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Simone Di Castri   CGAP   Microfinance Regulation And Supervision   Presentation Idlo Amman   June 2009
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Simone Di Castri CGAP Microfinance Regulation And Supervision Presentation Idlo Amman June 2009


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  • 1. Microfinance regulation and supervision microcredit microloans Yunus CGAP reglamentation de la microfinance Access to finance: policy, legal, and regulatory frameworks Amman, June 9-10, 2009 IDLO TW-373E Simone di Castri, Policy Analyst CGAP / World Bank Group
  • 2. Presentation outline Part I Part III • What is CGAP • Terminology Set the context: • Institutional Framework • Microfinance by the numbers • Policies • Diversity of financial services • Regulation and supervision • Diversity of formal providers • Context matters Part IV • Regulation matters • National Frameworks Part II • Regional Context Sharia-Compliant Financial Services Ala’a Abbassi will be analyzed on Sunday
  • 3. 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
  • 4. CGAP: Who we are 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. 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
  • 5. CGAP: What We Do PARTNERS OBJECTIVES KEY ACTIVITIES Donors & Increased funding • Market surveys Investors effectiveness • Standards and norms MACRO • Advisory services Governments More supportive policy • Advisory services environments • Awareness building • Research, policy analysis and standards Financial Market Improved systems, • Information platforms MESO Infrastructure information and technology • Reporting standards • Recognition of model practices Financial Service Diverse Institutions & • New business models MICRO Providers Delivery Channels (technology and graduation) GOAL: Financial access for the world’s poor
  • 6. 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
  • 7. 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
  • 8. Finance for All? access to finance poverty inequality growth • Informational Asymmetries ▫ Moral hazard ▫ Adverse selection • Transaction Costs
  • 9. 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
  • 10. 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
  • 11. 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
  • 12. 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
  • 13. 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
  • 14. 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
  • 15. Branchless Banking: Agent Model and M-Banking Traditional Branch ATM Agent with POS terminal Agent No agent branch within with (cashless) store mobile
  • 16. M-Banking: M-Pesa ownership legal structure e-money equivalent of e-money
  • 17. 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
  • 18. 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
  • 19. 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
  • 20. 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
  • 21. 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) 21
  • 22. Frameworks • Institutional • Policy • Legal and Regulatory
  • 23. 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
  • 24. 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.
  • 25. 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 Not only financial/banking regulation, but a multitude of laws and regulations affects financial inclusion, the provision of microfinance services and the access! 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! 25
  • 26. 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
  • 27. 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
  • 28. 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
  • 29. 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
  • 30. 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
  • 31. 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
  • 32. How to regulate? Prudential and Non-Prudential Regulation for • Some rules have both functions • Soft regulation • Self-regulation Should these norms differ from those applied to commercial banks that offer more typical financial products? 32
  • 33. The Costs of Regulation • Compliance • Supervision • Enforcement • Direct/Indirect/Hidden Substitution effect
  • 34. What to regulate? o Institution/s? o Activities? Syria (pending) o Deposit-taking? o Credit providers? institutions
  • 35. Capitalization requirements and risk management • Minimum capital • Initial reserve requirements Jordan For-profit entities (commercial companies) and NGOs are allowed to • Liquidity requirements engage in microlending with NO Capital adequacy / gearing ratios license & NO minimum capital • requirements) • Risk-weighting of assets • Loan loss provisioning • Loan loss provisioning fiscal treatment • Concentration of risk • Unsecured lending limits • Restrictions on use of funds
  • 36. 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
  • 37. 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
  • 38. Fiscal Concerns • Tax breaks Jordan Tax exemption for all MFIs (Cabinet decree 2004) • Taxes on income Syria NGOs: exempted SFBIs: corporate tax • Taxes on transactions Lebanon NGOs & Coops: exempted • Taxes on payroll Financial Institutions: corporate tax Egypt NGOs: exempted • Double taxation treaty MFCs: corporate tax • Others
  • 39. Intermediation
  • 40. 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)
  • 41. Consumer Protection Critical issues in the contractual relationship Transparency Suitability Fair treatment Privacy Before sale At the Sales practices moment of Information and ** sale disclosure Design of products *** Collection Customers’ During the and contracts practices data execution * **** ****** Redress and recourse After the mechanisms execution ****** * 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
  • 42. Interest Rates (1/2) JORDAN EGYPT LEBANON SYRIA Interest rate cap 9% (Civil Procedural Law) Interest rate cap 7% No interest rate cap on Interest rate cap 9% Financial Institutions are exempted (Civil Code) commercial (Civil Code) (Banking Law) Only banks are transactions (including SFBIs: set by CMC What is the legal status of current MFIs? exempted (Banking Law) “Small Loans” (like banks) A Financial Institutions is a company Cap on Civil whose objectives include financial activities transactions 12% with the exception of accepting unconditional deposits. 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.
  • 43. Interest Rates (2/2) CGAP 2004: IRs caps in 40 developing countries • 20 interest rates control • 13 usury limits • 7 de facto controls
  • 44. 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
  • 45. 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) • (MENA Update - April 2009) • • •
  • 46. Advancing Financial Systems for the World’s Poor Thank you!