An Analysis of the Legal Requirements for Microfinance Based on A Recent GTZ Study of 11 Countries Worldwide Stefan Staschen, June 2003
An Analysis of the Legal Requirements for Microfinance
Based on A Recent GTZ
Study of 11 Countries
Worldwide
Stefan Staschen, June 2003
June 27, 2003 Stefan Staschen, London School of Economics 2
Overview
Methodology and scope of study
Regulatory approaches: Who is regulated and by
whom and under which legal body? Who supervises?
How to draw the line between microfinance and
traditional banking?
Major regulatory instruments: Capital and provisioning
requirements, risk concentration, reserve and liquidity
requirements, ownership concentration, and sanctions
Outlook
June 27, 2003 Stefan Staschen, London School of Economics 3
Methodology and Scope of Study
Focus on legal frameworks either specifically catering
for microfinance institutions (MFIs) or being used by
institutions providing microfinance services
Co-operatives in most cases not included
Desk study nothing on enforcement, supervisory
practice, capacity issues
No claim to be representative, no bias in favour of
introducing a separate legal framework for
microfinance
List of Countries and Names of Institutional Types
Country Name of Institut. Country Name
Bolivia Private Financial Fund /
Open Savings and Loan
Cooperative
Kyrgyz Republic Microfinance Company /
Microcredit Company /
Microcredit Agency
Bosnia and
Herzegovina
Microcredit Organisation /
Bank Nepal Cooperative Society /
Development Bank /
Financial Intermediary
Society
Ethiopia Micro Financing Institution Pakistan Microfinance Institution /
Microfinance Bank
Ghana NBFI / Rural Bank South Africa Institution Conducting
Money-Lending
Transactions
Honduras Financial Private
Development Organisation Uganda Micro Deposit-Taking
Institution / Credit
Institution / Bank
Indonesia BPR (People‘s Credit Bank)
June 27, 2003 Stefan Staschen, London School of Economics 5
Who is regulated?
Prudential Regulation of deposit-taking MFIs
(Uganda, Kyrgyz Republic, Bolivia, Ghana,
Indonesia, Pakistan)
Prudential Regulation of all MFIs (Ethiopia,
Nepal)
Performance Monitoring of credit-only MFIs,
some of them non-profit (BiH, South Africa,
Kyrgyz Republic)
June 27, 2003 Stefan Staschen, London School of Economics 6
Different Levels of Rule-Making
Primary Legislation:
– Laws / Acts / Proclamation (Ethiopia) / Ordinance (Pakistan)
– Define „standards“ (broad framework), give general guidance
– Passed by Parliament or other legislative body
Secondary Legislation:
– Rules / Directives / (Prudential/Statutory) Regulations /
Resolutions / Decrees / Normative Acts (Kyrgyz Republic)
– Define „rules“ (e.g. benchmarks, concrete procedures)
– In most cases delegated to a third party (supervisory authority /
Ministry)
June 27, 2003 Stefan Staschen, London School of Economics 7
Where to Stipulate Microfinance- Specific Regulatory Requirements
Separate law for MFIs (Ethiopia, Uganda,
Honduras, Kyrgyz Republic, Pakistan)
Several legal windows allowing for
microfinance services provision (Nepal,
Ghana)
Microfinance-specific statutory regulations
under general banking law (Bolivia,
Indonesia)
June 27, 2003 Stefan Staschen, London School of Economics 8
Who regulates and supervises?
In majority of cases: The Central Bank – In some cases, statutory regulations must be approved by the
government (Pakistan / Nepal)
International trend: Introduce separate Supervisory Authority (Bolivia, Honduras: Superintendencia)
– In Bolivia, tasks of rule-making and supervision are separated
Other option: Delegate microfinance supervision to specialised agency (South Africa, planned for Rural Banks in Ghana)
– Statutory regulations to be approved by government body
June 27, 2003 Stefan Staschen, London School of Economics 9
Criteria for Choice of Regulatory Approach
Separate law or use of existing legal window: – Danger of fragmentation of legal framework
– Availability of 'lower tiers‘
– Possibility to introduce microfinance-specific regulatory requirements
– Size and maturity of microfinance industry
Delegation of rule-making power: – Accountability vs. independence and flexibility
– Expertise and capacity
June 27, 2003 Stefan Staschen, London School of Economics 10
Criteria for 'Line-Drawing'
Definition of permissible and prohibited businesses
Commercial vs. non-profit institutions (Kyrgyz
Republic, BiH, Honduras)
Restricting product charactistics
– Type of deposit facilities
– Duration of savings and time deposits
– Maximum loan size
Definition of target group
June 27, 2003 Stefan Staschen, London School of Economics 11
Limits for Credit Amounts Country Maximum loan amount as
percentage of capital
Maximum loan
amount in USD*
Maximum loan amount as a
multiple of GNI per capital
Bolivia 1 % for CACs category 1 to 4 (unsec.
credits) 2,050 – 76,000 2.2 - 81
Ethiopia Fixed amount 600 6.0
Ghana
10% for Rural Banks (for unsecured credits)
10% for deposit-taking NBFIs (unsec. credits)
6,200 190,000
21.4 655
Honduras 2 % - 5% depending on kind of security 1,200 – 3,000 1.3 – 3.3
Indonesia BPRs: 10 % (proposal) 5,500 – 22,000
(depending on area) 8.1 – 32.4
Nepal Cooperatives with limited banking license:
5%, 10% and 20% for first, second and following credits, respectively
650 – 2,600 (rural coop.)
6,500 – 26,000 (urban cooperative)
2.6 – 10.4 26 – 104
Pakistan Fixed amount 1,725 4.1
Uganda 1 % and 5 % for individual creditsand
group credits, respectively 2,700 and 13,500 9.6 – 48.2
June 27, 2003 Stefan Staschen, London School of Economics 12
Importance of 'Line-Drawing'
Regulatory arbitrage, i.e. financial institutions taking advantage of lower requirements
Regulatory ambiguity Uncertainty and dependence on interpretation by executive authority or courts
Regulatory overlap applicability of law unclear
June 27, 2003 Stefan Staschen, London School of Economics 13
Major Regulatory Instruments
Selection of regulatory instruments for MFIs not much different from that of banks:
– Entry requirements, ongoing regulations and exit
– Using combination of quantitative and qualitative indicators
Yet specification for MFIs are different – some tighter, some more relaxed
June 27, 2003 Stefan Staschen, London School of Economics 14
Minimum Capital Requirements
Range for deposit-taking MFIs from USD 24,000 (Ethiopia) to USD 8.6m (Pakistan)
In some countries, different amounts according to: – Area of operation (Pakistan, Indonesia)
– Range of financial products offered (CACs Bolivia)
– Retail vs. wholesale financial institution (Honduras)
For appraisal of requirements, it would be necessary to look at actual figures, ownership structure, maturity of industry, enforcement (only 1 out of 8 S&Ls comply in Ghana)
June 27, 2003 Stefan Staschen, London School of Economics 15
Ghana: Real/External Value of Minimum Capital Requirement
Figure 1: Minimum Capital Requirements for Deposit-Taking NBFIs in Ghana
0
1
10
100
1000
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Real value Nominal value External value in US$ (1993=1, logarithmic scale)
June 27, 2003 Stefan Staschen, London School of Economics 16
Capital Adequacy Requirements
Between 6% (Rural Bank, Ghana) and 20% (MDI,
Uganda) risk-weighted CAR
Important to look at
– exact definition of capital (core / total / supplementary
capital, etc.)
– Weights (Basel 1988 most common, but sometimes only 2
weights – 0% and 100%)
High CAR reduces return on equity (leverage
effect)
June 27, 2003 Stefan Staschen, London School of Economics 17
Provisioning Requirements
Wide range, e.g. 100% provisioning after 90 days in Uganda, after 360 days in Ethiopia, Pakistan, Nepal
Ghana: Allows provisioning on a basket basis instead of an individual loan basis
Uganda: Stricter provisioning for restructured loans
Indonesia (proposal): Provisioning based on number of instalments missed instead of number of days payments overdue
June 27, 2003 Stefan Staschen, London School of Economics 18
Provisioning Schedules
Days overdue 1 30 60 90 120 150 180 360
Ethiopia: Re-registered
Micro Financing Institutions
0% 0% 0% 25% 25% 25% 50% 100%
Pakistan: Microfinance
Institutions and
Microfinance Banks
2% 2% 2% 20% 20% 20% 50% 100%
Nepal: Co-operatives with a
Limited Banking
Transaction License
1% 1% 1% 25% 25% 25% 50% 100%
Indonesia: Bank
Perkreditan Rakyat
2.5% 25% 25% 50% 50% 50% 100% 100%
Ghana: Deposit-Taking
NBFIs
5% 20% 40% 60% 80% 100% 100% 100%
Uganda: Micro Deposit-
Taking Institutions
1% 25% 50% 100% 100% 100% 100% 100%
June 27, 2003 Stefan Staschen, London School of Economics 19
Provisions Against Risk Concentration
Risk-weighted capital adequacy requirement
Exposure limits:
– Maximum credit amounts to single borrowers
– Limits for aggregate outstanding loan portfolio
– Restricting investments in certain enterprises, usually defined as percentage of capital (individual firm/aggregate amount)
June 27, 2003 Stefan Staschen, London School of Economics 20
Reserve and Liquidity Requirements
Min. liquid assets as percentage of deposits
– Rural Banks in Ghana: Percentage rate depends on loan recovery rate (data availability is a problem)
– Less liquidity to be held against term deposits
– Definition of liquid assets crucial
Accumulating reserve fund from profits
Minimum reserves with the Central Bank
June 27, 2003 Stefan Staschen, London School of Economics 21
Ownership Concentration
Maximum shareholding
– General restriction (sometimes with exemption approved by Central Bank)
– Restrictions only for Executive Directors (except CEO, Pakistan)
– As a percentage of voting shares
– Distinguishing physical and legal entities
Transfer of shares subject to approval
June 27, 2003 Stefan Staschen, London School of Economics 22
Sanctions and Corrective Actions
Fines:
– Maximum nominal amount, sometimes
depending on certain indicators (# of days for
reporting, deficiency level for liquidity), or as
percentage of total assets (planned in
Indonesia)
Imprisonment
Suspension/removal of directors
June 27, 2003 Stefan Staschen, London School of Economics 23
Sanctions and Corrective Actions (Contd.)
Issuing warnings and policy directives
Management take-over
Putting MFI under receivership
Revoking the license
Liquidate MFI
UG/IN: Prompt corrective actions to preclude regulatory forbearance
June 27, 2003 Stefan Staschen, London School of Economics 24
Outlook
Use of study: Guideline, list of options,
indication of interesting cases – not more!
Issues to Study:
– Capacity
– Incentives
– Autonomy vs. accountability
Annex 2 of publication as summary