Denisse Sanchez Mora knows all about the challenges small businesses in Mexico face. From her office in Guadalajara, she dispenses commercial and legal advice to startups and entrepreneurs about how to grow their companies.
Thanks to a Ps3 million ($161,000) loan from HSBC, Sanchez Mora has been able to do the same: opening a new office in Aguascalientes, investing in technology and hiring 20 new employees.
Sanchez Mora’s business is one of the rarer ones. While small and medium-sized companies account for about nine out of every 10 businesses in Mexico, only around a third of those have access to bank financing, according to a recent central bank report. As of March, SMEs consumed 9.1% of all loans in Mexico, equivalent to just 2% of GDP, according to Moody’s.
“Credit extended to the private sector is about half of what would be expected for the country’s level of income,” says Norbert Schneider, principal investment officer for Mexico at the International Finance Corporation. “Despite numerous financial institutions operating in the market, financial services penetration remains low.”
One of the main and enduring impediments to faster credit growth is the sheer size of Mexico’s informal economy. At the end of 2017, almost 60% of the country’s workforce was employed in the informal sector, according to Mexico’s census bureau, INEGI. That means many companies active in this market lack the necessary credit history, accounting information or assets needed to secure a bank loan.
|Alejandro Valenzuela, |
The bulk of Mexico’s SMEs are also very small, which makes it complicated and costly for larger commercial banks to serve them, says Alejandro Valenzuela, chief executive at Banco Azteca, one of the few banks in Mexico that caters to low-income customers.
“If we divide the economy from A to E, the C, B and A sections are as well-banked as any other developed country in the world, but as you move into the very low market segments, there’s a long rupture before you get to D and E,” he says. “Those market segments operate in a very different manner, and the traditional banks in Mexico haven’t found a way to truly work in that market. They have tried, but the transaction costs are too high – monitoring lots of smaller loans is expensive and if you continue atomizing that, the margins are even smaller and the costs of monitoring go up exponentially.”
Some SMEs are also wary of borrowing from banks, not least those who remember being stung by the effects of the Tequila Crisis in 1994 when the government sharply devalued the peso, leading to a devastating rise in interest rates.
“In the 1990s, the interest rate was above 50%, so there’s still a lot of people who left everything behind then because they couldn’t afford to repay their loans, and so business people in Mexico are more risk-averse in terms of leverage,” says Manuel Rivero Zambrano, chief executive at Banregio, a Monterrey-based bank that specializes in SME loans (Manuel Rivero Santos, his father, is chief executive of the wider Regional group).
And it is not just an urge to keep earnings beyond the reach of the tax man that tempts small businesses to remain unbanked. Juan Parma, head of retail banking and wealth management for Latin America at HSBC in Mexico, says customer surveys suggest the main reason why people remain in the cash economy is not to evade taxes but because they view opening a bank account as complicated and expensive.
“The main reasons are complexity, fears of being charged fees they cannot pay and the fear of being a victim of a fraud with their bank account because they don’t understand how bank security works,” he says. “So they prefer to run their business on a cash basis than operating with a bank.’
Many SMEs prefer to get credit from their suppliers instead.
Felipe Carvallo, a senior credit officer at Moody’s in Mexico City says: “Even if the banks demonstrate to these SMEs that a loan from a bank will be cheaper, they don’t want to disrupt the commercial relationship they have with their supplier or they just distrust the banks, so they prefer to pay the higher interest rates.”
And some SMEs are simply not interested in growing, either because they lack the time or ambition or they wish to remain invisible. About 44% of SMEs that have been in business for five years have the same level of income that they had during their first two years, says Valenzuela.
“There’s a sense of mediocrity that hinders the development of SMEs,” he says. “They just stagnate.”
That does not mean commercial banks have given up on trying to push deeper into this sector. Between 2011 and 2016, loans to small and micro businesses were the fastest growing type of commercial loan to Mexican borrowers, with an average annual growth rate of 27%, according to Itaú BBA data.
Medium-sized companies recorded 17% growth over the same period, the data show. Small and micro businesses are classified as those with annual sales of less than Ps100 million or fewer than 50 employees, while medium-size companies are those with sales of Ps100 million to Ps250 million and up to 250 employees.
Yet a spell of heightened uncertainty spurred by US president Donald Trump’s frequent taunts about tearing up the North American Free Trade Agreement and, more recently, Mexico’s presidential election race has caused SME loan growth to stall. In the 12 months to June this year, lending to SMEs contracted by 1.3%, according to Mexico’s banking regulator, CNBV.
“Mexican banks tend to be very prudential and conservative when the operating environment is weakening, so we believe that is the reason why SME lending is decreasing,” says Alejandro Tapia, an analyst at Fitch Ratings in Monterrey.
That risk aversion also means many of the larger commercial banks only lend to SMEs if the loan is backed by a guarantee from Mexico’s main development bank, Nafin, which, in exchange for a fee, will agree to share any losses a bank incurs. Such is the importance of the development bank’s role, if you exclude guaranteed loans from the country’s lending data, SME credit penetration would be around 15 percentage points lower, says Carvallo. HSBC, for instance, says almost 100% of its SME loan book is covered by Nafin guarantees.
Other development banks are also active in providing funding and guarantees to Mexican lenders. Banregio, for instance, works with Fira (which specializes in agricultural development), while the IFC has supported SME-focused banks such as BanBajio and Banca Mifel.
“We’ve been able to leverage our relationship with development banks to reach more clients with cheaper funding, allowing us to have a more diverse portfolio,” says Rivero Zambrano.
Even so, he says Banregio relies less on development bank guarantees than some of Mexico’s larger lenders, with just 12% of the bank’s SME loan book backed by such agreements.
Instead, Banregio gathers more qualitative information on its borrowers, which gives it an edge when trying to determine the cost of risk. Typically that means talking to a company’s suppliers, clients and even competitors in other geographies, he says.
Development banks also play a key role in shovelling cash to underserved or overlooked corners of the market.
Nacional Financiero, for instance, has a number of targeted lending programmes that are sponsored by a handful of participating banks. One programme is Mujeres Empresarias, which provides capped-rate loans to businesses that are majority owned by women.
Since the programme’s launch in 2016, Nafin has backed Ps10.5 billion in loans to female-run businesses, 10 times more than the bank’s initial goal, says Tonatiuh Salinas, deputy director general for entrepreneurial banking at Nafin.
Another is Credito Joven, which offers loans to young entrepreneurs who would otherwise find it prohibitively expensive to access credit. Since 2015, the programme has provided Ps2.6 billion of loans and supported the creation of almost 6,000 companies across the country, Salinas says.
“One of our main roles is just to prove that some segments and some regions and some activities have market potential,” he says. “Before Credito Joven, there was no financial solution for them, so with a Ps2.6 billion portfolio and with a failure rate of less than 7%, we’re proving that this is a value segment in Mexico.”
That failure rate, however, is one of the reasons why the bigger commercial banks are reluctant to increase SME lending without a Nafin guarantee.
|Veronica Chau, |
“Most banks want to keep their impairment ratio stable and avoid increases or sudden changes in impairments,” says Veronica Chau, an analyst at Fitch Ratings. “Under current market conditions, the most vulnerable segment in the loan portfolio is SMEs and consumer lending, and while NPLs have been under control, there have been some individual cases where loans have got into trouble.”
A cumbersome legal framework also keeps a lid on potential loan growth. If an SME loan without a development bank guarantee sours, it can be difficult to find and repossess assets that have been pledged as collateral, says Carvallo.
“This is one of the general reasons why intermediation is so low in Mexico,” he says. “The processes are long and the courts are inefficient or sometimes corrupt. The main reform that could boost SME lending is to follow through on a previously approved plan to establish federal-level courts that would handle the repossession of guarantees in a much faster and efficient way. That could make a big difference.”
For now, jitters over risk are creating a funding gap that non-bank finance institutions are piling in to fill. While Mexico’s banking system as a whole expanded 9.6% in the year to the end of March, leasing companies – which can provide both credit products and operating leases – grew by 14% in 2017, according to Moody’s. And some of those leasing companies have been growing at an even faster clip. Unifin, the biggest independent leasing company in Mexico, has grown at a rate of around 40% to 45% over the last few years, albeit slowing last year to around 20% to 25%, says Chau.
“That is still a very fast pace – they have the resources to attend to SMEs when banks decide not to provide credit, and they are very profitable because this segment tends to have a little more risk,” she says.
While Unifin dominates, there are almost 50 leasing firms registered with the Mexican Association of Lessors, Credit and Factoring Companies. In the wider microfinance space – where the majority of Mexico’s companies reside – competition is even more intense.
There are just over 80 microfinance institutions registered with the ProDesarrollo Association, whose members account for roughly four out of five microfinance loans in Mexico. Yet it is estimated there are closer to 1,500 microfinance providers operating throughout the country, the majority of them unregulated. Most of these provide group lending, where small loans are distributed among a group of borrowers under the premise that if one borrower defaults, the other members in the group have to cover the losses.
Pablo Anton Diaz, research manager at Accion’s Center for Financial Inclusion in Washington, says Mexico’s microfinance market boomed after Compartamos, the country’s biggest microfinance lender, went public in 2007.
“That sent a massive signal to different venture capitalists and hedge fund managers that microfinance was a very profitable market, so right after that IPO you started having Compartamos copycats popping out of thin air; it has turned insanely competitive,” he says.
It is not hard to grasp why. Microfinance lenders charge eye-watering interest rates, averaging an annual effective rate of 75%, according to a recent study co-authored by the IFC. Some lenders even charge triple-digit rates. While the loan tenors are short – typically between five and 12 weeks – borrowers can often get caught in a spiral of indebtedness as they take out new loans to repay existing ones, or because they do not want to lose their place in a lending group.
The size of the profits up for grabs has also attracted predatory lenders.
“A lot of the investors that came into the market are not driven by social goals, they are just interested in making a quick profit,” says Anton Diaz. “There’s certainly a handful of institutions that are very socially minded who try to be responsible and not cause their clients to become over-indebted, but there are some bad apples out there and a few institutions at the lower end of the spectrum are not any different to loan sharks.”
Technology could help change things. Some fintech firms have been pioneering alternative scoring methods, which help assess borrowers with no formal credit history. Some of those methods include looking at utility bill repayments, psychometric tests and sundry other data points, such as how long it takes a borrower to fill out an online loan application or how often they hit the backspace key, says Anton Diaz.
Not only can fintech firms provide cheaper financing to borrowers than traditional microfinance institutions, they can also offer individual loans, potentially consigning the group lending model to the scrap heap.
|Juan Parma, HSBC|
Konfio, one of Mexico’s leading fintech lenders to SMEs, offers individual loans at about half the rate of an average group loan, Anton Diaz says.
A recently passed fintech law will also ensure the market is properly regulated, a relief for borrowers that otherwise have to rely on lenders that operate without any oversight. That legislation should also help commercial banks extend credit to riskier borrowers that lack the documentation banks currently need to underwrite a loan.
Parma says HSBC is in discussions with a number of technology firms about how it can bolster its digital capabilities, as well as with regulators to lobby for a rule change so that new customers can open a bank account online rather than in a branch.
Rivero Zambrano says Banregio is also in regular contact with fintech firms, although he cautions that the model is still unproven.
“They are doing great with lending but we’re not sure how they are going to do in terms of collecting,” he says. “One of the biggest lenders in Mexico is BanCoppel – they have 50,000 employees and 25,000 of those are collectors. There is a lot of interest rate that goes into paying for the collection, so we want to make sure those companies perform as they say they are going to perform.”
How all of that translates into greater financial inclusion for SMEs remains to be seen. Rivero Zambrano says tax incentives – such as waiving tax for very small businesses – might encourage some companies to become formal. But Parma says a 360-degree perspective is required; it is not only small businesses that need to change but their customers too. Just 37% of the adult population had access to a bank account at the end of last year, according to the IFC.
“If we have more bankarization across the board, that will mean more access to credit and that will mean growth not just for the banking industry but for the economy as a whole,” says Parma.