Access to finance: policy, legal, and regulatory frameworks

Amman, June 9-10, 2009IDLO TW-373E

Simone di Castri, Policy AnalystCGAP / World Bank Group

Microfinance regulation and supervision microcredit microloans Yunus CGAP reglamentation de la microfinance

Presentation outline

Part I• What is CGAP

Set the context:

• Microfinance by the numbers• Diversity of financial services• Diversity of formal providers• Context matters• Regulation matters

Part II• Regional Context

Ala’a Abbassi

Part III• Terminology• Institutional Framework• Policies• Regulation and supervision

Part IV• National Frameworks

Sharia-Compliant Financial Services will be analyzed on Sunday

Goals

• To find agreement on basic legal and economic concepts related to access to finance

• To discuss policy and regulatory approaches

• To compare frameworks in a number countries

CGAP is an independent policy and research center dedicated to advancing financial access for the world's poor.

It is supported by 33 development agencies and private foundations who share a common mission to alleviate poverty.

CGAP provides market intelligence, promotes standards, develops innovative solutions and offers advisory services to governments, microfinance providers, donors, and investors.

CGAP: Who we are

At a glance:

• 7 locations: offices in Washington DC, Paris and Bruxelles, with 4 regional representatives based in Abidjan, Dhaka, Moscow and Jerusalem

• 28 million dollar annual budget

• 18 European based members

• 60 staff

• 70 countries with CGAP activities

• 150,000+ copies of CGAP publications distributed globally in 2008

More supportive policy environments

Governments

Increased funding effectiveness

Donors & Investors

Improved systems, information and technology

Financial Market Infrastructure

Diverse Institutions & Delivery Channels

Financial Service Providers

CGAP: What We Do

MACRO

MICRO

MESO

• Market surveys• Standards and norms• Advisory services

PARTNERS OBJECTIVES KEY ACTIVITIES

• Advisory services• Awareness building• Research, policy

analysis and standards

• Information platforms• Reporting standards• Recognition of model

practices

• New business models (technology and graduation)

GOAL: Financial access for the world’s poor

Microfinance by the Numbers (1/2)

• Over 2.7 billion people in the world live on $2 or less a day• More than 2.5 billion potential clients have no access to financial

services • Estimates for total number of MFIs worldwide range from 7,000 to

12,000

Microfinance by the Numbers (2/2)

• Around 750 million savings and loan accounts in double-bottom line financial institutions

• Specialized MFIs account for about only 18 % of these accounts

Finance for All?

• Informational Asymmetries▫ Moral hazard▫ Adverse selection

• Transaction Costs

access to finance

poverty

growthinequality

Diversity of financial services

• Poor people need a wide array of flexible financial services

• A demand driven approach will encourage portfolio diversity by offering

the poor a variety of financial services: deposit services

a variety of loan products

insurance

transfer

payments

remittance services Secure

Convenient

Flexible

Diversity of formal providers

• NGOs (various forms)• Commercial finance (and leasing) companies• Financial cooperatives• Commercial banks• A variety of government-run and/or government-owned

financial service entities• New players on the scene:

▫ Nonbank retail agents supporting ‘branchless banking’ models▫ Mobile phone operators and nonbank prepaid card issuers

Bank Downscaling Model

• Definition: Downscaling is all about enticing mainstream commercial banks to provide microfinance services.

Downscaling is not a consumer lending to lower income clients• Advantages: already has the infrastructure and the banking

knowledge• Challenges: few bank managers have the vision or the desire to

“downscale” (conservatism)• Examples: Kazakhstan Small Business program (7 banks), Russia

Small Business Fund (17 banks), China Delelopment Bank Program (12 banks), Egypt Banque du Caire, Brazil Banco do Nordeste

Greenfield Model

• Definition: Greenfield banks are new institutions specialized in microfinance usually set up as corporations by a microfinance investment company in cooperation with a consulting firm and supported by a funder (mostly DFIs).

• Advantages: Greenfields have a banking license from the beginning and can offer a diversity of financial services. They focus on poor clients and reach new market segments.

• Challenges: High start-up costs, possible hidden subsidies => exit strategies for public funders

• Examples: ProCredit Banks in ECA; Advans in Cameroun; Opportunity Banks, BRAC in Afghanistan, ACLEDA in Laos

• Funders: KfW, IFC, FMO, EBRD, World Bank, DOEN Foundation

NGO Transformation Model

• Definition: a microfinance non governmental organization transforms itself into a licensed institution to raise deposits from the public

• Advantages: NGOs usually serve lower segments of the population and have a double bottom line (social responsibility). It enables the NGO to expand its services and outreach and poor people to access much needed voluntary deposit services.

• Challenges: transformation is painful for “non-bankers type”. The reporting requirements are expensive.

• Examples: Card Bank in the Philippines, EMT in Cambodia, BRAC in Bangladesh

Cooperative Model

• Definition: developing member-owned saving and credit institutions which are registered as cooperative

• Advantages: relatively low cost and enable members to have a say in the way the organization is run.

Financial cooperatives have emerged in 19th century – long experience

• Challenges: governance is often an issue as well as the supervision of cooperatives because cooperatives often fall under supervision authorities that lack financial knowledge

• Examples: Desjardin replications, Woccu members and saving and credit cooperatives in Africa

Branchless Banking: Agent Model and M-Banking

ATMBranch withinstore

Agent with POS terminal Agent with mobile

No agent (cashless)

Traditional branch

M-Banking: M-Pesa

ownership legal structure e-money equivalent of e-money

Successful business models: context matters

EACH COUNTRY IS DIFFERENT

DIFFERENT FACTORS MATTER

Political economy

Existing regulation

Strength of existing institutions

Stage of financial sector development

Existence of market infrastructures

Availability of technologies

Population density

Levels of poverty

Competition

Expanding access to finance: regulation matters (1/2)

“When we take savings in India, it is actually in violation of the law. I have a structure with eight entities in order to sidestep enough of the law that it stays below the radar.”Vikram Akula - McKinsey Consultant and Founder and Chair of SKS India

“Think of the financial sector as a three-legged stool; if the law is the seat of a three-legged stool, regulations are the legs. One leg is safety and soundness. One is profitability and innovation, and one is consumer protection. All these virtual legs are equally strong and supportive and each is essential to maintaining balance. It is through effective and balanced regulations and rules that the system has retained its integrity, its edge and its ability to deliver capital where it is needed. Regulations should allow this more risky activity to be profitable.”Diana Taylor - New York State Banking Superintendent

Expanding access to finance: regulation matters (2/2)

“Financial regulation around the world was designed to prevent fraud and to insure stability of the financial system, how did it evolve into an instrument that prevents innovation in financial services and broad access to credit? Unfortunately, it is no accident. Many intermediaries benefit from restrictions to competition and may see universal access as a threat. For this reason, the struggle to reform regulation in favor of microfinance is not an easy one.”Luigi Zingales - Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago

“Governments, including central banks, must balance the responsibilities they have been given related to their banking and financial systems. We have the responsibility to prevent major financial market disruptions through development and enforcement of prudent regulatory standards and, if necessary, in rare circumstances, through direct interventions in market events. But we also have the responsibility to ensure that the regulatory framework permits private sector institutions to take prudent and appropriate risks, even though such risks will sometimes result in unanticipated bank losses or even bank failures.”Alan Greenspan - former Chairman of the Federal Reserve of the United States

Terminological Confusion

• Different countries use same terms differently

• Different countries use different terms to mean the same thing

• Non-lawyers use terms differently from lawyers and regulators

• MFI and microfinance

▫ are not regulatory terms, except in a small number of countries where they have been added recently

▫ could mean many different things, depending on the country

e.g. proposed regulation in Egypt permits a loan of up to US$100,000 to be considered a microcredit loan, while in Lebanon the cap is placed at approximately US$6,000

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Microfinance is the provision of a broad range of financial services such as deposits, loans, payment services, money transfers and insurance products

to the poor and low-income households and their microenterprises.

By definition, microfinance is not subsidized credit, not a dole-out, not salary or consumption loans, and a cure-all for poverty.

Bangko Sentral ng Pilipinas (BSP)

Frameworks

• Institutional• Policy• Legal and Regulatory

Institutional Framework (e.g.)

refers to the implementation of bodies, policies and tools to support and promote the legal framework and the regulatory framework, but also a sector or an activity, such as the provision of financial services to the poor.

• Authority in charge of Banks/Coop/MFI/others licensing

• Authority in charge of Banks/Coop/MFI/others supervision

• Public administration in charge of financial sector support

• Public guarantee fund• APEX institution• Role of MFIs national/regional network

Policy Framework (e.g.)

• National Strategy and/or Policy of which Micro-Finance is a part▫ National Poverty Alleviation▫ Economic and Monetary▫ Financial Sector▫ Agriculture▫ SME▫ Microenterprises▫ Unemployment▫ Youth & Women

• Wholescale debt relief initiatives (generally in agricultural loans; ie India)

• Directed Lending / Priority Sector Lending

In India, public and private domestic banks are required to lend 40% of ANBC to priority sector, of which 18% to agriculture sector, and a major stake to micro and small enterprises. In Brazil, private banks must assign their mandated 25% of deposits to any agricultural clients, and 2% towards microfinance operations.

Access to Finance and Regulation

• Jordan No MF Regulation• Syria MF Decree (2007)• Lebanon No MF Regulation • Egypt Single Regulator Act / General Rules for Microfinance

Companies

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Regulation

Laws Set of rules adopted by a legislative body

Regulations Set of rules adopted by an executive body

Supervision External oversight aimed at determining and enforcing compliance with regulation.

Do not regulate what cannot be supervised!

Not only financial/banking regulation, but a multitude of laws and regulations affects financial inclusion, the provision of microfinance services and the access!

Basel Committee for Bank Supervision at BIS

BCBS• Established by G-10 in 1974• 13 Member countries, industrialized nations, represented

by central bank• Forum for cooperation on bank supervisory matters• Encourages convergence toward common approaches

and standards▫ no detailed harmonization▫ No supranational authority, legal force▫ Implementation of broad standards, guidelines tailored to

country context

Basel Capital Accords

• 1970s oil and debt crises highlighted need to better supervise internationally active banks

• Basel Capital Accord (1988) attempts to reduce bank failures by tying bank’s CAR to riskiness of loans

• Aligns capital standard with basic credit risk measurement framework

• Introduced in virtually all countries with internationally active banks

Basel II

• In process of implementation• Greater role played by bank management and market• Better align capital to underlying risk• Incentive to improve RM• Comprehensive coverage of risks

▫ Applicable to wider range of banks (more options)

• Proposed: largest internationally active banks (eg Citi, HSBC)• Reality: estimated 100 countries (and counting) plan to implement

Basel II▫ Should not apply to MF banks based on BCBS parameters (eg

asset size, international activity, supervisory capacity)▫ Mix data: 7% MFIs are banks, but extend 57% of microloans▫ Borrowing costs may increase, most MFIs will be subinvestment

quality

Basel Core Principles for Effective Bank Supervision (BCPs)

▫ 25 principles cover range of supervisory and risk management topics and issues

▫ Core Principles Methodology - facilitates implementation and assessment

Gold standard, benchmark for regulation and supervision of deposit takers

BCBS subgroups and MF: ILG and CPSS

• International Liaison Group – ILG▫ Forum to deepen BCBS engagement with

nonmember countries on range of issues• BCBS members (8) and nonmembers (16), EC, IMF, WB,

FSI, ASBA, Islamic FSB• Working groups: Capital (ILGC) and AML/CFT (AML/CFT

EG)• Main entity working on prudential MF issues• No explicit access/inclusion mandate in BCBS

• The Committee on Payment and Settlement Systems - CPSS

Why to regulate? Hypotheses

• to reduce the level of risk bank creditors are exposed to (i.e. depositors)

• to protect clients, and investigate complaints (i.e. representation of interest rates)

• to reduce systemic risk resulting from adverse trading conditions for banks causing multiple or major bank failures

• to avoid misuse of MFIs and banks for criminal purposes (i.e. laundering the proceeds of crime)

• to prosecute cases of market misconduct

• to protect banking confidentiality

• to direct credit to favored sectors or borrowers

• to license providers of financial services

• to maintain confidence in the financial system

• to attract investments

• in general, to reduce the moral hazard of the actors

• to increase financial inclusion (i.e. reducing adverse selection)

• to promote the development of the sector and access to finance

How to regulate?Prudential and Non-Prudential Regulation

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for

Should these norms differ from those applied to commercial banks that offer more typical financial products?

• Some rules have both functions• Soft regulation• Self-regulation

The Costs of Regulation

• Compliance

• Supervision

• Enforcement

• Direct/Indirect/Hidden

Substitution effect

What to regulate?

o Institution/s? o Activities?Syria (pending)

o Deposit-taking? institutions

o Credit providers?

Capitalization requirements and risk management

• Minimum capital

• Initial reserve requirements

• Liquidity requirements

• Capital adequacy / gearing ratios

• Risk-weighting of assets

• Loan loss provisioning

• Loan loss provisioning fiscal treatment

• Concentration of risk

• Unsecured lending limits

• Restrictions on use of funds

Jordan For-profit entities (commercial companies) and NGOs are allowed to engage in microlending with NO license & NO minimum capital requirements)

Ownership and Governance

• Standards for ownership officers• Restriction on foreign ownership• Other restrictions on ownership• Standards for managers• Possibility to create stock-options or other incentive tools

for management by the shareholders• Restrictions on managers• Other governance standards and restriction• Prohibited sources of funds

Accounting, auditing and reporting requirements and operational concerns

• Accounting norms▫ Estimated cost of auditing requirements▫ Estimated cost of reporting requirements

• Loan contract registration• Collateral registration• Loan recovering enforcement legal tools• Connected/insider business• Involuntary and voluntary liquidation procedures• Corrective action powers

Fiscal Concerns

• Tax breaks• Taxes on income• Taxes on transactions• Taxes on payroll• Double taxation treaty • Others

Jordan Tax exemption for all MFIs (Cabinet decree 2004)

Syria NGOs: exempted

SFBIs: corporate tax

Lebanon NGOs & Coops: exempted

Financial Institutions: corporate tax

Egypt NGOs: exempted

MFCs: corporate tax

Intermediation

Regulating Credit Only Financial Institutions

• Registration with authorities• Tax benefits• Annual financial statements/audits (perhaps only relevant if MFI is

borrowing from commercial banks) • Limited reporting of activities/business for statistical purposes• KYC (Know your customer)• Anti-money laundering/combat financing of terrorists (AML/CFT)• Consumer protection (particular attention to overindebtedness)• Interest rate regulation/usury• Consider possible abuses:

▫ across variety of products (not just credit);

▫ over life cycle of product (marketing, delivery, collection)

Consumer Protection

Critical issues in the contractual relationshipTransparencySuitabilityFair treatmentPrivacy

Before sale

Design of products and contracts

*

Information and disclosure

***

Sales practices**

At the moment of sale

Customers’ data

******

During the execution

Collection practices

****

After the execution

Redress and recourse mechanisms

******

* e.g. terms and conditions, rights and obligations, right to withdraw from the contract, to change product or switch provider, repayment breaks; unilateral changes and automatic adjustments; prevention of overindebtedness

** e.g. of rates, terms, and conditions, of rights and obligations, of the characteristics of the product or service, of redress and recourse, of changes in rates, terms, and conditions; what information and disclosure (type) and

how (language, format, timing, location) are provided; transparency (standardization, comparability, public availability)*** e.g. advertising and marketing, affordability, incentives for the agents, prevention of overindebtedness**** e.g. delinquency and privacy, incentives for the agents***** e.g. personal and financial; re: prevent overindebtedness****** e.g. procedures to detect and respond to mistreatment or abuse

Interest Rates (1/2)

JORDANInterest rate cap 9% (Civil Procedural Law)

Financial Institutions are exempted (Banking Law)

What is the legal status of current MFIs?A Financial Institutions is a company

whose objectives include financial activities with the exception of accepting

unconditional deposits.

EGYPTInterest rate cap 7%

(Civil Code)Only banks are

exempted (Banking Law)

LEBANONNo interest rate cap on

commercial transactions (including

“Small Loans” Cap on Civil

transactions 12%

SYRIAInterest rate cap 9%

(Civil Code)SFBIs: set by CMC

(like banks)

Microcredit rates have been dropping by 2.3 percentage points each year since 2003, much more steeply than the decline of bank loan rates. In the MENA region, interest yields declined by 3.9 percent between 2003 and 2006. (CGAP, 2008)400 sustainable MFIs reporting to the MIX in 2006, the median borrower paid bout 31% per year.

Interest Rates (2/2)

CGAP 2004: IRs caps in 40 developing countries• 20 interest rates control• 13 usury limits• 7 de facto controls

Regulatory Issues for Foreign Financing

• Equality of treatment of foreign investors with local investors in case of crisis

• Relevant procedure of conflict resolution in case of commercial disagreements with the public, private local and private foreign partners.

• Possibility to cash dividend from equity investments• Tax treatment of foreign investment• Foreign ownership restrictions and governance matters• Availability of hedging instruments and cost of hedging• Sequestering foreign direct investments for long periods of time

(Argentina, Brazil and Venzuela)• (in)Ability to repatriate profits

References

• Finance for All? Policies and Pitfalls in Expanding Access (The World Bank, 2008)

• The Portfolio of the Poor (Collins et al., 2009)• Consensus Guidelines: Guiding principles on regulation and

supervision of microfinance (CGAP, 2003)• Rethinking Banking Regulation (Caprio et al., 2008)• Islamic Microfinance, a Market Niche (CGAP, 2008)• Microfinance Regulation Curtail Profitability and Outreach? (Cull et

al., 2008)

• cgap.org (MENA Update - April 2009)• microfinancegateway.org• microfinanceregulationcenter.org• themix.org

Advancing Financial Systems for the World’s

Poor

Thank you!