellor.
These products are successful because they fulfil a need for no-personal involvement in the credit relationship from poor people, according to credit sociologists and historians, which avoids the feeling of anxiety or guilt of a personal relationship with the traditional banker. But as a result, risks are transferred to only one side: to the side, in case of a problem, of the one who has "made a mistake" in borrowing, and not from the side of the credit supplier. It is in this that lies one of the sources of the risk of new forms of overindebtedness.
