Published on December 7, 2008
The regulation of microﬁnance:
Regulatory frameworks IDLO TW-372E Microﬁnance: Building Inclusive Financial Sectors & Supportive Legal and Regulatory Frameworks (as a Tool to Achieve Poverty Reduction) in East Africa Simone di Castri IDLO Microﬁnance Project Research Coordinator November 2008
Today’s goals • To introduce to each other • To get information about workshop development, supports and following activities • To know IDLO MF Project • To agree on basic key concepts for further discussion • To discuss prudential and non-prudential regulation of MF • To exchange knowledge of countries frameworks 1
Introductions • IDLO staff Introduce your-self • Participants Name and nickname • Instructors Background • Observers Affiliation Description of your duties Expectations • Schedule Idea for follow-up publication • Handbook • Google Group • IDLO MF web site • Publications • VC Policy Dialogues • Rome summary conference 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 4
“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 5
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 and could mean many different things, depending on the country What is your definition of microfinance? 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) 6
Basic concepts Frameworks: • Institutional • and Policy • Legal • and Regulatory Not only ﬁnancial/banking regulation, but a multitude of laws and regulations affects ﬁnancial inclusion, the provision of microﬁnance services and the access! Regulation: Set of rules adopted by a legislative body (laws) or an executive body (regulations) Supervision: External oversight aimed at determining and enforcing compliance with regulation. Do not regulate what cannot be supervised! 7
Institutional framework • National Poverty Alleviation Strategy • Economic and Monetary policy • Financial Sector Strategy • SME policy • Unemployment strategy, • Youth & women • Priority sector lending • Governance of the microﬁnance sector 8
Institutional framework 2/2 Governance of the microﬁnance sector • National Strategy of which Micro-Finance is a part • Government Policy - Inﬂation/deﬂation policy - Wholescale debt relief initiatives (generally in agricultural loans; ie India) - Requirements regarding investments of state pensions and funds (ie Peru) - Community Development Finance type intiatives (public/private ﬁnancing partnerships USA, UK, Australia with tax incentives and public funding) - Nationalization risk (Bolivia, Ecuador, Russia) • Authority in charge of MFI licensing • Authority in charge of MFI supervision • Public administration in charge of MFI support • Public guarantee fund • APEX institution • Role of MFIs national/regional network 9
Why to regulate? • 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? 10
How to regulate? Prudential regulation (and supervision) function: to protect solvency of regulated institutions the stability of ﬁnancial sector for the safety of deposits Non-prudential regulation function: other than preventing insolvency • 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? 11
The costs of regulation • Costs of compliance, of supervision, of enforcement • Direct • Indirect What to regulate? • Institutions v. Activities • Deposit-taking institutions • Credit providers 12
Regulatory Framework – MFIs 1 Capitalization requirements and risk management • Minimum capital • Initial reserve requirements • Liquidity requirements • Minimum 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 Should MFIs and commercial banks be treated equally? Financial Requirements in Cambodia MFIs Commercial banks Minimum paid-up capital KHR 250 million KHR 50 billion Liquidity ratio 100% 50% Solvency ratio 20% 15% Capital guarantee 5% 10% 13 Reserve Requirement 5% 8%
Regulatory Framework – MFIs 2 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 14
Regulatory Framework – MFIs 3 Accounting, auditing and reporting, 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 15
Regulatory Framework – MFIs 4 Fiscal concerns • Tax breaks • Taxes on Income • Taxes on Transactions • Taxes on Payroll • Double taxation treaty • Others 16
Regulatory Framework – MFIs 5 Financial intermediation activity • Lending • Mobilizing deposits • Mobilizing savings • Borrowing in foreign currency • Type of investments MFIs are allowed to make • Type of transactions MFIs are allowed to enter into • Insurance services • Remittances transfers • Restrictions on geographical opérations • Interest rate caps 17
Credit-only Microfinance 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 • Interest rate regulation/usury • Consider possible abuses: - across variety of products (not just credit); - over life cycle of product (marketing, delivery, collection) 18
Interest rates CGAP 2004: IRs caps in 40 developing countries • 20 interest rates control • 13 usury limits • 7 de facto controls 19
Interest rates 2/2 20
Regulatory framework for foreign ﬁnancing Some issues donors and investors may consider before they invest in your country • 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 and more (AMT/CFT, US/EU regulation, etc.) 21
References • CGAP, Guiding principles on regulation and supervision of microﬁnance • UN, Building Inclusive Financial Sectors for Development, also known as the quot;Blue Book” • GTZ, USAID, ADB Database: • Microﬁnance Gateway • IDLO • CGAP/CAPAF • Worldbank DoingBusiness.org for property rights and contract enforcement and steps to register/license a business, taxation • Transparency Intl. Corruption index • IFAD Womenʼs rights to own/inherit/control property 22
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