Pedro owns a winery. To date, it registers several loans for working capital with different Microfinance Institutions - MFIs, totaling $.15,000. All credits report a repayment term of 24 months.
However, the current assets (made up almost entirely of inventories) of the business do not exceed $.3,000.
In simple terms, the borrowed money is not in the business.
The question is how nobody noticed, if the MFI's Credit Regulations stipulate the post-disbursement visit, to verify the destination of the credit.
The answer, although it may seem unrealistic, is that almost no one is interested in the final destination of the credit.
The mechanics of tremendous blunder are as follows: Most MFIs do not assess the client's real need for working capital. They only calculate the maximum quota that the surplus of the economic unit - family could bear in the maximum term granted for working capital credits. Therefore, they are not interested in whether it is used for working capital or not, as long as it has the ability to pay to cover the loan fee.
As an example, let's take the data from Pedro's winery:
· Inventories for $.3,000
· Average turnover: 7 and 15 days
· Average monthly sales: $.6,000 (corroborated with the methodology of good, normal and bad days).
· Average business gross margin: 25%
· Average monthly gross profit: $.1,500
· Family expenses: $.350
· Surplus of the family economic unit: $.1,150.
· Amount of debt: $.15,000
· Average interest rate charged: 2.00% TEM
· Term: 24 months
· Average monthly payment: $.793.07.
Quota / Surplus Ratio: 68.96%
Maximum Allowable Quota / Surplus Ratio: 70%
Which means that how the loan payment does not exceed the maximum of 70% of the Surplus of the Economic - Family Unit, it does not matter if the loan is intended for working capital or not. "Total, the business can afford it!"
The problem with all this is that the real destination of the credit is unknown, which in the worst case could be a parallel business that could affect the income-generating activity or a new investment that could imply the diversion of resources from the activity principal, to name a few cases.
On the other hand, the information reported to the Risk Centers is misrepresented.
In my opinion, the origin of all this is the error that exists in microfinance to evaluate the financing of loans for working capital and fixed assets in the same way.
The Family Economic Unit Surplus should only be used to evaluate the financing of fixed assets and not of working capital.
For the evaluation of working capital credits, the client's need should be considered first, such as:
• Business opportunity (extraordinary orders),
• Market growth,
• By campaign (school, Mother's Day, Christmas, regional holidays, etc.).
and, secondly, the maximum amount to lend. In the case of market growth, it should be a function of the installed capacity of the business. In the case of Pedro's winery: how is it explained that his inventories have been loaned five (05) times? Where would so much merchandise fit?
I have seen cases of merchants selling poultry at market stalls, whose inventories did not exceed $.300 and owed up to $.10,000 of working capital. That is, 33 times your inventories. And so I could continue listing.
In the case of a business opportunity, the credits should be cancellable, according to the business cycle.
In the case of campaign credits, the term should not exceed the duration of the campaign and should also be cancellable (normally 90 days).
Although it sounds incredible, on one occasion I was able to see very closely how an MFI granted credits for a 12-month Christmas campaign.
In all cases, it is necessary to monitor the destination of the credit, which should not be reduced only to financing fixed assets.
Summary
The granting of credits for working capital based on the maximum quota that could support the surplus of the economic unit - family in the maximum term granted for credits of this type, regardless of the destination of the credit; what has originated is the diversion of funds to activities unknown to the MFI, whose results could affect the recovery of the loans granted in the immediate future.
At the moment nothing is happening, since the debtors have endless financing alternatives that allow them to “refinance” their debts through the subrogation campaigns (purchases) of obligations that many MFIs carry out, but this will not be eternal. At the time this bad practice will take its toll on all of us and we will see who gets the ball in their hands.
