The Experience of Microfinance Institutions with Regulation and Supervision

Transcription

1 The Experience of Microfinance Institutions with Regulation and Supervision Presentation of Elisabeth Rhyne, Senior Vice President, Research, Development and Policy, ACCION International At the 5 th International Forum on Microenterprise InterAmerican Development September 10, 2002 Rio de Janeiro Until recently, regulated microfinance was so new that microfinance institutions and banking authorities barely shared a common vocabulary. A number of important papers over the years have advanced the thinking on the regulation and supervision of microfinance. 1 They have dramatically narrowed the vast initial gap of understanding. Yet, most of these writings have addressed the topic from a largely theoretical perspective, as there was not yet a sufficient body of actual experience to draw upon. Today there are enough regulated microfinance institutions with some length of experience that we can begin to bring a more practical dimension into the discussion. Using this practical experience we can examine what is and is not working, from specific details to the broad framework. ACCION International, whose Latin American Network currently includes 12 regulated microfinance institutions, has a great interest in promoting mutual understanding between regulators and the regulated. In order to contribute to greater understanding, we conducted a survey with detailed interviews of seven microfinance institutions, five from the Network and two outside it: BancoSol (Bolivia), Banco Solidario (Ecuador), Caja Los Andes (Bolivia), Calpia (El Salvador), Compartamos (Mexico), Finsol (Honduras), and Mibanco (Peru). These institutions represent six countries (see Table). Three are commercial banks while four are financieras. All, with the exception of Banco Solidario, underwent transformation from NGO into regulated institution, and thus they are in a position to compare the experiences of operating in an unregulated versus a regulated environment. The purpose of the survey was to examine the views of the institutions on the experience of being supervised, including perceived costs and benefits, and to glean some recommendations on changes the practitioners would suggest to the content and implementation of supervision. 2 1 See, for example, Christen and Rosenberg; Churchill and Berenbach; Hannig and Katimbp-Mugwaya; Jannson and Wenner; Rock and Otero; Staschen; Trigo; Valenzuela and Young; van Gruening, Gallardo, and Randhawa; and Vogel, Gomez and Fitzgerald. Detailed cites for these works may be found in the bibliography of Drake and Rhyne, Commercialization of Microfinance. 2 This survey was first described in The Experience of Microfinance Institutions with Regulation and Supervision: Perspectives from Practitioners and a Supervisor, Leslie Theodore with Jacques Trigo Loubiere in Deborah Drake and Elisabeth Rhyne, eds. The Commercialization of Microfinance: Balancing Business and Development. Kumarian Press, The first part of this paper draws heavily from that chapter.

2 Table 1: Background on MFIs Interviewed Institution BancoSol Banco Caja los Calpia 3 Compartamos FINSOL Mibanco Solidario Andes Country Bolivia Ecuador Bolivia El Salvador Mexico Honduras Peru Founded N/A Original NGO Commercial NGO NGO NGO NGO NGO Form License Date New Form Commercial Commercial FFP Financiera SOFOL Financiera Commercial Active 60,976 14,645 41,665 34,390 62,797 15,026 58,088 borrowers Portfolio (US$ million) $ 77.8 $6.3 $46.8 $26.5 $10.9 $6.3 $36.9 Note: Data as of end 2001 with exception of Calpia, which is end Benefits and Costs of Regulation The institutions involved in this study are overwhelmingly pleased to be regulated. All report that the benefits of being regulated outweigh the costs. None would even begin to contemplate reverting to their NGO status. This message is highly significant. It means that even when debate over specifics of regulation become heated, the underlying fundamentals are there: the process of becoming regulated has brought microfinance institutions the benefits they sought: Greater access to sources of funds for both equity and debt, especially commercial sources Ability to achieve growth and quantitative outreach goals: to serve more people Improved, more professional operations through meeting higher standards of control and reporting Greater ability to offer products beyond microcredit, especially savings and transfers. Enhanced legitimacy in the financial sector and with clients These very profound benefits must be weighed against very practical costs. Although MFI s cannot give exact figures, CGAP estimates that the cost of supervision is as much as 5 percent of total costs during the initial year and 1 percent thereafter. 4 However, it is important to note that many of the initial costs involve internal improvements required to meet supervisory requirements, most of which are necessary for running a strong microfinance institution. The only general negative factor that some institutions mentioned was a loss in ability to experiment with unconventional ideas, particularly those involving products or markets 3 Calpia statistics as of December 31, Draft CGAP guidelines on regulation and supervision of microfinance.

3 that have not yet proved their viability. This observation draws attention to the continued importance of NGOs as seedbeds for experimentation. Overwhelming Message: Get to Know Our Business If microfinance institutions have one core message for regulators and supervisors it is this: Learn more about our business! In their view a large share of the problems between MFIs and supervisors stem from a lack of understanding by the authorities of the unique characteristics of microfinance. There are two groups of people whose deep knowledge of microfinance is most acutely needed: policymakers involved in design of regulatory frameworks and norms and supervisors responsible for on- and off-site oversight of MFIs. Some of the institutions studied said that there was an ongoing tendency among the staff of supervisory agencies to regard microfinance as a particularly risky form of business and therefore to view differences from conventional banking as negatives to be corrected rather than legitimate differences arising from the nature of microfinance. This kind of interpretation could result in microfinance institutions being penalized for using practices that are effective or even essential for microfinance (key examples below). A strong recommendation to come out of the survey is the desire of microfinance institutions to work with supervisors who have received specialized training on microfinance. Observations from the Licensing Process For most of the institutions the licensing process was the most difficult aspect of being regulated, and several commented on the long time frame (as much as two years or more) required to complete the process. Nevertheless, they acknowledge that most of the internal improvements they were required to make during this process were beneficial, in areas such as internal control, reporting capabilities, branch physical security, and the like. Importantly, meeting minimum capital requirements was not a major issue, once the institutional form had been chosen (though some financieras might have chosen to become banks but for the higher minimum capital requirements). For most of the institutions, the minimum capital needed was the same or less than the amount of capital needed to achieve and maintain profitable operations, and therefore, it did not pose a binding constraint. On the other hand, the main difficulties posed by the licensing process involved finding an ownership and management structure that was acceptable to both the institution and the licensing authorities. Among the kinds of participants banking authorities were reluctant to approve were the following: The original NGO. In many cases banking authorities did not consider it appropriate for an NGO to own a major portion of a licensed institution. This issue has been resolved in nearly every case in a way that works for the MFI.

4 Foreign institutions such as donor-related institutions and international microfinance organizations. Only a problem in Honduras. Individuals in senior management with microfinance experience but lacking conventional banking backgrounds. In several instances, key personnel had to be changed. The bottom line here is that microfinance institutions are likely to continue to have owners and managers who do not fit standard expectations. They do not, however, automatically fail the fit and proper test, as many bring compensating factors to the table, in terms of specialized knowledge, deep long term commitment, reputation risk, etc. This is an area where flexibility is appropriate, and as regulators become more familiar with the microfinance sector, they are likely to become more comfortable making judgments about the suitability of individual players. The Heart of the Matter: Regulation and Supervision of MicroLoan Portfolios The most fundamental distinction between microfinance and all other forms of conventional banking is that the core clients of microfinance institutions are the selfemployed and informal enterprises, clients that conventional banking has traditionally excluded. The magic of microfinance is that it has developed techniques to lend to these households and enterprises without formal employment. Those techniques are built around several key principles, which are widely known as core best practices in microfinance: Focus on motivating the borrower to repay through promise of continued access to credit, peer pressure, loss or personal assets, and other collateral substitutes. Conservative approach to loan approval and loan size determination based on analysis of existing repayment capacity, or stepped lending. Strong delinquency management systems, including immediate, personal followup, staff incentives, and management information systems. Each of these key practices calls some aspect of standard regulatory norms into question. The challenge of regulation for microfinance is to remove the obstacles to best practice posed by traditional norms, while developing appropriate norms that enable sound judgment about whether a given MFI is applying best practice principles safely and successfully. Some of the areas where MFIs said that their best practices conflicted with standard banking regulations include the following: The definitions of secured and unsecured lending that tend to place most microloans in the unsecured category (with the accompanying limits on acceptable volumes and risk classification). In particular, the non-recognition of standard forms of guarantee used in microfinance, such as group guarantees or non-standard collateral.

5 Loan documentation requirements unsuitable for informal businesses without actually improving the safety of the portfolio. In fact, both BancoSol and Mibanco experienced resentment from clients regarding increased loan documentation requirements after they became commercial. Existing clients viewed the demand for such documentation as evidence the lenders no longer trusted them. Classification of microfinance in same grouping as consumer lending. Though the loan sizes and terms are similar, these kinds of lending are based on entirely different lending techniques and repayment comes from a very different source (salary versus self-employment). Each type of lending needs its own set of norms. Inappropriate methods of supervising the portfolio: regulators spend too much time looking at individual loan folders and not enough testing the quality, timeliness and reliability of MIS and examining portfolio quality control systems in general. This is an area where work is only just beginning to give regulators the tools they need to assess microfinance portfolios not with leniency, but on their own terms. Areas Where Microfinance May Need Special Norms In order to provide a succinct summary regarding the need for rigorous regulatory norms that are adequately tailored to microfinance, a helpful exercise is to look at the indicators and categories included in the ACCION CAMEL, which ACCION adapted from the original regulatory tool created by the authorities in the United States. There are 21 major indicators within the 5 C-A-M-E-L areas (See Table 2). For all but 5 or 6 of these indicators, microfinance differs sufficiently from standard banking that special characteristics need to be taken into account or that quantitative indicators can be expected to fall in different numerical ranges (and thus need to be interpreted differently). Table 2. ACCION CAMEL Key Indicators, Showing Areas Where Microfinance Differs from Conventional ing Norms CAPITAL ADEQUACY Capital Adequacy Ratio Minimum capital requirement lower Leverage ratio higher Adequacy of Reserves Provisioning policy should fit microcredit terms Ability to Raise Equity Unconventional owners (NGOs, donors) may have difficulty with this ASSET QUALITY Portfolio Quality No need for concern about large loan concentration Focus on quality of delinquency management systems Write-Offs and Write-Off Should fit microcredit terms and experience Policy Portfolio Classification Treatment of loans with unconventional form of

6 System guarantee Productivity of Long Term No change Assets Infrastructure Allowance for low-cost infrastructure suitable for reaching the poor Management Governance/Management Unconventional owners and sometimes managers Human Resources Different staff profile, salaries Importance of incentive systems Controls, Audit Internal audit must take lending methodology into account Information Technology Delinquency monitoring focus Strategic Planning and No change Budgeting Earnings Return on Assets May be higher than the norm Return on Equity No change Efficiency Administrative costs expected to be well above standard commercial banking Indicators and benchmarks specific to microfinance are needed here Interest Rate Policy Interest rates well above standard commercial banking Liquidity Productivity of Current Assets No change Liability Structure May differ substantially from most other banks Liquidity Ratio No change Cash Flow Projections No change The Challenge for the Future The microfinance institutions we surveyed stressed repeatedly the need for regulators and supervisors with a deep knowledge of microfinance. ACCION is working in this area by developing the CAMEL instrument as a tool for supervisors and training supervisors in its application. At the same time, work continues on regulatory norms and supervisory practice. While there are many efforts going on here, three deserve special recognition: the handbook for supervisors being developed by the IDB; general policy guidelines now in discussion draft by CGAP; and a tool for portfolio due diligence also now in discussion draft by CGAP. These initiatives all deserve attention and support. They are the building blocks that will eventually fully close the remaining gap between the emerging microfinance industry and the regulatory and supervisory authorities.

7 Since October, 2000, Elisabeth Rhyne has been ACCION International s as Senior Vice President for Research, Development and Policy. Ms. Rhyne directs ACCION's research efforts to develop new financial products for the poor, including rural lending products, housing credit and savings and remittances. She is also leading ACCION's operations in Africa. Ms. Rhyne's experience in microfinance also includes her work as Director of the Office of Microenterprise Development at the U.S. Agency for International Development (USAID) from 1994 to 1998, where she developed and managed USAID's microenterprise program. Ms. Rhyne earned a master's and Ph.D. in public policy from Harvard University. She holds a bachelor's degree in history and humanities from Stanford University.