Group I: POLICY
AND REGULATORY ENVIRONMENT FOR MICROFINANCE INSTITUTION
Members: Mr. Saleem Ullah (Pakistan) Mr. Kah Leong Wang (Singapore) Mr. Kachesa Chookole Bbenkele (South Africa) Mr. Sidup Belaman (Brunei Darussalam) Mr. Saman Ghasemi (Iran) Mr. Achmad Rofi’ie (Indonesia)
1. Introduction A
conducive policy and regulatory environment is widely accepted as an
important prerequisite for the development of a viable, sound and stable
microfinance sector. One may question that microfinance in most parts of
the world has grown in the absence of specific financial
sector policy. Bangladesh, the world’s leader in microfinance
has yet to have a formal framework for microfinance, but its policies
and regulations could be instrumental in promoting financial services to
the poor. The conducive policy environment, however, is required both
for formal and informal microfinance programs. The NGOs and donors etc
don’t initiate/expand their programs in areas/countries having
restrictive policy environment. The exceptional growth of microfinance
in the last two decades is also attributable to the overall supportive
policies adopted by the various governments. The objective of formulating the guidelines on microfinance policy and regulatory issues is to disseminate the best practices in the developing countries and provide them a basic layout/structure of microfinance policies and regulations normally required for the development of a sound, stable and vibrant microfinance sector. The guidelines however are suggestive in nature and the governments and policy makers are encouraged to review the guidelines and consider for introduction in their countries after necessary customization. 2. Policy and Regulatory
Environment The policy and regulatory environment for MFIs very much depends on the governments’ intention and commitment to promote the sector. The major features of a conducive policy & regulatory environment will be discussed in the following segments. However, the governments and policy makers should review this guideline in the light of their own environment and introduce the necessary changes, if any, to ensure the development of a sound and vibrant microfinance sector best suited to their economy. The following points are required in the development of a microfinance:
3. Conducive Economic
Policies for Microfinance Low inflation, substantial investment in education, health and physical infrastructure and an effective and transparent governance system are some of the economic policy issues which directly affect the provision and effectiveness of microfinance services. High inflation erodes the already weak purchasing power of microfinance clients, forcing them to default in their loan payments which cause further dip into the poverty cycle. The governments, by maintaing low inflation rates and creating empolyment, business and investment opportunities can enable the poor to gradually increase their purchasing power and asset base so as to get out from vicious poverty cycle. Investment in social sector, education, health and physical infrastructure creates business, investment and capacity building opportunities for the poor, which enables them to productively use the microfinance services. Empirical evidence shows that the areas/countries where micofinance services were provided along with investment in physical and social infrastructure, have experienced visible improvement in poverty conditions and living standards of the poor. For government agencies, it is advisable to make investments in social and physical infrastructures and develop the framework for delivery of services to the masses instead of directly delivering microfinance and other services to the poor. The non-existence of an effective and transparent governance system has been one of the major reasons for the poor state of social and physical infrastructure in most of the developing countries. A transparent and effective governance system with well defined authorities and responsibilities, built in control systems, effective monitoring mechanism and the board accountability is a pre-requisite for success of any sector of the economy including microfinance. In a number of developing countries, huge resources made available by donor agencies and governments for poverty alleviation were largely wasted without making any impact on the poor, primarily due to weak governance and monitoring systems. The governments, besides allocating resoureces for poverty alleviation, will have to demonstrate political will and commitment to develop and enforce a transparent governance systems in order to make a visible impact on the poverty levels which has been exhibiting a rising trend in most of the developing countries. 4. Government’s
Commitment to Promote the Sector Governments’ and policy makers’ belief in the utility and importance of microfinance and their sustained commitment demonstrated through sector friendly policies is critical for growth of the sector. It sets the tone and pace of development and gives direction to the stakeholders to plan and initiate different types of services to support the poor. The best way to demonstrate a government’s committment to promote the sector is to formulate and issue their national microfinance policies explicitly, by defining its plans and strategies for the sector. While some countries have already developed and issued their national policies for microfinance, others, though developed, have yet to institute the policies. The policy makers are encouraged to develop the policies in consultation with the stakeholders and formally issue the same to demonstrate their firm commitment to promote the sector as well as to give direction to the stakeholders. The National Policy for Microfinance may inter alia cover the followings:
5. Financial Market and
System Approach for the Development of Microfinance Traditional approach and financial markets/systems approach are the two most commonly used approaches for provision of micro and rural finance services. The traditional approach assumes that the poor cannot save and pay market rates of interest on their loans. Based on this assumption, governments and donor agencies have to channel heavily subsidized funds to a selected target group. The results, however, in almost all the countries, which adopted the approach, had not been encouraging as there was limited outreach to the target sectors, gross abuse of subsidized credits, acute repayment problems, collapse of institutions and most importantly, the non-development of financial market conducive to support the sector. The finacial market and system approach considers micro and rural finance as an important part of over all financial system, dispels the myth that the poor cannot save and pay market rate interest on loans and encourages the provision of demand driven financial services to the poor through self sustainable institutions. The financial markets approach assumes that the poors are able to generate economic surpluses, which enable them to repay the real costs of loans and also to save. The unprecedented success of BRI of Indonesia, Bancosol of Bolivia and ASA & BRAC of Bangladesh supports the assumptions of the financial markets approach. This approach requires the governments and policy makers to develop conducive policy and regulatory environment and implement the necessary support and financial infrastructure for MFIs in order for them to deliver the various financial services to the poor and micro enterprises. 6. Partnership and
Collaboration with Stakeholders Partnership
and collaboration with practitioners and stakeholders should be the
hallmark of the policy formulation process. These countries, including
Indonesia, Philippines, Pakistan and Bolivia, amongst others, which have
institutionalized the consultation mechanism have been able to produce
remarkable results both in policy formulation and increase its outreach
of services to the poor. It is highly recommended that the
governments/central banks should consider forming Microfinance
Consultative Groups/forums in their respective countries by having the
representation of major stakeholders viz. the practitioners (from both
formal and informal sectors), Central Bank, relevant government
ministries and donor agencies to deliberate upon the microfinance policy
issues and to make recommendations to the governments/central banks on
such policy issues. The partnership and collaboration with stakeholders
would help to develop trust between the policy makers and practitioners,
thus enabling the central bank to develop sector-friendly policies and
regulations and to provide an effective platform to ensure sustained
growth in the sector. 7. Creation of Apex
Institution and Capacity Building Support Limited capital base and unstable sources of fund has been one of the major impediments to growth of the microfinance sector. Most NGOs do not normally have the capacity and collaterals to raise commercial funds from the money/capital markets but have to rely largely on grants and credit lines from donor agencies to expand their programs. The countries who created apex instituions like PKSF of Bangladesh have been able to provide stable sources of on lending funds and capacity building grants to the MFIs. The apex institutions are particularly useful for countries where microfinance is at evolutionary or initial stage of development that requires handholding by government and policy makers at least for the medium term in order to attain maturity. The financial market approach emphasizes building of institutional capacity of MFIs to deliver the services on longer term basis. It requires governments and policy makers to create support mechanisms for MFIs to build their capacities through trainings, consultancy support for information systems and product development and grants for network expansion. Although the support system for MFIs is imperative, however, it should only finance the institutional building cost of MFIs rather than subsidising the operational cost in order that the system can be made effective. 8. Conducive Legal and
Regulatory Framework Microfinance in most parts of the world have been developed without any specific legal and regulatory framework. The NGOs and other microfinance programs not covered under any proper legal, regulatory and supervisory framework have been and are still the major providers of microfinance to the poor. With such results, one could hardly see any reason in developing the legal & regulatory framework for MFIs. However, with increased recognition of microfinance as an important poverty alleviation tool, there is a consensus amongst the governments and practitioners that the outreach of services should be increased manifold to reach out to the maximum number of the poor in medium and long term. The NGO-MFIs however, given their capacity and resource constraints, could not be solely relied upon to increase the outreach; other institutions such as specialized microfinance banks, commercial banks etc with capacity to raise public savings to finance their operattions will have to be established/permitted. Furthermore, the NGOs, though established with a social cause of serving the poor, were utilizing handsome grants from government and donor agencies. There is thus a need to ensure transparency in their governance by way of adequate disclosure about their operations so as to check the financial health of these institutions. Some countries, including Pakistan, Bolivia, Cambodia, Uganda, etc, have developed separate legal and regulatory frameworks for microfinance banks whereas others, such as the Philippines, has made changes in their existing regulatory framework to allow establishment of second tier banks to extend microfinance services to the poor in both the urban and rural areas. The legal and regulatory framework in all these countries is applicable only to MFIs involved in deposit mobilization from the general public to finance their operations whereas NGOs have been encouraged to form their own associations/networks to promote transparency, good governance and dissemination of information about their operations. The countries that have adopted the tiered approach of regulation and supervision of microfinance institutions suggest self regulation for NGO-MFIs through associations/networks and formal and conducive regulatory framework for MFIs mobilizing public savings to finance their operations. The developing countries are therefore encouraged to explore the following tiered approach of regulation and supervision of MFIs as it not only caters to a diversity of microfinance institutions, but also helps to promote transparency, discipline and maturity in such institutions. Self
Regulation
The NGO-MFIs are encouraged/required to form their associations/networks to function both as a representative body/focal point for MFIs to promote microfinance and to hold dialogue forum with policy makers and government agencies for capacity building of MFIs, dissemination of information and ensuring discipline amongst its members. The network/associations normally undertake the following functions:
Formal
Regulatory Framework
There is a wide spread consensus amongst policy makers and practitioners that the institutions interested in deposit mobilization from the public to finance their operations by providing a range of financial services to the poor including credit, savings, payment transfers etc should come under a formal regulatory framework. The developing countries are encouraged to develop their own legal framework or make appropriate changes to their existing frameworks so as to allow the establishment of more financial institutions to provide financial services to the poor. The ideal legal framework normally addresses following areas:
It should be highlighted that the framework should neither create entry barriers (such as high capital requirements) nor allow the mushrooming of weak and under capitalized microfinance institutions. It should ideally provide adequate incentive to the private sector to invest in this pro-poor sector as well as to ensure adequcy of cushion to the depositors in the form of strong capital base. Experiences from different countries show that unusually low capital requirement have resulted into an enormous growth of weak and under capitalised micro and rural banks making it difficult for central banks/supervisory agencies to ensure effective supervisory oversight and thus giving rise to systemic risk to the financial system in such countries. Whereas in countries with high capital requirements, the growth of formal microfinance banks has been low and less than satisfactory. The functions and activities to be prescribed for MFIs in the framework should also allow for flexibility to offer a wider range of services to the poor and facilitate MFIs in achieving break even level and generate profit at the earliest. However, such flexibility should not result in a loss of focus of the MFIs from their core market and objective of serving the poor. The policy makers should carefully evaluate their local conditions and ensure active consultation with stakeholders before finalizing the framework. As the primary objective of the regulatory framework is to ensure soundness and stability of the microfinance institutions and safety and the interest of the small depositors are safeguarded, framework should be simple, yet flexible so as to promote efficiency and innovation in the delivery of services to the poor. The major features of the regulatory framework for MFIs are recommended as follows:
9. Responsive Regulatory
and Supervisory Framework The regulatory framework will remain ineffective without an equally responsive supervisory framework. The supervisory function primarily ensures compliance with the regulations and monitors the risks inherent in/assumed by MFIs. Though the experience of microfinance supervision is limited, it is advisable to use risk based supervision with focus on assessing the quality of risk management systems in place and identifying and measuring the risks to which the MFI is exposed to. The supervisory bodies may use following approaches/tools to monitor and assess the level of risks assumed by MFIs and their operating and financial health:
Off-site
Surveillance Off-site surveillance is undertaken based on periodic information- monthly, quarterly or annual reports received from MFIs. Through off-site surveillance the supervisor continuously monitor the risks taken by individual MFIs and trends thereof, the operating performance and financial health of the MFI viz a viz its peer members and assess overall performance and condition of the microfinance sector. It is also used to identify grey areas of MFIs enabling the supervisors to effectively target the scarce on-site supervisory resources on such areas. On-Site
Examination
On-site examination of MFIs is an important supervisory tool to assess the quality of control structure and environment in place in the MFI, the reliability and capacity of accounting and information system, which produce operating and financial information for consumption of different stakeholders including the supervisor, the accuracy of information submitted to it on periodic basis, the quality of credit, investments and other assets porfolio and most importantly the risk management systems put in place by the MFI and level of risks assumed by MFI and coverage thereof. The supervisor should develop compehensive manuals/guidelines for reviewing different areas of operations/risks particularly the credit risk as it is entirely different than that of commercial banks. 10. Capacity Building of
Central Bank/Regulatory Body in Microfinance The capacity of policy makers and regulatory/supervisory agencies to formulate policies, which allow flexibility and innovation while ensuring soundness and stability of microfinance sector is an important condition for development of a self sustainable and vibrant microfinance sector. The position however, in most of the countries is not satisfactory and central banks and policy makers have very limited microfinance related capacities. With wide consensus on commercialization of microfinance and delivery of services through formal and informal institutions it is critical for central banks/regulatory agencies to develop their capacities in microfinance to be able to uphold prudential regulation standards and discipline while allowing flexibility and keeping an open mind to the uniqueness of microfinance. |