Latin Entrepreneurship Is Stifled by Lending Curbs

Garbanzo bean exporter Jesus Barrios has more to worry about these days than a four-year drought, burner worms and a fungus called Texas rot.

What’s really hurting his Hermosillo, Mexico-based operation--and small and mid-size businesses throughout Latin America--is exorbitant interest rates.

To finance a $500,000 shipment of beans last month, Barrios paid 40% interest to a local bank.

That might have been OK in Mexico’s insular, pre-globalization days. But these beans were headed to Spain, where they compete with beans from U.S exporting giants such as Cargill and Archer-Daniels-Midland, which can borrow money at 10% or less.

As a result, Barrios’ beans cost $15,000 more to ship than the competitors’. “That put us in a hole and so we have to save that somehow,” Barrios explained, by hiring fewer people, buying less equipment or cutting back on expansion plans.

Small and mid-size businesses up and down Latin America are in the same squeeze, even as foreign companies with access to cheaper credit besiege their home turf.

The reason: Would-be business borrowers in Mexico and other Latin nations are severely limited in what they can pledge as collateral for a secured loan.

It’s an arcane practice but a perennial issue across Latin America, where the promise of economic growth has for decades fallen short. The limits on lending are one of the reasons: They act as a rope around the neck of any business that wants to grow.

And free trade and globalization have given the region’s credit predicament a new urgency. The World Bank estimates the economic penalty of the region’s backward credit market at up to 15% in annual output of goods and services.

But now a number of governments have undertaken reform initiatives, led by Mexico and urged on by the World Bank, the International Monetary Fund and, not coincidentally, U.S. banks eager to expand Latin operations.

“The backbone of any strong economy or developing economy is always its entrepreneurial piece, the small-business piece, and those are the areas that are not getting credit here,” said James McCabe, president of Bank of America Mexico in Mexico City.

Most lenders in Latin America do not recognize commonly used U.S business loan collateral such as accounts receivable and intellectual property.

Nor will they accept hard assets such as machinery and inventory unless they can physically take possession until the loan is repaid. That, of course, would deprive businesses of the productive use of the very assets they need to get ahead.

There are good reasons why Latin American banks are so cautious in extending credit. Latin courts give them precious little protection against loan defaults, and foreclosure in some countries can take up to five years.

The upshot is that when Latin Americans can get commercial loans, they typically pay 30 to 40 percentage points more in interest than the Kansas cattlemen, Australian wheat farmers, Taiwanese paper manufacturers and other foreign firms they compete with at home and abroad.

This stifles the entrepreneurial spirit of people such as Barrios, who, if he were in Arizona, could use his warehouse full of garbanzos, raisins and sesame seeds as loan collateral.

Not in Mexico: For loan security, he can use only the real estate he owns, which is of relatively little value.

“I end up not taking any risks,” explained the garbanzo exporter.

Efforts are underway in Mexico and elsewhere to change that.

New rules pending in the Mexican Congress would allow business borrowers to put up assets other than real estate as collateral--specifically items such as machinery, inventory, accounts receivable and patents.

The reform also would benefit Mexican lenders by shortening the foreclosure process to as little as six months from the current three-year average.

That, if accompanied by other needed judicial and regulatory reforms, would ideally entice foreign banks such as Bank of America and Citicorp to do more Mexican lending, creating competition and driving down interest rates.

On Monday, the Organization of American States took up the Mexican package as a possible model for all Latin nations.

Parallel reform movements are underway in Argentina, Honduras and Peru, said Heywood Fleisig, a former World Bank official and now head of the Washington-based Center for Economic Analysis of Law that consults with several Latin nations.

“The economic importance of this for Latin America is just enormous,” Fleisig said.

Across Latin America, Fleisig sees inaccessible credit as widening the gulf between U.S. and Latin American incomes and economic growth.

“It’s no coincidence that per capita income is four times higher in the United States than Argentina,” Fleisig said. “The amount of U.S. movable capital is also about four times as high. And it requires capital to produce income. In Argentina, producers can’t buy that capital equipment on credit and can’t get private loans to finance it.”

The problem is perhaps most visible in Mexico. There is a growing economic wedge between the haves--the big industrial concerns and maquiladoras in the north that have access to low-interest loans from U.S. suppliers or banks--and the have-nots in the interior geared to the domestic market that must borrow from Mexican banks at high rates.

This bifurcation has “negative implications for the economy, for income distribution and for regional development,” said Fernando Montes-Negret, the World Bank’s finance sector leader for Mexico.

Mexico’s credit reform package, to be taken up by legislators next month, has the support of Mexico’s three major parties, an unusual consensus.

“This law would go a long way to giving Mexican borrowers access to credit on equal terms with their U.S. and European competitors,” said Boris Kozolchyk, director of the National Law Center for Inter-American Trade, a think tank affiliated with the University of Arizona that helped draft the Mexican package.

But it is fraught with political risk. Many Mexicans are against any move that appears to help the banking industry on the heels of its $100-billion government bailout after the 1994 peso crisis and ensuing deep recession.

And secured-credit reform is only part of what’s needed to energize Mexico’s anemic loan market, some observers say. Reforms in bankruptcy law and judicial and regulatory procedures are also essential if Mexico’s banking market is to play the role of fostering growth and entrepreneurship.

“No one step is going to change things dramatically, but this is a step in the right direction,” said B of A’s McCabe. His bank essentially limits its Mexican lending to commercial borrowers with assets in the United States that can act as collateral.

Even if the reforms are adopted, people such as lamp merchant Jose Avila of Veracruz will think twice about again going into debt. The dysfunctional credit system has made thousands of Mexicans distrustful of banks and leery of borrowing.

Avila lost two houses to foreclosure after soaring interest rates following the peso crisis made his business loans unpayable.

“There is a general fear of losing what you have won,” Avila said.

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Chris Kraul is a Times staff writer and Jose Diaz Briseno is a researcher in The Times’ Mexico City bureau.