Mitigating Inequality through Micro-financing

Andres Delgado, Jose Pastor & Giovanni Sanchez

Universidad Catolica San Pablo & Cornell University ILR School

Executive Summary: Despite high rates of economic growth in Peru, income distribution remains
unevenly distributed at high-levels. This sort of distribution, if left unchecked, creates growing social
tensions and contributes to conflicts between extractive corporations and local communities. The most
successful experiences of combating income inequality in Latin America have been through formal job
creation. A powerful instrument for job creation is microfinance because supports a crucial part of the
Peruvian economy: small enterprises. Therefore, for mining corporations who desire mitigated social
conflict in the communities they work in, supporting micro-finance should be embraced as an important
tool.

The Role of Mining in Peru

Mining plays a fundamental role in Peruvian economy. According to a 2012 study made by the
Peruvian National Society of Mining, Oil and Energy (Sociedad Nacional de Minera Petrleo y
Energa), mining is the main activity to export products with 59% of total exports, with a $ 27
361 million income. Represent 14.5% of Perus GDP. Is the main tax payer with over 15% of
total resources and represented over 21% of total private investment in the country reaching an
amazing $ 7 200 million according to the same source. Some estimations announce that in a 10
year period investment will reach $ 43 000 million. Thanks to the mining companies and its
taxes, they are the main financer of regional and local governments budgets, mostly in mining
regions with over 20% participation, which means that thanks to these incomes local and
regional governments are able to execute more projects or invest in bigger ones. That percentage
decreases in non mining regions but represents still 11% of their budget, which shows it
represents 1/10 of total incomes. Finally, regarding employment it benefits over 820,000 people
with 177 000 direct employments and 650 000 indirect employment according to the Peruvian
National Society of Mining, Oil and Gas.
Contingencies and Inequalities
In despite of these outstanding results the inequalities and redistribution of the richness is still a pending
debt. First, the magnitude of the available funds are rare if compared with the needs they face. Second, the
assignation criteria of the resources by the state and allocate them creating negative effects. Third,
regional and local governments have major issues to invest the resources in the best way possible.
(Barrantes et l., 2005) It is important to consider some impacts that mining industry has over
communities that are not shown by most of the media, which end up in:

.Any benefits to the community may be unequally shared;

 Corporate community initiatives may be seen as poor recompense for damage to livelihood,
environment and community;
Social tensions in communities due to the changes brought about by mining can give rise to
violent conflict. According to the Ombudsman office report of December 2014, there are 210
social conflicts in the country, which 139 are related to social environmental problems. Out of
those 139 social conflicts, 69.8% are related to the mining industry.
Regarding location, the most conflictive regions in Peru are, paradoxically the ones with a lot of mining
activities which could help us prove that economic growth is not equal to development and that even
though money can be invested, it won't guarantee adequate redistribution.
For example, ncash is one of the regions with a lot of social conflicts (22) even though their mining
investment will reach over $ 7 000 million dollars with project Las Bambas, Las Chancas and Haquira. It
is followed by, Apurmac (22) y Puno (18) Cusco (16), Ayacucho (14), Cajamarca (14), Junn (12), Piura
(12).
Micro Finance: Potential Solution
Given the comparatively low number of jobs created by the extractive industries, diversifying Perus
economy will be key to rectifying such shortcomings in future. Microfinance is powerful instrument for
achieving this diversification.
History of Microfinance
Micro-finance programs provide small loans to groups of individuals (primarily women) who would be
ineligible for conventional bank loans (due to a lack of capital and/or literacy) or subject to the high
interest rates of informal lenders (Hermes and Lensink 2007; Yunus 1995). Microfinance began with the
work of Muhammad Yunus, an economist in Bangladesh who received the Nobel Peace Prize in 2006 for
developing microfinance programs through the creation of the Grameen Bank.
While the traditional model of microfinance focused exclusively on poverty-alleviation, a new, financial
systems approach, has evolved in recent years. The financial systems approach focuses more on access to
microfinance services for poor entrepreneurs through minimalist programs based on banking models. It
stresses the importance of financial self-sufficiency, professional staff, and cost efficiency for client
(Kellett 2011).
Impacts of Microfinance
Impact assessments have demonstrated that financial services for the poor improve peoples lives by
increasing their incomes and improving their capacity to pay for social services (CGAP 2003). These
impact assessments have explored two areas:
1) Income growth, asset building, and reduction of vulnerability; and
2) Analyzing beyond enterprise measures (assets, employment, revenues) to include multiple
dimensions of poverty, including overall household income, social improvements in health and
education, and empowerment (in terms of increased self-esteem and control of household
resources among women)
The results of these impact assessments have been positive:

Microcredit leads to an increase in household income. The use of loans and deposit services can
result in a diversification of income sources or enterprise growth.
 Access to financial services enables clients to build and change their mix of assets. Microcredit
can be used for land acquisition, housing construction or improvements, or the purchase of
animals and consumer durables.
Poor people are very vulnerable and move from one crisis to another. Access to microfinance
enables them to manage risk better and take advantage of opportunities.
Job creation in single -person enterprises appears negligible.
However, when the total number of enterprises is combined, client households often create work
for others.
For example, in Peru, each microfinance client created three additional working days per month
for non-household workers.
Microfinances Winning Track-Record in Peru
According to a report from the Economist Intelligence Unit's Global Microscope, Peru offers the best
microfinance business environment for the third year running.
One of the main contributors to this was the creation of Entidades de Desarrollo para la Pequea y
Microempresa (EDPYMEs). These insitutions were created as a specialized vehicles for microfinance and
are regulated by the SBS. These non-deposit-taking institutions are often owned by non-governmental
organisations (NGOs); the difficulty in raising capital, particularly through deposit-taking, has been the
one weakness of this otherwise potent microfinance vehicle. (EIU 2010).
Furthermore, Microfinance can support a crucial part of the Peruvian economy: Peru has around 3.1
million micro and small enterprises which employ about 70 percent of the economically active population
(EAP ) and generate about 42 percent of Gross Domestic Product (Peru21 2007).
While microcredit isnt a perfect solution, few other tools have, to date, been as successful fostering
entrepreneurship and generating employment. (Davidson 2013).
Mechanisms for Supporting Microfinance
In the next section of the brief we will discuss various mechanism extractive corporations can use to
support microfinance in Peru. The described procedures help generate the funds necessary to ensure the
operation of microfinance institutions.
Mecanismos para canalizar fondos de la Compaa Minera con las IMF
El procedimiento a seguir de las industrias extractivas para generar los fondos necesarios que garanticen
la operacin de las Micro financieras se brinda a travs de financiamiento que se puede dar de las
siguientes maneras:
Mechanisms for Supporting Microfinance
In the next section of the brief we will discuss various mechanism extractive corporations can use to
support microfinance in Peru. The described procedures could help generate the funds necessary to ensure
the operation of microfinance institutions.
1. Non-reimbursable funds. Corresponds to grants made by the company to MFIs that need these funds to
conduct its operations and / or to extend them to areas where the social impact is required. As loans
granted by the MFIs are not backed by a collateral, but by an equity analysis, as a general rule non-
reimbursable funds are applied to MFIs that have:
Portfolio Risk between 4-8%.
 Expenses Provision for doubtful credits with a minimum of 5%
Hedging higher than than 200%
Number of borrowers per loan officer between 50 and 100%
Geographic location that facilitates relationships between client - MFI

2. Contingent Recovery Funding : The company finances these operations when there is a reasonable
possibility that will lead to recovery if the MFI is in state of insolvency. If funding does not generate an
immediate recovery, the operation becomes non-refundable. The beneficiary of the transaction agrees to
reimburse the contribution also in cases where the project or business resulting from the operation of
technical cooperation to be funded by other financing institution. Funds are applied to MFIs that have:
Costs of Financial Resources under 10%

3. Reimbursable Funding: Corresponds to loans that are given to MFIs that have high rates of return, and
use this funding as cash flow operations support . To make reimbursable funding, it should be performed
a cost benefit analysis based on three indicators:

A return on capital to stay for more than one year on average higher than 20%
Return on Assets increased to 6%
Return on Portfolio higher than 20%

It is crucial to monitor the performance of MFIs regarding the use of funds provided to support their
operations. The following monitoring regulations are set:

Prudential regulations; Regulations for which the financial strength and sufficient liquidity is analyzed
so that you can repay its depositors, as long as the have and
non-prudential regulation, also called "regulation of activities", which is not responsible for monitoring
and assessing the financial soundness of the institution, but focus on three main objectives

- The protection of consumers of financial services

- Enabling several institutions that provide a combination of appropriate products and services, and
- Providing information to governments to implement economic and financial policies.

MFIs that only lend money evidently have no risk to their depositors (since there are none) and they are
not subject to prudential regulations. However, as noted, should be subject to non-prudential regulation.

How can donors increase the impact of financial services for the poor?
1. Prioritize large scale outreach. Support financial institutions with potential for sustainability and
growth.
2. Invest in a range of promising financial institutions to ensure that diverse clients at many income levels
are reached, extending outreach both outwards and downwards as far as possible.
3. Promote the twin goals of sustainability and impact; monitor MFI progress against both goals.
4. Encourage market research to better understand client preferences and the constraints that prevent the
poor from taking best advantage of financial services (i.e. literacy, land titles, etc.).
5. Support proactive institutions that develop delivery mechanisms and products to meet client needs..
Sources:

https://www.cgap.org/sites/default/files/Consensus-Guidelines-Guide-to-Regulation-and-Supervision-of-
Microfinance_Oct-2012-Spanish.pdf
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america-latina,5787.html
https://www.cgap.org/sites/default/files/Consensus-Guidelines-Guide-to-Regulation-and-Supervision-of-
Microfinance_Oct-2012-Spanish.pdf
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http://www.academia.edu/4844907/Microfinance_and_Economic_Inequality_in_the_Peruvian_
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http://projourno.org/2013/09/the-truth-about-microfinance-in-peru/