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Microfinance Legal-Regulatory Environments:An Assessment Tool for Policy and Programming Decisions

Patrick MeagherIRIS Center, University of Maryland

Microfinance Legal-Regulatory Environments:An Assessment Tool for Policy and Programming Decisions

Patrick MeagherIRIS Center, University of Maryland

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OverviewOverview

• Why a tool?

• Structure and content of the tool

• Using the tool:– Factor analysis– Scenarios and case studies– Policy/program development

• Examples

• Discussion

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Why a Tool?Why a Tool?

The main question:

How to help policymakers and aid donor agencies identify priorities, lessons, and cost-effective solutions that correspond to their specific situations?

Why this is important

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Why a Tool?Why a Tool?

Recognized need for effective regulation and supervision that:

Does not overburden regulator Provides modicum of legal recognition to MFIs

eager to access formal funding sources.

Problem: extent, nature and reach of optimal public oversight depends on many factors in the economy, the financial services market, and the institutional environment

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Environment for microfinance is shaped by a range of institutional factors:

• Governance quality: policymaking, red tape, efficiency, corruption

• Financial, private sector, revenue policies• Commercial law and enforcement mechanisms

Policymakers, donors, stakeholders need to:• Sharpen diagnostic of market conditions and focus on

key institutional constraints• Move beyond traditional responses: free money,

microfinance window

Why a Tool?Why a Tool?

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Policymakers and aid donors are increasingly asked to provide assistance to the development of policy frameworks. These requests (often by MFIs) may be self-interested or ill-informed.

They need to consider all relevant aspects of the market environment when designing microfinance programs and policies -- BUT: They often lack instruments to determine whether the situation

warrants government intervention, and how to implement it. Time and resources are limited. Inappropriate institutions, policies, and programs have a high

cost.

Why a Tool?Why a Tool?

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Growing body of resources: • CGAP Consensus Guidelines, • WBI Microfinance Regulation Training Toolkit,• CGAP/IRIS Resource Center on Regulation

and Supervision on Microfinance Gateway (http://www.cgap.org/regulation)

The assessment tool builds on these sources of information to facilitate the design of policies and programs that fit specific situations

Why a Tool?Why a Tool?

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Evaluate key factors in the microfinance legal-regulatory environment

Factor analysis leads to policy/program scenarios and decision-points

Real case-studies show lessons learned and benefit/cost of different choices at decision-points

The composite “picture” shows how policy/ program choices fit together, aids prioritizing & sequencing

Structure of ToolStructure of Tool

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• Economic and MF market conditions

• Governance institutions

• Business/investment policy climate

• Financial services regulation

• Regulatory capacity

• Transformation options

Key factorsKey factors

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Is low access to finance a binding constraint to SMMEs and low-income households? NO

Economic and Market ConditionsEconomic and Market Conditions

Analysis Responses

Demand suppressed by instability? Predation? Adverse climate for SMMEs?

Address security, governance, business climate until demand recovers

Demand met by social transfers, charity, public or directed lending: Adequate? Efficient?

Examine causes of poverty, cost efficiency of system. Sequence transition to private finance.

Demand met by informal finance: Adequate and sustainable? Why informality?

Examine and address: costs of informality, product mix and price, entry barriers, formalization

Demand met by formal finance: Sustainable? Crowded market?

Focus on institutions’ governance, sustainability, entry conditions

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Is low access to finance a binding constraint to SMMEs and low-income households? YES

Economic and Market ConditionsEconomic and Market Conditions

Analysis Responses

Dysfunctional banking sector: policy, governance, solvency problems. NBFIs few or unviable.

Focus on financial restructuring, social safety nets; strengthen NGO-MFI sector

Banks well-run and supervised, but limited reach. Few NBFIs.

Address bank incentives, commercial environment, tiered financial licensing (“windows”)

Full range of banks and NBFIs, some deepening but insufficient

Address bank & NBFI incentives, competition, product mix

Market will meet demand over time, with continued deepening and down-scaling by banks, etc.

Facilitate transformation of NGOs, informals as appropriate

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Key concerns:– Rule of law, property rights, contract enforcement– Integrity of financial system, regulatory capture,

corruption, policy distortionEffectiveness of governance determines

policy/program design:– Impact: weak gov. may impede, distort, or undermine

reforms; strong gov. may make reforms unnecessary– Sequence: key concerns must be addressed

before/along with regulation– Focus: in adverse setting, try non-state standards,

oversight, enforcement

Governance InstitutionsGovernance Institutions

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Key concerns:– Investment, commercial, tax laws– Organizational form, registration, governance, capital

requirements– Trust and efficiency in transactions, dispute resolution– Politics: biases against enterprise, banking, foreigners, interest,

profit? Bureaucratic empire-building?

Impact on MF policy choice, impact:– Impact: reduced if setting is adverse – e.g. corporate or tax

rules may make new MFIs unprofitable– Sequence: address business climate before/along with financial

regulation. Focus on the most cost-effective reform.– Caveat: financial reform may be distorted by political biases

Business/investment policy climateBusiness/investment policy climate

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FS regulation facilitates microfinance:– Clear rules, appropriate incentives and treatment of

risks, no regulatory arbitrage– Focus: MFI capacity, transformation, other

FSR is neutral or ambiguous:– Legal effect of silence/vagueness:

• Permissive: use existing licenses for now• Prohibitive: new license (“window”) OR amendment to

allow/facilitate the activity within existing system

FSR creates obstacles

Financial Services RegulationFinancial Services Regulation

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Financial Services RegulationFinancial Services Regulation

Problem Response

Entry barriers: minimum capital, documentation, procedure, structure, ownership, fitness test

Ensure neutral, permissive rules within risk-based framework?

Define microfinance as an activity permitted to existing licensed institutions, with special conditions

Mandate services (CRA)? Provide incentives?

Adjust an existing services tier?

A new MFI tier (“window”)?

Analysis: is benefit/cost of reform greater than for status quo?

Capital, liquidity requirements: capital adequacy, reserves, provisioning rates & schedule

Supervision and reporting: frequency, on and off-site, intrusiveness, burden

Operating rules: branching, security, records, interest rates, products, concentration, control

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Key question: Sufficient capacity to implement proposed regulations?

Key concerns:– Public sector & corporate governance– Quality and incentives of officials– Skill base: accounting, audit, enforcement– Match between responsibility & resources

Response: match reforms to capacity– Do not overextend regulators– Develop basic systems and skills, secure necessary

authority

Regulatory CapacityRegulatory Capacity

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Key questions:– How important are NGOs as a segment of

existing or potential MFIs?– Is the transformation procedure clearly

defined? How difficult, costly?

Reponses:– NGOs important but transformation process

unclear/costly define, streamline process– Otherwise: focus on new MFIs, other

Transformation OptionsTransformation Options

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South Africa:• Situation: Banks well-run and supervised, but limited reach. Few

formal, effective NBFIs.• Diagnosis:

– Weaknesses in economic conditions, commercial framework gradually being addressed

– Key constraint: restrictive bank licensing & usury laws

• Response:– Phase 1: liberalize microlending; set conditions; delegate licensing,

market integrity & consumer protection to “hybrid” regulator

– Phase 2: address bank incentives, reform FS tiers, etc.

• Problem: chronic economic & commercial environment problems, FS concentration & lack of competition, populist politics

Case study analysis: exampleCase study analysis: example

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Composite ‘picture’Composite ‘picture’

Factors:

Economic and MF market conditions

Governance institutions

Business/investment policy climate

Financial services regulation

Regulatory capacity

Transformation options

Analysis:

Assess each factor (e.g. positive or negative), address specifics of the situation, identify causes.

Which constraints are binding? Rank in order of priority.

Response:

Propose responses to each binding, high- priority constraint. Rank in terms of benefit/cost.

How do responses inter-relate? Are they consistent – or need to be adjusted?

Sequence the responses – start with basic ‘building blocks,’ politically feasible steps, ‘quick wins’

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The tool is to be used for participatory development of policies & programs

Can we apply it to Brazil? If so:– Break into 6 groups– Each group analyzes one factor– Report back: analysis of factors, composite

analysis, discuss/develop responses

Policy/program developmentPolicy/program development

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• Why a tool?

• Structure and content of the tool

• Using the tool:– Factor analysis– Scenarios and case studies– Policy/program development

• Examples

RecapRecap

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• Do you think this tool can be useful to policymakers? To international donor agencies? Others?

• Is it relevant to your work?

• Where is it appropriate to use it? Brazil? Elsewhere?

• How can it be improved? What changes would you suggest?

QuestionsQuestions

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Thank You