Transforming Informal Economies: An Analysis of the Impact of Microloans in Rio De Janeiro

AUTHOR SUMMARY

In our literature review, we examine the role of microcredit in Rio de Janeiro’s informal economy. Our analysis highlights how microloans empower entrepreneurs, foster economic growth, and encourage business formalization. We explore initiatives like Viva Cred and the Crediamigo program, alongside agencies like AgeRio, shedding light on their contributions to sustainable development. Despite challenges in accessing traditional financing, microcredit interventions, exemplified by case studies like Barbearia DH and Cervejaria Complexo do Alemão, showcase tangible benefits for entrepreneurs and communities. Overall, our review underscores microcredit’s vital role in transforming informal economies, promoting entrepreneurship, and driving inclusive economic development in Rio de Janeiro.

Introduction

Microloans, also referred to as microcredit, have emerged as a vital tool in transforming informal economies, playing a crucial role in promoting economic development and financial inclusion for small-scale entrepreneurs. This literary review aims to analyze the impact of microcredit in the specific context of Rio de Janeiro, considering its economic and social peculiarities.

Microloans in Brazil, anchored in the granting of low-value loans, play a significant role in offering financial resources to small informal entrepreneurs and micro-enterprises. The Brazilian approach, following a minimalist trend, emphasizes assisted credit granting, with socioeconomic analysis carried out by credit agents. The study focuses on micro, small and medium-sized companies, defined in advance, and explores the microfinance mechanisms offered by Finep and BNDES in the State of Rio de Janeiro.

Microcredit in Rio de Janeiro is exemplified by initiatives such as Viva Cred, which originated in 1997, and the Crediamigo program, implemented in 2009. AgeRio, with its oriented productive microcredit, plays a fundamental role, offering financing to formal entrepreneurs and informal with reduced rates and specialized guidance.

Economic informality in the Metropolitan Region of Rio de Janeiro is analyzed, going back to the historical conditions that gave rise to this practice. Microloans emerge as an effective instrument in combating informality, providing accessible and flexible alternatives that encourage the formalization of business.

The Brazilian financial system faces challenges in meeting the needs of micro and small businesses and self-employed workers. Microcredit, by offering more accessible conditions, encourages formalization, promotes financial inclusion and contributes to sustainable economic growth. Finally, this article presents exemplary case studies, such as Barbearia DH, the Brincalalá enterprise and Cervejaria Complexo do Alemão, highlighting how microcredit boosted the success of these entrepreneurs and contributed to local economic dynamics.

Microcredit

Microcredit can be defined as “the granting of low-value loans to small informal entrepreneurs and micro-enterprises without access to the traditional financial system, mainly because they are unable to offer real guarantees. It is a credit aimed at production – working capital and investment – and is granted using a specific methodology” (Alexandre, 2010).

The Brazilian approach to microloans is based on assisted credit granting, aiming to minimize bureaucracy as much as possible. Before granting credit, a socioeconomic analysis of the entrepreneur is carried out, in which the client’s intention and capacity are assessed. This process is conducted by a credit agent, who travels to the location of productive activity. The agent assesses payment needs and conditions, in addition to monitoring the progress of the business over time. When microcredit is intended for a single individual, guarantees similar to those in the traditional system are required, such as a guarantor or sale of assets. According to Maraysa R. Alexandre,

the steps for granting credit with the solidarity guarantee are: requesting credit, which involves filling out registration forms, collecting documents and carrying out registration searches; an evaluation visit carried out by the credit agent in which he analyzes the need for credit and payment capacity, in addition to evaluating the affinity between the group’s components; group meeting that is led by the credit agent and, at which the credit is consolidated, the loan conditions are detailed and the group member requests the amount of the credit, in addition, the name of the group is chosen and the coordinator is elected who you will be responsible for the single bill; disbursement, which is the release of money into the account of each component; credit monitoring in which the application of credit is verified. (p. 39)

There are currently two ideological trends linked to the way customers are treated concerning microcredit. The first is called developmental and, as the name suggests, argues that microcredit should be used as an instrument to combat poverty, associated with other forms of support1 for small entrepreneurs. The second, known as minimalist, argues that microfinance institutions must respect sustainability, offering financial services, without the need to link the concession to prior training. In Brazil, the minimalist trend is followed (Alexandre, 2010).

According to Mário Neto,

In Brazil, a differentiation was established between three credit services: microcredit, productive microcredit and productive and oriented microcredit. The first refers to credit for low-income populations. The second is small-value credit for productive activities. The third refers to credit for productive activities based on the personalized relationship between the microcredit institution and the entrepreneur, through credit agents. (p.25)

Microfinance and Financial Intermediation Operations

The objects of this study will be micro, small and medium-sized enterprises, which will be defined under the Brazilian Micro and Small Business Support Service (SEBRAE), which defines them as:

1. Micro-enterprises: up to 19 employees;

2. Small companies: from 20 to 99 employees;

3. Medium-sized companies: from 100 to 499 employees.

In Brazil, there are two main bodies involved in financing micro, small and medium-sized enterprises: the Studies and Projects Financier (Finep) and the National Bank for Economic and Social Development (BNDES). This study will analyze the main microfinancing mechanisms of these two bodies within the State of Rio de Janeiro’s limits.

Finep is a public company, linked to the Ministry of Science and Technology. It is characterized, more specifically, as a federal agency that promotes innovation and technological development, operating in all areas of the innovative process. It was created in 1967, to institutionalize the Studies, Projects and Programs Financing Fund, established in 1965 (de Paula, 2015).

The National Bank for Economic and Social Development (BNDES) is a public company linked to the Ministry of Development, Industry and Foreign Trade. Founded in 1952, the bank is currently the main long-term financing instrument in Brazil.

In 2012, the BNDES Innovation credit line was established to increase competitiveness through investments in innovation incorporated into the business strategy, encompassing improvements in both products and procedures and marketing strategies. The bank provides advantageous financing conditions for small and medium-sized companies. Analytical research carried out by Ernani Filho and Fernando Puga (2006) concludes that financial support had a positive impact on companies that received financing from BNDES, compared to those that did not receive support, during the period from 2001 to 2005. The analysis also indicated that financing contributed to the increase in jobs, being more significant in small companies financed.

BNDES also offers support for investments in micro, small and medium-sized companies through three products: BNDES Automatic, BNDES Card and Credit Limit. The first provides financing of up to R$20 million (US$ 5 million) for projects to implement, expand, modernize projects and even invest in Research and Development (R&D). The second is a pre-established revolving credit of up to R$1 million (US$ 200,000), intended to finance investments and acquisitions of approved products, including innovative services.

In turn, the Credit Limit is a revolving line of credit aimed at BNDES customers with a low risk of default. In the context of BNDES Automático, the MPME Inovadora Program, introduced in 2014, offers financing for micro, small and medium-sized companies to support investments necessary to introduce innovations into the market. BNDES states that “companies with annual revenue of up to R$90 million (US$ 18 million) that have, since 2011, made investments in technological services through the BNDES Card or accessed the SIBRATEC, SEBRAETEC or SENAI SESI Innovation programs” (BNDES, 2014).

BNDES and Finep have some financing modalities for micro, small and medium-sized companies, including:

1. Refundable financing: loan of resources to support innovative activities in Brazilian companies, following Federal Government guidelines. The terms, rates and other financing conditions are defined following the Lines of Action established in the Operational Policy of the two institutions, and interest rate equalization may be used.

2. Non-refundable financing: can be granted to public institutions or private, non-profit organizations, to support scientific, technological and innovation projects. The economic subsidy modality consists of the application of non-refundable public resources, directly to companies, so that the costs and risks inherent to innovative activities are shared with them. It is an instrument widely used in developed countries (Finep, 2015).

3. Investment via Venture Capital: a form of financing that consists of participation, through the acquisition of shares or other financial instruments that do not require guarantees, in companies or ventures with great growth potential, in exchange for the prospect of a high return in the medium and long term. Due to their specificities, are the ones most suited to this instrument, especially innovative technology-based companies, which do not have access to the capital market or other traditional forms of financing, but offer high return prospects (Pinto, 1997).

Informality in Rio de Janeiro’s Economy

Economic informality refers to the practice of economic activities that occur outside the limits and regulations established by the State. These activities are characterized by the absence of formal registration, formal employment contracts, payment of taxes and other legal obligations. In informality, transactions often occur directly between the parties involved, without the mediation of official institutions. Common examples of informality include street vendors, unregistered self-employed service providers and informal workers.

The presence of informality results from the growth of modern activities, which present a greater supply of work than demand, as evidenced by the scarcity of opportunities in rural areas and the so-called microelectronic revolution, which incorporated technical advances into modern activities. The heterogeneity of work activities is one of the central characteristics of informality. In addition to workers without a work permit and/or formal employment contract, the informal economy includes self-employed labor (or self-employed workers) and small employers. The latter engage in a variety of occupations, such as musicians, seamstresses, shoemakers, mechanics, hairdressers, private tutors, and others. The Metropolitan Region of Rio de Janeiro is an eloquent example of this phenomenon of informality (Guerra, 2009).

The history of informality in Rio’s economy dates back to historical periods in which accelerated urbanization and industrialization coexisted with precarious working conditions. Since the beginning of the 20th century, Rio de Janeiro, as Brazil’s economic and cultural center, has attracted a heterogeneous population in search of opportunities. Population growth and rapid urbanization created a context conducive to the emergence of informality, as many newly arrived individuals were compelled to seek means of subsistence outside the traditional structures of the formal labor market (Guerra, 2009).

In the scenario of those employed without a formal contract, a younger layer stands out, motivated by various reasons, such as a lack of experience in the profession and completing internships, for example. The probability of obtaining a job and the career earnings prospects of an incomplete university student who works as an intern in a large company differ significantly from the professional opportunities and expectations of a worker in small commercial establishments or in the service sector. This distinction represents a categorization within the scope of segmentation.

In this context, the Metropolitan Region of Rio de Janeiro assumes a self-employed profile, where income is not uniform among those without a formal contract and the self-employed. The income of the unregistered worker may depend on their productivity or union interventions, while the self-employed worker is subject to the characteristics of their business and the income of their clients. According to Brazilian Institute of Geography and Statistics (IBGE) data, more than 20% of workers point to restrictions on the formal market as a significant factor in entering the informal economy. This data contrasts the exclusion paradigm, indicating that entry into the informal market occurs due to the lack of opportunities in the formal sector.

Microloans in Rio de Janeiro: Viva Cred, Crediamigo and AgeRio

The offer of microcredit emerged in the city of Rio de Janeiro in 1997 with the institution Viva Cred. Viva Cred originated from an initiative by Viva Rio, an NGO established in Rio de Janeiro in 1993 in response to a crisis in the city that focused its efforts on members of the city’s communities. Using the individual credit methodology, Viva Cred’s operations were initially restricted to the Rocinha Favela community, later expanding to other locations. Today, in addition to the headquarters in Rocinha, there are units present in the community of Rio das Pedras, Maré, Glória - in the West Zone - and a unit in the interior of the State, located in the city Macaé.

When providing individual credit, the institution stipulates that the business has been operating for at least six months. The amount of credit, intended for working capital or fixed assets, varies from R$300.00 (US$60.00) to R$15,000.00 (US$3,000). The term for loans can reach twelve months, if the destination is working capital, and up to twenty-four months, if it is for fixed capital. The interest rate is 3.9%, with a credit opening fee between 2% and 5%. The guarantee required to obtain the loan is the presentation of a guarantor, although this requirement is waived for customers with a positive credit history (Alexandre, 2010).

Microcredit operations at the institution have an average value of R$1,802.00 (US$360.40), with an average term of ten months. At the end of 2008, the institution’s portfolio balance was R$4,437,766 (US$887,553.20), made up of 3,407 clients. The default rate was around 4%, and microcredit operations represented a loss of 1.89% of the capital invested in the institution (Alexandre, 2010).

As of February 2009, Viva Cred began implementing the Crediamigo program in Rio de Janeiro. Crediamigo considerably increases the chance of reaching a significant portion of this audience, due to lower interest rates, a more substantial financial volume and the managerial skill of a program that is recognized not only in Brazil, but also in Latin America. In addition to these positive aspects, the partnership brought a great boost to Viva Cred by enabling the offer of microcredit through the solidarity credit methodology.

Through the partnership, Viva Cred expanded its range of products, adopted more affordable rates and began requiring customers to have a bank account to receive credit. Other changes included the implementation of a more detailed analysis, which may result in a longer credit processing, and the obligation of a guarantor or joint guarantee in all cases of granting, even for customers with a favorable credit history, something which was previously not required in these cases. In addition, the organization implemented several changes, including a more in-depth selection process, a more structured training program, a more rigorous collection approach and a more active presence of credit agents in the field, promoting activities such as joint efforts and lectures.

AgeRio’s oriented productive microcredit offers financing to formal and informal entrepreneurs at reduced interest rates, with the guidance of competent professionals. In collaboration with SEBRAE, the program also provides financial education. The agency, through its credit agents, analyzes the entrepreneur’s business, assessing the need for credit, payment capacity and income generation capacity. After formalizing the contract, the agency monitors the appropriate use of the productive investment. The proximity of credit agents to low-income microentrepreneurs was fundamental to achieving the success stories that will be presented and analyzed later.

Microloans in the Fight against Informality in Rio de Janeiro

At this point, it is not an exaggeration to say that the Brazilian financial system is deficient in meeting the needs of micro and small companies, in addition to not being effective for self-employed workers. The main challenge for small business owners when seeking resources is the lack of guarantees, a barrier that financial institutions face when trying to reduce the risk of operations. This is due to the scarcity of reliable information about businesses and the difficulty for banks to assess risks without solid guarantees.

The banking sector does not support investments and is reluctant to share business risks. Thus, the informal sector lacks investments, and when they occur, they are predominantly financed with their resources. Although banks play a crucial role in the economy by providing credit, taking deposits and offering a variety of services, the lack of support for the small business sector limits their impact on economic development.

In the Brazilian context, especially for those seeking small loans, the financial system is structured based on public sector financing needs and high credit risks. Banks lend to a few, applying high spreads and concentrating their operations on a limited group of customers, avoiding a significant expansion of the volume of credit.

The relationship between businesspeople and banks is generally punctual, localized and short-term. Banks rarely finance investments, and when they do, they impose requirements that make resources more expensive. This ends up compromising the capitalization of businesses, resulting in a limited contribution from the Brazilian banking system to financing new ventures. The lack of risk sharing between banks and entrepreneurs leads to a significant drain on the profits of companies that depend on banks for their business. In this scenario, the demand for credit is naturally low, as borrowers prefer to rely on their capital to manage their activities, aware that access to bank financing can compromise the health of their businesses (Santos, 2009).

Thus, it is concluded that microcredit, by offering more accessible and flexible conditions, encourages formalization by providing attractive financial alternatives. This not only drives financial inclusion but also creates an enabling environment for sustainable economic growth. Encouraging the expansion of small businesses boosts the demand for formalized labor, reducing unemployment rates and boosting local economic dynamics.

There are three interesting examples of the role of microcredit in combating informality in Rio de Janeiro – all driven by the previously analyzed AgeRio’s guided productive microcredit. They are: Barbearia DH, Brincalalá and Cervejaria Complexo do Alemão.

In 2020, Horácio Silva de Mattos was one of the entrepreneurs who benefited from a R$5,000 (US$1,000) microloan. He is the owner of DH Barbearia, a beauty salon active since 2013 in the Rocinha Favela. Rocinha is the largest favela in Brazil, located in the South Zone of Rio de Janeiro and home to approximately 70 thousand inhabitants. The emergence of Rocinha dates back to the subdivision of farms on the old Fazenda Quebra-Cangalha farm, giving rise to a community characterized by socioeconomic disparities and facing significant infrastructure challenges. The venture represents the realization of an old dream for Horácio, who started saving money to make his idea a reality. Using microcredit resources, he was able to renovate the space, replace the stock and face the expenses arising from the period of social isolation (Pamplona, 2023).

Intending to contribute to the education of children aged between one and five years old, Samara Teixeira innovated the proposal for her enterprise, Brincalalá. The design aims to reinvent the experience of traditional children’s parties, incorporating elements such as music, storytelling, visual arts and activities that promote psychomotor development. To make this initiative viable, the entrepreneur turned to AgeRio and obtained financing of R$15,000 (US$3,000). This amount was directed towards the acquisition of toys and essential materials for recreation, holding an average of eight parties per month in the cities of Niterói and Rio de Janeiro. Samara was recognized as one of the winners of the 2015 Brazilian Entrepreneur Award, in the Creative Business category (Xerez, 2018).

Finally, Marcelo Ramos and Gabriel Romualdo, son-in-law and father-in-law, respectively, began their business journey by establishing a craft beer bistro in their garage. The proposal to obtain credit to improve and transform the space was presented to AgeRio by the entrepreneurs. The bistro, known as Estação R&R, achieved success in the Complexo do Alemão Favela region. Complexo do Alemão, located in the North Zone of Rio de Janeiro, is one of the city’s newest neighborhoods. Its creation, in 1993, resulted from the promulgation of law nº 2055. With a population of approximately 180 thousand inhabitants, the neighborhood is made up of the favela communities of Nova Brasília, Reservatório, Alvorada, Morro das Palmeiras, Casinhas, Fazendinha, Canitá, Pedra do Sapo, Mineiros, Morro do Adeus, Morro da Baiana, Matinha, Grota (also known as Joaquim Queiroz) and Morro do Alemão

By expanding its portfolio to more than 300 national and international brands, the bistro attracted both the local public and visitors from outside the community. With the financial support provided by AgeRio, including credits for working capital and fixed investment, the entrepreneurs decided to launch their brand, called Complexo do Alemão. In 2015, the bistro achieved a weekly revenue of 7.3 Brazilian minimum wages (around US$2,061). The introduction of their line of craft beer earned them recognition, winning the “Successful Business” award in the same year (Brito, 2018).

Conclusion

In short, one of the main findings of this study is that microloans, by offering more accessible and flexible conditions, present themselves as an effective instrument in combating informality. The challenges faced by small business owners and self-employed workers when seeking resources from the conventional financial system, characterized by a lack of guarantees and a reluctance to share risks, are alleviated by microcredit. By providing attractive financial alternatives, microcredit not only boosts financial inclusion, but also creates an enabling environment for sustainable economic growth.

In the Brazilian context, marked by deficiencies in meeting the needs of micro and small companies, microcredit emerges as an essential catalyst for the development of the informal sector. Investments in the informal sector often depend on their resources, given the lack of support from the banking sector, which is reluctant to share business risks. This dynamic results in a limited contribution from the banking system to financing new ventures, which, in turn, negatively impacts the expansion of small businesses.

The specific cases presented vividly illustrate the positive impacts of microcredit on the lives of entrepreneurs and the economic dynamics of communities. These examples not only highlight the diversity of sectors benefiting from microcredit, but also highlight the importance of financial support in realizing dreams and consolidating successful ventures.

All analyses point to the continued importance of microcredit as a transformative agent in informal economies. Financial inclusion, encouraging entrepreneurship, generating formal jobs and boosting local economic development are interconnected aspects that reinforce the relevance of microcredit as a powerful tool in the search for more inclusive and sustainable societies. Moving forward, continued collaboration between financial institutions, governments and non-governmental organizations is essential to expand and enhance microcredit programs, thereby driving the positive transformation of informal economies around the world.