International Experience of the Effect of the Regulatory Framework on the Choice of Legal Form
This section discusses international experience of the effect of regulatory frameworks on the choice of legal form by MFIs. It shows that a number of countries have introduced regulatory frameworks for the provision of microfinance services. The experience has been that, contrary to the fear of central banks, while these frameworks have enabled transformation of some institutions they have not resulted in large numbers of MFIs needing to be supervised.
The earliest initiatives to bring microfinance under formal regulation and supervision were undertaken in Latin America. These entailed either the registration of microfinance institutions as licensed commercial banks, as private financial funds (PFFs) or as regulated private finance companies (Sociedad Financiera de Objeto Limitado). Essentially, a PFF (in Peru for instance) has to be a corporation with a minimum paid up capital equivalent to US$1 million, just one-third of the amount required for a commercial bank. Table 5.1 contains the minimum capital requirements for commercialization in other countries of the region. In addition, however, there is a stringent constraint on operations as the maximum portfolio allocation to loans is just twice the value of equity. PFFs are basically subject to the supervision methods applied to banks supplemented by special methods developed for MFIs including assessment of the credit methodology and visits to clients.
Table 5.1
Minimum Capital Requirements for Commercialisation
|
Countries |
Financiera
(US$m) |
Commercial Bank
(US$m) |
|
Bolivia |
1.0 |
5.6 |
|
Ecuador |
1.3 |
2.6 |
|
El Salvador |
1.0 |
2.5 |
|
Honduras |
5.0 |
8.0 |
|
Mexico |
2.2 |
N/A |
|
Peru |
N/A |
5.6 |
The trend to regulated microfinance started in Bolivia in 1992 when the microfinance activities of the NGO, Prodem, were transformed into BancoSol which was registered as a licensed commercial bank. In 1995, in Ecuador, Banco Solidario was established as a commercial bank while Procredito, Bolivia was transformed into Caja los Andes, the first organisation to become a Fondo Financiera Privado (Private Financial Fund - PFF) under new legislation to create a specific structure for regulated non-bank microfinance institutions. Also in 1995, Calpia was established as a Financiera in Ecuador, FINSOL in Honduras was established in 1999 while in Peru the NGO ACP gave birth to Mibanco as a commercial bank in 1998, and in Mexico the NGO Compartamos was transformed into a Sociedad Financiera de Objeto Limitado as a regulated private finance company in 2001.
As with NBFCs in India, one difficulty during the process of licensing and approval is mobilizing the capital and creating the ownership structure required to satisfy regulatory requirements. “Ensuring adequate capital provides protection to institutions against various risks, allows for absorption of losses and, therefore, instils confidence amongst investors, lenders, clients and regulators. The question in microfinance is “what is an adequate level of capital?” It is widely accepted that the minimum capital requirements for specialised MFIs need not be as high as those for full service commercial banks because of the low portfolio size and the fact that the portfolio is not concentrated in a few large loans. Levels that are too high may discourage MFIs from commercialisation while low levels may allow unqualified entrants and also may not provide enough control incentive to owners.” As is apparent from Table 5.1, the minimum capital requirements for MFI transformation are quite high in most Latin American countries and these effectively limit entry of large numbers of MFIs into the regulated financial sector.
In Africa, a number of countries have started to put regulatory frameworks for microfinance into place. Particularly advanced in this field are Uganda and Ethiopia. “There are presently over 500 organisations in Uganda offering microfinance, together providing financial services to approximately 550,000 clients, the majority being women. Group lending is the predominant lending methodology using a blend of solidarity groups and village banking. Many MFIs require clients to deposit compulsory savings that are then locked in and not made available to the client until s/he has repaid the MFI loan. MFIs are not legally allowed to mobilise savings and on-lend them, leaving them operating either outside the legal framework or within traditional co-operative or formal sector banking laws. Only two organisations fall in the latter category and are currently regulated by the central Bank of Uganda (BoU) – one commercial bank, Centenary Rural Development Bank (CERUDEB); and one specialised microfinance credit institution, Commercial Microfinance Limited (CMFL).
“As the microfinance sector has grown, there has been increasing recognition of the need for change due to the fact that:
· MFIs’ emphasis on credit often exclude the risk-averse poorest who would rather save in order to meet future needs and crises than to incur debt through getting a loan. But the legal framework has prohibited MFIs from offering voluntary savings services
· There has been increasing pressure from low income clients in general to add more flexible savings services, thus providing depositors with security, convenience, liquidity and, ideally, some rate of return. Again the law has constrained this development
· If priced correctly, savings instruments can contribute to institutional self-sufficiency and to wider market coverage
“Realising the need for a user-friendly legal and regulatory framework, the BoU issued a Policy Statement on Microfinance Regulation and Supervision in 1999. This categorised financial institutions into four ‘Tiers’:
1. Commercial Banks, licensed under the Financial Institutions Statute 1993
2. Credit Institutions, licensed under the Financial Institutions Statute 1993
3. Microfinance Deposit-Taking Institutions (MDIs), to be licensed under the new Micro Deposit-Taking Institutions Act, 2002 (MDI Bill)
4. Institutions involved in microfinance that do not qualify for Tier 1, 2 or 3, eg smaller NGOs, membership-based savings and credit associations, and community based organisations (which will not be regulated or supervised by the Bank of Uganda)”
The MDI Bill was introduced in the Ugandan Parliament in 2002 and then went through an extensive process consultation during which MPs had to be convinced of the need for such legislation. Its impact on the choice of legal form is yet to be seen.
Experience of the effect of regulation on the choice of legal form in selected countries of South and South-east Asia is summarized in Table 5.2 on the following pages. It is apparent from the table that
1 A number of countries in Asia have legislation and/or regulatory frameworks that are specifically designed to promote outreach beyond the traditional markets served by commercial banks. Prominent amongst these are the BPRs of Indonesia and the Rural Banks of the Philippines.
2 Where such frameworks are not specifically restricted to microfinance, they have resulted in the creation of large numbers of financial institutions with substantial governance problems and have also resulted in over-stretching the supervisory resources of central banks.
3 However, where these frameworks are limited to and specifically designed for enabling the provision of microfinance the situation is very different. Relatively few MFIs are able to qualify for registration in their ability both to raise adequate capital and to satisfy the management requirements of regulatory authorities. Thus, there are just 6 microfinance oriented Rural Banks in the Philippines, 9 licensed MFIs in Cambodia, 5 private development banks in Nepal and just 5 microfinance banks in Pakistan (not included in Table 5.2).
Everywhere, central banks (and supervisory authorities) are still gaining the experience necessary to undertake effective yet supportive prudential supervision of regulated MFIs. A study of the costs and benefits of supervision, undertaken in Latin America, found that MFIs believe that from their perspective the benefits of being regulated outweigh the cost.
