Executive Summary Lack of access to financial services is often a critical constraint to the establishment or expansion of viable microenterprises. It is now generally accepted that populations traditionally excluded from the formal financial sector can, in fact, be a profitable market niche for innovative banking services, and that microfinance can be very important in reducing poverty. Despite the rapid growth of microfinance institutions (MFIs) in recent years their outreach remains very small compared to the potential demand. Moreover, few MFIs have yet attained any significant degree of self-sufficiency. While microfinance has the potential to make an important contribution to poverty reduction in the region, this requires the development of a microfinance sector that is able to reach large numbers of poor people on a sustainable basis. This, in turn, requires increased attention to all aspects of microfinance, including the policy and regulatory environment. While the nine countries included in the study differ in terms of their level of economic development, social conditions and institutional structure, the study suggests that an effective policy and regulatory environment for microfinance is likely to include a number of common elements. Arrangements for direct support Active support from government and/or donor agencies, including direct financial support, is a necessary catalyst to the establishment of a viable microfinance sector. MFIs in all countries have received considerable support from their governments and/or donor agencies. In the past, most of this has been in the form of financial assistance direct to an individual MFI. This support has been largely ad hoc in nature. The Guiding Principles for Selecting and Supporting Intermediaries, agreed by major donor agencies in October 1995, provide a number of suggestions as to how support by donors and government can best be directed to maximising outreach and sustainability. All governments and donor agencies should ensure that their support for MFIs is consistent with the Guiding Principles. Most countries included in the study have some form of second tier microfinance institution which channels funds from the government and/or donor agencies to individual MFIs. The most successful of these is the Palli Karma Sahayak Foundation (PKSF) in Bangladesh. Where they operate well, second tier microfinance institutions are a very effective means for supporting MFIs. Governments and donor agencies should channel their support for microfinance, as much as possible, through efficient and well-managed second tier institutions. At the same time, there is evidence both from Asia and from other regions that second tier institutions do not always operate on a sound basis, and may be subject to significant administrative, political and technical difficulties. If second tier institutions are to play an effective role, it is clear that there are a number of critical issues that need to be addressed. Most importantly, they should establish and enforce appropriate performance and reporting standards for the MFIs that they fund. They should also operate as independent entities, support MFIs based on the standards they achieve rather than the model they follow, avoid restrictive interest rate policies, and develop appropriate criteria for funding scaling-up, institutional development and equity. Seven of the nine countries included in the study still impose directed credit requirements, whereby banks are required to lend a certain proportion of their loan portfolio to particular sectors. These are an inefficient means of reaching the poor, and impose economic costs. In some countries, the government operates specific microfinance programs in which funds are channelled through the banks. Such programs have generally not been successful and may ‘crowd out’ more effective programs. Where public funds are available to support microfinance, it is more appropriate to channel them through second tier microfinance institutions and specialist MFIs, rather than through the banking system. An apparent exception to this analysis is in Indonesia, where some microfinance programs channelled through banks with a genuine commitment to outreach, in particular, Bank Rakyat Indonesia and the rural banks (BPRs), appear to have been successful. One important way in which commercial banks can become involved in microfinance is through linkages with NGOs and self-help groups. Other than in India and Indonesia, there is little positive support for linkages from policymakers. Central banks should take a more active role in encouraging linkages, by documenting and publicising successful examples, issuing clear guidelines that the banks can follow, and other measures. The other main category of microfinance programs is those operated directly by government agencies. In general, governments should abolish direct microfinance programs and channel the funds through well-managed second tier microfinance institutions or MFIs instead. Regulation of non-bank microfinance institutions In most countries, MFIs are able to obtain registration under the general provisions applying to NGOs and cooperatives. The broad requirements are generally quite simple. The only exceptions to this appear to be Malaysia and Thailand, where the usual registration procedures for NGOs may not permit an institution to engage in microfinance. In these countries, governments should establish simple registration procedures suitable for MFIs. NGOs engaged in microfinance should be required to be registered. On the other hand, in some cases MFIs are subject to unnecessary and burdensome rules and regulations, and the rules are not transparent. Unnecessary restrictions should be removed, and the discretionary powers vested in regulatory agencies should be limited as much as possible. Only two countries, Nepal and Thailand, impose general ceilings on the interest rates that MFIs can charge borrowers. In a number of other countries, however, there are ceilings on interest rates under government microfinance programs or as a result of various other actions by government. Countries that impose interest rate ceilings should either remove them or set them at levels that are consistent with the sustainability of efficient, well-managed MFIs. Other countries should avoid policies that reduce the interest rate margins available to MFIs. MFIs which do not accept deposits from the general public are not subject to prudential regulation or supervision by a government agency in any country included in the study. There are also no compulsory reporting requirements designed specifically with the needs of MFIs in mind. This situation is appropriate. It is generally agreed that where MFIs do not accept deposits from the public, it is unnecessary to subject them to full prudential regulation and supervision. Nevertheless, it is clear that at present, most MFIs do not have adequate standards. The challenge is to find cost-effective ways of improving the standards, in terms of both performance and reporting, of the large numbers of MFIs that are not currently operating on a sound basis. In those countries with second tier microfinance institutions, these institutions can play a very important role in developing standards for the microfinance sector. Such institutions have an effective mechanism through their lending programs for enforcing any standards that they develop. Standards should be based on results achieved rather than the model used, have a proactive role in facilitating improvement in the performance of the microfinance sector over time, and be developed through a process of wide consultation with MFIs. There is a broad range of experience that second tier institutions can draw on in establishing standards. Another approach to establishing performance and reporting standards for MFIs is through self-regulation. In this regard, the Philippine Coalition for Microfinance Standards is the most important initiative in Asia at present. At this stage, however, it is doubtful that any country has an apex body for MFIs with the necessary resources or authority to monitor and enforce a comprehensive system of self-regulation. Hence, self-regulation may need to be reinforced with some legal or quasi-legal system of incentives or compulsion. In general, MFIs are not permitted to accept deposits from the general public unless they establish regulated banks. In terms of mobilising savings from members, in most countries the situation is somewhat ambiguous. Generally, regulatory authorities tend not to intervene so long as MFIs mobilise savings from members only, but MFIs do not have a clear legal basis for doing so. Laws should be clarified to make it clear that MFIs are permitted to require loan-linked deposits or compulsory savings as a condition to receiving a loan, and to use them in their lending programs. Some MFIs also offer voluntary savings facilities. It would generally not seem appropriate to permit MFIs to use voluntary savings in their lending programs unless effective protections are in place. One option is to permit MFIs to mobilise voluntary savings from members if they establish an earmarked account with a regulated financial institution. Regulation of banks There is considerable scope for regulated banks to become involved in microfinance. Some specialist MFIs may wish to establish regulated banks, and some traditional banks may wish to become involved in microfinance. The particular combination of supportive policy and regulatory environment and political leadership which underlies the success of Bank Rakyat Indonesia deserves close study throughout the region. One critical factor affecting the extent to which regulated banks become involved in microfinance is the scope for the establishment of small banks. Of the countries in the study, only Indonesia and the Philippines have a permissive policy environment for the establishment of small banks. Governments in other countries should ensure that the minimum capital requirements for establishing banks are realistic for small banks operating at the local level, and that there are no other restrictions preventing the establishment of small banks. Another critical factor is interest rates. Interest rate ceilings on small loans by banks should be removed, or at the very least set at levels that are sufficient to enable banks to operate microfinance programs sustainably. Capital adequacy ratios should be higher for small microfinance banks than for standard commercial banks, reflecting higher risk and other factors. Microfinance banks should also provision their overdue loans, based on time overdue, more aggressively than conventional banks, but provisioning requirements must accept that microfinance loans are generally unsecured. There are a number of other prudential standards sometimes applied to commercial banks that may not be appropriate for small microfinance. |
