THE REGULATORY
FRAMEWORK FOR
MICROFINANCE
INSTITUTIONS
PRESENTED BY
RACHAEL S. MUSHOSHO
RESERVE BANK OF ZIMBABWE
4/13/2015
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Presentation Outline
 Introduction
 Characteristics of microfinance
 Role of microfinance Institutions
 Rationale for Regulating MFIs
 Issues and Approaches
 The Regulatory Framework
 Regulatory Structures
 Supervisory Challenges
 Prudential Versus Non-Prudential
 Conclusion
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Introduction
 Microfinance refers to the provision of
financial services to the low income, the poor
and marginalized, including the self
employed- financial intermediation.
 To most, microfinance means providing very
poor families with very small loans (microcredit) to help them engage in productive
activities or grow their tiny businesses.
 Overtime microfinance has come to include
broader financial services such as insurance,
money transfers and savings
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Characteristics of Microfinance
Clients
 Typically low income people with no access
to formal financial services
 Self-employed and household-based
entrepreneurs
 In rural areas includes farmers and small
businesses into food processing, agriculture
 In urban areas may include artisans,
shopkeepers, vendors, manufacturing, etc.
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Characteristics of Microfinance
Clients cont…
 Small businesses
 Usually owned and operated by one person
 Family members assist
 Little capital invested
 It is taken as a form of employment
 Less than 10 employees
 High number of women
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Characteristics of Microfinance
 It is not simply banking but also a
developmental tool
 Small loans typically for working capital
 Informal appraisal of borrowers and
investments
 Collateral substitutes- group or relationships
 Access to repeat loans depends on
repayment performance
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Role of Microfinance Institutions
 Financial depth and diversity - contribute to
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economic growth and development
Promotes financial inclusion which in turn helps
the poor build assets and better manage risks
Poverty reduction and improvement of living
standards
Social intermediation – provision of microfinance
often integrated with developmental activities
such as training in practical skills,
entrepreneurship, etc.
Achievement of the MDGs
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Role of Microfinance Institutions
Cont…
 Microfinance plays a critical role in fostering
economic growth and development by
increasing productivity and employment
opportunities.
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Preconditions
Preconditions for MFIs to play a useful role in economic
development include:
 Enabling environment
 Improved infrastructure
 Government policy
 Stable macro-economic environment
 Low inflation rate
 Low lending interest rate
 Stable exchange rate
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Preconditions Cont…
 Appropriate regulatory and supervisory framework
 Long-term and sustainable source of funds
 Removal of interest rate ceilings
Setting interest rate ceilings would discourage
outreach to poorer customers.
 MFIs should be allowed to charge rates of
interest that enable them to cover costs.
 Disclosure of charges
 Promote competition
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Rationale for Regulation
 Various reasons for regulating microfinance
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institutions
In order to reach significant scale and to provide
adequate service to clients, microfinance institutions
need to go beyond government and/or donor support
to attract private capital and to mobilize savings.
To allow for an orderly development of the sectorMost microfinance institutions started as donorfunded institutions and have to seek alternative
strategies to survive due to donor fatigue
Shift from donor-funded NGOs to more commercially
oriented entities- regulations lays the foundation for
such transformation
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Rationale for Regulation Cont…
 Ensure financial sector stability- though players in the
microfinance sector have little systemic impact,
failure can have negative impact on the credibility of
the financial sector
 To render legitimacy and confidence to the sectorattract long-term funding to the sector
 Investors, donors, need to have confidence in the
systems in which the recipient of the funds operates
in.
 Regulation sets minimum acceptable standards and
gives confidence in MFIs as a safe destination of
donor or investor funds
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What is Regulation?
 A regulatory framework includes the laws, regulations,
guidelines, rules and codes that regulated entities are required
to comply with and an institution or structure for enforcing
compliance.
 The regulatory structure is therefore an institutional form which
carries out supervision of the regulated entities.
 Supervision has broadly been defined as a process of enforcing
the regulatory framework. It includes the interaction between
the regulatory authority and the regulated institutions that
enables the regulatory authority to:
 Monitor the financial soundness of the regulated
intermediaries
 Proactively identify and respond to emerging trends and
problems in the industry and at specific institutions.
 Enforce compliance with regulations
 Manage the exit of failed institutions from the financial
system with the aim of preventing financial system instability
and losses to small, unsophisticated depositors.
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What is Regulation? Cont…
 The regulation of financial institutions is
generally explained as a response to the
need for systems to maximize the
mobilization and intermediation of funds,
enhance efficiency in the allocation of capital,
ensure appropriate risk management, and
protect depositors.
 Focus is financial sector stability and
depositor protection
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What is Regulation? Cont…
 Standard banking regulation and supervision
tend to impose ineffective and overly
burdensome requirements on MFIs if the
same is applied without modification.
 In determining the regulatory and supervision
structure to be applied to microfinance
markets, policymakers need to take into
account a whole range of issues.
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Issues and Approaches
 Need to be clear about the rationale of regulation and
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supervising the sector
The general structure must be translated into specific
prudential norms, supervision and reporting systems,
and rules governing entry and operations of MFIs.
The implementation of these norms and systems.
Norms and systems should be designed in ways that
make them easy to administer;
Supervisory body should have the necessary
resources and capacities to ensure proper
implementation of the norms and systems
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Issues and Approaches Cont…
Issues that need to be taken into account when designing regulation for
the microfinance sector:
 its attempt to deepen financial markets - to serve micro-enterprises and
poor households;
 its high unit costs of lending;
 its approach of physically taking banking services to clients who have
few other options to receive financial services;
 the relatively undiversified and sometimes volatile nature of MFI credit
portfolios;
 Any regime of regulation that is adopted must cope with the special
problems of regulating and supervising MFIs.
 These include:
the absence of owners’ capital to draw on to meet capital calls for most MFIs;
the fact that MFI lending modalities make audits and corrective
steps difficult;
the potentially high costs of MFI supervision.
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Issues and Approaches Cont…
 Different cost structures and Funds sources;
 The difference in institutional orientation, with
some MFIs clearly profit-oriented while others
are committed to providing services to the
poorer segments of the population on a nonprofit basis;
 The fact that most MFIs began as
unregulated credit NGOs, with a focus on
social goals rather than financial
accountability and sustainability;
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Issues and Approaches Cont…
 The fact that MFIs deal in savings and credit
transactions with relatively low value in
relation to the financial system as a whole and as a result are unlikely to have problems
that cause broad systemic instability;
 The market risk posed within the
microfinance sector itself when MFIs
(especially large ones) are not properly
managed and monitored.
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Regulatory Framework
 The regulation and supervision of microfinance
institutions by an independent regulatory agency is
relatively new in many countries.
 The introduction of regulatory framework for MFIs in
many countries was mainly aimed at addressing a
number of concerns in the MFI industry.
 A number of MFIs are operating in an unregulated
market. This is because regulatory agencies focus
their regulatory resources on deposit-taking MFIs
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Regulatory Framework Cont…
 It should be noted that a sound regulatory
structure for MFIs is critical in ensuring that
MFIs perform their functions efficiently.
 A regulatory framework can either stimulate
or retard the growth and development of MFI.
Excessive regulations can stifle MFIs’ growth
 Appropriate regulations promote market
development.
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Regulatory Framework Cont…
 Given that most MFIs have or are evolving from NGO forms to
commercial forms, there exists a wide array of regulatory structures for
MFIs.
 There is no ideal regulatory structure that fits all countries as regulatory
structures are dependant on:
MFI industry development,
 Legislative environment,
 Resources,
 Capacity.
 The regulatory structures may be one or a combination of the following
forms:
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Primary registrar
Network of MFIs
Self-regulatory body
Apex institution
Delegated authority
Central bank
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Regulatory structures
Primary Registrars
 In a number of countries MFIs are registered as legal
entities under various pieces of legislation. In the case
of Zimbabwe, MFIs may be registered as legal entities
under the following pieces of legislation:
 The Money Lenders and Rates of Interest Act;
 Banking Act [Chapter 24:20] through the Minister of
Finance invoking section 3 of this Act.
 Cooperatives Societies Act [Chapter 24:05] Registrar
of Societies
 Private Voluntary Organizations Act [Chapter 7:05]
 Regulation and supervision by the Primary Registrars’ is
non-prudential.
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Regulatory Structures Cont…
 Network of MFIs
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Various national and international networks exist
that offer support to MFIs.
These networks may comprise formal and informal
MFIs.
Networks play a regulatory role in the sense that
they develop performance standards and best
practices which member organisations are
encouraged to strive to achieve.
Failure to abide by the norms of the network often
leads to loss of benefits that such networks offer
which include capacity building opportunities
(training and systems implementations) and
financial services (e.g. grants and guarantees)
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Regulatory Structures Cont…
 Self-Regulatory Body
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This is a body that is formed, owned and controlled by
member MFIs to be supervised. It can be an association of
MFIs (Zimbabwe Association of Microfinance Institutions)
Self-regulatory bodies play a useful role in regulating market
conduct by formulating codes of conduct and other norms for
members.
The self-regulatory body has the primary responsibility for
monitoring and enforcing agreed norms.
Evidence suggests that this regulatory structure is not
suitable for prudential supervision as participating institutions
often do not have enough incentive to induce them to hold a
rigorous line when problems arise. For instance, they would
find it difficult to sanction closure of an ailing member.
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Regulatory Structures Cont…
 Apex Institution
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In some countries there is an apex institution or national fund
that does wholesale lending to local MFIs.
As an investor, such an apex is by its nature a kind of
regulatory structure.
The Apex evaluates and monitors the soundness of the MFIs
it lends to. For MFIs that fail to meet its standards, the
sanction is denial of loans. In this regard, MFIs strive to
comply with the terms and conditions of the borrowing which
would include:
 Financial soundness (adequate capital);
 Achieving and maintaining acceptable profitability;
 Ability to meet obligations as they fall due (liquidity);
 Having a competent Board of Directors; and
 Having annual audited financial statements
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Regulatory Structures Cont…
 Delegated Supervision
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Delegated supervision is an arrangement where a government
financial supervisory agency delegates direct supervision of
financial institutions to an outside body, while monitoring and
controlling that body’s work.
Delegated supervision can be conducted by an apex regulatory
structure, an association of MFIs or audit firms.
Delegated supervision has its own issues which need to be clearly
understood before a decision is taken to implement it. Some of
these issues include:
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Who will pay the costs of delegated supervision?
If the delegated supervisor is unreliable and its delegated authority
must be withdrawn, is there a realistic fallback option?
When a supervised institution fails, which body will have the
authority and ability to clean up the situation by intervention,
liquidation, or merger?
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Regulatory Structures Cont…
 Financial Supervisory Agency
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The central bank in a number of countries is the
financial supervisory agency that is responsible for
regulating banks and other financial institutions
including MFIs
Financial supervisory agencies focus their resources
on deposit-taking MFIs and apply non-prudential
supervision on credit only MFIs.
There is limited financial and human resources to
effectively supervise all MFIs.
Other central banks have raised the minimum start-up
capital for MFIs as a way of rationing prudential
supervision.
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Tiered Approach to Regulation
Tiers
Institutions
Supervisory
Category
Supervising Agency
Tier 1
Banks and Building
Societies
Prudential Supervision
Reserve Bank
Tier 2
Microfinance Banks
Prudential Supervision
Reserve Bank
Tier 3
Savings & Credit Union
Cooperatives
Prudential Supervision
Discretional
Ministry responsible for Cooperatives
Tier 4
Microfinance Institutions
Non-Prudential
Supervision
Reserve Bank
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Supervisory Challenges
 There are regulatory challenges that arise
when supervisory authorities attempt to apply
a regulatory structure to an evolving sector
such as the MFI sector. Some of the
common challenges in the MFI sector include
the following:
Corporate Governance;
• Shareholding limited
• Board of Directors
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Supervisory Challenges Cont…
 Regulatory Arbitrage
 Limited delivery channels in rural areas
 Cost
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Pricing of products
Limited sources of funds
Supervisory
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Regulation of MFIs
 The continuum of institutions providing microfinance
cannot develop fully without a regulatory environment
conducive to their growth
 Without such an environment, fragmentation and
segmentation will continue to inhibit the institutional
transformation of microfinance institutions
 A transparent, inclusive framework for regulation will
preserve the market specialties of different types of
microfinance institutions - and will promote their
ultimate integration into the formal financial system
 Require standard registration documents and
procedures
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Regulation of MFIs
 In order to reach its full potential, the
microfinance industry must eventually be able
to enter the arena of licensed, prudentially
supervised financial intermediation, and
regulations must eventually be crafted that
allow this development
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Prudential or Non-Prudential
Supervision
 Prudential regulation should not be imposed on
“lending-only” microfinance institutions (MFIs) that
merely lend out their own capital, or whose only
borrowing is from foreign commercial or noncommercial sources or from prudentially regulated
local commercial banks.
 Depending on practical costs and benefits, prudential
in some cases may not be necessary for regulation
MFIs that take cash collateral (compulsory savings)
as part of a loan contract, but do not take other
savings (especially if the MFI is not lending out these
funds).
 Financial cooperatives—at least large ones—should
be prudentially supervised
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Prudential or Non-Prudential
Supervision Cont…
 Designers of new regulation for microfinance
need to pay much more attention than usual
to issues of likely effectiveness and cost of
supervision.
 In issuing financial intermediation licenses,
the government invites public reliance and
implicitly promises effective measures to
mitigate depositor risk.
 Before issuing licenses, a government needs
to be clear about the nature of such promises
and its practical ability to honor them.
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Prudential Supervision Versus Nonprudential
Prudential
 Aimed at protecting the financial system
 Protect safety of small depositors
 More complex, difficult and expensive
 Minimum capital requirements, lending limits,
corporate governance issues, and standard loan
documentation
Non-prudential
 Focus on conduct of business
 Applied to non-deposit taking MFIs
 Disclosure of effective interest rates
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Conclusion
 Microfinance institutions are increasingly becoming
formalised and this has implications for the suitability
of existing regulatory structures for microfinance
regulation.
 Therefore, a well-developed and properly regulated
MFI sector is an important component of a broad,
balanced, efficient financial system that spreads risks
and adds to systemic stability.
 Regulatory authorities should consider extending
deposit insurance to MFIs as well as engendering
public confidence in this growing sector that is
providing financial services to low-income citizens
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THANK YOU!!!
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