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Evaluating the Paulson Plan

Latin America Advisor

US Treasury Secretary Henry Paulson earlier this month announced a three-pronged initiative to expand bank lending to small businesses in Latin America. What impact will the initiative have on lending to small businesses in the region? What effect could it have on Latin America's economies in general?

Eduardo Levy Yeyati, Financial Sector Advisor for the Latin American and the Caribbean Region at the World Bank and Director of the Center for Investment Research at Universidad Torcuato Di Tella University in Argentina: The initiative is certainly welcome, but its potential should not be overstated. This is not the first attempt to adapt prudential requirements to the needs of small and medium enterprises (SMEs), and the fact that SME lending is still an issue suggests that the problem goes beyond paperwork and relates, for example, to the high degree of informality prevalent among small businesses, and to the cost and uncertainty in effectively seizing the collateral, rather than to traditional rationing or lack of collateral. Besides, as a recent studies indicate, at least in Latin America SME lending is constrained less by banks' unwillingness to lend than by a lack of loanable projects, a reflection not only of a deficit in the capacity of small firms to formulate projects, but also of a lack of demand on their side, as they find internal capital a cheaper (and more flexible) source of finance than bank funds. Moreover, it is not clear why the development of scoring models or the streamlining of bureaucratic procedures cannot be undertaken directly by the current players (the banks, in the first case; the local supervisor, in the second). In this light, the most promising element of the proposal is possibly the second one, which entails a subsidy component that may be justified based on the externalities of small firms (e.g., regarding labor intensity and job creation) and the market imperfections associated with fixed costs and asymmetric information (particularly in the case of new firms without a credit track record). Here again, one wonders what is the comparative advantage of the Treasury vis a vis a specialized national development bank or agency.

Maria Velez de Berliner, President of the Latin Intelligence Corporation: According to Pyramid Research, Latin America has on average 13 small businesses to each large one. By Latin American standards, these small business enterprises (SBEs) thrive despite government corruption, bureaucratic red tape, onerous tax systems, and Byzantine regulatory systems. Any extension of credit to SBEs is needed and welcome. Every SBE deserves to grow and prosper. However, Latin America, not the US, needs to establish lending targets if this program is to help its economies grow, create employment, improve the skills pool, and alleviate poverty. The key is which sectors will stimulate growth and development in the long run. Development in the 21st century demands a large technical skills pool, high levels of education, access to technology, and capital to acquire it. Technical skills development, higher education accessible to the majority, and advanced technology introductions or acquisitions are a must if Latin America is to move from the commodities-for-export trap and be prepared to face China and India on a relatively level playing field. This is where US lending should go. Creditworthiness verification, loan collateral, and other requisites for granting loans are technicalities. Lending to the wrong sectors is not. Avoiding this requires an overall strategic objective. If the program is to help SBEs import US capital goods and skills not directly related to education, technical development, and growth, lending will benefit the US, not Latin America.

Tapen Sinha, ING Comercial America Chair and Professor of Risk Management at Instituto Tecnologico Autonomo de Mexico: In many Latin American countries, the main engine for new jobs has been small (most often informal) businesses. In Mexico, for example, in the past decade over 80 percent of new jobs were created by small businesses. This was the reason why Vicente Fox, the immediate past president of Mexico, talked about financing changarros. Henry Paulson declared 'they [the small businesses] have good ideas, markets to serve, and the skills to operate in an often tough environment. They can also form constituencies that drive governments to strengthen their business climates and improve governance. But they often are frozen out of the formal financial sector. It is estimated that only 10 percent of small businesses in Latin America have access to financing from banks and commercial lenders. The other 90 percent depend on friends, relatives or other informal sources of capital that can charge 10 percent or more in daily interest.' The Paulson plan has three elements: First, it will promote the spread of new lending models that fit the unique characteristics of smaller companies. This capacity-building facility would be housed in the Multilateral Investment Fund (MIF) of the Inter-American Development Bank. Second, the Overseas Private Investment Corporation, and the IDB Group's Inter-American Investment Corporation will assume a portion of the risks associated with this lending. Third, to reduce the burden of regulations or bureaucracy, the US Treasury's Office of Technical Assistance and the MIF will work with local authorities to review existing regulations. If the plan succeeds, in the long run it will help reduce the tide of illegal migration to the US from the region.

Republished with permission from the Inter-American Dialogue's daily Latin America Advisor newsletter. 

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