Regulation and Supervision of Microfinance Institutions ... · PDF fileREGULATION AND SUPERVISION OF MICROFINANCE INSTITUTIONS Case Studies Edited by Craig Churchill The MicroFinance

REGULATION AND SUPERVISIONOF

MICROFINANCE INSTITUTIONS

Case Studies

Edited by

Craig Churchill

The MicroFinance NetworkOccasional Paper No. 2

Regulation and Supervision Case Studies

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TABLE OF CONTENTS

TABLE OF CONTENTS ........................................................................................................................ i

TABLE OF TABLES ............................................................................................................................ iii

CONTRIBUTORS................................................................................................................................. iv

ACKNOWLEDGMENTS ..................................................................................................................... vi

LIST OF ACRONYMS ........................................................................................................................ vii

INTRODUCTION .................................................................................................................................. 1

PROJECT PURPOSE ................................................................................................................................. 1BACKGROUND....................................................................................................................................... 2

INDONESIA........................................................................................................................................... 5

Shari Berenbach

BACKGROUND....................................................................................................................................... 5BANK RAKYAT INDONESIA UNIT DESA ................................................................................................... 8SUPERVISION OF MFIS IN INDONESIA.................................................................................................... 10

BANGLADESH.................................................................................................................................... 15

Janney Carpenter

CONTEXT: THE FORMAL AND SEMI-FORMAL FINANCIAL SECTORS ........................................................ 16EXISTING REGULATION: THE GRAMEEN BANK CHARTER ...................................................................... 21THE REGULATION DILEMMA: HOW MUCH AND HOW TO DO IT WELL? .................................................. 25OBSERVATIONS AND CONCLUSIONS...................................................................................................... 31

PHILIPPINES ...................................................................................................................................... 35

Eduardo C. Luang and Malena Vasquez

MAJOR LEGISLATIVE INITIATIVES FOR FINANCIAL SECTOR REFORM....................................................... 35ROLES AND RESPONSIBILITIES OF REGULATORS .................................................................................... 38MICROFINANCE STANDARDS INITIATIVE............................................................................................... 39

BOLIVIA.............................................................................................................................................. 43

Rachel Rock

BOLIVIAN REGULATORY FRAMEWORK.................................................................................................. 43CREATION OF BANCOSOL .................................................................................................................... 49LOS ANDES: THE FIRST BOLIVIAN PRIVATE FINANCIAL FUND ............................................................... 55

COLOMBIA......................................................................................................................................... 59

Shari Berenbach

FINANCIAL SECTOR IN COLOMBIA ........................................................................................................ 59FINANSOL ........................................................................................................................................... 61

MicroFinance Network

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PERU.....................................................................................................................................................69

Rachel Rock

ECONOMIC CONTEXT ...........................................................................................................................69PERUVIAN FINANCIAL SYSTEM: STRUCTURE AND ACTORS .....................................................................70CAJAS MUNICIPALES ............................................................................................................................75CAJAS RURALES...................................................................................................................................82EDPYMES..........................................................................................................................................82CONCLUSION .......................................................................................................................................85

KENYA .................................................................................................................................................87

Janney Carpenter, Kimanthi Mutua, and Henry Oloo Oketch

CONTEXT: THE FORMAL AND SEMI-FORMAL FINANCIAL SECTORS IN KENYA .........................................87K-REP BANK LIMITED ..........................................................................................................................89CONCLUSIONS AND LESSONS ................................................................................................................97

WEST AFRICA ....................................................................................................................................99

Anne-Marie Chidzero and Gilles Galludec

HISTORY OF THE LAW ..........................................................................................................................99STATUS OF IMPLEMENTATION OF THE LAW..........................................................................................100FEATURES OF THE LAW AND THE DECREES OF APPLICATION.................................................................101DEVELOPMENTAL IMPACT ..................................................................................................................104ISSUES...............................................................................................................................................104

SOUTH AFRICA ................................................................................................................................107

Rudolph Wilhemse and Steven Goldblatt

MICROENTREPRENEURS AND ACCESS TO FINANCE...............................................................................107FINANCIAL SYSTEM INSTITUTIONS......................................................................................................108BANKING LAWS AND REGULATIONS ....................................................................................................110SELF-REGULATION FOR MICROFINANCE INSTITUTIONS ........................................................................114

BIBLIOGRAPHY...............................................................................................................................117


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TABLE OF TABLES

Table 1: Microfinance Institutions In Indonesia............................................................................6

Table 2: Summary Overview MFIs in Indonesia ..........................................................................7

Table 3: Supervisory Arrangements in Indonesia........................................................................ 10

Table 4: Banking Supervision Reports....................................................................................... 11

Table 5: BRI Village Unit Loan Classification and Reserves ...................................................... 11

Table 6: Loan and Deposit Size Comparison of BRI Unit Desa and Village-owned Banks .......... 12

Table 7: Financial Institutions in the Philippines ........................................................................ 37

Table 8: Reporting Requirements of the Bolivian Supervisory Structure..................................... 48

Table 9: Bolivian Superintendent’s Risk Classification and Provisioning Requirements .............. 49

Table 10: History of Savings Mobilization at BancoSol (millions US$)...................................... 55

Table 11: History of Growth: Pro-Credito/Los Andes Business Loans (millions US$)................. 56

Table 12: Financial Institutions in Colombia.............................................................................. 60

Table 13: Loan Provisioning Policies in Colombia ..................................................................... 61

Table 14: Financial Institutions in Peru...................................................................................... 71

Table 15: Peruvian Provisioning Requirements .......................................................................... 74

Table 16: CMAC Credit Products ............................................................................................. 78

Table 17: EDPYME Provisioning Requirements ........................................................................ 84

Table 18: K-Rep Bank Ltd. Shareholders .................................................................................. 92

Table 19: Financial Institutions in South Africa ....................................................................... 109


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CONTRIBUTORS

Shari Berenbach has over fifteen years of experience in the microfinance industry, having workedin nearly two dozen countries in Latin America, Asia, and Africa. She served as the Director ofPrograms for Partnership for Productivity and worked as a microfinance consultant for USAID,the World Bank, and the International Finance Corporation. In 1997, Ms Berenbach became theExecutive Director of the Calvert Social Investment Foundation, a corporate foundation that servesas a bridge between the capital markets and community economic development.

Janney Carpenter is a Managing Director of Shorebank Advisory Services (SAS), the consultingsubsidiary of Shorebank Corporation, a development bank based in Chicago, Illinois. Ms.Carpenter’s expertise is in development finance and microenterprise credit, both in the UnitedStates and internationally. In microenterprise, she has assessed best practices, provided strategicand business planning help, and conducted assessments and evaluations. In development finance,she has designed and helped establish several development finance institutions, includingcommunity development banks and loan funds.

Anne-Marie Chidzero is a Private Sector Development Specialist with emphasis on micro, small,and medium enterprise development. She shares her time between CGAP (the Consultative Groupto Assist the Poorest), where she works as an Operations Analyst, and the Private SectorDevelopment Department of the World Bank. Most of her microfinance work has been in Africa,where she has conducted financial appraisals of microfinance institutions, organized and conductedtraining programs for practitioners, donors, and governments, and led the World Bank’sdiscussions with the Central Bank of West Africa on a regulatory framework for microfinanceinstitutions.

Craig Churchill is the Coordinator of the MicroFinance Network and the Director ofCalmeadow’s Washington, DC, office. Over the past five years, he has been Director of theResearch and Program Evaluation at ACCION International, has done research for the WorldBank, and worked as an advisor to Get Ahead Financial Services in South Africa.

Gilles Galludec joined CGAP in December 1996 as a Financial Management Specialist. He hasaccumulated eight years of experience as a practitioner in the financial sector in Africa. Heworked as a banking expert for Postal Savings in Gabon, where he designed and managed thefinance and treasury department for four years. He also spent four years in Benin as a FinancialController of FECECAM (a major credit union network) to reorganize the accounting, internalcontrol, and management information systems.

Steven Goldblatt is an advocate at the Johannesburg Bar, retained as a legal advisor by the Landand Agricultural Policy Centre and the Minister of Agriculture and Land Affairs. He was amember of the Strauss Commission on Rural Financial Services.

Eduardo C. Luang is the Bank Project Director of TSPI Development Corporation and isprimarily responsible for setting up the proposed TSPI Bank. His tasks include preparing theoperating manuals and conceptualizing the organizational and operational details required toestablish and operate a thrift bank. He has 28 years of experience in banking and was VicePresident and Chief Operating Officer of Comsavings Bank. He has also served as a consultant


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for two foreign banks, State Mortgage and Investment Bank in Colombo, Sri Lanka, and People’sBank of Zanzibar, Ltd., Tanzania.

Kimanthi Mutua, currently the Managing Director of K-Rep, has over 20 years experience infinance in general, and small and micro enterprise development in Africa in particular. His specialskills lie in the design and management of microenterprise finance operations, the design andinstallation of management information systems, and financial analysis. He has played a principalrole in designing and implementing all of K-Rep’s microenterprise development programs. Overthe past 15 years, Mr. Mutua has authored numerous publications on various issues in the fields ofenterprise development and microfinance.

Henry Oloo Oketch is currently K-Rep’s Manager of the Research and Innovations Department.He has been involved in NGO development work since 1987. Mr. Oketch has extensive skills andexperience in the design of management information and monitoring systems, as well as appraisaland evaluation of micro enterprise development projects. He has provided consulting services tothe ILO, USAID, Ford Foundation, SNV/NOVIB (Uganda), World Vision International, ChristianChildren’s Fund, University of Edinburgh, and the Kenya Industrial Estates on micro and smallenterprise evaluation and system design.

Rachel Rock is the Director, Program Evaluation and Policy Development for ACCIONInternational. She is responsible for researching and documenting issues in the microfinance fieldfor ACCION’s publication series and is a member of the research team for the USAIDMicroenterprise Best Practices project. Before joining ACCION, Ms. Rock worked in communitydevelopment in the Dominican Republic and in strategic political consulting in several LatinAmerican countries. She also developed training materials for Working Capital, a domesticmicrocredit program in New England.

Malena Vasquez is a Corporate Planning Specialist of TSPI Development Corporation. Her workinvolves corporate planning, monitoring, and research. She has worked with TSPI for over fiveyears.

Rudolph Wilhemse is the chairman of EFK Tucker, Inc., a Johannesburg firm of attorneys. Hehas been involved in a number of initiatives relating to the provision of development finance to low-income communities.


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ACKNOWLEDGMENTS

The MicroFinance Network, with the financial support of the British Department for InternationalDevelopment (DFID), the World Bank’s CGAP, and a private foundation, has undertaken thisresearch project to promote a greater awareness of appropriate regulatory and supervisoryapproaches for microfinance. The authors thank the funders of this project for their support.

An expert panel of bank supervisors served as advisors to this research. Their contributions helpedto ensure that this study considered the concerns and limitations of supervisory bodies. Mostimportantly, they repeatedly emphasized that, for the most part, bank superintendents are notparticularly interested in small financial institutions that do not pose a significant threat to thestability of the financial system. This panel includes:

• Hennie van Greuning, the former Chairman of the South African Reserve Bank, currentlyemployed at The World Bank

• Jorge Castellanos, the Colombian Banking Superintendent from 1994 to 1995, nowworking for JP Morgan in New York

• Luis Cortavaria, the former Banking Superintendent of Peru, currently working with theInternational Finance Corporation (IFC)

• Christopher Beshouri, a Financial Economist at the United States Department of Treasury

The authors are indebted to a long list of other readers and advisors to this project including:Elisabeth Rhyne (USAID); Richard Rosenberg and Joyita Mukherjee (CGAP); David Wright(DFID); Maria Otero and Carlos Castello (ACCION International); Barbara Calvin and StefanHarpe (Calmeadow); Robert P. Christen; Jacques Trigo LoubiPre (Bolivian Superintendent ofBanks and Financial Institutions); Maria Eugenia Iglesias (Finansol); Cliff Kellogg (Shorebank);Stuart Rutherford; Harald Huttenrauch and Mark Wenner (Inter-American Development Bank);Robert Vogel (IMCC); Mengistu Alemayehu (International Finance Corporation); Todd Farington;Jacinta Hamann (COFIDE); Don Johnston (HIID); Edgar Lasso (Finance Company Delegate tothe Colombian Banking Superintendent); and the staff of BCEAO.

The editor thanks the members of the MicroFinance Network for supporting this research, inparticular those members that have contributed their time and resources directly to this project:ACCION International, Accion Comunitaria del Peru, BancoSol, Bank Rakyat Indonesia, BRAC,Calmeadow, Finansol, K-Rep, and TSPI Development Corporation. The perseverance andcooperation of all the authors during this two year project is also greatly appreciated.


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LIST OF ACRONYMS

ADB Asian Development Bank

AfDB African Development Bank

AMEDP Alliance of Micro Enterprise Development Practitioners

ASA Association for Social Advancement

BAP Bankers Association of the Philippines

BCEAO Banque Central des Etats de l’Afrique de L’Ouest

BKD Baden Kredit Desa

BKK Badan Kredit Kecamatan

BRAC Bangladesh Rural Advancement Committee

BRI Bank Rakyat Indonesia

BSP Bangko Sentral ng Pilipinas

CAF Corporacion Andina de Fomento

CAMEL Capital Adequacy Asset Quality Management Earnings Liquidity

CAS/SMEC Cellule d’Appui et de Suivi des Structures Mutualistes ou Coopérativesd’Epargne et de Crédit

CBK Central Bank of Kenya

CD Certificate of Deposit

CDF Credit and Development Forum

CGAP Consultative Group to Assist the Poorest

CIDA Canadian International Development Agency

CMAC Cajas Municipales de Ahorro y Crédito

COFIDE Corporacion Financiera de Desarrollo

CRAC Caja Rurale de Ahorro y Credito

EDPYME Entidades de Desarrollo para la Pequena y Microempresa

FEPCMAC Federation Peruana de Cajas Municipales de Ahorro y Credito

FONCODES Fondo Nacional de Compensacion y Desarrollo Social

FONDEM Fondo para el de la Desarrollo Microempresa

FMO Nederlandse Financierings-Mautschappij Voor Ontwikkelingslanded

FRASA Fondo Revolvente del Sector Agrario

GDP Gross Domestic Product

GTZ Gesellschaft fur Technische Zusammenarbeit

IDB Inter-American Development Bank

IFAD International Fund for Agriculture

IFC International Finance Corporation

IFI Instituto de Fomento Industrial

IIC Inter-American Investment Corporation

IPC Interdisziplinare Projekt Consult


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K-Rep Kenya Rural Enterprise Program

KUK Kredit Usaha Kecil

KURK Kredit Usaha Rakyat Kecil

LPD Lembaga Perkreditan Desa

LPN Lumbung Pitih Nagari

MFI Microfinance Institution

MIS Management Information Systems

NBFI Non-Bank Financial Institution

NCC National Credit Council

NGO Non-Governmental Organization

NHFC National Housing Finance Corporation

PARMEC Prôjet d’Appui à la Réglementation des Mutuelles d’Epargne et de Credit

PCFC Peoples Credit and Finance Corporation

PDIC Philippine Deposit Insurance Corporation

PFF Private Financial Fund

PKSF Palli Karma Sahayak Foundation

PRODEM Fundacion para la Promocion y Desarrollo de la Micro empresa

ROSCA Rotating Savings and Credit Associations

ROA Return on Assets

SACCO Savings and Credit Cooperative

SBS Superintendencia de Banca y Seguros

SCC Savings and Credit Cooperatives

SDID Société de Développment International Desjardin

SDR Special Drawing Rights

SDS Social Development Society

UEMOA Union Economique et Monetaire d’Ouest Afrique

USAID United States Agency for International Development


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INTRODUCTION

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Project Purpose

The MicroFinance Network is a global association of microfinance institutions (MFIs)commited toimproving the quality of life of low-income communities through the provision of credit,and other financial services.1 Network members believe these services should be provided bysustainable and profitable financial institutions that reach large numbers of clients not currently servedby the traditional banking sector.

This research is designed to serve as a resource for bank supervisors, regulators, and policy makers.The Regulation and Supervision Project of the MicroFinance Network reviews case experiences innine countries that have some experience with MFIs and draws conclusions regarding approaches toregulation and supervision that are suited to the unique characteristics of those institutions. Countrieswere selected for review because of the presence of a MicroFinance Network member and because thissample presents a range of regulatory responses in diverse settings. The principal findings from thisproject are summarized in the first volume. The country case studies, presented in this second volume,offer a detailed analysis of the field experience.

Experiences in Bangladesh, Indonesia, and Bolivia provide evidence of the potential of microfinanceinstitutions to provide financial services on a large scale. While these are exceptional cases, themicrofinance community is emulating these models of success. Under proper conditions, including anappropriate regulatory environment, there will be an increasing number of successful MFIs in thecoming years. It is hoped that regulators will be proactive in their preparations for the microfinancewave. It is not necessary, desirable, or realistic to regulate all microfinance institutions. However, ifthese services include mobilizing voluntary savings from the general public beyond closedcommunities where common bonds exist, it is critical that some form of supervision be involved.

The cases examined highlight two general approaches to regulating microfinance institutions. Thesituations in Bolivia, Kenya, and Colombia show the experiences of regulating MFIs within theexisting regulatory framework, either as a commercial bank or as a finance company. Theseexperiences also highlight mismatches between the standard regulatory framework and the provisionof microfinance services. The cases from Peru, West Africa, and Bolivia again provide insight intoinitial attempts to create special categories of laws designed specifically for microfinance institutions.

A third set of experiences, from South Africa and the Philippines, demonstrates a learning process –for MFIs and policy makers – designed to create standards for the local microfinance industry. Whileit is too early in the development of these efforts to have a significant bearing on the discussion, they

1 Microfinance institutions (MFIs) assume a variety of institutional forms. While these cases speak most frequently

about non-profit microcredit programs that create regulated MFIs, other institutional types include government-owned banks that operate microfinance units, commercial banks that create microfinance subsidiaries, and creditunions. Successful MFIs typically provide a range of financial services to low-income communities, such as savings,personal or consumption loans, housing and enterprise loans.


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do suggest possible first steps towards identifying an appropriate regulatory approach formicrofinance.

Background

The emergence of the microfinance industry presents an unprecedented opportunity to extend financialservices to the vast majority of the economically active population. In developing countries,traditional banks typically serve no more than twenty percent of the population. The remainingcommunities historically have not had access to formal financial services, yet this non-traditionalmarket is immense. The World Bank estimates that the potential global market for microenterprisecredit currently stands at about 100 million clients.

In the last twenty years, leading MFIs have devised appropriate financial service technologies tobecome profitable financial intermediaries. These developments have established the means to extendfinancial services to excluded sectors, thereby laying the groundwork for the microfinance industry.Through the provision of these services, MFIs deepen the financial system and expand the economiccontribution of low-income communities. Just as new agricultural technologies spawned the greenrevolution in the l970s and 1980s, new financial technologies are producing the microfinancerevolution in the 1990s.

As they mature, many MFIs are realizing that they need to enter the formal financial system to fundtheir growth and to provide the diversity of financial services demanded by their target market.However, just as traditional lending techniques are inappropriate for the characteristics ofmicroenterprises, traditional banking regulation and supervisory practices are ill-suited to the uniquerisk profile of a microfinance institution.

In many countries, bank regulators now face the challenge of determining whether to regulate theemerging microfinance sector at all. If so, they need to consider an appropriate regulatory approach.As unregulated financial entities, MFIs have had considerable freedom to adapt operating methods toserve their target markets effectively. This has led to the development of a small but growing numberof robust, specialized financial institutions, innovative delivery methods, and an extension of thefinancial services market. As more MFIs grow in scale and complexity, regulators may seek tosupport their growth while safeguarding the financial system and protecting the interests of MFIclients. This is particularly important since these clients typically come from the most vulnerablesectors of the population.

When regulation is warranted, it requires coherent prudential guidelines that will allow the growth ofthe microfinance sector while protecting the interests of small savers and supporting the integrity ofthe financial sector as a whole. While appropriate regulatory approaches must be consistent with theregulatory framework of a given country, the case studies point to field lessons that illuminateappropriate regulation of this segment of the financial market. The essence of these lessons is toconsider the risk profile of microfinance institutions and rigorously apply prudential guidelines whereMFIs are vulnerable, but to offer flexibility in risk-control measures that do not apply to themicrofinance sector. Such effective regulation may be accomplished through exemptions andmodifications to existing financial-sector guidelines or through the establishment of specializedregulatory regimes.

Whichever means regulators adopt, they should be cautious not to move too hastily to establish anyregulations, nor to create regulations based only on one institutional model. There is a danger that


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regulations designed for the risk profile of commercial banks will box MFIs into practices that requirereplicating traditional banking practices, thereby losing their ability to reach their target market.

There is also a danger that the proliferation of MFIs, in response to a seemingly limitless market formicrofinance services, may exceed the regulators’ capacities of supervision. Yet, once MFIs areregulated entities, depositors may not adequately evaluate their risk. It is necessary to find a balance.Regulators should consider a line below which the financial markets are better left unregulated andfocus their attention on those institutions with the potential to obtain significant scale. In addition,until regulators develop an expertise with microfinance, it is probably preferable not to license toomany institutions.

While it is neither possible nor desirable to regulate all microfinance institutions, an increasing numberof MFIs are reaching significant scale, intend to mobilize savings, and merit further consideration bybank regulators. The case studies review some of the experiences to date of jurisdictions that haveattempted to shape regulation and supervision to the specific characteristics of microfinance.

While the cases in this publication are organized geographically, the issues and approaches transcendregions. K-Rep is encountering many of the same regulatory obstacles in Kenya that BancoSolcontinues to experience in Bolivia five years after creating the world’s first commercial bank dedicatedsolely to microfinance. South Africa and the Philippines are involved in similar processes to identifyan appropriate regulatory framework for microfinance in their countries. The crisis that occurredwith Finansol in Colombia could occur in Bangladesh or elsewhere unless similar ownership andgovernance issues are resolved. More than half of the countries in this small sample are struggling todetermine the appropriate role for government sponsored apex institutions. All countries are dealingwith the challenges that result from a lack of industry standards and common definitions for financialand performance indicators.

The new world of microfinance is not large. The MicroFinance Network, as a global association,seeks to make it even smaller so that important lessons can quickly cross national and regionalboundaries, and advance the field. This publication is an important step in striving for that objective.


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INDONESIA

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Shari Berenbach

In terms of scale, variety, and volume of MFIs, market penetration, and profitability, themicrofinancial services market in Indonesia is the most developed in the world. Indonesia is one offew countries where the microfinance market extends to the village level. There are more than fifteenthousand village banking units providing savings and credit to nearly seventeen million clients. Thiscase study focuses on a description of the microfinance institutions in Indonesia and a brief overviewof the legal and regulatory framework for the microfinancial services market as a whole. This chapteralso reviews the Bank Rakyat Indonesia’s (BRI) Unit Desa System, the largest microfinanceinstitution in the world, and gives special attention to the MFI supervision methods applied inIndonesia.

Background

The experience with village-based microfinance institutions in Indonesia dates back more than onehundred years and is part of the Dutch colonial legacy. Particularly in Central Java, the Dutchintroduced village-owned banks known as BKD (Badan Kredit Desa). In the late 1960s, during aperiod of monetary instability and high inflation rates, many of the village-owned banks faltered. Inthe 1970s and 1980s, building on its village banking tradition, national and provincial developmentbanks successfully promoted the effective delivery of rural financial services through village-levelbanking units. Today, a web of small banking institutions has evolved, providing financial services atsub-district market towns and in villages. This includes the traditional village-owned banks mentionedabove, the BRI village units, at least six provincial village banking networks, and private village bankssuch as Bank Dagang Bali.

While the data presented in Table 1 on the following page provide an overview of the microfinancialservices market in Indonesia, Table 2 illustrates the variation among these financial institutions. Forexample, the village-owned banks and several of the provincial village banking networks2 average loansizes below US$50 and savings deposits below US$10. The average loan size and deposit of the BRIvillage units, the largest of this set, are US$664 and US$178 respectively.

2 For the purpose of this case study, the provincial village banking networks are those that were promoted by

provincial governments. These may be owned by the provincial government (Badan Kredit Kecamatan-BKK, KreditUsaha Rakyat Kecil-KURK), owned by the village (Lembaga Perkreditan Desa-LPD), or owned by their clients(Lumbung Pitih Nagari-LPN).

Table 1: Microfinance Institutions In Indonesia3

BRI VillageUnits

Village-OwnedBKD LPD KURK BKK-CJ LPN BKPD-LPK

Number of Units 3,581 5,345 631 1,426 3,525 193 326

Location Country Java Bali E. Java C. Java W. Sumatra W. Java

Date Creation 1983 1927 1985 1987 1971 1932 1971

Loans US$ million 1,700 28.0 9.9 5.2 21.8 1.9 37

Deposits US$ million 2,800 1.0 7.4 1.3 3.9 1.0 22.5

Borrowers (000s) 2,559 1,073 94 171 564 19 218

Depositors (000s) 15,758 235 204 177 496 57 405

Average Loan Size (US$) 664 26 105 30 39 100 170

Average Deposit Size (US$) 178 4 36 7 8 18 56

Lending Rates (percentage) 84.4 53.6 84.4 84.4 54.8 59.3

Avg. Loan Term (weeks) 52 12 43 12 12 24 26

Compulsory Saving no yes yes yes yes yes yes

Savings Rate (n) 13-15 15 12-24 12 12-15 0-24 12-24

Savings/Loans 1.64 0.03 0.78 0.22 0.18 0.54 0.60

3 Data for BRI is derived from member statistics provided by the BRI to the MicroFinance Network as of August 1996. The number of village-owned banks as of year-

end 1996 was provided by the Cooperative Division of BRI, which is responsible for their supervision. Estimates for the number of private village banks is dated asof 1992 and cited in “Report on the FID in Indonesia, October 1992.” All other data is as of 1991 and is derived from Chaves, Rodrigo and Gonzalez-Vega, Claudio,“The Design of Successful Rural Financial Intermediaries: Evidence from Indonesia”; World Development Vol. 24, no. 1. pp. 65-78, 1996.


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Table 2: Summary Overview MFIs in Indonesia

#Units#Clients(000s)

Loans(US$000s)

Deposits(US$000s)

BRI Village Units 3,581 15,758 1,700 2,800

Village-Owned Banks 5,345 1,073 28 1

Provincial Village Banking Networks 6,101 1,421 76 36

Total 15,027 19,325 $1,804 $2,837

More important are the following common features: (i) financial services are provided wherecustomers are located – in the villages or district market towns; (ii) loans are granted on an individualbasis and, with the exception of the BRI, are secured by character reference rather than collateral; (iii)savings mobilization is an important source of funding; and (iv) each unit is treated as a profit center,with its own profit and loss statement and balance sheet.

Legal and Regulatory DevelopmentsBanking regulation implemented in 1988 was aimed at increasing the efficiency of the financial sectorby augmenting competition in the industry. It removed all significant barriers from the establishmentof new rural microfinance institutions. The Banking Law of March 1992 restructured the ruralfinancial markets with the creation of two categories of financial institutions: commercial banks andsmallholder credit banks. This law limits the smallholder credit banks to the intermediation of non-checking account deposits, while commercial banks are allowed to provide all modern bankingservices. The law establishes three types of smallholder credit banks: private, government, andcooperative. Since 1992, the village-owned banks and the provincial village banking networksoutlined above have had to adopt the legal format of one of the three smallholder credit banks.

There is great ease of entry in establishing a new smallholder credit bank. To obtain a license, banksponsors meet a minimum capital requirement of approximately US$25,000, demonstrate theirbanking expertise, and present a feasibility study including an organizational diagram.4 Private villagebanks are the most rapidly growing segment of the smallholder bank market.

In 1992, Bank Indonesia5 further promoted microfinancial services through the Kredit Usaha Kecil(KUK) regulation. This regulation requires every financial intermediary in the country to lend twentypercent of its loan portfolio to small borrowers. Compliance with this regulation may be achieveddirectly by the financial institution’s own lending or indirectly by lending the corresponding amount toanother intermediary whose main line of business is loans to small-scale borrowers. The effect of theKUK regulation has been to channel substantial financial resources to the thousands of rural financialunits. For example, the Export-Import Bank of Indonesia has allocated its KUK funds to CentralJava’s provincial village banking network. The KUK regulation can be effective in Indonesia becausethousands of financial intermediaries with the capacity to conduct small-scale lending already exist.

The Economic and Social Environment for MicrofinanceA number of economic factors in the Indonesian environment have contributed to the remarkablesuccess of the MFIs in that country. During the 1980s and 1990s, while the village banking networks

4 According to Article 16 of the Banking Law.5 Bank Indonesia, the central bank of Indonesia, is both responsible for monetary policy and for the regulation and

supervision of the banking industry.


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were being developed, Indonesia enjoyed comparatively high rates of growth of output accompaniedby rapid growth of rural incomes and a reduction of poverty. Profitable investment opportunitiesemerged for the microentrepreneur as domestic markets became more integrated and internationalbarriers to trade were reversed. The rapid economic growth was coupled with the liberalization of thefinancial markets and a stable macroeconomic environment. Indonesia has not experienced significantdomestic inflation in recent years.

Since microfinance combines both economic and social agendas, it is not surprising that the socialenvironment in Indonesia also contributed to the creation of the world’s most sophisticatedmicrofinance market. Political stability and a strong presence of government at all administrativelevels contribute an effective institutional framework for the development of the MFIs. Indonesiabenefits from a high degree of social cohesion. This traditional social structure is particularlyimportant to the success of microfinance as it contributes to financial contract enforcement.Furthermore, high population density in a number of provinces greatly enhances the efficiency ofdecentralized banking systems and allows individual banking units to attain profitability quickly.

The most important factor in Indonesia’s microfinance success, however, is that the authoritiesrecognize the developmental benefit obtained by promoting organizations that permanently providefinancial services at market prices. While not all the economic and social elements mentionedpreviously must be present to create a successful microfinance industry, the emphasis on properpricing to allow the creation of sustainable institutions is critical.6

Bank Rakyat Indonesia Unit Desa

Bank Rakyat Indonesia is one of the largest commercial banks in Indonesia with US$13 billion in totalassets as of August 1996. It is also the most prominent institution in Indonesia’s microfinance sector.Originally one of five state-owned development banks, BRI today operates as a commercial bankowned by the government. Besides its standard commercial banking services and extensive branchnetwork throughout the country, it also operates the BRI Unit Desa division with total assets of US$3billion. Of the 44,000 BRI employees, 23,000 are employed in the Unit Desa’s activities. Althoughthe Unit Desa system represents only 23 percent of the Bank’s total assets, it generates 40 percent ofits total revenues, achieving a 4.7 percent return on assets.

The Unit Desa division had its origins in 1970 when the government charged BRI with serving thefinancial requirements of the Indonesian rice-intensification program. BRI established more than3,600 village units between 1970 and 1983, primarily in sub-district market towns. Bank Indonesiaprovided capital for these rural credits in the form of three percent liquidity credits, and the Ministryof Finance provided administrative operating subsidies.

By the early 1980s subsidies were discontinued, requiring BRI to adopt a new approach to ruralbanking. At this point, the Ministry of Finance, and particularly its Center for Policy andImplementation Studies, pressed for a significant liberalization of bank regulations. In July 1983, theMinister of Finance granted BRI authority to charge ‘break-even’ interest rates on commercial loansand savings. BRI responded to the new regulatory environment by adopting three significant policychanges to revitalize the Unit Desas:

6 This discussion draws heavily from Chaves and Gonzalez-Vega (1996).


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1. Transformation of the village units from subsidized credit conduits to full-service rural banks.

2. Internal treatment of the Unit Desas as semi-autonomous profit centers rather than simply aspostings in BRI’s overall accounts.

3. Evaluation of the village units based on their profitability rather than on hectares covered ormoney lent.

In January 1984, the operations of the Unit division began its new program financed by borrowings atinterest rates that reflected the cost of funds. In combination with lending rates that allowed a positivemargin, BRI established a built-in incentive to mobilize resources from savers, thus laying thegroundwork for the creation of a viable rural banking system.7

BRI’s success can be traced to a number of factors:

1. The use of scarce high-level management resources for microfinance development;

2. The development of financial instruments designed and priced specifically to meet localdemand and return profits;

3. Simple, transparent accounting and reporting procedures;

4. Treatment of each village unit as a profit center, with its own profit and loss statement andbalance sheet;

5. Attention to the appropriate timing and sequencing in building the village unit system;

6. The creation of specialized staff training and incentive systems that emphasize responsibilityat the unit level;

7. A decentralized management structure;

8. Knowledge of local markets;

9. Respect for and close relations with the units’ predominantly rural, lower-income clients;

10. A well-designed and implemented supervision process.8

7 This section draws heavily from Boomgard, James and Angell, Kenneth, “BRI’s Unit Desa System: Achievements

and Replicability” in Otero and Rhyne (eds.) The New World of Microenterprise Finance. West Hartford, CT:Kumarian.

8 These points are drawn from Sugianto and Robinson, Marguerite, “Commercial Banks as Microfinance Providers,”November 1996, prepared for the USAID Commercial Banks and Microenterprise Finance workshop, Washington,DC.


10

Supervision of MFIs in Indonesia

With over 15,000 microfinance units in Indonesia and decades of experience, there are importantlessons learned about the supervision of microfinance institutions. The most important is that whileBank Indonesia has the legal responsibility to supervise all MFIs, it only directly supervises about onethousand units, which mostly include private village banks. As shown in Table 3, Bank Indonesia hasentered into a third-party arrangement with various agencies to provide MFIs with direct supervision,including on-site audits. For indirect supervision (e.g., monitoring field reports), MFIs provide somereports directly to Bank Indonesia. Bank Indonesia’s reliance on third parties to conduct directsupervision is reasonable given that the various village units account for ninety-eight percent of thebanking institutions but less than one percent of the total assets of the financial system.

Table 3: Supervisory Arrangements in Indonesia

# Units Supervisory BodyBRI Village Units 3,581 BRI-Village Unit Division

Village-Owned Banks 5,435 BRI-Small & Cooperative Division

Provincial Village Banking Networks 6,131 Provincial Development Banks

Private Village Banks 1,000 Bank Indonesia

BRI Supervision of the Unit DesasThe Unit Division oversees its own village network. This division’s operations are independent ofBRI’s commercial branch network, which offers a range of commercial banking services to a higher-end market. Separate from the BRI’s commercial banking branch network, the Unit Desas form theirown branch network. Pricing policies are set for the system as a whole and consistent administrativesystems are used across all units. Different from most branch arrangements, however, there isconsiderable local financial intermediation (e.g., collecting savings and on-lending from the samevillage unit), and each unit is evaluated for profitability.

In most BRI branches, there are two managers of the Unit division reporting directly to the bank’sbranch manager. The Unit Desa manager is responsible for visiting each unit weekly, to review thereports submitted, and to ensure their veracity. This responsibility may include supervising up to nineunits. If there are more than nine units in a given branch area, a Unit Officer is assigned to providesupport to the Unit Manager.

The BRI Unit Desa’s supervision of its own system includes elements of prudential control, standardmanagement, and financial controls. Regular reports comprise the documentation provided to the BRIUnits. These are outlined in Table 4. The monthly Progress Report includes twenty-seven keyindicators, which are tracked on a monthly basis to observe positive or negative performance trends.Performance indicators are ranked by color-coding: on-time repayment is ranked positive (green) ifless than two percent of the portfolio is in arrears; poor (red) status is assigned for those withdelinquency of greater than 4.5 percent; satisfactory (yellow) rating is provided for portfoliodelinquency above 2 percent and less than 4.5 percent. If a branch’s performance is poor, the UnitManager will visit borrowers directly, and new loans may be withheld until the Unit’s performanceimproves.


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Table 4: Banking Supervision Reports

Reports Information Included Report Submitted toDaily Reports Trial balance Branch

Weekly Reports Liquidity Report Branch

Monthly Reports Progress Report, Balance Sheet,Income Statement

Branch, Regional, and Head Office

Quarterly Report Personnel Report Branch, Regional, and Head Office

Semi-Annual Report Past performance indicators forContest Achievement

Branch and Regional Office

Annual Report Balance Sheet and IncomeStatement

Branch, Regional, and head Office

Every six months, BRI conducts an achievement contest between the units. Those units qualifying fortop ranking receive cash prices and certificates of recognition presented by the BRI Director. The BRIUnit Division defines target criteria, which include profitability, client growth, increases in the loanportfolio and deposits raised, delinquency controls, and other administrative and management factorssuch as office appearance.

To avert potential fraud, dual controls are applied. Specifically, one unit officer is responsible forissuing loan disbursement checks, which are then signed by another officer. Staff involved incollusion or fraudulent practices are dismissed. Cash at BRI units is limited to four percent of thetotal savings and is evaluated on a quarterly basis.

The Unit Desa’s loan classification and reserve system are relatively conservative. As shown in Table5, loans up to ninety days late are substandard and require a fifty percent provision; loans greater thanthree months overdue require a one hundred percent provision; and a complete write off occurs aftertwelve months.

Table 5: BRI Village Unit Loan Classification and Reserves

LoanClassification Delinquency

Loan Loss Reserves:3% Total Portfolio +

“Before Due” Late Payment 0%

Substandard Up to 3 months 50%

Doubtful 3-9 months` 100%

Bad-debt 9-12 months 100%

Write off Above 12 months 100%

BRI Supervision of the Village-owned BanksBesides supervising its own Unit Division on behalf of the Bank Indonesia, BRI also performs thisfunction for the village-owned banks. BRI’s relationship with the village-owned banks dates back to1929. It is possible to consider that BRI has almost an implicit statutory authority for the 5,345village-owned banks. To administer this responsibility, BRI established a Cooperative and Villagedivision dedicated to this purpose. The village-owned banks pay for the supervisory costs, which BRIcalculates based on an annual budget prepared this service.


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As part of its regulatory oversight function, BRI establishes the interest rates charged on loans,interest rates paid on savings, and the maximum loan size. BRI is responsible for ensuring effectiveinternal control of the village-owned banks. Supervisors oversee about twenty village-owned banksand are required to make monthly visits. This is relatively close supervision considering that somevillage-owned banks are only open one day a week. In addition to the supervisors, there is also atraveling bookkeeper who works with about five village-owned banks.

The reporting requirement for village-owned banks is not as extensive as that provided by the UnitDesas. Under the supervision of BRI, village-owned banks produce a monthly balance sheet, incomestatement, and a portfolio report, which they submit to Bank Indonesia for review.

BRI’s responsibility to set interest rates on loans and deposits raises concern about the possibility ofcurbing competition from the village-owned banks. Closer examination, however, points out that theBRI Unit Desas and the village-owned banks reach significantly different sub-markets. This is mostnotable when considering their average loan and deposit size, as shown in Table 6.

Table 6: Loan and Deposit Size Comparison of BRI Unit Desa and Village-owned Banks

Banking Unit Average Loan Size Average Savings Savings InstrumentsBRI Unit Desa $664 $178 Various Instruments

Village-owned Banks $26 $4 Passbook Savings

The close relationship between BRI and the village-owned banks has important benefits for BRI.While BRI and the village-owned banks do not appear to compete for deposits, the village-ownedbanks are significant depositors at BRI. For example, a study notes that at one village-owned bank,sixty-eight percent of the total assets of the bank were deposited with BRI. Deposits from the village-owned banks equal thirty-seven percent of the value of BRI’s total assets. The study also notes thatthe village-owned banks have almost come to function as village posts for the Units.

Bank Indonesia Supervision of the Private Banking UnitsBy 1992, Bank Indonesia was responsible for supervising about 1,000 village banking units, including661 privately owned village banks and thirty cooperative-owned village banks. In the early 1990s,Bank Indonesia was further developing its supervision process, consisting of monthly, quarterly,biannual, and annual reports consistent with the formats used by commercial banks.

Bank Indonesia has also developed a CAMEL-based (Capital Adequacy Asset Quality ManagementEarnings Liquidity) statistical analysis to serve as an early warning device to indicate a variety ofpotential problems, including portfolio quality and liquidity. The system is designed to prompt an on-site visit by a supervisory team if problems arise. A 1992 report indicated that this early warningsystem was too closely modeled on indicators used in standard commercial banking and did notsufficiently adjust to the distinct features of micro finance.9 A more up-to-date review of this systemmerits further examination.

9 Report for the USAID Financial Institution Development Project in Indonesia, October 1992, and revised January

1993, provided to the author by Rodrigo Chaves.


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Supervision IssuesThe experience from Indonesia points to a number of important lessons regarding the supervision ofmicrofinance institutions.

Third Party Supervision is a Viable Alternative. Because of the volume of institutions to supervise,it has proven effective to contract-out prudential supervision to a third party. Bank Indonesia isfortunate to have appropriately qualified institutions, such as BRI and municipal development banks,to perform these functions. The supervision of effective regulation, however, should not be confusedwith abdicating responsibility to form appropriate regulatory guidelines. This should remain with thestatutory body responsible for regulation, regardless of whether the direct supervision is conducted bya third party or by an in-house division. The objective of the supervision should be to verify theaccuracy of data, monitor financial controls, and ensure adherence to bank regulations.

Simplification of the Supervision Methods. The greater number of institutions engaged in third-party supervisory arrangements and the higher volume of MFIs that require supervision, lead to theimportance of simplifying and standardizing the supervision process. For example, because of itssimplicity – and the fact that most village banks are not computerized – BRI firmly recommends theuse of cash accounting in place of accrual accounting. Loan classification should be definedaccording to standard, measurable indicators (e.g., days late as opposed to a qualitative analysis).Reports should be standardized, incorporating the same information for each period. The supervisionprocess should be designed towards increasing efficiency and reducing individual discretion.

Still a Challenge to Adjust to the Unique Features of MFIs. Even in Indonesia, after more thantwenty years’ experience with large scale microfinance, concern remains regarding the imposition ofcommercial banking methods and norms on MFIs. Sugianto and Robinson (1996) commented thatregulators required the same level of planning and documentation to open a four-person village-ownedunit as they would require of any commercial bank branch. They also found the requirements tonotarize the proof of collateral excessive for the needs of MFIs. Portfolio reporting formats used byBank Indonesia required MFIs to report on individual loans instead of analyzing the performance ofthe portfolio as a whole. There is also concern that some sections of the banking industry still favorsubsidized lending, leading to overall pricing distortions in the microfinancial services market.

Importance of Prudential Supervision of the Savings of the Low-income. The most importantlesson to come from the Indonesia experience is that it is possible to exert prudential supervision overinstitutions that provide savings services to the low-income market. Previous conventional wisdomcontended that, given their small size and great number, it is simply not economically viable orphysically possible to exert prudential supervision over thousands of small MFIs. Experience fromIndonesia shows that this is not the case. Even with average deposit sizes of less than US$5, if anappropriate and efficient system is adopted, it is possible for savings facilities to meet their cost ofsupervision. Financial services for low-income communities can be just as reliable as those offered allsectors of the society.


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15

ÐÐ

BANGLADESH

ÓÓ

Janney Carpenter

Bangladesh has one of the oldest and most diverse microfinance sectors in the world, including someof the largest and most sophisticated microfinance institutions.10 The three largest MFIs, for example– Grameen Bank, BRAC, and ASA – served a combined membership of more than four million peopleas of December 1996.11 In Bangladesh, the unique circumstances of no regulatory oversight and alarge, well-funded non-governmental organization (NGO) community have resulted in the ad hocevolution of sophisticated and innovative MFIs seeking to alleviate poverty. Most MFIs inBangladesh combine microcredit with a strong education and social-change agenda to address thestructural poverty of rural landless individuals, so credit (and financial services) may be only part oftheir development activities.

Most MFIs in Bangladesh are NGOs, which are exempt from oversight by the central bank despitetheir ability to lend and collect deposits from members. According to the local trade association, 351NGOs provide microfinance services, credit and savings, though the four largest NGOs representabout 80 percent of the total loans outstanding.12 This chapter focuses on those organizations forwhich microfinance is the sole or primary activity and that are striving for financial self-sufficiency.

At present, the only MFI in Bangladesh regulated by the central bank is the Grameen Bank, thecountry’s largest microlender. Grameen was organized under a special, one-time bank charter issuedby the Ministry of Finance in 1983. Grameen has lent more than US$1.17 billion to about two millionmembers.13 Its innovation in peer group lending has become a local and global model for lending tothe asset-less persons.14 The Bangladesh Bank (the central bank) has traditionally viewed NGOs asdistinct from other financial institutions because of their social and development missions. However,as MFIs continue to expand and solicit member savings to finance loans, the Bangladesh Bank mustreconsider whether it needs some regulatory oversight to protect individual depositors and savers fromfraud and mismanagement.

10 This case study was written with assistance from: Cliff Kellogg of Shorebank Corporation, who conducted field

research in Dhaka; David Wright, Senior Advisor at the Department for International Development, UK; and StuartRutherford of Dhaka, Bangladesh; all of whom reviewed drafts and shared their valuable insights.

11 Credit and Development Forum, “CDF Statistics: Microfinance Statistics of NGOs,” Published in Dhaka,Bangladesh, April 1997 based on December 1996 data.

12 Ibid.13 As of December 1996, the exchange rate for the Bangladesh Taka was Tk. 42: US$1. Over the past few years, the

90-day Government Treasury Bill Rate has been maintained at 3-5%, and annual inflation has run 6-10%.14 The Grameen Bank pioneered a lending model that extends loans to members of five-person peer groups, thereby

replacing traditional collateral with peer pressure and incentives to maintain access to additional loans. ManyBangladesh microcredit organizations use the same model, or variations on it, because of its effectiveness with low-income, rural populations.


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This chapter highlights the current formal and semi-formal financial sectors in Bangladesh, how theGrameen Bank fits within the banking regulatory and supervisory framework, and the challenges ofdesigning an appropriate regulatory framework for MFIs in a country with limited experience inregulation and supervision. The case study is organized into the following sections:

• Context: The Formal and Semi-formal Financial Sectors;

• The Grameen Bank;

• The Regulation Dilemma: How Much and How To Do It Well?

• Observations and Conclusions from Bangladesh.

The Bangladesh Bank is currently reviewing the need to monitor and oversee MFIs as part of a WorldBank study.15 This presents Bangladesh with an opportunity to revisit these questions and create anappropriate oversight framework to protect depositors in these specialized financial intermediaries. Asless sophisticated consumers with little political representation, the most compelling argument forregulation of MFIs is to protect member savings. However, the Bangladesh Bank must exerciseregulation and supervision carefully to avoid quashing specialized financial intermediaries that havedeveloped innovative and effective ways of serving low-income persons.

Context: The Formal And Semi-Formal Financial Sectors

Financial services in Bangladesh come from three areas: informal sources (family, friends, ROSCAsand savings clubs,16 and moneylenders); the semi-formal sector of NGO microlending; and the formalsector of agricultural and nationalized commercial banks, along with ten privately owned banks. Likemany countries, only the formal sector is regulated, with no regulation or supervision specificallyfocused on MFIs. The public policy reasons for regulating the financial sector are: (i) individualdepositors need protection from fraud and mismanagement by financial institutions because the publicdoes not have the information or expertise to evaluate those risks; and (ii) if the government providesdeposit insurance or financial support to the financial sector, it imposes some risk parameters on thoseinstitutions. As MFIs push further into financial intermediation and use member savings as a majorfunding source, some degree of oversight under the first rationale may be appropriate. At present,depositors and funders of NGO microfinance institutions rely primarily on the integrity ofmanagement to protect their funds.

The Formal SectorAs of December 1996, the formal financial sector in Bangladesh consisted of thirty-two bankinginstitutions: fifteen national commercial banks (state-owned commercial banks), two agricultural banknetworks (also state-owned), ten privately owned banks, and a few recently established non-bankfinance and leasing companies. The Bangladesh Bank is the primary regulatory authority. Though

15 In 1997, The World Bank lent US$100 million to the Bangladesh Bank to finance PKSF, a quasi-governmental

foundation that on-lends funds to NGOs that extend microcredit. This included US$5 million in technical assistancegrants, in part to review these issues.

16 Rotating Savings and Credit Associations (ROSCAs) and savings clubs are actively used in Bangladesh, according toStuart Rutherford’s essay “Informal Financial Services in the Dhaka Slums.” In Wood and Shariff (editors), WhoNeeds Credit. Zed Books, London and UP Dhaka. 1997.


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much smaller than the central bank, the Ministry of Finance is a political cabinet position andtherefore also wields significant influence.

Structure of the Formal SectorThe fifteen national, state-owned commercial banks are the largest institutions. While their primaryfocus is urban-based lending to the formal sector, they may also provide agricultural credit andmicrocredit through special rural-based programs. For the banks, collection rates on microloanprograms are generally below twenty percent.17 Agricultural banks generally focus on crop-basedlending to larger enterprises. Private banks tend to operate in urban areas, avoiding the rural creditsector because of the high transaction costs and perceived risk. In addition, a small number of creditunions and financial co-operatives also exist, few of which focus on the low-income market (seediscussion under semi-formal sector).

The Bangladesh Bank has encouraged bank lending to rural low-income communities by offeringfunds at a below-market interest rate to banks that undertake direct microlending. The nationalcommercial banks have also provided financing to MFIs on occasion, although there are no formalincentives for banks to lend to or invest in MFIs. A recent loan to the Association for SocialAdvancement (ASA), a NGO microfinance institution, by Agrani Bank, one of the nationalcommercial banks, was fully secured by ASA’s headquarters building and received no specialtreatment. The Bangladesh Bank, however, confirms that it “encourages” national commercial banksto lend to Grameen Bank. In 1995, the national commercial banks bought the full issue ofgovernment-guaranteed bonds floated by the Grameen Bank.

The RegulatorsBank regulation is conducted by the Bangladesh Bank and the Ministry of Finance. The Bank has theresponsibility to establish regulations and supervise the banking sector. It has the power to license andexamine all banks in the country and exerts great influence over the state-owned banks and theirdirectors, in part due to its accountability to the Ministry of Finance. It has a staff of approximatelysix thousand and is headed by a governor appointed by the Ministry of Finance.

The Ministry of Finance is a cabinet-level position within the government, and the Minister is a directpolitical appointee. Where the jurisdictions of the two agencies meet or overlap is unclear, but theMinistry of Finance is influential over the Bangladesh Bank.

Bank Regulatory Framework and SupervisionLike most central banks, the Bangladesh Bank has the authority for both prudential (or preventive)regulation that aims to limit the risks undertaken by banks in their quest for profits and growth, andprotective regulation that gives it the power to grant and revoke banking licenses and to assumecontrol of a mismanaged financial institution. Bank regulatory reform has been underway since 1989to strengthen the effectiveness of the Bangladesh Bank’s oversight of the formal financial sector and tobring supervision practices closer to international banking standards. In 1989, the Bangladesh Bankliberalized interest rates, ended government mandates on the allocation of credit to industrial sectors(although some interest rate subsidies remain for priority sectors such as agriculture), and introduced

17 “Staff Appraisal Report on Bangladesh Poverty Alleviation Microfinance Project.” August 14, 1996. Private Sector

Development and Finance Division, South Asia Region. The World Bank.


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risk-classification systems for reporting delinquency and portfolio quality.18 In late 1994, regulatoryreform continued as the Bank updated the risk-classification systems and permitted the licensing ofprivate and foreign banks, and non-bank financial institutions.19

Since 1994, there have been no usury laws for banks or MFIs, and fewer restrictions on banks’permitted business activities and pricing.20 Banks are required to submit an interest rate “band” fortheir lending in the current period, but this can be adjusted monthly. Banks are not required to lendonly to formally registered companies or to those which administer value-added taxes.

While the Bangladesh Bank’s regulations require banks to report financial condition, portfolio quality,and earnings to the central bank on a regular basis, the reporting standards remain less stringent thaninternational banking standards. For example, banks are only required to report as delinquent thoseloans unpaid after one year, and loans unpaid after two years are reported as bad debts. One thousandof the six thousand staff positions at the Bangladesh Bank are dedicated to examining the thirty-twonational commercial banks. While the central bank has strengthened considerably, it continues toaddress many challenges in the formal financial sector.

The Semi-Formal Sector: Microfinance InstitutionsAs noted above, most MFIs in Bangladesh are NGOs registered under the Societies Act of 1860,exempting them from central bank oversight. Most have a donor-funded loan pool and hold memberdeposits in a low-risk investment portfolio to pay interest on their savings. Several large MFIs,however – including ASA, Buro Tangail, and BRAC – use member savings to fund their lendingactivity as loan demand has outstripped the supply of donor capital.

The permissiveness of the current regulatory environment allows NGOs to undertake nearly all theactivities they need to meet their development objectives. They can accept deposits, extend credit, andraise capital from donors and private sources. While many organizations have used this flexibility toachieve impressive development impact through creative design, efficient branch networks, andvisionary leadership, their members and funders rely solely upon management to avert fraud,mismanagement, and/or unforeseen circumstances.

The few MFIs that have adopted a legal form with some regulation face minimal oversight andmonitoring. Although a legally chartered bank, Grameen faces minimal supervision. Financial co-operatives are chartered under the Co-operative Societies Ordinance of 1984, permitting them tomobilize deposits from the general public in addition to their members.21 While the government’sRegistrar of Co-operatives regulates these institutions, the registrar has little preventive or protectiveregulation and conducts minimal to no supervision. The largest financial co-operative is FederalSavings, with 26,000 members in urban Dhaka; SelfSave started just recently, and the SocialDevelopment Society (SDS), an existing NGO, is considering use of the ordinance. Now that MFIshave discovered this legal form, there is the potential for rapid expansion of financial co-operativeswith minimal supervision or oversight to protect depositors.

18 Circulars #33 and #34.19 Circular #20.20 Prior to 1994, agricultural lending was capped at 15% annual interest.21 Chapter IV, Article 32 of the Law was revised under Ex-President Ershad to allow more competition for the

country’s poorly performing banks by allowing co-operatives to take on more banking functions with fewerrestrictions than allowed under the British legislation.


19

For those MFIs that are expanding to serve large numbers of low-income persons, and using membersavings to invest in loans and other higher risk instruments, the risks to members’ savings haveincreased significantly. Examples of the heightened risks include:

• Buro Tangail and ASA have funded loan growth from member savings for several years, andASA now raises deposits from the general public, calling them “associate members”;

• SDS mobilizes large amounts of savings by selling contractual savings products in ruralvillages, a vehicle that is often overlooked by those focusing on credit-giving NGOs;

• Federal Savings, a financial co-operative, collects weekly savings from 26,000 members andis growing rapidly, with minimal oversight from the Registrar of Co-operatives;

• Grameen Bank offers 11 different loan products to boost average loan volume per borrower,and has funded the jump in loan demand by issuing debt capital (1995 bond issuance) andincreasing savings per member.

Most of these institutions have strong and charismatic leaders, relatively weak boards of directors, andminimal outside financial review or audit. They will most likely continue to pursue savingsaggressively to fund their lending because the demand for credit exceeds the sources of donor capital.As they assume more of the risks associated with financial intermediaries, these MFI face twochallenges: (i) the need to strengthen their self-regulation and internal controls; and (ii) the possibilityof government regulation through the central bank or some other supervisory body.

So far, the regulatory framework has not caught up with the evolution of microfinance in Bangladesh.The few NGOs that have considered applying for a standard commercial banking license have eitherbeen denied approval or have found the process too time-consuming and uncertain to warrant thepursuit.

Finally, MFIs have faced little pressure or incentive to change the status quo. International donorshave been willing to finance their activities with minimal internal or external oversight requirements,and senior managers see no benefits and many problems with any regulation by the government.While there have been serious cases of fraud and/or mismanagement by NGOs resulting in the loss ofmember savings, they occurred in the 1980s and appear to have faded from memory.22

Structure of The Semi-Formal SectorA few large institutions dominate the microfinance industry in Bangladesh. In June 1996, GrameenBank and three NGOs served eighty-five percent of the active micro-borrowers.23 Grameen, BRAC,and Proshika have traditionally been the largest microlending organizations; Grameen has more than1,000 branches across Bangladesh, BRAC has 375, and Proshika lends to village organizations inmost districts. Each of these was started in the 1970s or early 1980s with a strong politicalempowerment and social change mission to help low-income persons. Some younger NGOs, such asASA and Buro Tangail, emphasize providing streamlined financial services and achieving financial 22 According to Stuart Rutherford, two notable cases include SEDO (Socio-Economic Development Organization),

which collected savings from many villages and failed to return them; and BURO (predecessor to Buro Tangail),which used members’ savings to pay salaries and administrative costs when donor funding failed to materialize,leaving thousands with lost savings.

23 The total number of micro borrowers in Bangladesh in June 1996 was approximately five million. They were beingserved by Grameen (2 million) BRAC (1.4 million), ASA (440,000) and SWANIRVAR Bangladesh (350,000).From Credit and Development Forum (CDF), Vol. 2, No. 1.


20

self-sufficiency in a shorter time frame. ASA is now the third largest MFI in Bangladesh, and BuroTangail is growing rapidly.24

In general, most MFIs are increasing loan volumes and improving cost-effectiveness to achievefinancial self-sufficiency (or to reduce their dependence on subsidies significantly). While most MFIsin Bangladesh are striving for financial self-sufficiency, many provide non-financial services for theirmembers, which require annual donor support. Some of these complex NGOs are separating theirdevelopment and financial services activities to allow the latter to break even or achieve profitability.In addition, there has been a strong shift to the provision of financial services, rather than just credit.While most microlenders still require weekly savings as a screening device for members, ASA, BuroTangail, and BRAC have all launched voluntary savings products to meet their members’ liquidityneeds.

Regulators and IntermediariesThe Grameen Bank is regulated and supervised by the Ministry of Finance because of the bank’sunique charter. The 1983 Ordinance exempts Grameen from regulation by the Bangladesh Bank,although the Ministry of Finance delegates some of its monitoring responsibilities for Grameen to thecentral bank (this is described in greater detail below).

Those NGOs large enough to receive foreign funding are overseen by the NGO Bureau, which mustapprove all foreign aid inflows. To receive foreign funds, the NGO must submit a work plan and abudget for the proposed project. However, the Bureau does not conduct any assessment, examination,or evaluation of the financial condition of the NGO or the financial viability of the project. Fundersare responsible for completing their own risk assessment before funding an NGO, with no third partysupervision or monitoring other than annual financial audits and periodic evaluations and assessments.

One entity that will exert increasing influence over NGO microfinance institutions is the Palli KarmaSahayak Foundation (PKSF), a government-funded foundation created in 1990 to provide loans toNGOs engaged in microcredit. PKSF is becoming a more significant presence through its receipt of aUS$100 million World Bank loan in 1997 for lending to NGOs. While PKSF does not regulate MFIs,it can influence the semi-formal sector by setting performance and reporting standards for itsborrowers. One of its goals is to encourage professionalism and better management practices amongmicrocredit organizations. PKSF lends money at 4 to 5 percent for three and four year terms, andcurrently funds more than 200 NGOs. The government appoints the board, and the board elects amanaging director.25

Finally, the Credit and Development Forum was established in 1996 as a trade association formicrocredit NGOs, but has primarily served as an information clearing house thus far.

In summary, given the trends in the semi-formal financial sector in Bangladesh, regulators andfunders/investors should reassess whether NGOs that accept deposits should be exempt from centralbank oversight. Some regulation and supervision are necessary if NGOs are mobilizing savings andserving as financial intermediaries. However, it must be carefully designed and well executed to avoid

24 Buro Tangail had more than 30,000 members as of December 1996, according to an interview with Buro Tangail

Head Office. ASA had 544,000 active borrowers according to their March 1997 newsletter.25 The Managing Director of Grameen Bank is the current chairman of PKSF’s Board.


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opening a bureaucratic noose for the effective financial services sector for Bangladesh’s low-incomecommunities.

Existing Regulation: The Grameen Bank Charter

The only central bank-regulated MFI in Bangladesh today is the Grameen Bank. Grameen’s formaland legal bank status allows it to raise capital and collect deposits to finance its commitment toprovide banking services to low-income persons. In theory, this forms the basis for Grameen’spermanence as a banking institution. Grameen Bank evolved from an initiative sponsored byChittigong University, to a project of the Bangladesh Bank, to a specially chartered institution in 1983with the passage of the Grameen Bank Ordinance by the Bangladesh Parliament..26 While Grameendoes not attract private capital with market rates of return, and still receives substantial donor fundingfor its development activities, the Bank’s operating costs are covered more than one hundred percentby internally generated revenues.

This section describes the regulations in the Grameen Bank Ordinance, and the supervision andmonitoring performed by the Bangladesh Bank and Ministry of Finance.

Regulation in the Grameen Bank OrdinanceThe Grameen Bank Ordinance is a special charter adopted in 1983 that describes the formation of theinstitution, its management and governance structures, supervision by the Ministry of Finance,ownership structure, and functions. In effect, the ordinance serves as its articles of incorporation andmajor policies.

Like a standard commercial bank charter, the Grameen Ordinance addresses licensing requirements toensure a prudent structure for the bank and ongoing supervision, and monitoring requirements forbanking operations. For banks, typical licensing and supervision requirements include:

• Restricted entry into banking through strict licensing procedures and minimum standards;

• Restrictions on permitted business activities and limitations on certain risks (e.g., credit andforeign exchange risks);

• Capital adequacy requirements for both minimum amount as a financial cushion and on risk-adjusted gearing ratios that assess capital relative to risks undertaken;

• Limits on ownership by any one party;

• Liquidity and cash reserve requirements;

• Thorough information disclosure through periodic reporting to the central bank;

• Demonstrate need for banking services in a geographic service area; and

• Strict limits on insider and related lending that might put the bank at undue risk.

26 The Grameen Bank Project was sponsored by the Rural Economics Programme of the Department of Economics,

University of Chittagong, in 1976. It was subsequently adopted by the Bangladesh Bank and the nationalcommercial banks as a way to deliver credit more effectively to the rural landless.


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The major features of the Grameen Ordinance parallel most of those requirements, but were adaptedto fit the microfinance mission. Specifically:

• Capital Requirement: Grameen began with an initial capital base of Taka 10 crore (US$2.5million), with additional paid-in capital of Taka 7 crore (US$1.75 million), or US$4.25million compared to US$3.25 million for a standard commercial bank in Bangladesh.However, there are no ongoing capital adequacy or liquidity ratio requirements for GrameenBank.

• Ownership stake by the Bangladesh Bank: Ownership of Grameen Bank is shared byBangladesh Bank and Grameen’s clients (member-shareholders). The central bank amendedthe ordinance in 1990 to reduce its ownership from 60 to 25 percent, with member-shareholders increasing their stake proportionately.

• Compliance with standard (relatively weak) portfolio risk classifications, includingdelinquency, loan-loss provisions and write offs. While Grameen has developed more detailedand useful internal reporting systems, it reports delinquency to the Bangladesh Bank using thesame measures as formal banks (i.e., loans more than one year past due are delinquent, andloans more than two years past due are considered bad debts).

• Branching Restrictions: Grameen must request Bangladesh Bank approval to open a newbranch. In practice this has been a formality since no request has ever been denied. For newbranch approval, the central bank prepares a brief “feasibility study” that describes the area,the population, demographics (percentage of women and landless; literacy rates, if available;and typical occupations), and the opinions of local politicians and local national commercialbank officers.

• Access to Bangladesh Bank funds: While Grameen Bank cannot access central bank lines ofcredit, the Bangladesh Bank amended the Ordinance in 1990 to add a provision for theissuance of bonds and debentures that are guaranteed by the Government of Bangladesh,dramatically increasing Grameen’s access to the capital markets. The interest rate is 1-1.5percent below market rates, with interest-only payments during the term of the bond.27

• No limitations on the scope of activities: As long as business functions are conducive to theobjectives of the Grameen Bank, they are permitted activities. Grameen has been authorizedto collect savings from non-members since 1987, but has only recently emphasized savingsmobilization.

• Board Structure: According to the 1990 amendment, governance is by a twelve-memberboard of directors, of which three are government appointees and nine are elected by member-shareholders. Member-shareholder representatives are elected through a regional process of aseries of local elections. The Chair of the Board is appointed by the government from theboard’s appointed directors. All directors serve three-year terms. The managing director isan ex-officio Board member with no right to vote.28

27 In 1995, Grameen floated US$1.25 million of bonds in three-, five-, and ten-year tranches, which were bought by

four national commercial banks and two private banks.28 In the 1983 Ordinance, the board was comprised of the managing director, three government appointees, two

members from the managing directors of the national commercial banks, a woman experienced in working with rurallandless, and four member-shareholders.


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• Bangladesh Bank Approval on Senior Management: While the board appoints the managingdirector, any selection must have prior approval of the Bangladesh Bank. To date, the onlymanaging director has been Dr. Mohammed Yunus, Grameen Bank’s founder.

• Taxable Status: For at least the first ten years, no taxes were due on any profits. The boardof directors determines the permitted use of profits.

The primary means for the Bangladesh Bank to influence Grameen is through its board representation.According to several individuals, the government’s board participation has been relatively passive,endorsing the decisions of management. In practice, the government relies on the annual external auditrather than a CAMEL assessment to ensure that no major financial problems are occurring. Agovernment-approved accounting firm conducts the annual external audit, and all reports to the centralbank are based on those audited statements.

Today, by admission of both Grameen and the central bank, Grameen Bank operates largelyindependent of government, despite the regulation and supervision elements in the Ordinance. This“light hand” has allowed Grameen to operate with minimal restrictions and to continue its innovationsand growth. While the actual implementation of oversight is fairly weak, the Bangladesh Bank has thepower to revoke Grameen’s charter and provides Grameen with an incentive to develop the internalsystems needed to avoid financial disaster.

Supervision and OversightAlthough the Ministry of Finance technically supervises Grameen Bank, it has delegated the review ofmonthly reports and new branch requests to the central bank. While not specified in the Ordinance,Grameen’s monthly reporting requirements to the Bangladesh Bank include the following informationby regional office:

• Loans disbursed (for the month, cumulative, to men, and to women);

• Loans realized (repaid);

• Loans unpaid after one year (delinquent);

• Loans unpaid after two years (bad debt);

• Housing loans disbursed;

• Savings in the Group Fund (funds managed by Grameen on behalf of members);

• Loans extended from the Group Savings Fund;

• Number of members.

No quarterly reports are required; Grameen submits a brief annual report with audited financialinformation. No ratio analysis or trend reporting on portfolio quality, and no cost or profitabilityinformation is required. Other than these reports, all oversight occurs through governmentparticipation on the board of directors and government ownership of stock. No on-site examinationsor other control procedures are in place to assess the typical CAMEL parameters.29

29 Capital adequacy, Asset quality, Management depth and quality, Earnings quality, and Liquidity.


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Observations on Grameen’s ExperienceGrameen’s unique legal status and leadership role among Bangladesh MFIs evolved out of severalstrategic and organizational decisions made by Dr. Yunus, its founder and Managing Director:

1. Strong leadership and early support from the Bangladesh Bank: While at ChittigongUniversity, Dr. Yunus persuaded Bangladesh Bank to assume sponsorship of the microcreditproject. In addition, he hired several senior staff formerly employed by Bangladesh Bank.They became familiar with the borrowers, the lending activity, and the quality of managementand staff. When Grameen won the sponsorship of Bangladesh Bank, it provided operatingfunds and a revolving loan facility through one of the national commercial banks. In effect,Grameen served as an intermediary lender, lending bank funds to the rural landless, anddepositing collected payments with the national commercial banks required to participate bythe Ministry of Finance. Grameen retained control over the program design and the creditdecision-making. After several years of operation as a “project,” Grameen decided that thearrangement was unworkable and sought the central bank’s endorsement for the specialcharter. Dr. Yunus played a pivotal role in this process both as the visionary for a new typeof organization and as a manager able to inspire the confidence of the Ministry of Finance andgain political access.

2. An ownership structure that does not create strong stakeholders: The central bank’sownership interest in the Grameen Bank has helped ensure its continued support of Grameenand has provided some political cover for its activities since anything owned by theBangladesh Bank should be above reproach. As new Grameen members have bought shares,the government ownership interest has steadily fallen, reaching twenty-five percent in 1990and approximately eight percent in 1996.30 While outside ownership should theoreticallystrengthen the accountability of management, in this case the central bank’s investment wasmanaged passively.

3. Relatively passive governance by the board of directors: The board of directors reflects theshareholders – the central bank has three seats, and the rural landless representatives make upthe balance. While board representation by members of the target group does helpmanagement remain focused on their needs and issues, the lack of private business persons orexperienced managers on the board presents certain dangers to Grameen. Without a strongboard of directors to challenge and complement management’s information and decisions,senior management can pursue its own interests.

4. Streamlined, standardized credit delivery and a strong credit culture: Grameen’s lendingmethodology was designed to show that it was possible to lend to low-income persons and berepaid on time. The relatively rigid program structure ensures consistency throughout theorganization and a clear focus on repayment. This focus has established a credit culture thatincludes strong discipline, unquestioning commitment, and a cost-effective vehicle for creditdelivery.

5. Strategic use of foreign donor support: Grameen managed to maintain access to both donorfunding and capital markets (via central bank guarantees), but only as long as its corebusiness remains poverty alleviation through microenterprise credit. Zero-cost capital frominternational donors fueled geographic expansion, loan volume growth, and ancillary

30 Interview with Muzzamel Huq, Grameen Bank. December 1996.


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development programs.31 This growth enabled Grameen to reach loan volumes that permitfinancial self-sufficiency, and donors required minimal accountability by management. Large-scale donor funding ended in 1994.

6. Focus on issues of concern to the Bangladesh Bank: Grameen made a conscious decision toaddress the financial viability concerns of the central bank by building large reserves ofcapital to support loan assets, maintaining access to outside funding sources, and developingstrong internal control systems. In addition, Dr. Yunus recruited selected senior managersfrom the central bank to help run Grameen, thereby reducing their concerns aboutmanagement capacity.

Combined with consistent and excellent execution of operations, these strategic business decisionshave allowed Grameen the freedom to pursue its agenda and build a capital base to support itscontinued growth. So far, there have been no reasons for the supervision by the Ministry of Financeand central bank to become more rigorous.

The central bank and Ministry of Finance view the Grameen charter as a one-time exception and havenot used it again. The regulatory and supervision requirements described in the Ordinance clearlyshow that it was written for one organization rather than as a potential model for development financeinstitutions.

At present, there is no formal, regulated legal status for MFIs in Bangladesh. For those consideringthe transition to a regulated financial institution, the only choice is to secure a standard commercialbanking charter. A commercial bank license requires meeting the minimal capital, capital adequacy,and liquidity standards of regular commercial banks. The next section reviews some alternativeapproaches to regulating and strengthening the MFI sector, and the tradeoffs that these approachesrequire.

The Regulation Dilemma: How Much and How To Do It Well?

As mentioned above, Grameen’s legal banking charter provides it with clear parameters for providingbanking services to low-income persons. Its legal status and implied regulatory oversight have givenGrameen authority to collect savings deposits and make loans. Grameen has therefore avoided ill-defined NGO mandates which do not specify when an NGO’s saving and lending activity begins toinfringe on the formal financial sector laws. Recognizing these advantages, BRAC and ASA havebeen pursuing different strategies to achieve more formal status. BRAC has sought to convert itssavings and credit program into a commercial bank that could operate parallel to the surviving,subsidy-funded NGO, but its 1994 application to the Ministry of Finance was denied. ASA hassoftened its social change agenda and has focused on achieving financial viability, with an eye on afuture conversion to a non-NGO legal status.32 Both MFIs are reevaluating the pros and cons ofregulated financial institution status to assess whether the tradeoffs provide more benefit than harm totheir organizations.

31 Grameen has housed non-credit and higher-risk credit activities in separate corporations to isolate the Bank from

these risks and costs.32 Rutherford, Stuart. ASA: The Biography of an NGO. The Association for Social Advancement. Dhaka,

Bangladesh. August 1995.


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This section examines the possible regulatory approaches for MFIs and the tradeoffs those mightentail from the perspective of MFIs, the Bangladesh Bank, and international donors who are the defacto investors in many Bangladesh MFIs.

Possible Regulatory Frameworks

External regulation is only one of several important elements to create well-managed and permanentfinancial institutions. The others all fall under the rubric of “self-regulation.” For banks and otherfinancial intermediaries, prudent oversight and supervision is undertaken by several different agentsrepresenting the interests of either shareholders, management, or the public at large. The primaryagents for that oversight are:

1. A strong board of directors that establishes sound business, financial, and risk managementpolicies and holds management accountable for implementing those policies effectively;

2. Effective internal controls and an internal audit function to confirm that those policies arefollowed and procedures are effective;

3. High quality external auditors who are knowledgeable and competent in microfinance as anobjective check on internal systems to protect against fraud and mismanagement; and

4. External supervision by a central bank or its agent to ensure that management does not misuseits power to use depositors funds for its benefit.

Designing an appropriate regulatory framework requires consideration of several factors: the financialcondition and structure of local microfinance institutions; their role(s) within the financial servicesindustry; and the capacity of the regulating entities to administer external regulation and supervisioneffectively.

With those factors in mind, the five main options for regulation include:

1. No external regulation: This is the current environment for most MFIs (and effectively forthe Grameen Bank) and it has produced an innovative and strong microcredit industry inBangladesh. However, some regulatory oversight is needed now that MFIs are puttingmembers’ savings at greater risk.

2. Self-regulation: This would require individual MFIs to strengthen their institutions and sharefinancial information on a consistent basis. For an MFI to regulate itself, it requires threeelements: (i) an independent board with the technical expertise and authority to holdmanagement accountable; (ii) well-formulated and properly implemented internal control andrisk management policies; and (iii) high quality auditors who are educated aboutmicrofinance. Self-regulation is only possible if these three elements are combined withtransparent disclosure.

3. Hybrid approach of part self-regulation, part supervision by a third party: Under thisblended approach, MFIs would be held responsible for meeting higher standards of financialreporting and performance analysis, and the regulatory authorities would contract to a thirdparty to monitor their compliance with those standards. For example, to ensure consistentlypresented financial information, the regulating entity could contract with an accounting orconsulting firm to conduct routine financial audits of MFIs, including standardized financialpresentation and ratio and trend analysis. Full disclosure would allow investors and


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depositors to make rational choices, however this presumes that they have choices of financialservices providers.

4. Regulation through the existing legal and regulatory framework: MFIs could apply for astandard banking license if they met all the requirements for a commercial bank, such asBRAC attempted to do in 1994. To date, the Bangladesh Bank has resisted granting bankcharters to MFIs. Since some development financial institutions in other countries havethrived under the regulatory oversight imposed by commercial bank status, this option shouldbe given greater consideration.

5. Regulation through MFI-specific regulation: Some countries have created a distinct legalstatus and regulation for non-bank MFIs, such as Bolivia and Peru as discussed in detailbelow. In some cases, these institutions are supervised through a separate unit within thecentral bank or delegated supervisory authority. In Bangladesh, this mechanism was used tocreate the Grameen Bank charter, but the central bank does not currently plan to use thisapproach again.

In general, the greater the financial risk and the more money at risk by depositors, the more importantexternal regulation becomes to avoid what economists call “moral hazard” by management andowners. This suggests the need for separate tiers of regulation and supervision based on quantitativemeasures.

In Bangladesh, MFI managers and donors (the largest outside stakeholders other than members) arespecifically concerned about several issues. The first issue is the creation of financial reportingguidelines that push MFIs to report consistently, accurately, and transparently so outsiders can haveaccurate information and make “apples to apples” comparisons.33 Second, the local microfinanceindustry needs to establish minimum standards for financial condition and financial performance toprevent MFIs from putting depositor funds at undue risk. This might include basic risk assessmentthrough key ratios for capital adequacy, asset quality, self-sufficiency, and liquidity. Third, thecentral bank must develop the capacity to design appropriate regulation and administer supervisioneffectively. Experience from around the world suggests that the most effective forms of financialregulation are those that create incentives for institutions to develop strong risk management policiesand internal controls.

By becoming involved in unregulated financial intermediation, the microfinance community inBangladesh is putting its reputation on the line. If a large MFI experiences problems that threatenclient savings, all will suffer by association – and possibly by a regulatory reaction from thegovernment. Given the limited capacity of the central bank, the local microfinance industry needs totake the lead in proposing a regulatory option that protects itself and its clients from risk.

33 This implies some responsibility on the part of funders and others who might receive this information to maintain its

confidentiality and to interpret it correctly.


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Pros and Cons from the MFI Perspective

From the MFI’s perspective, formal regulation has advantages and disadvantages. Some of thesetradeoffs are discussed below.

Access to member deposits vs. some restrictions on activity: As regulated entities, financialinstitutions agree to limit the risk of their activities and to comply with monitoring requirements inexchange for the use other people’s money to fund their loans. While an unregulated NGO may havemore flexibility to operate a wider range of programs, a regulated MFI can fund its portfolio growthwith more readily available capital than donor funding. In Bangladesh, loan demand has exceededdonor capital for larger MFIs, which has constrained growth. For those MFIs, access to memberdeposits is critical for long-term viability.

Political Independence: Because the Bangladesh Bank is closely tied to the Ministry of Finance, aregulated MFI might be vulnerable to political influence. According to several interviews, BangladeshBank is not independent of government and exerts significant influence over all banks. Thegovernment may be tempted to impose interest rate ceilings or other restrictions to ensure that MFIsare not taking advantage of their constituency. In contrast, an NGO can operate relatively independentof government authority as long as it meets the legal requirements of its legal status and complies withthe NGO Bureau’s requirements for receiving foreign donor funds. Regulated MFIs in other countrieshave protected themselves from government interference by assembling directors or shareholders withimpeccable political and civic credentials or with the international credibility to shelter theorganization from unnecessary government involvement

Maintaining access to both NGO and market funding sources: A primary disadvantage ofbecoming a commercial bank is the loss of NGO status and the accompanying access to subsidized orgrant funding. The apex financial institution in Bangladesh, PKSF, can only lend to NGOs.34 MFIswill only be willing to make this tradeoff if they are certain they can achieve financial self-sufficiencyand gain some significant benefit in return (e.g., access to non-member deposits or the government’sguaranteed bond issuance capacity). In Kenya, for example, K-Rep Bank Ltd. will conduct all thecredit and savings operations under a commercial banking license, and the surviving NGO willcontinue with grant-funded activities. MFIs in Bangladesh would need to separate their financialservices programs from their non-financial activities and operate them as separate though coordinatedorganizations, even if the non-financial programs receive a cross-subsidy.

The costs and benefits of regulatory compliance: MFIs perceive a high cost of complying with thesupervisory requirements of the Bangladesh Bank or other government agencies. This is in part due toa reasonable fear that over-regulation will stifle the semi-formal financial sector. However, the costsof compliance with government reporting are incurred up front, and become marginal once the systemsare in place to produce information required monthly or quarterly. The long-term benefits ofregulatory oversight include:

34 This is in contrast to COFIDE (Corporacion Financiera de Desarrollo), the apex financial institution in Peru, which

is only able to on-lend to regulated financial institutions. This restriction on COFIDE’s lending was a primarymotivation behind the creation of the EDPYME (Entidades de Desarrollo para la Pequena y Microempresa)category.


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• Accountability to a third-party for prudent supervision, including systematic financialreporting, adequate management information systems, and other measures;

• Objective oversight by someone less absorbed in the development mission and more focusedon the overall health of the financial institution; and

• Approval requirements before major strategy or management shifts are made, imposing amoderating influence.

However, poorly structured and executed oversight can impose high costs with few benefits. Anappropriate framework, administered carefully and with a light hand, is essential. While regulatedMFIs should receive no less rigorous review than other financial institutions, prudent supervisionshould be conducted by those familiar with an MFI’s unique mission and the way it mitigates riskdifferently from other lenders. This is a significant concern in Bangladesh, given the central bank’scurrent capacity and its continuing focus on formal sector reforms.

Non-NGO status allows for the creation of owner/investors: One of the sticky issues for NGOs thatare financial intermediaries is how to encourage self-regulation among entities with no owners. Theprinciple of self-regulation is based on the assumption that owners will seek to preserve their capitalinvestment and therefore maintain vigilant oversight of management. The board of directorsrepresents shareholders in that function. NGOs typically have three groups of stakeholders:management and staff, the board of directors, and clients. Transforming a NGO into a formalfinancial institution creates a fourth interest group: owners/investors who will focus on financialperformance and long-term viability. By selecting investors wisely, an MFI can recruit organizationsthat can add value to the institution in the form of financial resources, political cover, or managementexpertise. Investors/owners are also more likely to hold management accountable to the mission andpolicies of the MFI, particularly if they hold seats on the board.

The Donor/Funder PerspectiveIn Bangladesh, most donor agencies that fund MFIs have been active in microenterprise developmentfor some time and are currently the only “investors” in most MFIs. Many have invested large amountsin both the older microcredit organizations (like Grameen, BRAC, and Proshika) and the new breed ofMFIs (like ASA and Buro Tangail). From the donor perspective, some outside regulation or standardsetting is important for three main reasons.

First, while donors have committed large amounts to many of these institutions, they have minimalleverage over management once funds are committed, and have typically not included performanceclauses in their commitments. Many donors view their funding commitments as investments in long-term institutional development and capacity building, yet grant funding is not conducive to buildingpermanent microfinance institutions.

The second reason is that compliance with financial reporting requirements and standardized ratioanalysis should provide more transparent and consistent financial reporting. Donors rely on financialsprovided by the MFI and upon reports from outside consultants to determine the financial conditionand issues facing an MFI, but the financial information is often inaccurate, poorly compiled, oraccounting policies have changed between reporting periods.

Third, regulatory oversight helps protect and enhance a donor agency’s “investment” in a NGOthrough periodic monitoring and minimum performance standards. While donors expect a social


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rather than financial return on their investment, they would ideally like to maximize that return. Themost effective way to maximize that return with an MFI is if the grant can leverage private financialresources from other sources. Periodic monitoring should help the institution to leverage donorresources.

Donors do not want MFIs to meet lower regulatory standards or less rigorous supervisoryperformance standards than formal financial institutions. Meeting the highest standards of prudentregulation strengthens the MFI’s prospects for strong financial performance and permanence as adevelopment institution. In addition, regulated MFIs should serve as models demonstrating theviability of providing microfinancial services. This demonstration effect is another form of socialreturn that some donors would like to achieve.

The Central Bank PerspectiveTo date, the microfinance position of Bangladesh Bank is based on the following assumptions:

1. There is no public policy issue to protect depositors, because the members of MFIs areprimarily net borrowers rather than net savers and thus are at minimal risk for financial loss ifan MFI fails;

2. Although microcredit organizations accept savings from members, deposits are held in trustand are not used to finance loans or other risks that are incurred through financialintermediation; and

3. Microcredit organizations are in the development business rather than the financial servicesindustry.

As described above, all three of these assumptions are no longer valid. The primary issues for theBangladesh Bank include: which MFIs should be regulated, what level and nature of regulatoryoversight is appropriate, and what is the best way to exercise supervision.

Which MFIs should be regulated?Given the number and variety of microcredit organizations in Bangladesh, the central bank must definethe points of distinction that might result in different types of regulation and supervision. These mightinclude:

1. Those institutions that meet the requirements of the formal commercial banking charter: Ifthe Bangladesh Bank permits MFIs to become banks under this measure, no changes would berequired in either preventive or protective regulation. Bank MFIs might retain an affiliationwith a separate NGO or a “parent” holding company, as long as the financial institutionoperates on a stand-alone basis and meets all “safety and soundness” regulatory requirements.BRAC has considered this strategy, which is similar to that pursued by BancoSol in Boliviaand K-Rep in Kenya.

2. MFIs that accept member savings for financial intermediation: By creating a new legal formfor non-bank MFIs, the central bank can establish some protective standards to reduce thechances for fraud and mismanagement to cheat thousands of depositors. MFIs would assessthe tradeoffs between access to member deposits and perhaps other limited banking functionsin exchange for some level of oversight. This would require new regulations and supervisory


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standards, but supervision could be based on off-site reporting rather than in-depth on-siteassessments, and could even be contracted to a third party.

What degree of oversight is appropriate?As noted above, many believe that MFIs organized as formal banks should meet the requirements ofall banks under the current regulations (or perhaps to a higher standard for portfolio risk monitoring,which has greater significance for MFIs). For non-bank MFIs, the degree of regulation should matchthe MFI’s business and financial risks, both of which are slightly different from those of conventionalbanks. The design of such regulation must weigh the incentives needed to encourage self-regulation,and the importance of having some teeth so the MFI sector takes the regulations seriously.

The Bangladesh Bank led the world in supporting a specialized lending institution to complement therole of commercial banks when it issued the Grameen special charter in 1983. Yet, it has chosen notto use that option again despite its power to create professionally managed microfinance institutionsthat can achieve large scale impact in Bangladesh. If specialized legislation is not appropriate, thensome heightened oversight or financial reporting requirements should be required of MFIs that takedeposits.

What is the local capacity to exercise appropriate supervision?Because microfinance is significantly different from conventional banking, the countries that haveestablished MFI-specific laws have created specialized units within the regulatory authority tosupervise them. In Bangladesh, the central bank might delegate the supervisory role to a high qualityand reliable third party.

Observations and Conclusions

While Bangladesh has minimal regulation of MFIs, its experience does yield several observations toinform the debate among regulators and MFIs around the world. For example, the “light hand”approach towards regulation has proven successful in fostering a diverse industry of innovativemicrofinance institutions. The Grameen Bank’s peer group lending approach, which replaces assetcollateral with peer pressure and introduces strong incentives for maintaining access for the next loan,fits well with the cultural and economic conditions of Bangladesh. This approach has been exportedto countries around the world, as well as modified by other MFIs in Bangladesh, to create successfulmodels for microfinance.

However, microfinance institutions need to enter a second phase of strengthening their organizationsand operating as prudent and effective financial intermediaries. MFIs need to improve their chancesof building permanent, sustainable institutions and cultivate the elements needed for adequate self-regulation. A strong board of directors, internal controls and risk management systems, and highquality external audits may help avert a perceived need for top-down regulation from the central bank.External regulation should be the additional, not primary, safeguard for prudent financialmanagement. Steps for Bangladesh MFIs – both NGOs and regulated MFIs – should include:

Strengthen governance and boards of directors: While MFIs in Bangladesh traditionally have weakboards and dominant executive directors, the role of the board is becoming more important.Executives should want a strong board to provide guidance to their organizations. Boards shouldapprove policies for business activities, financial risk, risk management, and internal controls, and


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hold management accountable for implementing those policies. Boards should focus on the bigpicture, yet be aware of details so they can identify potential problems. Board members should bedrawn primarily from the private sector, including resource people who complement management’sskills. By thinking of themselves as the stewards of the MFI’s capital, board members can assumegreater responsibility to identify organizational development and strategic priorities. Boardrepresentation by clients may keep the organization focused on the end-customer, but thoserepresentatives are unlikely to push the MFI to address financial and organizational issues.

Create a role for outside investors or stakeholders: For regulated MFIs, a for-profit structurecreates a fourth group of stakeholders: shareholders. This group complements management and staff,the board, and clients by focusing on the bottom line and the health of their capital investment in theorganization.35 For NGO MFIs, there is no formal ownership and therefore no investors with a capitalinvestment to lose. This suggests that self-regulation will not be as effective for NGO microfinanceinstitutions. However, NGOs can create an equivalent set of stakeholders with a similar role for theorganization. An “equity-equivalent” investment for an NGO might be a long-term subordinated debtinstrument with equity-like terms, or other instruments that might attract private investors. The right“investors” will probably bring value to the organization through access to financial resources, someprotection from government interference, and management experience from a like-minded financialinstitution.

Adopt transparent and consistent financial reporting: A frequent criticism of MFIs is thequestionable accuracy or completeness of their financial statements and reporting. Followinggenerally accepted accounting principles and transparent recording of transactions among and betweensubsidiaries will enhance the credibility of MFIs with investors and funders.

Invest in high-quality annual audits from a reputable firm with microfinance experience: Whilemany organizations view audits as an annual review of the numbers and a rubber stamp on accountingpractices, a good auditor and accountant can add significant value to MFIs with complicated financialstructures that need to be segregated into separate “lines of business” with appropriate performancemeasures and tracking systems. The importance of knowledgeable auditors is reinforced in theColombian case described below.

A combination of incentive-based supervision and external regulation for the largest institutions maybe the best approach in Bangladesh. As with other financial institutions that accept deposits, someoversight is needed to ensure that MFIs accepting individual savings do not take undue risks withthose funds. Some regulatory framework establishing minimum standards is needed. Those standardsshould include requirements for financial audits by an approved firm and summary financial reportingon basic parameters (such as capital adequacy, asset or portfolio quality, earnings and cash flow, andliquidity). To be effective, such regulation must have some power to grant or revoke an MFI’sauthorization to conduct its activities. To minimize the regulatory burden on MFIs, supervisionshould be based on off-site reporting of information, rather than in-depth on-site assessments.

The approach should maximize the role of self-regulation. Bangladesh has a unique set of marketconditions: the MFI industry is large, diverse, and has many sophisticated institutions, and theregulatory environment and capacity are relatively weak. MFIs and donors (the de facto investors)are concerned that regulation of this sector will create burdensome reporting requirements and limit

35 This issue is discussed at greater length in the Kenya chapter below.


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the institutions’ development impact. Ideally, regulation should be applied judiciously with strongincentives for MFIs to self-regulate as much as possible.

Supervisory responsibility could be delegated to a third party, rather than conducted by theBangladesh Bank. Considering the capacity constraints of the Bangladesh Bank and the need to avoidcreating a rigid bureaucracy, the central bank could delegate the supervisory responsibilities to a thirdparty. The third party would monitor reporting information submitted by regulated MFIs and preparea summary report to the central bank to identify problems. Ideally, this third party should be a neutralagent with the capacity to conduct financial analysis and assessments of MFIs. Examples of possiblethird parties include:

• A high caliber accounting or consulting firm that would develop standardized audit formats toensure a systematic approach to annual audit procedures, and review annual audited financialinformation. This should be a firm with experience working with MFIs and NGOs, and havecredibility with executive directors.

• PKSF, the quasi governmental foundation that is a lender of government funds to MFIs and has anagenda of building financial and portfolio management capacity among NGOs. Because it is alender to these organizations, however, PKSF has a strong conflict of interest with such asupervisory role.

• A trade association, such as the Credit and Development Forum, assuming it could dramaticallystrengthen its financial expertise and knowledge and earn credibility among MFIs.

Among these three examples, the accounting or consulting firm is the most logical fit because of itsprivate sector background, in-depth understanding of the financial issues facing NGOs and MFIs, andits financial expertise. The conflict of PKSF’s role as a lending intermediary is very significant, andwould undermine the confidence and integrity of the supervisory process.

For mature and large MFIs, the cost of compliance with well-designed regulation is relatively low andhas many benefits. By meeting those requirements, an MFI will provide better quality financialservices over time and become a permanent financial institution with the credibility to leverage moreresources and investment. Those that receive a commercial bank charter should receive no specialtreatment, meeting the same standards as other financial institutions.

In summary, MFIs do not need less stringent oversight and monitoring. They need well-designedregulation that is appropriate to their market niche and their financial risks. Bangladesh has been acradle for innovation in microcredit, but now needs to catch up to microfinance institutions elsewhereby focusing on financial services and creating the building blocks of permanent, sustainableinstitutions. MFIs in Bangladesh are beginning to develop a greater commitment to financial self-sufficiency and permanence without ongoing subsidy than in years past. The drive to build permanentinstitutions is needed, because the competition to deliver financial services will increase as existingorganizations become larger and as banks and other private businesses seek to cash in on a viablemarket.


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35

ÐÐ

PHILIPPINES

ÓÓ

Eduardo C. Luang and Malena Vasquez

In the Philippines, local microfinance institutions have begun a dialogue with regulators and policymakers to define the appropriate regulatory approach for their environment. Through initial efforts tooutline best practices in the field and to establish industry standards, Philippine MFIs are educatingregulators and vice versa. The Philippine case demonstrates a familiarization process, representingone possible path towards identifying an appropriate regulatory response to the dynamic growth ofmicrofinance. This case briefly outlines the regulatory environment for financial institutions in thePhilippines and then describes the familiarization taking place through the microfinance standardsinitiative.

Major Legislative Initiatives for Financial Sector Reform

As with many developing countries, the Philippines has experienced significant financial sector reformin recent years. Some of these reforms are creating opportunities for small businesses and theinstitutions that finance them.

Magna Carta for Small Enterprises. Approved in July 1991, the Magna Carta for Small Enterprisesmandates that all lending institutions must set aside five to ten percent of their total loan portfolio(estimated to be about US$1.1 billion), making it available for small enterprise credit or purchasingsmall enterprises’ promissory notes from lending institutions or NGOs. The law defines “smallenterprise” as any business activity or enterprise engaged in industry, agribusiness, or services withtotal assets of US$190,000 and below.36

The Magna Carta specifically addresses the credit needs of the larger and more established small andmedium businesses. Despite the law, banks are generally not enthusiastic about providing loans tosmall and medium enterprises traditionally regarded as “unbankable,” much less to microenterprisesthat have assets below US$5,700. There have been some positive responses to the law. A few bankshave opened foundations to provide lines of credit to selected NGO intermediaries for on-lending tolow-income customers. In addition, the Bankers Association of the Philippines (BAP) set up a CreditGuaranty Corporation to lend to small enterprises.37

The enactment of the Magna Carta has paved the way for some NGO MFIs to access credit fromcommercial banks, including the BAP Credit Guaranty Corporation and bank foundations for on-lending to microentrepreneurs. In 1993, for example, TSPI Development Corporation, a local NGO,initiated a linkage project that encouraged commercial banks to open their resources to the low-incomemarket and for some NGO MFIs to access bank funds using its equity as leverage.

36 Exchange Rate: US$1 = P26.298; 91-day Government Treasury Bill rate = 11.476%.37 The average loan disbursed through this mechanism is US$10,000.


36

New Rural Bank Act. The New Rural Bank Act, approved in April 1992, governs the establishmentand operation of rural banks to provide adequate credit facilities to farmers and merchants, or tocooperatives of farmers and merchants, and to people in rural communities in general. The New RuralBank Act provided a “tax holiday” for all rural banks by providing an exemption from national tax(except income and municipal taxes) for five years from the effective date of the law.

New Central Bank Act. In June 1993, the New Central Bank Act established the Bangko Sentral ngPilipinas as an independent central monetary authority, providing policy directions in the areas ofmoney, banking, and credit, and to supervise and regulate bank operations. The New Central BankAct paved the way for restructuring the Philippine financial system. This law also liberalized theestablishment of local banks and deregulated the foreign exchange system in the country.

Foreign Banks Act. The Foreign Banks Act, approved in May 1994, liberalized the entry and scopeof operations of foreign banks in the Philippines to pursue the following objectives:

1. To attract foreign investments;

2. To enhance efficiency of the domestic financial system through increased competition; and

3. To make the Philippine banking system more globally competitive.

Ten additional foreign banks have been allowed to open branches in the Philippines, bringing thenumber of foreign banks operating in the country to fourteen. Although the number of new playerswas limited to ten, foreign banks not included in the ten are allowed to set up offices in the Philippinesby establishing banks organized under the General Banking Act in partnership with local investors.Foreign banks can own as much as sixty percent of the equity in a locally incorporated bank. Theliberalization of the Philippine banking sector has significantly increased the competition.

Thrift Bank Act. Approved in February 1995, the Thrift Bank Act provides for the regulation andoperation of thrift banks, which include savings and mortgage banks, private development banks, andstock savings and loan associations. The Thrift Bank Act standardized the operations of all banksclassified as thrift branches. This law allowed a more attractive environment for thrift banks with aprovision of incentives previously only enjoyed by rural banks. The incentives include a five-year taxholiday from all national taxes (except income and municipal taxes) and unrestricted branching rights.

The Thrift Bank Act is expected to encourage the creation of thrift banks dedicated to microfinancethat will enjoy the same tax privileges as other thrifts. TSPI Development Corporation is currentlycreating a private-development bank dedicated to microfinance that falls under this category.

Except for the Magna Carta for Small Enterprises, the Philippines does not have approved legislationdirectly affecting microfinance. Philippine banking laws do not govern the microfinance operations ofNGOs or cooperatives. Credit cooperatives, which provide loans to their members, are licensed andregulated by a separate entity, the Cooperative Development Authority. Microfinance NGOs operateoutside the formal financial system and therefore are neither licensed nor regulated by the centralbank. Microfinance NGOs working with low-income communities are registered as non-stock, non-profit corporations with the Securities and Exchange Commission. Although NGOs do not have aproblem with their legal identity in the Philippines, they recognize that the lack of appropriate legalregistration inhibits them from supplying important financial services to their target market.Specifically, NGOs are not allowed to mobilize deposits that could help widen their resource base andmove the institutions toward self-sufficiency.


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A recent initiative by the Philippine government to increase the access to credit in low-incomecommunities is the establishment of the Peoples Credit and Finance Corporation (PCFC) approved byPresident Ramos in February 1996. PCFC is the new government financial intermediary providingcredit to microentrepreneurs through NGOs, cooperatives, and rural banks. To date, PCFC hasgranted loans to seventy-three NGOs and other microfinance institutions, totaling US$7.2 million.PCFC has a loan portfolio of more than US$76 million for microfinance. This is composed of US$38million as capital infusion by the Land Bank of the Philippines. The balance of US$38 million willcome from the Asian Development Bank and International Fund for Agriculture.

A summary of the financial institutions in the Philippines is presented in Table 7.

Table 7: Financial Institutions in the Philippines

Type PurposeMinimum

Capital (US$)38DepositTaking39

ApproximateNumber

Commercial banksand specializedgovernment banks

Service financialrequirements ofcommerce andindustry

76 - 171 million PS, CA, TD,IL

Over 66,000head officesand branches

Thrift banks Mobilize smallsavings and providelong and mediumterm financing

1.5 - 9.5 million PS, CA, TD,IL

Over 1.000head officesand branches

Rural banks Provide credit needsin the rural areas forpurposes of country-side development

76,000 - 760,000 PS, CA, TD,and IL

Over 1,500head officesand branches

Wholesale/retailfinance companies

Financing forindustrial,commercial, andconsumer accounts

3.8 million IL Over 50 headoffices andbranches

Pawnshops Retail lending 3,800 None Over 2,000branches

Lending investors Retail lending 3,800 None Over 1,700branches

38 The minimum capital requirement depends on where the institutions operate. It is much more expensive to operate

in Metro Manila.39 Types of deposits permitted: Passbooks [PS], checking account [CA], time deposits [TD], inter-bank loans [IL].


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Roles and Responsibilities of Regulators

Bangko Sentral ng Pilipinas: The Central Bank. The banking superintendency in the Philippines ispart of the central bank. The Bangko Sentral ng Pilipinas (BSP) is well staffed. Bank examinerpositions are filled by certified public accountants who have passed the central bank entranceexaminations. Key positions in the central bank are filled by career personnel who have undergonespecialized training in central banking and have completed several years of service in the agency. Thenew BSP is well funded, with paid-up capital of US$380 million. It is a prominent entity in thefinancial system of the Philippines, influencing lending rates as well as foreign exchange rates, andcontrolling the money supply.

The Bangko Sentral ng Pilipinas is an independent body. The New Central Bank Act states:

The State shall maintain a central monetary authority that shall function and operate as anindependent and accountable body corporate in the discharge of its mandated responsibilitiesconcerning money, banking, and credit. In line with this policy, and considering its uniquefunctions and responsibilities, the central monetary authority established under this Act, whilebeing a government-owned corporation, shall enjoy fiscal and administrative autonomy.

The BSP Governor is appointed by the President of the Philippines for a six-year fixed term, subjectto confirmation by the Commission on Appointments, consisting of elected members of Congress. TheGovernor is also the Chair of the Monetary Board, the policy-making body of the central bank.

Department of Finance. The Department of Finance is responsible for the government’s revenue-raising programs and matters relating to the country’s policies on taxation. The head of this office isthe Secretary of Finance, is a senior cabinet-level position. The Secretary of Finance supervises themajor revenue-producing units of the government, namely the Bureau of Internal Revenue and theBureau of Customs. The President of the Philippines appoints the Secretary, subject to confirmationby the Commission on Appointments. This is a political position, and the incumbent serves at thepleasure of the President.

The Department of Finance supervises the National Credit Council (NCC), which was created toimprove access to credit for the basic sectors (i.e., rural residents and farmers, operators of smallenterprises and the self employed, and the low-income) normally excluded from the formal financialsystem. One of the major tasks of the NCC is to rationalize various government credit programs. Atthe moment, there are at least 111 special- or directed-credit programs for specific sectorsimplemented by 44 government agencies having estimated total resources of US$1.2 billion. TheSecretary of Finance also acts as Chair of the NCC.

Philippine Deposit Insurance Corporation (PDIC). The PDIC covers all deposits of financialinstitutions authorized to accept deposits from the public. The agency insures deposits with balancesnot exceeding US$3,800 per person. Membership with the PDIC is mandatory for all banks operatingin the Philippines. PDIC is authorized to examine banks and sanction those found violating PDICrules. PDIC is a government-owned and -controlled corporation that is adequately capitalized. Thepermanent insurance fund is US$114 million, and revenue is derived from various sources such as:


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1. A premium based 0.2 percent per annum of the average outstanding deposits of all bankslicensed to accept deposits;

2. Investment income;

3. Receivership fees; and

4. Fines from banks violating PDIC rules and regulations.

PDIC staff members are professional, and key senior officers are recruited from the banking andaccounting professions. Sitting on the board of the PDIC, as provided by its charter, are the Secretaryof Finance (who is the ex-officio Chair), the Governor of the central bank, PDIC President (with afixed term of six years), and two members from the private sector appointed by the President of thePhilippines for a six-year fixed term.

Microfinance Standards Initiative

In the Philippines, most microfinance institutions are cooperatives and non-governmentalorganizations. Compared to cooperatives, which are regulated and have recently established a set offinancial and performance standards, NGOs operate outside the formal financial system. But whiletheir informality is an element in their relative success in reaching the lower-income segments ofsociety, most NGO microfinance institutions are characterized by marginal outreach and lowabsorptive capacities. The institutions attribute these characteristics to, among other things, the lackof common standards to guide their growth and increase their capacity. A tactical coalition of NGOpractitioners and other interested parties is therefore taking the initiative to establish commonstandards for NGO microfinance operations. This represents a first step towards some form ofregulation.

The need for standards for microfinance emerged because of developments in the international andlocal arenas in the past five years:

International: Standards have become critical because of the emergence and wider recognition ofsuccessful microfinance models, including the Grameen Bank, BRI’s Unit Desa, and BancoSol;and the high profile that has accompanied the World Bank’s CGAP initiative and the Micro CreditSummit.

Local: Government, NGOs, and other private-sector groups are increasingly focused onmicrofinance as a poverty-alleviation tool. However, a closer examination raises concerns aboutlimited outreach and absorptive capacities of MFIs. The creation of the People’s Credit andFinance Corporation as an apex microfinance lending institution and the willingness of somebanks to lend to microfinance NGOs have also heightened the need for industry standards.Wholesale lenders require mechanisms to assess the health of prospective borrowers and tomonitor their performance.

Tactical CoalitionThe process of establishing performance standards for microfinance in the Philippines has involvedassembling a multi-sectoral coalition consisting of thirty-four member institutions, including:


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• Leading NGO microfinance practitioner coalitions;

• The Supervision Unit of the Central Bank;

• People’s Credit and Finance Corporation;

• Two commercial banks that lend to NGOs for microfinance;

• Other government planning and regulatory bodies;

• Private foundations, academic, and research organizations; and

• Donor agencies.

A core group (the Project Advisory Group) of members serves as the governing and policy-makingbody of the coalition and the project. The initial funding for this project came from USAID, and theproject is managed by TSPI. Coalition members are expected to commit to the project. Thiscommitment includes the time and active participation of individual representatives, and variousresources of their respective institutions such as information, technical expertise, cash, and logisticalcontributions.

The project also benefits from generated data on international best practices and microfinance issuesand the expertise of international resource persons who will be contracted to help train selected keyintermediaries.

Objectives, Strategies, and OutcomesThis two-year project started in August 1996 to develop and promote standards for microfinanceoperations that will increase access to financial services on a viable and sustainable basis in low-income communities. In particular, the standards are expected to:

1. Help NGOs build their capacity to increase their outreach on a sustainable basis and toincrease their access to capital markets;

2. Guide banks and other resource holders to identify and support key players; and

3. Assist the government in providing an enabling environment, particularly policies that willallow microfinance to be an effective poverty instrument.

The first four months of the project centered on organizing the implementation structures, deployingstaff, and forming the coalition and Policy Advisory Group. To develop and market the standards,this project will assume the following major activities in the next twenty months:

Design and conduct a national microfinance survey: This survey aims to create a reliable statisticalbaseline of approximately five hundred NGOs involved in the delivery of credit and savings services tolow-income communities. From this survey, a smaller sample of NGOs will be identified for in-depthevaluation and training to achieve outreach and sustainability.

Conduct regional forums: The project will conduct meetings in key regions of the country to buildawareness among coalition members and other interested groups about microfinance, the need forstandards, and to elicit their active participation in and support of the project.


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Conduct advocacy forums: Preparations are underway to conduct a series of local seminars toprovide a broader understanding of the principles, challenges, and needs of microfinance, and to offertraining on the mechanics of the operations and management of sustainable microfinance institutions.Notable international resource persons are being tapped to help design and conduct these sessions.There are three audiences for these sessions:

1. A basic training seminar for officers and decision-makers of NGO practitioners wanting toexpand for greater outreach and sustainability;

2. A shorter forum for government officials, policy makers, banking regulators, private sectorleaders, and donor agencies; and

3. A detailed seminar for middle- and technical-level representatives of the participating agenciesin the high-level forum.

This project is expected to produce five primary outcomes. First, through the survey, it will create arich database on the state of microfinance in the Philippines. Second, the project will establish a set ofperformance standards developed and accepted by the core members of the coalition and perhaps otherMFIs as well. Third, it will produce a collection of best practices in Philippine microfinance. Fourth,selected NGO intermediaries will be trained and assisted to improve their support systems to scale upand move towards viability. Fifth, this project will influence national policy and regulatory agencieson standards and specific reforms working towards a favorable regulatory environment formicrofinance.

The Importance of Government ParticipationThe involvement of the central bank and the National Credit Council is a key element in this project.As top planning and regulatory entities, they will contribute significantly to formulating acceptableand workable standards by providing information regarding government fiscal and economic policies,the regulation and supervision of financial institutions, and the possibilities and implications ofregulating microfinance intermediaries.

As mentioned above, the project includes an advocacy objective to create a policy environment thatsupports the growth of a range of microfinance institutions. The participation of these agenciesenables them to be exposed to and appreciate microfinance. Through their involvement in this project,they will more fully comprehend the characteristics, approaches, and operations of microfinancepractitioners and the critical issues for MFIs, such as deposit-taking, regulation and supervision, andthe transformation of NGOs into formal financial intermediaries.

Under this project, the Supervision and Examination Sector of the central bank is responsible forevaluating and making recommendations regarding the licensing of bank and non-bank financialintermediaries, including microfinance institutions. It is hoped that the participation of the centralbank will allow it to become more aware of the policy and regulatory issues affecting non-bankmicrofinance institutions, which will ultimately result in a more friendly microfinance policyenvironment. The participation of NCC will assist the council in fulfilling its task of coordinating andrationalizing government credit policies and improve the access to financial services in low-incomecommunities.


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ObstaclesThere are two major risks to the success of this project. First, since the coalition is the prime mover ofthe project, its ability to function is crucial for the project to fulfill its purpose and objectives.However, the coalition is not a formal, legal organization but rather a tactical alliance of variousautonomous organizations with a common objective of establishing standards for microfinanceinstitutions. Thus, building a strong and committed coalition is given utmost importance in thisinitiative.

Second, the project has a set a two-year deadline. Time is a critical constraint as many of theparticipating entities are busy with their operations. Moreover, although the project will benefit fromthe rich and diverse experiences and resources (technical, informational, organizational) of thecoalition members, the diversity and distinct interests of the participating institutions may complicateaspects of project implementation.

The coalition recognizes these risk factors and has purposely designed structure and governancepractices to provide a coordinated system in which the project can operate effectively and efficiently.


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ÐÐ

BOLIVIA

ÓÓ

Rachel Rock

The Bolivian Superintendency has been particularly innovative in the regulation and supervision ofmicrofinance. The process began with the authorization in February 1992 of Banco Solidario, S.A.(BancoSol), as the first private commercial bank in the world dedicated to the exclusive provision offinancial services to the microenterprise sector. A second significant step came in April 1995, whenthe Bolivian government enacted a decree that regulates the incorporation and operation of the PrivateFinancial Funds (PFFs). PFFs are non-bank financial intermediaries designed to serve the smallbusiness and microenterprise sector.

This chapter will address three main areas: (i) the key aspects of the Bolivian regulatory framework,including general regulations governing the financial sector and specialized regulations established in1995 for the PFF structure; (ii) the major regulatory issues facing BancoSol as a commercial bankserving the microenterprise sector; and (iii) the operations of Caja de Ahorro y Prestamo Los Andes,S.A. (Los Andes), Bolivia’s first PFF.

Bolivian Regulatory Framework

The Law on Banking and Financial Institutions40

The Law on Banks and Financial Institutions (the Law), enacted in April 1993, was the culmination ofa successful process of institutional reform begun in 1987, which included a series of measures aimedat strengthening the private banking system. In late 1988, when this reform process was beginning,the Bolivian banking system captured deposits of less than US$500 million, the average term ofdeposit was sixty-five days, and the rate of interest on deposits in foreign currency was over 16percent. Bolivian banks could count on practically no credit from foreign financial institutions.Further, the closing of several insolvent banks had just been ordered, and little was known about theactual financial situation in the rest of the banking system.

As a result of the reform process, as of October 1995, deposits captured came to US$2.42 billion,average terms of fixed-term deposits are 216 days (approximately seven months), and the averageinterest rate on deposits in foreign currency are approximately 9 percent annually. Not only has directexternal credit recovered – as of October 1995 it comes to more than US$400 million – but someBolivian banks are beginning to place debt paper in foreign markets. These figures were the result ofnew banking regulation that mandated the following:

40 This section was originally prepared by Jacques Trigo LoubiPre, the Superintendent of Banks and Financial

Institutions in Bolivia, and it appears in From Margins to Mainstream: The Regulation and Supervision ofMicrofinance, edited by Rachel Rock and Maria Otero, ACCION International, Monograph Series No. 11, 1997.


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• No interest rate ceilings.

• No directed credit mechanisms.

• Legal reserves are set at minimal percentages above which the central bank must remuneratefunds so set aside.

• The scope of banking supervision is expanded to include all non-bank financial intermediariesand companies that provide services to the financial system.

• Minimal capital requirements are denominated in bolivianos equivalent to a constantinternational unit of value, the Special Drawing Rights (SDRs) of the International MonetaryFund.

• The minimum operating equity of the financial intermediaries is determined by weighing theirrisk assets, consistent with the Basle Accords, setting the minimal operating coefficient at 8percent. This coefficient was amended in October 1995 to a minimum of 10 percent.

• Entry criteria for new actors to the market is based on a rigorous review of the solvency andcapabilities of the founding shareholders.

The Law lays down limits on the operations of financial entities for the purpose of minimizingexposure to the risks inherent in financial activity with the following prohibitions:

• Loans to a borrower or borrower group may not exceed 20 percent of the intermediary’s networth.

• Loans to a borrower or borrower group may not exceed 5 percent of the intermediary’s networth, if these loans are not guaranteed.

• A total loan portfolio without guarantees may not exceed twice the net worth of the financialinstitution.

In addition, the Law seeks to limit conflicts of interest in the management of banking institutions.Loans cannot be made to borrowers or borrower groups related to the lending institution. Itfurthermore places limits on the ability to tie up resources in fixed assets, and requires banks tomaintain and publish their income statements and balance sheets at their true values, authorizing theSuperintendency to determine the system for bookkeeping and asset valuation, and to inspect the banksand require that they provide information periodically.

Banks must consolidate their financial statements to include any incorporated branches andsubsidiaries engaged in intermediation or financial services, as well as those of insurance companiesthat have received bank investment. This mechanism prevents the evasion of prudential standards ofcapitalization or spread of risk used to assess a bank’s solvency.

The Legal Framework for Private Financial Funds

The supply and demand of microfinanceAn assessment of the supply and demand for credit in the Bolivian financial system indicated the needfor a new type of entity specializing in micro and small business finance. A considerable portion ofthe potential demand for financial services among low-income sectors was not being met by thecurrent regulated institutions, nor by the NGOs specialized in providing credit to these sectors.


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The main institutions providing credit in Bolivia are banks, mutual companies with savings and loansoperations, and credit unions, which together represent a credit supply of US$3.73 billion, based onthe direct and contingent portfolio as of June 1995. The banks account for 90 percent (US$3.43billion) of that credit supply; they hold a diversified portfolio in different productive and commercialsectors and serve primarily large and medium-size economic units.

The mutual companies with savings and loan operations for housing account for 6.6 percent (US$203million) of the total portfolio, covering mainly the housing finance needs of middle-incomewage-earning sectors. Credit unions account for 3.2 percent (US$97 million); they mainly financehousing needs, as well as small businesses and merchants.

The total number of borrowers in the banking system increased from less than 86,000 individuals andentities in June 1990 to 180,559 in June 1995. Of this 1995 total, 61,172 – or more than one-third ofthe entire banking system – borrowed from BancoSol. The clientele of the mutual companiesincreased from 24,000 borrowers in June 1992 to 31,243 borrowers as of June 30, 1995; borrowersfrom credit unions equaled 41,042 as of June 30, 1995.

The banking system, excluding BancoSol, invests 94 percent of its resources in loans greater thanUS$10,000, which account for 18.8 percent of all borrowers in the system. In recent years manybanks have begun aggressive programs to make small loans mainly for consumption purposes. Loanshave also been made to finance housing construction or purchases for both high- and middle-incomesectors. The structure of the BancoSol portfolio stands in marked contrast to these characteristics ofthe “traditional” banking system. BancoSol began operations in January 1992 and of its US$26million portfolio (as of June 1995), 92 percent is made up of loans of amounts less than US$10,000,for a total of 61,172 borrowers, whose average outstanding loan is US$457.

Financial intermediaries have been engaged in important efforts to expand their client base.Nonetheless, the economically active population in Bolivia numbers some 2.1 million persons, morethan 1 million of whom are self-employed workers. Whereas the formal business sector includes morethan 100,000 enterprises, the informal urban microenterprise sector numbers some 600,000enterprises nationwide.

The current coverage of BancoSol and Bolivia’s microcredit NGOs, which serve approximately85,000 microenterprise borrowers, falls short of the potential demand. To meet the demand, which iscentralized in urban areas, the traditional financial institutions commercial banks, mutual companies,and credit unions-would have to serve over 450,000 additional borrowers.

Those institutions currently participating in the microfinance market, in the supervised and thenon-profit sectors, are insufficient to guarantee efficient financial intermediation formicroentrepreneurs and small businesses. Multiple-service banking is an excessively broadframework for lending operations to microentrepreneurs and small businesses, requiring minimumcapital that overprotects microlending operations and acts as a barrier to entry. A new type of entitywas needed to deepen the Bolivian financial market.


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Private Financial FundsIn April 1995, the Bolivian government enacted Supreme Decree 24000, which regulates theincorporation and operation of the Private Financial Funds (PFFs). An example of a PFF, Los Andes,is provided in the last section of this chapter. The main characteristics of these institutions are asfollows:

Purpose: This special category of financial institution was established to finance the activities ofmicro and small businesses, as well as to make loans to individuals for durable goods purchases.Private Financial Funds may also engage in small-scale consumer credit operations.

Incorporation: The PFFs are organized as corporations. This legal form allows for timely increasesor replenishment of equity when required by the Superintendency of Banks and may also help attractfinancial institutions from abroad, private as well as public.

Minimum operating equity: The establishment of a PFF requires US$1 million in capital. Bankincorporation in Bolivia requires US$3.2 million.

Capital adequacy: The PFFs must maintain net worth equivalent to at least 10 percent of their assetsand contingencies weighted on the basis of risk.

Financial operations: Private Financial Funds are permitted to perform financial leasing andfactoring, in addition to traditional lending. The PFFs may provide financial services such as makingdrafts and payment orders, foreign-exchange operations, and buying and selling of foreign currencies.They may receive savings and time deposits, and contract obligations with second-tier bankinginstitutions. The PFFs are also able to carry out operations and channel their resources throughfinancial institutions overseen by the Superintendency of Banks and are subject to the credit limits laiddown by the Law on Banks and Financial Institutions. Before receiving an operating license, PFFsmust have managers with extensive experience serving the small business and microenterprise sectors.

Limits: PFFs are restricted from several types of banking operations. These include capturingdemand deposits, foreign trade operations, trust operations and other charges of fiduciary duty,investments in enterprise capital, participation in the underwriting and placement of securities, andmutual fund management. Some additional restrictions are as follows:

• The loan made to a borrower or borrower group may not exceed 3 percent of the net worth ofthe PFF.

• Credits with personal guarantees may not exceed 1 percent of the PFF’s net worth, howeverPFFs are authorized to make loans with security pledges in the form of movables, jewels, andother valuables. This practice is hardly used in the Bolivian financial system today, but giventhe characteristics of the target market may be a viable solution to the question of loanguarantees.

• A PFF may not maintain a credit relationship with an institution of the national financialsystem for more than 20 percent of the PFF’s net worth; PFFs are also subject to anyoperative restriction that the Superintendency of Banks deems prudent.

• To avoid conflicts of interest, shareholders, statutory auditors, directors and managers, andindividuals or entities associated with a PFF may not obtain loans, directly or indirectly, fromthe institution.


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Special Regulations for Small Business and MicrocreditThe Bolivian Superintendency recognized the need to make provisions in the 1993 Law to allow forthe large volume of small loans characteristic of microfinance institutions. Because the small size ofmicroloans allows them to be considered minor risks, when classifying and evaluating assets and theiraccruals in the calculation of equity position (which includes the limit on the total amount of loansmade with a personal guarantee to twice the financial institution’s net worth), the following exceptionsare made:

• Banking institutions should exclude from this limit all loans they make that are equivalent toUS$2,000 or less, or 1/1000 of the institution’s net worth, whichever is greater. This appliesto BancoSol though as explained in the next section, this exception does not fully allowBancoSol to reach its target market within the established regulatory framework.

• Non-bank institutions, including PFFs, should exclude from this limit loans equivalent toUS$500 or less, or 1/20 of 1 percent of the institution’s net worth, whichever is greater.

Similarly, the Superintendency of Banks qualifies the loan portfolio for operations up to US$5,000,including special treatment based on an evaluation of payment capacity, taking into account theanalysis of assets, liabilities, and cash flow in the borrower’s socioeconomic unit (considering thebusiness and household jointly). An appropriate qualification is also made in light of the borrower’scredit history. Such measures reduce the unit cost of managing microloans for financial institutionsspecialized in this area.

Supervision of MFIs in Bolivia

Internal capacity of the SuperintendencyA 1995 Inter-American Development Bank (IDB) study of financial sector reform rated the qualityand the quantity of Bolivia’s supervisory personnel as adequate for overall supervision of the financialsector.41 Among the Superintendency’s strengths is its ability to collect financial performanceinformation from institutions. According to this study, the Superintendency could, however, improveits analysis of this raw data. Trend analysis and comparisons between institutions would greatly helptheir managers. The Superintendency has some 100 employees, 40 of whom are inspectorsresponsible for monitoring a total of US$5 billion in assets.

Currently, the Superintendency carries out both the auditing and examining functions. Auditing isbased on past performance and uses Generally Accepted Accounting Principles (GAAP).Examination is a future-oriented process and assesses such factors as the institution’s earnings andloan collection procedures. Outside observers advocate for the Superintendency to transfer theauditing task to the private sector to alleviate some of the workload. While the agency has a cadre oftrained and competent regulators, there are often delays in reporting the results of examinations. Asconditions can change rapidly within a financial institution, particularly a microfinance institution,timeliness of reports is critical.

In the meantime, steps have been taken to improve the Superintendency’s ability to assess the progressof microfinance institutions. Bolivian regulators have received training in microfinance. USAID in

41 Westley, Glenn D. 1995. “Financial Reforms in Latin America: Where Have We Been, Where Are We Going?”

Washington, DC: IDB.


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Bolivia is currently funding an internal capacity-building project for regulators in both credit unionsand microfinance.

Reporting RequirementsThe supervisory structure requires all Bolivian financial institutions to submit reports on a daily,weekly, ten-day, monthly, quarterly, thrice yearly and yearly basis. These reports constitute theoff-site monitoring of the bank’s operations and serve as an early warning system in case of aproblem. Table 8 lists these requirements.

Table 8: Reporting Requirements of the Bolivian Supervisory Structure

FREQUENCY REPORTSDaily Funds captured

Average interest rates

Weekly Inter-bank operationsReserve requirementTotal deposits by contractual maturity

Every 10 Days Liquidity levels

Monthly Credit bureauFinancial statements (Consolidated and disaggregated by regions and by branches)Consolidated adjustmentsVerification of legal financial requirements (Compliance with financial ratios)Fluctuations in share price Risk-weighted asset report

Quarterly Changes in financial situationChanges in equityNotes to financial statementsStatement of institutional compliance (regarding labor laws, taxes, etc.)Quarterly financial information

3 Times / Year Loan portfolio classificationBoard meeting minutesBreakdown of deposits by sizeLiquidity management policies

Yearly External auditing reportPublished audited financial statementsAnnual reportPublished list of shareholders


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Loan classification system and provisioningAn effective supervisory structure must assess an institution’s credit risk and mandate appropriatelevels of provisioning. The Bolivian system of classifying loans takes into account the size of the loan,the length of delinquency of the loan, the existence (or not) of a tangible guarantee, and the economicsituation of the client. There are no distinctions made between consumer and business credit for thepurposes of provisioning. Financial institutions are required to report their loan classification to thenational credit bureau on a monthly basis.

Loans are separated into four groupings:

1. Those equal to US$20,000 or more

2. Loans between US$5,000 and US$20,000

3. Loans less than US$5,000, and a loan term of one month or more, or payments that aremonthly or less frequent

4. Loans less than US$5,000, and a loan term less than one month, or payments that are lessthan one month.

Using these factors, each loan is classified into one of four categories based on delinquency, with eachcategory requiring a given level of provisioning as outlined in Table 9. For unsecured loans ofUS$20,000 and more, regulations require 100 percent provisioning. As the Superintendent considersBancoSol’s group loans as single loans, the larger ones (comprised of 4 to 5 US$4,000 to US$5,000loans) require 100 percent provisioning. In Bolivia, loans of more than US$20,000 are to beevaluated by a supervisor at least every six months. Loans equal to or less than US$20,000 are to beevaluated once a year.

Table 9: Bolivian Superintendent’s Risk Classification and Provisioning Requirements

Classification of Loan Between US$5,000and US$20,000

Less than US$5,000and term > 1 month or

monthly or lessfrequent payments

Less than US$5,000and term < 1 monthor payments are < 1

monthPotential Problem Loans 6-30 0% 6-30 0% 6-15 0%

Deficient Loans 31-90 10% 31-60 10% 16-30 10%

Doubtful Loans 91-180 50% 61-90 50% 31-60 50%

Lost Loans >180 100% >90 100% >60 100%

Creation of BancoSol

In February 1992, Banco Solidario, S.A. (BancoSol), commenced operations as the first privatecommercial bank in the world dedicated solely to providing financial services to the microenterprisesector. BancoSol grew out of a successful Bolivian NGO, PRODEM (Fundacion para la Promociony Desarrollo de la Microempresa), which was established in 1985 by prominent members of theBolivian business community, ACCION International, and Calmeadow in response to the growingdemand for financial services among Bolivia’s informal sector. This section analyzes the process of


50

establishing a regulated institution and how the regulatory framework affects microfinance operationsfrom the perspective of BancoSol.

BancoSol entered the regulated financial sector as a commercial bank because the Private FinancialFunds (PFFs) discussed above did not yet exist. In meeting the requirements to become a commercialbank, BancoSol confronted an array of regulatory issues and was a test case in the applicability ofbanking regulations to microfinance institutions.

PRODEM: Restrictions on GrowthAs a NGO, PRODEM had accomplished many of the characteristics of a successful microfinanceinstitution – visionary leadership and clarity of purpose provided by its board of directors, rapidgrowth, achievement of operational self-sufficiency within eighteen months of operation followed byfinancial self-sufficiency in 1990, and high portfolio quality. However, it was reaching less than 3percent of the potential market. Access to funds was its limiting factor. Donor funds could not keeppace with PRODEM’s ability to expand. PRODEM’s local commercial capital supply ofUS$710,000 in 1991 could not support the US$2 million per month lending pattern.42 As anunregulated NGO, it could not rely on the potentially much larger voluntary savings of its clients andthe public.

Entering the Formal Financial SectorThe formal process of establishing BancoSol commenced in late 1989 with the creation of a committeeto manage the planning and transition of PRODEM into BancoSol. Several prominent localbusinessmen provided the vision and leadership for this effort. The committee was charged withfulfilling the requirements for entry into the formal sector, which included: (i) raising the minimumcapital; (ii) fulfilling legal and technical requirements; (iii) detailing financial information about theowners and experience of the managers of BancoSol; and (iv) demonstrating operational capability tothe Superintendency.

Raising minimum capitalLegal incorporation of a commercial bank required a minimum US$3.2 million in equity. Initial plansoutlined the funding to come from concessionary loans and donations. However, the project gained anincreasingly commercial structure as negotiations advanced. In the end, equity funding came fromthree types of sources: PRODEM’s loan portfolio (35 percent); external institutions, including theInter-American Investment Corporation (IIC), Calmeadow, ACCION International, FUNDES, theRockefeller Foundation, and SIDI/France (46 percent); and Bolivian individuals (19 percent). By theend of 1991, the committee had raised nearly US$5 million of equity financing, US$1.8 million morethan the required minimum.

During this process, PRODEM assumed a new role by becoming the research and development arm ofBancoSol, and shifting its focus to rural lending. PRODEM was to continue to establish newbranches and sell them to BancoSol once they became profitable.

42 Drake and Otero, 1992. Alchemists for the Poor: NGOs as Financial Institutions. ACCION International.


51

Legal and technical requirements of becoming a bankIn completing the two-step process of establishing a commercial bank in Bolivia – obtaining approvalfor a bank charter and gaining authorization to operate – there were legal and technical dimensions.The legal requirements dictated raising a minimum capital base of US$3.2 million, fulfilling therequirements of legal incorporation, and issuing stock. The technical requirements centered on thedevelopment of a detailed feasibility study for BancoSol, which projected a positive return within threeyears and provided a well-defined business plan.

Though the legal requirements were time consuming, the technical process was perhaps more difficult.The committee had to convince the Superintendency of the importance of BancoSol’s mission intargeting the micro sector and its chances of success in using a lending methodology devoid oftraditional guarantees. Here began a process of negotiation and mutual learning between the MFI andthe Superintendency, which continues today and has been one of the main ingredients of success in theformation and operation of BancoSol. The mutual objective has always been to deepen the Bolivianfinancial system by using a market-driven approach to provide access to credit to greater numbers ofmicroenterprises.

To familiarize regulators with the distinct characteristics of microfinance, the committee took them tovisit PRODEM’s branch offices, to meet with the accountants, loan officers, and clients, and towitness operations firsthand. The project leaders also worked with the Superintendent to brief him onthe incorporation process. Not only did the Superintendent have prior experience with credit unionsand cooperatives, he was also personally enthusiastic about the idea of BancoSol as an instrumentallink in democratizing credit in Bolivia.

While the Superintendency quickly accepted the mechanics of the lending methodology, it alsorecognized the associated costs and questioned whether BancoSol could earn a good rate of return. Inaddition to requiring that BancoSol make a profit after three years, the Superintendency appropriatelyrequired that the bank perform financially at a level comparable to other banks. The project leadersrealized that BancoSol would have to raise its interest rates. Determined to commence operationsmaintaining PRODEM’s rate of 4 percent a month, the bank planned to move to a fluctuating interestrate policy after the first year. The rate would vary with the market rate and the changing costs ofoperations.43

The Superintendency also questioned how the bank would fund itself over time, asking specificallyabout deposit mobilization. It is in this regard that BancoSol would differ most from other financialinstitutions. Because it began operations with donated capital and because PRODEM was prohibitedfrom capturing savings, there was very little experience to demonstrate BancoSol’s potential.Ultimately, the Superintendency exercised a measure of leniency, recognizing that the equityinvestments far exceeded the minimum requirements.

Financial information and management experienceThe Superintendency required extensive legal and financial information about the bank’s founders,who were to assume its legal responsibility, and about other investors. As the specifics of theserequirements were designed for the incorporation of a traditional bank, the process provedcomplicated. The major challenge was in applying the documentation requirements to thenontraditional investors such as PRODEM, the multilaterals, and the nonprofit organizations.

43 Glosser, 1994. “The Creation of BancoSol in Bolivia,” in Otero and Rhyne (eds.).


52

Operational requirementsObtaining a bank charter took seven months. Authorization to operate came four months later, inFebruary 1992. Ironically, by Bolivian standards, the formation of BancoSol occurred faster than theaverage traditional commercial bank.

Once BancoSol had obtained its bank charter, management had ninety days to demonstrate its capacityto operate a bank. This included such tasks as the development of operational and security manuals toensure standardized procedures, as well as the secure and efficient handling of cash. More importantwas the capacity to generate the requisite reports measuring, among other things, deposit levels,interest rates, inter-bank operations, assets and liabilities, and liquidity reserve requirements. Severalnew systems were required to manage the liabilities side of the balance sheet.

Major Regulatory Issues Facing BancoSolThe challenge of creating a microfinance bank within the commercial bank regulatory regime hashighlighted several incongruities that BancoSol and Bolivian regulators are still resolving. Theseissues include portfolio restrictions, loan documentation, write offs, and branch openings.

Portfolio restrictionsAs mentioned above, the April 1993 Law on Banking establishes that the portion of a financial entity’sportfolio backed by personal guarantees may not exceed twice the equity of the institution. Asubsequent resolution in November 1993 further stipulates the exemption of loans for bankinginstitutions that are less than US$2,000 or less than 1/1000 of the institution’s equity (US$600 in thecase of BancoSol), whichever limit is greater.

BancoSol’s loan portfolio was US$35.1 million as of June 1996. Of this, 15 percent consisted ofloans below US$500. The bank uses the solidarity group lending methodology in one loan (averagesize of US$2,000) is shared between four to five people. Rather than considering this as 4 to 5smaller loans, the Superintendency counts it as a single larger loan, often exceeding the US$2,000limit set for unsecured lending. Given net equity levels of approximately US$7 million, regulationsallow for US$14 million in unsecured lending. BancoSol has approximately US$24 million inunsecured loans, which results in US$10 million, or 27 percent of the portfolio, in noncompliance.44

This restriction affects BancoSol as a microfinance intermediary far more than the traditionalcommercial banks given its credit technology and loan sizes. Though intending to reduce exposure tocredit risk, this restriction does not take into account the viability and proven track record of thesolidarity group lending mechanism. Demanding tangible guarantees undermines a basiccharacteristic of the microlending model.

BancoSol understands that this restriction is intended to protect the interests of its thousands of clients.The bank argues, however, that this regulation results in unreasonable capital adequacy standards andrestricts its financial leverage, directly limiting its portfolio growth, outreach, and profitability.BancoSol estimates that if it had complied with this resolution, it would have missed some 22,300clients, which represents 35 percent of its borrowers.45

44 BancoSol, 1996.45 Ibid.


53

The Superintendency is aware of how this regulation limits BancoSol’s operations and is seekingalternatives. BancoSol has recommended that the Superintendency adapt the resolution to apply tothose institutions serving the microenterprise sector by raising the threshold loan level from US$2,000to US$10,000 and increasing the percentage of equity from 0.01 percent to 0.15 percent. The latterwould result in a US$10,500 maximum loan amount at present equity levels of US$7 million. As ofthis writing, the Superintendency had not yet determined the viability of this recommendation and isworking with institutions serving the microenterprise sector to craft a broad-based solution.

DocumentationThe Bolivian regulatory framework calls for detailed loan application requirements, which fall intofour general areas: general personal information; risk analysis data; financial information to determineloan size and guarantee structure; and information related directly to each loan, such as individualcredit history.46

Most of the required documentation is superfluous to a character-based lending methodology thatrelies on the personal relationship between loan officer and borrower, and a qualitative loanassessment. It is especially onerous where each loan officer is managing hundreds of loans; it ties loanofficers to their desks when they need to devote maximum attention to client follow-up in the field.Ease and flexibility of obtaining credit, which are fundamental elements in attractingmicroentrepreneurs to pay the necessary high interest rates, are also undermined. Operational costs ofBancoSol, which are already much above traditional commercial banks, are further increased.

To address this issue, BancoSol has proposed the following guidelines for documentation relevant tomicrofinance operations. These include evaluating the economic and financial status of its clients atleast once a year rather than with each disbursement; verifying the use of loans greater than US$3,000only, rather than of all loans made; continually evaluating the risk assessment of a family unit butwithout the regulatory requirement of a signed affidavit by the spouse verifying their assets/liabilitiesand income/expenses; and maintaining adequate files of original documents according to theregulations.47

Write offsFor the first time in its four-year history, BancoSol has begun to write off unrecoverable loans. Giventhe nature of solidarity group lending – small amounts backed by personal guarantees – the legal costsof recuperating the losses can easily exceed the outstanding balance. In Bolivia, one set of proceduresapplies to loans of US$1,000 or less, and another to loans above US$1,000. For small loans,regulations allow banks to avoid a legal process by establishing internal procedures. BancoSol hasproposed packaging non-performing assets subject to an internal write off approval process. Theprocess will include a report and recommendation by the following individuals in order: loan officer,branch credit committee, regional manager, loan administration manager, and shareholder’srepresentative, followed by final approval by the board of directors.

For loans above US$1,000, each case would be handled individually. BancoSol has presented twoprocedures for collection. The first is to initiate a judicial process. Once debtors, guarantors, and thejudge have been notified, a lawyer will prepare a detailed report with the documentation endorsing the

46 Ibid.47 Ibid.


54

termination of the judicial action due to a lack of sufficient recourse. This report will be evaluated bythe regional manager who made the initial recommendation and then presented to the shareholder’srepresentative who previously brought the case before the board of directors.

The second option would avoid a judicial process and involves situations in which the client receivesan extension on a loan, documented in an addendum to the original contract. Usual extensions aregiven for ninety days in order to give clients a chance to pay before commencing legal action.BancoSol is proposing a process that gives a total of 180 days to allow for the erratic income streamsof clients. If a payment has not been made after the first ninety days, BancoSol will initiate a judicialprocess for collection as outlined in the first option.

Branch openingsBolivian regulations for branching are based on the centralized structure of traditional financialinstitutions. The Superintendency authorizes the opening of agencies operating on a full-time schedulethat are expected to become full-scale branches. There are many areas of Bolivia where there is ademand for financial services but where BancoSol does not have a branch office. Initial demand inany given area may not justify the systems and staff costs of a full-scale branch office that operatesfive days a week. Depending on the size of the market and existence of competition, it may take up totwo years to generate enough business to cover the costs of operating a branch full time withconventional hours and its own accounting capacity.

For BancoSol, there is no rationale for opening more branch offices without achieving the break-evenpoint. BancoSol has proposed two options for overcoming this dilemma. The first is the authorizationto open mini-offices that operate on a specific part-time schedule, with accounting and operationscentralized in a nearby larger branch closest to the new one. This new office would be allowed toaccept loan applications and disburse loans, accept loan payments, open savings accounts, receivedeposits, pay out deposits, and close out deposit accounts. The other option also involves opening asmall office on a part-time schedule with all of the functions just listed except it would be prohibitedfrom accepting loan payments and opening savings accounts. It would also house its accountingoperations in the nearest branch office, and its hours would be determined by the branch office.

Accessing Additional Sources of CapitalSince the primary motivation behind the formation of a commercial bank was the NGO’s inability tofund its growth, this section briefly discusses BancoSol’s success in accessing the capital markets.

Mobilizing savingsBancoSol began its savings program in 1992 as it began operations. There were four stages planned:pilot project, expansion, consolidation, and market penetration. The pilot project tested threeproducts: a liquid savings account, a money-market account, and a fixed-term deposit account. Eachof the first two accounts is available in both Bolivianos and dollars. The fixed-term account is onlyavailable in dollars. In 1995, BancoSol expanded the savings program from two to twelve branches.The history of BancoSol’s savings mobilization is presented in Table 10.


55

Table 10: History of Savings Mobilization at BancoSol (millions US$)

IndicatorsJune1996

Dec.1995

Feb.1995

Aug.1994

Sept.1993

Active Portfolio $35.0 $33.7 $26.3 $26.0 13.5

Total Savings $8.7 $7.1 $6.0 $4.9 $2.6

% of Portfolio Financed by Savings 25% 21% 22% 19% 19%

The process of implementing voluntary saving products had to overcome the challenge created by theforced savings program of PRODEM, which required clients to deposit a percentage of their loan,creating a compensating balance for the institution. This mechanism became tied to the client’s abilityto receive credit. Although this requirement was eliminated, not all clients understood the differencebetween forced and voluntary savings.

Other sources of capitalAs a bank, BancoSol’s position in obtaining foreign sources of capital was fundamentally changed. In1994, BancoSol successfully placed its first certificate of deposit (CD) in the U.S. capital market withthe investment management company Scudder, Stevens & Clark for US$500,000. Later in 1994,Partners for the Common Good purchased a US$250,000 certificate of deposit, followed in 1995 byBank of Boston (US$500,000), Calvert Social Investment Fund Managed Growth Portfolio(US$260,000), and Calvert World Values Global Equity Fund (US$260,000). Several individualinvestors have also purchased BancoSol CDs.

Investor support by recognized financial institutions has great significance for the movement towardestablishing full financial intermediation for the micro sector. Becoming a bank also allowedBancoSol to access capital on behalf of the microenterprise sector through inter-bank facilities andthrough bonds placed in the domestic and international capital markets.48 What is now a novel ideamay in time become an accepted part of the financial systems of Latin America.

Los Andes: The First Bolivian Private Financial Fund

In July 1995, Caja de Ahorro y Prestamo Los Andes (Los Andes) was established as the first BolivianPrivate Financial Fund. Los Andes grew out of the non-governmental microlender Pro-Credito, withthe technical assistance of the private consulting firm IPC (Interdisziplinare Projekt Consult) asfinanced by the German development agency, GTZ.

48 Gonzalez-Vega, et al., 1996. “Banco Solidario S.A.: The Challenge of Growth for Microfinance Organizations,”

Ohio State University, Rural Finance Program.


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Regulatory Features of Los AndesThe minimum capital required is US$1 million. The majority of the total paid-in capital to Los Andesof US$600,000 came from Pro-Credito. To reduce the tax impact on a newly established PFF,organizational costs up to US$64,000 may be deferred to future years. Los Andes did not defer any ofits start-up costs.

Los Andes is required to provision according to the norms established by the Superintendency ofBolivia outlined in Table 9. In addition, it chooses to provision a more conservative amount of 100percent for doubtful loans when it is only required to provision 50 percent. The majority of LosAndes’ loans fall into the third grouping of loans equal to less than US$5,000 and a loan term lessthan one month or payments that are less than one month. Los Andes does not account for interestuntil it is received and therefore does not provision or write off interest on bad loans.

Los Andes in OperationFrom its inception as Pro-Credito in 1991, the institution was planning to enter the regulated financialsector. In contrast to BancoSol, no operational changes were implemented once it became a PFF.Sophisticated management information systems (MIS), which integrate data on savings and creditoperations, were already in place. Consequently, Los Andes has been able to provide the requiredreports to the central bank and Bolivian Superintendency with few modifications. In contrast to manyother microfinance institutions, the Los Andes loan officers have backgrounds and training inbusiness.

As shown in Table 11, Los Andes achieved significant outreach first in its three and one-half years ofoperation as Pro-Credito, and then during its first year of operations as a PFF. Pro-Credito sold itsUS$4.4 million portfolio to Los Andes to commence operations.

Table 11: History of Growth: Pro-Credito/Los Andes Business Loans (millions US$)

Indicators 1992 1993 1994 199549

Year-end outstanding portfolio $0.7 $1.4 $2.9 $5.9

# of loans outstanding 1,163 3,173 7,684 13,849

Total amount loaned $2.6 $4.4 $9.0 $15.6

# of loans made 4,346 7,771 20,023 31,146

Average loan size $598 $566 $450 $500

As of June 1996, Los Andes had 106 employees, of which 53 were loan officers. No human resourcesdepartment currently exists. Los Andes has nine branch offices, each of which has one administrativemanager, five to seven loan of officers, a cashier, and a data-entry person. Loan officers manage, onaverage, 400 clients each, though some of the more experienced loan officers manage more than 600clients.

All of Los Andes’ loans are individual loans. Prospective borrowers must have had at least one yearin business and demonstrate the capacity to repay. Clients must also provide a spouse’s co-signaturewho in many cases jointly owns the asset being used to guarantee the loan. In addition, loan officers

49 In June 1995, Pro-Credito became Los Andes.


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work hard to understand the income stream of the household as opposed to focusing on the business,and they work with their clients to establish effective payment plans. Los Andes also provides smallbusiness loans up to US$36,000 to enterprises with assets equal to more than US$20,000. Most ofLos Andes’ loan operations are in urban areas, though it is experimenting with rural credit as well.

Los Andes also offers a unique emergency line of short-term credit to clients in La Paz, which can beguaranteed with jewelry. A client is eligible to receive 50 percent of the worth of the item provided.Similar to a pawn shop, clients can access credit very quickly. At year-end 1995, Los Andes had anactive portfolio for this line of credit equal to US$131,301, comprised of 2,105 loans averagingUS$62.

Los Andes began capturing savings in May 1996. Most of its deposits are institutional investors infixed term deposits. Los Andes is confident of a demand for savings services. First, it recognizes theneed to establish its reputation as a trustworthy institution with the microenterprise sector. Second, itis aware of the expense associated with managing small-scale savings.

In its articles of incorporation, Los Andes adopted a policy of reinvesting all profits back into theinstitution rather than distributing dividends to shareholders. For the short term, Los Andes believesthis policy will protect it from the pressures of performing for the commercial markets. It alsorecognizes, however, that without distributing dividends, Los Andes will have difficulty attractingprivate individual investors.

Los Andes’ main competition is BancoSol and NGO microlenders, though it anticipates the entranceof several other PFFs into the microenterprise sector in the near future. As with BancoSol, thesuccess of Los Andes has measurably changed the perception of low-income borrowers as good creditrisks, and the PFF hopes to continue to broaden and deepen its outreach.

The Bolivian Superintendency of Banks is considered to be one of the most innovative in LatinAmerica. It is making significant strides in creating a competitive financial market and is committedto opening the financial sector to microenterprises. The Superintendency remains fundamentallyconcerned with the prudential regulation and supervision of microfinance, but understands that itsdistinct characteristics require adjustments to certain regulations. It has, however, been unable toresolve several key issues with which it continues to grapple. Whatever the adjustments, however,they will be made so as to maintain symmetry among institutions in the financial system and avoidpreferential treatment of one institution over another.


58


59

ÐÐ

COLOMBIA

ÓÓ

Shari Berenbach

Although regulation for microfinance is a relatively new phenomenon, one regulated MFI has alreadyexperienced a financial crisis. Finansol S.A., a regulated finance company that was initially majority-owned by Corposol, a Colombian NGO, underwent a crisis resulting in its financial restructuring andthe liquidation of the parent NGO. This experience provides valuable insights into: (i) regulatoryfactors affecting MFIs; (ii) governance and management issues; and (iii) an effective work-outstrategy. These insights, plus background information about the Colombian financial sector in generaland Finansol in particular, form the basis of this chapter.50

Financial Sector in Colombia

Financial Sector Legal FrameworkPrior to the Banking Reform Law of l990, the financial sector in Colombia was highly regulated andconsisted of four types of specialized financial institutions. Commercial banks had the greatestflexibility in services. In addition to typical commercial banking activities, they could provide foreignexchange and trust functions. However, commercial banks were limited to offering short termdeposits, and interest rates on savings accounts were set by the government. Development banksspecialized in longer-term loans for targeted sectors of the economy.51 They were solely permitted toaccept term deposits of ninety days or greater. Similar to commercial banks, they were able to investin foreign currency. Savings and housing corporations held a monopoly on sight deposits and theiractivities were closely regulated. Finance companies were permitted to issue certificates of depositsfor terms of thirty days or less.

Before the 1990 reforms, the financial sector was stymied for three main reasons. First, it waspractically impossible to create new financial institutions. Second, foreign exchange transactions werelimited. Most importantly, the state held seventy percent of the total assets of the financial system,dampening competition in the financial markets.

50 The material for this chapter was based upon interviews with: Edgar Lasso, the Finance Company Delegate to the

Banking Superintendent; Carlos Castello, ACCION International’s Vice President of Latin American Operations;Maria Eugenia Iglesias President of Finansol S.A., representatives of FUNDES and ProFund; and BankingConsultant Beatriz Marulanda.

51 In Colombia, what is commonly referred to as a development bank is called a finance corporation. And, what iscommonly referred to as a finance company is called a commercial finance company. To aid readers, the terms mostcommonly associated with the functions provided, development bank and finance company are utilized here.


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Table 12: Financial Institutions in Colombia

Institutional TypeMinimum Capital

(US$ Million) Deposits Number of EntitiesCommercial Banks $22.8 • Passbook savings

• Site deposits• 30 day CDs• CDs and long-term bonds

32

Development Banks $7.1 CDs, passbook savings,52

long-term bonds22

Finance Companies $4.2 CDs, passbook savings,long-term bonds

22 Finance Companies44 Leasing Companies

Housing and SavingsCorporations

$5.7 Passbook savings, CDs 9

Cooperatives N/A. Passbook savings, CDs approx. 100

The 1990 banking reform introduced fundamental changes to the system. While the law did notabandon the tradition of specialized financial institutions, it was designed to generate competition.The four principal types of financial institutions remained, but numerous adjustments were introduced.New kinds of financial operations were authorized, the market was opened to foreign investment,explicit guidelines for opening a new financial intermediary were established, and the transformationof one type of institution to another was facilitated (e.g., a finance company could become acommercial bank or a savings and housing corporation could become a finance company).Restrictions on lending terms were lifted so that all types of financial institutions could extendmedium- or long-term financing. Features of these institutions are summarized in Table 12.

Laws introduced since l990 furthered the financial sector reform. In l993, a new law permittedsavings and housing corporations to diversify the services they provided and to establish affiliationswith other financial institutions. This law also authorized the operation of leasing companies.Subsequently, caps on the interest rates that could be charged by savings and housing corporationswere lifted, and finance companies were given access to central bank credit lines. The collective effectof the reforms was to eliminate captive markets, to increase competition, and to further efficiency inthe financial markets.

The Usury Law, which forms part of the commercial code, has had far-reaching implications for thefinancial sector. The law restricts all institutions from charging more than one and one half times thebenchmark interest rate. This benchmark is defined by the Banking Superintendency. It is calculatedas an average of the interest rates charged to the business sector, which is similar to the primebusiness rate in the United States. From the perspective of the Banking Superintendent, allcommissions and service fees charged by the financial institution are included within the interest rateallowable. Related services, such as insurance premiums or training service fees, fall outside theinterest rate calculation.

52 Passbook savings can be authorized by the Banking Superintendency if the development bank’s capital equals or is

greater than the minimum capital for a commercial bank.


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Supervisory and Governing InstitutionsThe Banking Superintendency operates autonomously and is responsible for granting licenses, insuringdeposits, conducting supervision, and intervening in the case of a banking crisis. Its budget isfinanced directly from an annual charge paid by the financial institutions. There is a separate unit inthe Superintendency for each of the four principal types of financial institutions described above. Thecentral bank is responsible for establishing monetary policy, and the Ministry of Finance establishesthe legal framework for the financial sector as a whole.

The supervision and provisioning guidelines vary according to commercial, consumer, and housingloans. Housing loans are secured by liens on real property and are extended by housing and savingscooperatives; commercial loans may be secured through liens on assets, chattel mortgages, co-guarantees, and are extended by commercial banks. Consumer loans are typically smaller in size,unsecured, and are extended by finance companies.

From a banking supervision standpoint, consumer credit falls within a ‘blind spot’ for regulators.Since the loans are unsecured, bank examination techniques that evaluate the documentation of thesecurity are not meaningful. The only methods available for bank regulators are (i) to compare thelending operation to the operating manuals, and (ii) to track portfolio delinquency once it hasdeveloped, as an ex post measure. Consequently, bank examiners only learn of a delinquency problemafter it has grown to significant proportions. It is also important to note that, while the overallprovisioning guidelines in Colombia, outlined in Table 13, are not as demanding as in some countries,guidelines for consumer financing are the most stringent. These features of the banking sector inColombia significantly influenced the problems encountered by Finansol discussed below.

Table 13: Loan Provisioning Policies in Colombia

Categories Loan Loss Provisions Commercial Consumer HousingNormal Up to 30 days Up to 30 days Up to 30 days

Potential Problem 1% of principal interestreceivable

31-60 days 31-60 days 31-120 days

Deficient 20% principal 61-120 days 61-90 days 121-180 days

Doubtful 50% principal plus 100%accrued interest

121-360 days 91-180 days 181-360 days

Lost 100% principal plus100% accrued interest

Greater than 360days

Greater than 180days

Greater than360 days

Finansol

BackgroundFinansol emerged from Corposol, an NGO dedicated to providing services to microentrepreneurs inColombia’s informal sector.53 Corposol was founded by influential local business persons with

53 Corposol was initially established as ACTUAR Bogota and adopted the name Corposol in 1993. This section draws

heavily on a presentation made by Carlos Castello and Maria Eugenia Iglesias at the MicroFinance Network’sannual conference in 1996; see “Establishing a Microfinance Industry,” edited by Craig Churchill.


62

support from ACCION International, a US-based NGO. From its start in 1987, Corposol grew at anunprecedented rate, providing training and access to credit for more than 3,000 clients in 1989 and tonearly 25,000 active borrowers at the end of 1992. Corposol was also one of the first microlendinginstitutions to begin its lending activities by obtaining lines of credit from commercial banks, initiallythrough the personal guarantees of the founders and afterwards through guarantees from ACCION’sBridge Fund and FUNDES, a Swiss foundation. However, these sources of capital were insufficientto sustain the institution’s rapid growth.

By 1992, Corposol began to explore ways to tap directly into financial markets. Corposolcommissioned a feasibility study to consider various options of becoming a regulated financialintermediary. Corposol elected to purchase the license of an existing finance company. This had acost advantage since the capital requirement for a finance company of US$4 million comparedfavorably to the US$13.7 million required at that time to establish a commercial bank.54 Thelimitations on its function as a finance company were activities in which it was not interested anyway,such as foreign exchange transitions. Furthermore, the Bank Superintendency’s approval process forpurchasing an existing license was considerably faster than for issuing a new banking license.Therefore, operations of the finance company could begin within weeks of the purchase.

In October 1993, with seventy-one percent of the shares, Corposol became the controlling owner of afinance company, which was renamed Finansol. Joining Corposol as minority shareholders wereinternational development organizations (ACCION International, Calmeadow, and FUNDES) with acombined holding of twelve percent; IFI (Instituto de Fomento Industrial), a local development bank,with seven percent; and private individuals with ten percent.

DeteriorationFinansol inherited from Corposol an excellent loan portfolio, a proven lending methodology (i.e., shortterm, working capital loans and sequential step lending), large volumes, and consistent operationalprofitability. Nevertheless, several factors led to the deterioration of Finansol’s financial position.

Usury law: Before establishing the finance company, Corposol’s cost of lending (administrative andfinancial costs) was about thirty-six percent of its average portfolio. Interest fees to meet these costswould have exceeded the usury limits at that time. To cover its full operating costs and comply withthe Usury Law, Corposol charged a training fee with each loan disbursement. This strategy permittedthe institution to raise adequate revenues to operate profitably and to remain in compliance with theUsury Law.

After purchasing the finance company, this arrangement continued, with the functions split betweenthe two organizations. Finansol provided the loans and Corposol provided the “training” services.Since Corposol’s revenues in training fees were tied to loan disbursement and credit officers remainedCorposol employees, this arrangement encouraged the approval and disbursement of new loansregardless of the loan quality. This created a perverse incentive. Since Corposol generated most of itsoperating revenues through training fees charged concurrently with loan disbursement, it had anincentive to disburse loans without a corresponding incentive for loan collection. Finansol had littlecontrol over loan-generation activity.

54 The minimum capital requirement to establish a bank in Colombia has subsequently increased to US$22.8 million.


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Independent management: Finansol lacked independent management. The team hired to manage thenew finance company consisted of experienced bankers. However, during its first year, the originalbanking team conflicted with Corposol management. The NGO manager was a particularly dynamicand persuasive individual with grandiose plans for expansion to numerous related and unrelatedsectors. Corposol’s leadership prevailed; the experienced banking team resigned, and a new managerwith allegiances to the NGO’s management took control of Finansol.

Rapid expansion of untested new products: Corposol diversified its products and services whileexpanding quickly. In l992, the German consulting firm, IPC, conducted an in-depth review ofCorposol that reported favorably upon the organization’s dynamic leadership and sound portfolio.With this clean report, several development organizations increased their support for Corposol andfinanced its expansion into new programming areas such as: Mercasol, a chain of retail outlets formicroentrepreneurs to purchase supplies with credit lines; Agrosol, a rural credit program withborrower groups of twenty or thirty clients and different repayment schedules than the urban program;and Construsol, a home improvement loan scheme.

The new services themselves were not the problem; the problems stemmed from how they wereintroduced, the rate at which they were introduced, and the institution’s capacity to manage thediversification. The designs of these services were poorly conceived. For example, Mercasol wasintended to build upon the very successful model introduced by the Carvajal Foundation. However, inthe Carvajal approach, the NGO provides only the common service facility and brings in privatedistributors to service the microenterprise clients. Corposol not only established the facility but alsoset out to assume the role of middleman. Corposol was venturing into functional areas that it was notprepared to undertake. The rate of growth was also alarming, particularly given that the servicesbeing offered were untested. During 1995, the microfinance portfolio grew from US$11 to US$35.

Institutional constraints: The institutional capacity of the organization could not sustain thediversification and rapid growth. The organization appeared most vulnerable in two areas. It couldnot train new field agents quickly enough to meet the rapid increase in its operations; therefore, anincreasing share of the total field personnel was new and inexperienced. Furthermore, themanagement information systems that had been designed for one type of product could not quickly andeasily incorporate the product diversification. Important data were therefore not included in the MIS.Corposol management and its board were leading an ever larger and more complex organization withless than complete information.

Deviation from basic banking principles: In addition to the issues raised above, Corposol strayedfrom basic banking principles. Corposol borrowed short and lent long. While ninety percent ofCorposol’s portfolio was financed with ninety-day certificates of deposit, a portion of these funds wereused to participate in long-term real estate transactions purported as a hedge against inflation. Notonly did this lead to a mismatch of maturities, it once again called upon Corposol to venture into afunctional area (real estate development) that it was not well-prepared to undertake. In anotherexample, to stop the monthly deterioration of the profit and loss statement caused by provisioning theincreasing number of delinquent loans, management launched a massive portfolio refinancing thatincluded extending loan terms. This response provided brief cosmetic relief at the tremendous cost ofhiding and worsening Finansol’s asset quality.

Management response to banking regulations: Management made poor decisions in response tobanking regulations. In 1994, the Colombian government attempted to control inflation by limiting theasset growth of regulated financial institutions to 2.2 percent per month – an extremely low figure,


64

considering that annual inflation was more than twenty percent. Finansol was affected immediately,but as an NGO Corposol was not. It became expedient for Corposol to retain a portion of the loans topermit the combined portfolio to grow at a faster rate than the regulated system. Thus began apractice of shifting portfolios between the institutions that lacked transparency and misrepresented thefinancial position of both institutions. This practice, combined with the interrelated lending functionsconducted by Finansol and Corposol, made it exceedingly difficult for internal or external reviewers(e.g., board members, regulators, auditors) to gain an accurate assessment of the financial health ofthe two companies.55

Transparency: The lack of separation – operationally, financially, and culturally – between the newfinancial intermediary and the parent NGO led to a confusion of purpose, a lack of independence, andinadequate management and financial information to assess the performance of either the operations orthe loan portfolio. Although the internal auditing group reported developments to management, theirreports were largely disregarded. In addition, a clean audit by the external auditors led the board andothers to believe that the problems were not severe. In this information vacuum, charismaticleadership was able to conceal the true performance of the operations and to mislead those who werecritical of the new products and services. The minority shareholders of Finansol were unable tounderstand the performance of the various joint initiatives, given the extensive transactions betweenFinansol and Corposol. As a result, the underlying financial status of Finansol was masked.

Crisis and ResolutionAlarmed by Finansol’s growth rate and the deteriorating loan quality, the bank superintendencyincreased its supervision of the situation. Despite the clean report issued by international auditors,ACCION International, a minority shareholder, conducted its own diagnostic exercise that illuminatedmany of the problems facing Finansol. The rapid increase in loan delinquency triggered provisioningexpenses and significantly eroded the capital position of the company. In September l995, theFinansol management team was forced to resign; in October, Luis Fernando Tobon, a prominentbanking consultant formerly with Citibank, was brought in to analyze the operations and design acorrective plan. In December l995, the Superintendency required Finansol and Corposol to sever alloperational ties.

Finansol regained control over its loan portfolio by eliminating new product offerings, returning to itsoriginal lending methods, and taking management responsibility for the credit extension staff. Inaddition, it implemented a comprehensive plan to reduce costs, improve reporting and budgeting, andfocus on quality hiring, training, and evaluation. In March 1996, Maria Eugenia Iglesias, a formercolleague of Tobon’s at Citibank and who had extensive local and international banking experience,was hired as the new President of Finansol.

To track the progress of the turnaround, Finansol split the portfolio into a “New Bank” containingloans since October 1995, and an “Old Bank” with the past portfolio. The trend of the New Bank’sperformance indicators has performed according to established targets. In the first quarter of l996,Finansol eliminated non-productive assets that at one point had comprised a significant portion of allassets, and in the second quarter of l996 it effected a capital increase of US$2 million to cover loanlosses.

55 Analysts charged with evaluating the performance of Finansol S.A. had to generate a set of consolidated financial

statements in order to arrive at an accurate understanding of the financial health of either Finansol or Corposol.


65

Since Colombian banking rules mandate the gradual provisioning of delinquent loans, the effect ofwriting-off the Old Bank’s debts flowed regularly through Finansol’s books for the first nine monthsof 1996. Overall, Finansol provisioned more than US$6 million. The cumulative effect of themonthly losses eroded Finansol’s net worth to such an extent that it violated the Superintendency’srule that a regulated financial institution may not lose more than fifty percent of its starting net worthin a given fiscal year. In May l996, Finansol’s equity position fell below this limit, creating asituation in which the Superintendency could have intervened.

The potential ramifications of intervention were significant. It could have sent a signal to the marketthat Finansol’s crisis was escalating, rather than reaching a resolution. Not only could this havecaused Finansol’s collapse due to the lack of market confidence, but it may have affected the broaderColombian financial market as well, since Finansol had issued paper amounting to approximatelyUS$30 million. Accordingly, averting this crisis was of utmost concern to all parties, and intenseefforts to launch a re-capitalization plan were initiated to forestall intervention.

Re-capitalizationIt was not until late l996 that Finansol’s capital was replenished. The process was complicated byseveral factors: (i) serious financial difficulties at Corposol, which preoccupied its bankers and madenew investment in Finansol difficult; (ii) increasing operating losses, as Finansol was effectively shutdown by the Superintendent for six months; and (iii) an overall negative economic climate exacerbatedby political uncertainty.

Nevertheless, with an additional investment by Profund, the conversion by IFI (Colombia’s second-story development bank) of some of its debt to equity and some additional investment from Corposol’sbankers in the hope of recovering some of their lost capital, Finansol was brought back from the brinkin December 1996. Corposol, the NGO, was forced into liquidation.

In early 1997, Finansol started operations again from a much-reduced base, about US$10 million inassets, having made practically no new loans while gradually repaying debt during the lengthyrestructuring process. Today, Finansol faces the daunting challenge of rebuilding its portfolio,retraining and restarting its loan distribution and collection systems, and reestablishing itself as asound financial intermediary.

LessonsThe Finansol crisis demonstrates vulnerable features of MFIs and suggests safeguards that could beadopted to mitigate risk. Bank regulators and microfinance professionals can learn multiple lessonsfrom this situation:

• Stick to basics: The first lesson from the Finansol case is that the crisis had nothing to dowith its basic microlending methodology. The methodology worked fine when it wasimplemented correctly.

• NGO owners: A NGO is not inherently bound to the same standards of economicperformance or financial prudence that may be reasonably expected in the business sector.While this concern is not insurmountable, the NGO parent must ensure that it sets standardsappropriate to the financial sector in dealing with its regulated microfinance subsidiary. Fromthe Finansol experience, it is apparent that NGOs should not be owners of MFIs unless they


66

are operated separately, and the only financial link is ownership. This relationship must betransparent, and any financial exchange must include proper transfer pricing. Also, NGOsshould not fully control the board and management of an MFI. It would be appropriate forregulators to monitor the financial health of an NGO when it is the majority owner of aregulated financial entity and in some cases to require consolidated financial reporting bepresented so that an accurate assessment of the financial health of the regulated financialintermediary may be determined.

• Insider dealing: This case highlights the need for banking supervisors to develop tools tomonitor insider dealing. All insider dealing should be reported to supervisory bodies, and theSuperintendent should have authority to challenge questionable transactions.

• Auditors: It is premature to discuss bank supervision if audits are not performed properly.At Finansol, neither the internal nor external auditors properly performed their function.Internal auditors reported their findings to management, when in fact they should havereported to the board. External auditors did not have a good understanding of the uniquecharacteristics of microfinance, and therefore were not able to assess the situation effectively.This suggests a need for training.56

• Hazards of Regulations: It is important to note that regulatory restrictions, such as the usurylaws and limits on portfolio growth, constrained the finance company’s development andcontributed to the adoption of inappropriate financial practices at Finansol/Corposol. Theseeconomic, as opposed to prudential, regulations often have undesirable side effects and shouldbe considered with great care.

Important lessons can also be derived from the resolution of the crisis. Not surprisingly, support wasmost forthcoming from those institutions with the most to lose. Local financial intermediaries withoutstanding credit lines were very involved in the recapitalization process. They required Corposol tosurrender its majority stockholder position in Finansol through a debt-for-equity swap with its banksto whom those shares were pledged. International support organizations, such as ACCION,Calmeadow, FUNDES, and ProFund, had both their financial resources and credibility at stake.These organizations took a lead in the restructuring process. Private business leaders, who hadoriginally owned ten percent of Finansol, took on a less-active role. Multilateral donor institutionswere unable to respond in a timely fashion, and their participation in the work-out was effectedindirectly through ProFund, a donor-supported equity fund. Finally, Citibank-Colombia, which hadnot participated in Finansol prior to the crisis, stepped in during the work-out. Citibank’s involvementheld important symbolic importance, as Finansol moved from its prior NGO ownership structure to aprivate sector ownership.

This experience suggests the type of ownership mix that may be appropriate for microfinanceinstitutions. It highlights the importance of having owners with something at risk, who are able tomonitor their investment, and who have – or can find – deep pockets, in the event of a crisis.

Finally, all parties involved have commended the Superintendency for its firm but flexible approach tohandling the crisis. At numerous junctures during the crisis, the Superintendency could haveprecipitously intervened. Such an action would have closed Finansol’s access to the capital marketsand prompted the institution’s insolvency. Once the crisis situation became apparent, the

56 Under contract with CGAP at the World Bank, Deloitte & Touche are currently preparing auditing guidelines for

microfinance institutions.


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Superintendency carefully monitored the situation and prompted corrective measures. In April 1996,the Superintendency required that Finansol cease new lending until it could resolve its difficulties. InMay 1996, when the Superintendency could have intervened, it made it clear that it would work withall parties as long as a credible restructuring effort was underway. The Superintendency was able tomaintain discipline and exert pressure on the parties to arrive at a timely resolution.

The experience of Finansol provides some very valuable lessons. As MFIs become full-fledgedparticipants of the financial sector, they are also vulnerable to mismanagement. The work-out ofFinansol, though still incomplete, demonstrates that microfinance institutions, like other financialintermediaries, have developed the capacity to address and resolve institutional crises. The crisis atFinansol has taken over a year to resolve, and despite overcoming numerous hurdles, Finansol is stillin the process of reestablishing its operations. Even after an intense period of negotiations with theColombian banking Superintendency, two successive injections of new equity capital, and the transferto a new president, it is premature to declare victory. Another year will be required to prove that theinstitution has returned to sustained profitability.


68


69

ÐÐ

PERU

ÓÓ

Rachel Rock

Since 1980, when the Cajas Municipales de Ahorro y Crédito (CMAC) were first created, thePeruvian financial system has had a regulated legal framework designed to provide financial servicesto low-income sectors of the population. Initially the microenterprise sector was not a stated target ofthe CMACs’ services. By the early 1990s, however, several factors had changed. First was agrowing acceptance of the effectiveness of microfinance in alleviating poverty. Second, thegovernment of Alberto Fujimori implemented a series of structural changes that liberalized thefinancial sector. The government specifically included the microenterprise sector as a target of itsplans to promote economic growth. Third, external funds became available for channeling to themicroenterprise sector as a result of financial liberalization.

Also in the early 1990s, two additional regulated legal frameworks were created to reach the smallbusiness and microenterprise sectors: the Caja Rurale de Ahorro y Credito (CRAC) and the Entidadde Desarrollo para la Pequeña y Microempresa or Small Business and Microenterprise DevelopmentInstitution (EDPYME). The CRAC framework was designed to reach the rural small business andmicroenterprise sector, while the EDPYME framework was created to bring unregulated, NGOmicrofinance institutions into the formal financial sector.57

After briefly outlining the economic context of Peru, this chapter details the broad structure of thePeruvian financial system, the experience of the Cajas Municipales, and the early experiences with theCajas Rurales and EDPYMEs.58

Economic Context

Peru is among South America’s poorest nations, with a large percentage of the population ofindigenous heritage. It’s society has been plagued by violent guerrilla movements, the most wellknown being The Shining Path, which have tapped into deep dissatisfaction by low-incomecampesinos isolated in mountainous regions of the country. In Peru, 48 percent of the economicallyactive population work in enterprises that provide jobs for four or fewer persons.59 Thesemicroenterprises historically have had no access to credit from the formal financial system. As aresult of the density of demand by microentrepreneurs for financial services combined with a lack ofsupply, non-governmental organizations have filled the void as has happened in similar undeveloped 57 The creation of a private sector commercial bank dedicated to microfinance, to be called Mi Banco, is in process.

Operations are expected to commence by early 1998. Also, several changes are occurring within theSuperintendency of Banks, the most significant of which was a recent change in leadership.

58 A large portion of the research for this case study was completed by Shari Berenbach. Other individuals whocontributed their insights and edits to this chapter include Harald Huttenrauch (IDB); Jacinta Hamann (COFIDE);and Todd Farrington.

59 Lepp, 1996. “Financial Products for MSEs - the municipal savings and loan banks of Peru,” in Small EnterpriseDevelopment, Vol. 7, No. 2, June, 1996.


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countries around the world. In 1996, there were approximately 27 NGOs providing financial servicesto the microenterprise sector in Peru.60

After years of instability, the 1990s returned Peru to relative economic growth. The FujimoriGovernment implemented structural reforms to liberalize the economy. Between 1991 and 1994,inflation decreased from 139 percent to approximately 15 percent, and exchange rates stabilized.Peru’s GDP grew from -5.5 percent in 1990 to 7 percent in 1993, to nearly 13 percent in 1994. Since1994, growth continued though at a moderated pace as the government became concerned with threatsof inflation. Growth is expected to be around 6 to 7 percent for 1997.

These reform measures included a new General Law of Banking, Financial, and Insurance Institutionsenacted in April 1991 which replaced an outdated 1931 law.61 The reforms introduced considerableflexibility into the banking sector and authorized the Superintendent to create new types of regulatedfinancial institutions. Already in existence prior to the 1991 law were the Cajas Municipales,municipal-owned credit and savings banks first created in 1980 to serve those sectors of thepopulation without access to the formal credit system. Several Legislative Decrees issued after 1991served to augment regulated microfinance in Peru, including a decree in 1992 creating the CajasRurales,62 and another in 1993 creating the EDPYME framework.63

Other changes resulting from the 1993 Law include: (i) equal treatment of all financial institutions interms of authorized operations, reserve requirements, minimum capital requirements, and loanportfolio limitations; (ii) application of standards determined at the Basle Accords; (iii) the removal ofthe discretionary practices of the central bank in creating targeted credit programs; (iv) marketdetermined lending and deposits rates. For both the CRACs and the EDPYMEs, resolutions weresubsequently issued by the Superintendent of Banks to clarify the regulation of these types of financialinstitutions.

An additional banking Law was passed in December 1996.64 A subsequent regulation to this 1996law regarding provisioning requirements has been introduced in 1997. Current debate over thestringency of these changes remains underway.

Peruvian Financial System: Structure and Actors

Structure of the SystemThe liberalization of the financial system with the 1991 banking law resulted in the collapse of twocommercial banks, a mortgage bank, a finance company, a savings and loan institution, nearly 15housing mutuals, and 4 state development banks. As a result, new forms of financing were required.

60 This estimate is taken from the “Worldwide Inventory of Microfinance Institutions” by the World Bank’s

Sustainable Banking with the Poor project, which used three criteria to establish its list of institutions: 1) offersmicrofinancial services, 2) has a minimum of 1,000 clients, and 3) was founded on or before 1992. The number ofinstitutions in Peru puts it at the high end of the Latin American countries, outnumbered only by Colombia (47),Ecuador (34) and Guatemala (33).

61 This 1991 law is Legislative Decree No. 637.62 1992 Legislative Decree No. 25612.63 1993 Legislative Decree No. 770.64 1996 Legislative Decree No. 26702.


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Most urgently, the government had to fill the void in the credit gap left by the insolvency of the StateAgricultural, Industrial, Mining and Housing Banks. The CRACs and the EDPYMEs were created inthis context.

Currently, the Peruvian financial system consists of eleven types of institutions, three of which werecreated by the December 1996 Law on Banking. Table 14 outlines these various institutional types,purposes, minimum capital requirements, deposit taking capacity and number. Although in five of theeleven categories no institutions yet exist, the creation of a legal framework implies the potential for acontinued deepening of the Peruvian financial system.

Table 14: Financial Institutions in Peru65

Institution Type Purpose MinimumCapital(US$)

Deposit TakingCapacity

Number ofInstitutions

1. Commercial Bank Multiple Banking 5.6 million PS, CA, TD, IL Approximately 25

2. Finance Company Multiple banking(reduced-scope),consumer andlong-term credit

2.8 million PS, CA TD, IL Approximately 5

3. Real EstateInvestment Company (1)

Mortgagefinancing

2.8 million PS, CA, TD, IL None

4. Credit Cooperative(2)

Savings andCredit

256,000 PS, TD, IL None

5. Cajas Rurales Rural credit 256,000 (3) PS, TD, IL 16

6. Cajas Municipales Microfinance 256,000 (3) PS, TD, IL 12

7. EDPYMEs Microfinance 256,000 (3) From COFIDE,commercial banksand other sources

1 is established, and13 applications awaitapproval from SBS

8. Leasing Company Leasing 922,000 Bonds Approximately 5

9. Factoring Company Factoring 512,500 (4) None

10. Loan GuarantyCompany

Guaranties 512,500 None None

11. Trust Company Trusts 512,500 None None

PS = passbook savings; CA = current accounts; TD = term deposits; IL = international lending.

(1) Recently created by the December 1996 General Law on Banking, Legislative Decree No. 26702(2) A credit cooperative can only capture deposits from the public and in so doing enter the financial system if it raises

the required capital and applies for special authorization from the Superintendency of Banks. Currently, no creditcooperative has raised the required capital yet there are numerous small closed cooperatives, grouped in federations.

(3) The Cajas Municipales, Cajas Rurales, and EDPYMEs are able to broaden their operational authority withincreased capitalization. In terms of deposits, at US$1.4 million an institution can offer passbook savings, termdeposits and international lending; at US$2.8 million an institution can offer current accounts without offeringoverdraft protection; at US$5.6 million an institution has the full operational authority of a multiple bank.

(4) Pending regulation by the Superintendency of Banks.

65 All dollar equivalents in this chart and throughout the remainder of this chapter were calculated using an exchange

rate of US$1 = S/ 2.64.


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Legal Restrictions within the Financial SystemUsury law: Though at one time a usury law did exist, it was dismantled some years ago. Currently,there is total freedom to set interest rates at necessary levels to cover costs.

Registered businesses: Commercial financial institutions are required to lend only to formallyregistered businesses. In the case of informal microbusinesses, financial service contracts are madewith the business owner as an individual personal loan rather than as a business loan.66

Sales tax: While there is no formal regulation which prohibits financial institutions to lend tobusinesses that do not charge a sales tax, the risk classification of such assets is so high that it is notfinancially viable. Instead, there is a simplified sales tax system which microentrepreneurs canemploy and thereby gain access to credit.

Institutional requirements: Cajas Rurales and EDPYMEs are both required to organize ascorporations (sociedades anónimas) and therefore are fundamentally private sector in nature. CajasMunicipales, though created as municipally-owned institutions are now required to convert tocorporate form within a year as set by the December 1996 Law on Banks.

Dividend restrictions: Restrictions are the same for all financial institutions and require that beforedistributing dividends, an institution must maintain minimum required equity levels and adequate loanloss provisions.

Restrictions on lending to related parties: The total loans of a financial (and microfinancial)institution to related parties cannot exceed 7.5 percent of the net effective equity. This total includesany shareholders with more than a 4 percent direct or indirect ownership stake in the institution. Thetotal lent to directors and employees of the institution cannot exceed 7 percent of the regulatory capitalof the lending institution. No preferential conditions can be extended that are not also available toother clients.

Financial System Regulatory AgenciesThe primary regulatory agency is the Superintendency of Banks and Insurance (Superintendencia deBanca y Seguros or SBS). Created in 1931, the SBS is charged with the task of regulating theoperations and activities of banks and all other financial institutions. The Peruvian constitution andlaws provide for total autonomy of the SBS.

The Peruvian central bank was established in 1920. With the exception of the 1980s when it becameoverly bureaucratized, the central bank carries out the typical mandate of setting monetary policy andissuing currency. The central bank’s primary role in the regulation of banks and other financialinstitutions is to administer and oversee the norms governing reserve requirements, the granting ofrediscounted lines of credit, and the placement of bonds in the open market. The central bank is alsoconsidered completely autonomous under the law.

The Corporacion Financiera de Desarrollo (COFIDE) is another significant entity involved in thePeruvian financial system.67 Originally established to fund projects directly, in 1992 COFIDE’s

66 The Fujimori government recently began to put pressure on informal enterprises to become registered. A growing

percentage of these informal enterprises have complied.


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charter was amended to become a second tier financial institution to channel credit lines into thebanking system. The change in mandate reflects a belief that local financial institutions can moreeffectively evaluate the credit risk of individual loans than could COFIDE.68

COFIDE can only channel lines of credit to regulated entities, which precludes lending to NGOsinvolved in microfinance. In addition, COFIDE can only lend up to three times the net effective equityof an institution and does not want to supply more than 30 percent of the total liabilities of theinstitution. Because the Cajas Municipales were the only regulated microfinance institutions in Peruin 1990, and they were limited by the resources of the municipality in which they were located,COFIDE was constrained in its ability to channel increasingly available amounts of internationalfunds to the microenterprise sector. COFIDE’s solution was the EDPYME regulatory framework,discussed in detail below.

COFIDE has 100 employees and total assets of more than US$700 million. Of this total, US$500 isin their portfolio. COFIDE funds consist of both government as well as loans from multilateralinstitutions including USAID, IDB, and the Corporacion Andina de Fomento (CAF). An additionalsource of funds has been from the IDB Micro-Global program which funnels resources through localLatin American central banks, which then channel guaranteed finance and technical assistance tocommercial banks and other financial institutions for microlending. COFIDE’s portfolio of US$500million is channeled to 66 institutions in total, of which US$120 million is directed specifically to themicrofinance sector through 35 specialized microfinance institutions including 12 Cajas Municipales,17 Cajas Rurales, 4 Cooperatives, and 1 EDPYME.

Funding for microfinance also flows through the Fondo Nacional de Compensacion y DesarrolloSocial (FONCODES), and the Fondo para el Desarrollo de la Microempresa (FONDEMI),specialized government capital funds. These two second tier funds make up the principal semiformalfinancing in Peru and fund much of the NGO microenterprise activity.

Regulation and Supervision of MicrofinanceWithin the Superintendency, the Departamento de Análisis de Entidades Financieros “E” is chargedwith the task of supervising microfinance institutions. In so doing, it works closely with the otherareas of the SBS, such as the Credit Bureau and the legal department. This microfinance supervisiondepartment monitors the major reporting requirements of MFIs, which include:

• Daily report on interest rates charged;

• Semi-monthly report on reserve position;

• Monthly financial statement report;

• Monthly report on effective equity level and risk-weighted assets;

• Monthly report on principal debtors;

67 There is an Economics and Finance Ministry though it is scarcely involved in the banking system.68 In addition to these long-established agencies, the Fujimori government augmented its strategy to make formal credit

available to the large Peruvian microenterprise sector. The Micro and Small Enterprise Program was established in1994 as part of the Ministerio de Industria, Turismo, Integracion y Negociaciones Internacionales (MITINCI), thegovernment entity established to implement and coordinate these policies.


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• Thrice yearly report classifying debt quality to establish a credit rating;

• Annual report.

To supervise these institutions, regulators monitor portfolio quality, review the borrower qualificationprocess, cross reference clients with the Credit Bureau, verify credit methodology to ensure it isemployed consistently, review client files, and analyze indicators of delinquency. Attempts to controlfraud begin with the review of the relevant personal and professional credentials of the staff, followedby a full review of the institution’s insurance policy (especially as it relates to risks associated withbanking), the relevant credentials of the internal control staff and close supervision of all policies andprocedures in handling and recording transactions. Finally, the 1996 Law obligates microfinanceinstitutions to follow all standard procedures used by banks in handling, transporting, and depositingcash.

Peru’s risk classification system conforms with international standards in its adoption of the followingfive categories: normal loans, potential problem loans, deficient loans, doubtful loans and lost loans.A distinction is made between commercial, consumer and mortgage credit.69 Consumer credit is thoseloans made to an individual. Commercial credit is those loans made to a business. Becausemicroloans are made to individuals (to obviate the requirements that commercial loans only be made toregistered businesses), they are classified as consumer loans.

Provisioning requirements for the two categories of loans are outlined in Table 15.70

Table 15: Peruvian Provisioning Requirements

Consumer Credit

Classification Days Delinquent Provisioning1. Normal Loans 9 days or less 0%

2. Potential Problem Loans 9-30 3%

3. Deficient Loans 31-60 30%

4. Doubtful Loans 61-120 60%

5. Lost Loans 120 days or more 100%

Commercial Credit

Classification Classification Criteria Provisioning1. Normal Loans No indications of reduced payment capacity by debtor. 0%

2. Potential ProblemLoans

Early indications of potential problems which may affectpayment capacity such as, a critical labor situation,inaccurate financial information, conflict of interests withinbusiness. Debtors current payment sources, however, do notdepend on third parties.

1%

3. Deficient Loans Debtor shows signs of reduced payment capacity which willnot be overcome in the short-term.

25%

69 For this document, only commercial and consumer credit is discussed.70 As of the writing of this document, discussions were underway in Peru regarding the further tightening of the

provisioning requirements.


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4. Doubtful Loans Debtor shows signs of reduced payment capacity which willnot be overcome in the medium-term.

50%

5. Lost Loans Debtor shows no ability to repay the loan. 100%

Write Offs: Regulations allow for the writing off of bad debts and its associated provision if 100percent of the loan has been provisioned for, if it has no collateral on which to draw, and repayment isconsidered very unlikely .

Capital Requirements: As indicated in Table 14, the minimum capital requirement for microfinanceinstitutions (Cajas Municipales, Cajas Rurales, and EDPYMEs) is US$256,000. Regulations oncapital adequacy for the Peruvian financial sector require that the risk-weighted assets of the portfoliodo not exceed 11.5 times the institution’s regulatory capital. This ratio must be further reduced to 11times by December 31, 1999.

Reserve Requirements: Institutions must keep 9 percent of their domestic-denominated deposits, plusan additional 45 percent of their international-denominated deposits, on reserve with the central bank.

Branching: Branching requests must be accompanied by a feasibility study and approved by theSBS. A financial institution can only expand into areas of business that are complementary to theirfinancial activities and must meet the minimum capital requirements associated with that particularindustry or activity.

With the regulatory parameters outlined, the remainder of this chapter addresses the three regulatedmicrofinance institutional frameworks: Cajas Municipales, Cajas Rurales, and EDPYMEs.

Cajas Municipales

The Cajas Municipales de Ahorro y Crédito (CMAC) were created in May 1980 by legislativedecree.71 By law, Cajas Municipales are charged with making financial services available to personsand enterprises that do not have access to formal sector intermediaries. Cajas Municipales mustachieve this objective such that the value of the institution’s equity capital in real terms is maintained.Two key goals motivated this law. The first objective was to decentralize financial intermediationthroughout the country and stem the flow of resources from rural areas to the capital city, Lima. Thesecond goal was to democratize credit by making it accessible to low-income individuals. CMACswere established as quasi-public, non-profit regulated institutions with principal owners being thelocal Provincial Council.

The first Caja Municipal was established in 1982 in Piura.72 Later in 1982, support began from theGerman Technical Cooperation Agency (GTZ) when they hired financial consultants from the Germanconsulting firm, IPC. IPC developed a plan to form a national federation of Cajas Municipalessimilar to the German savings bank model known as Sparkässe. In 1985, a three way partnership wascreated between GTZ, the municipal Savings Banks of Germany and the Peruvian Superintendent of

71 Much of the information in this section was taken from Inter-American Development Bank, “Loan Document for a

Global Program for Microcredit in Peru,” September 1995; and a comprehensive case study entitled, The CajasMunicipales of Peru: An Organizational Review, prepared by Jill Burnett for CALMEADOW. The CMACs werecreated by 1980 Legislative Decree No. 23039.

72 The CMAC in Lima does not belong to the CMAC system and is regulated by a different legislation.


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Banks. IPC served as the on-going technical assistance provider for this project, a relationship whichcontinued through 1996.

Between 1984 and 1992, eleven additional Cajas Municipales were established. In 1987, theFederation Peruana de Cajas Municipales de Ahorro y Crédito (FEPCMAC) was created as thenational coordinating agency for the network of Cajas Municipales. FEPCMAC’s principalobjectives are to promote the creation of additional Cajas Municipales, to audit and control theoperations of the Cajas, and to provide technical assistance to each agency as needed.

The primary mission of the CMACs, shaped by social and financial objectives, is the promotion ofeconomic development in Peru’s provincial regions through small and micro business loans. TheCajas Municipales adhere to several management principles:

• Achieve full cost-recovery through interest charges and thereby avoid decapitalization;

• Operate according to an institutional strategy which defines the range of services provided and thetarget market; and

• Employ efficient financial technologies to compete effectively with local financial institutions.

The CMACs follow a prescribed institutional growth pattern which begins with lower risk activities.During the first year of operation, institutions offer only savings facilities and gold “pawn” loans.Riskier services are gradually added on with microenterprise lending usually begun in the third year ofoperations. Theoretically, this period will have given the institution adequate time to achieve efficientoperations.

Initially, the Cajas Municipales financed their lending portfolio using capital provided by theprovincial governments as well as with deposits mobilized through its operations. A 1990Government Decree authorized the CMACs to access funds from national and international capitalmarkets and established the Fondo Peruana CMAC (FOCMAC) to channel capital. In 1993, theCajas Municipales deliberately set out to mobilize available international funds for microenterpriselending, the majority of which came from FONCODES, the specialized government capital fund,COFIDE, and the IDB.

Financial ProductsIn December 1996, the total outstanding loan portfolio for the federation of Cajas Municipales wasUS$62 million, and total savings was US$40 million.73 The Cajas Municipales offer a range of bothcredit and savings products. The exact mix of products, terms, conditions and credit assessmentprocedures may vary with each institution. The CMACs offer three credit products, pawn loans,personal loans, and business loans, which are detailed in Table 16.

73 Superintendencia de Banca y Seguros (SBS) - Peru. 1996. Informacion Financiera de Cajas Municipales, Cajas

Rurales y Almacenes Generales de Depósito. Lima, Peru: SBS.


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The Cajas Municipales gradually incorporated microenterprise lending – business loans – into theiroperations after five years of testing based on IPC experience in other Latin American countries. In1993, the CMACs made a strategic decision to focus on microenterprise credit.

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Table 16: CMAC Credit Products74

CreditProducts

# of LoansDisbursed

inNetworkDec. 1996

Total Amt.Loaned byNetwork

(US$)Dec. 1996

As a % ofTotal

NetworkPortfolioDec. 1996

AverageSize of

Loan orAccount

Dec. 1996Interest Rate

RangesAverage

TermTarget Sectorfor Product

Application &Guarantee

RequirementsDisbursement

Procedures

1. PawnLoans

263,709 $26million

16.5% $85 6-9.5%monthly

2 weeks - 3months

Low-incomeclientsdependent onmoneylenders

Gold or silverjewelry;75 ID,usually anelectoral card

Instant creditdelivery of up to 50-60% of the value ofthe pawned object76

2. PersonalLoans77

41,629 $21million

13.4% $357 5%-7%(comparedto bankeffectiverate of 10%)

1 month to2 years

Salariedemployeesunable to gaineasy access tobank creditwho may below-income

Salaries orsavings held inCTS Accounts(see below)

Assess client cashflow and creditrating; arrangeagreement withemployer forpayment; disburse,2-3 days

3. BusinessLoans

139,184 $110million

70% $823(Range insize inFederation$264-$924)

4.5-5.5%(vary bylocal marketand costrecovery

WorkingCapital: 1-12 months;Fixed asset:6 mos. - 2

Informalentrepreneursunable toaccess creditfrom banks

Real assets(houses, vehicles,household goods)and co-signedguarantees

Assess entirehouseholdenterprise; borrowersigns a promissorynote or bill

74 Sources: SBS, 1996; Burnett, 1995.75 No less than 43 percent of all households (and 37 percent of low-income households) in cities that have Cajas Municipales own gold or silver jewelry, making it a

viable item to pawn (Lepp, 1996).76 Loan can be renewed up to three times consecutively using the same object.77 Personal loans were introduced in the Cajas Federation in 1991.

needs) years accepted


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As a result of that strategic decision, the number of pawn loans as a percentage of the total Federationcredit portfolio disbursed has steadily decreased from 30.2 percent in December 1993 to 17 percent inDecember 1996. Personal loans amounted to 22 percent in 1993 and 14 percent in December 1996.Business loans made up 48.1 percent of the credit portfolio for the Federation of Cajas Municipales inDecember 1993 and 69 percent in December 1996.

New microloan products continue to be offered to respond to market demand. Such products include:specialized agricultural and fishing credit products, and automatic credit (expedited loan disbursementfor clients with a stellar credit history) and parallel loans (additional loans available during peakproduction seasons).

Since inception, the CMACs have incorporated voluntary savings facilities into their operations.Given the stated objective of intermediating the funds of local savers and borrowers, such serviceshave always been fundamental. In 1993, total savings in the Federation equaled approximately US$10million. By the end of 1996, this figure had increased to US$40 million. This growth resulted fromimproved macroeconomic conditions in Peru, as well as an increasingly visible and strengthened imageof the Cajas Municipales. The three savings products offered are: deposit accounts, term deposits,and so-called Compensation for Time in Service or CTS accounts.

Of the US$40 million in savings captured in December 1996, 40 percent were in savings accounts and60 percent in term deposits. Eighty-eight percent of savings came from individuals and 12 percentfrom institutions. The following is a brief description of the CMAC savings products:

Deposit Accounts: CMACs offer two types of deposit accounts. One is a current accountwithout checking. The other is a passbook savings account. The interest rates offered range from1-1.2 percent. As of September 1995, 92 percent of the active savings accounts held deposits ofless than US$500. The target sector for these accounts are low-income individuals who haveaccess to traditional bank services but prefer the CMAC’s friendly services. Payment orders canbe issued from these accounts which may be used among local businesses. The lack of checking isconsidered a major disadvantage by microenterprise clients.

Term Deposit Accounts: As of September 1995, 79 percent of term deposits were for amountsless than US$1000. Terms offered are 1, 3, 6, 9, 12, 18, 24, 36 months. An example of aninterest rate structure used within the CMAC for term deposits is: 31 days at 1.7 percent, 90 daysat 1.8 percent, 180 days at 1.9 percent, 360 days at 2.0 percent, and 720 days at 2.2 percent. Thetarget sector for this product include private individuals, public institutions, and enterprises.

CTS Deposits: CTS accounts are comparable to pension funds and they can also serve as aguarantees for personal loans. These deposit accounts offer interest rates in the range of 2 to 2.2percent and are used by salaried employees.

The experience of the Cajas Municipales has shown that savings and credit clients remain distinct. Inparticular, microenterprise clients have not usually deposited savings into the Cajas system but ratheruse banks that provide checking facilities. This suggests that CMACs are not providing adequatedeposit facilities for microentrepreneurs.

Other services offered include bill payment services and foreign currency operations. Current clientsand others are able to pay for utilities, school bills, municipal taxes and other charges through theCMACs. Though expensive, this service is an important element of the Cajas Municipales’ image of


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being a functioning part of the formal financial system. In addition, both savings and credit is offeredin US dollars as well as Peruvian soles. The Peruvian economy, like other economies which haveexperienced periods of hyper-inflation, is highly dollarized and hence there is a strong demand forcredit in dollars.

Role of the FEPCMACFEPCMAC (the Federation) was established in 1983 as the coordinating body for autonomous CajasMunicipales and as a public institution within the Ministry of Industry with economic, financial, andadministrative independence. To fund the Federation, individual CMACs make monthly contributionswhich are augmented by funds from the GTZ and the IDB. FEPCMAC serves as a conduit forinvestment and grant capital to the individual Cajas. In addition to its financial role, the relationshipand activities of the Federation as it relates to individual Cajas Municipales fall into three main areas:auditing, assessing operations, and training staff.

Through FEPCMAC, GTZ and IPC have contributed significant management training andinstitutional capacity building at an estimated cost of nearly US$7.5 million between 1985 and 1995.In 1993 and 1995, the IDB contributed grants of US$500,000 to the Federation for institutionaldevelopment purposes. In total, an estimated US$10 million has been invested in the development ofthe system of the Cajas Municipales.

By serving as the central representative for the individual agencies, the Federation helps to securefinancing for the CMACs. The Federation administers FOCMAC, the government fund established in1990 to channel national and international financing to the Cajas Municipales. Though FOCMAC issupervised by the SBS, the Federation plays an essential role in obtaining necessary authorizationfrom the SBS to negotiate lines of credit with lenders.

The Federation is also responsible for monitoring the financial performance of the CMAC system.This effort has been an essential component of the supervision of the Cajas network by providing SBSwith accurate financial performance information. The Federation has an internal auditing departmentheaded by a director appointed by the government. This allows for complete autonomy of thisindividual from the CMAC system. Three levels of audits are performed on the individual CajasMunicipales: (i) an annual formal audit by the SBS; (ii) an annual audit conducted by the Federationusing its own consultants; and (iii) the continual monitoring of operations by FEPCMAC’s internalauditing department.

In addition, detailed unaudited financial reports are produced by each individual Caja and by theFederation for the whole system on a monthly, quarterly and yearly basis. These reports includeincome statements, balance sheets, and portfolio indicators, and are reviewed by the boards of eachinstitution and by the board of the Federation. Monthly aging of portfolio reports are also producedfor three aggregate levels: by loan officer, by individual Caja, and by the total system. Provisioning isthen determined by analyzing the trends in these indicators.

The use of the Federation by the SBS to supervise the CMACs results in an intelligent division oflabor that has effectively monitored the financial activities of the CMAC system for most of the lastten years. This relationship is the result of many years of work and relationships, and is dependent onthe uniformity of the standards of the individual CMACs. Whether this could be replicated in othercountries, or even within the Peruvian financial sector for the CRACs or EDPYMEs is an openquestion.


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In recent years, the efficacy of the overall supervision of CMACs has been criticized as severalirregularities have appeared in individual CMACs. With the availability of external funds and thepressure to disburse them, the prudential supervision of the CMACs has been undermined. Inresponse to these issues, the privatization of the CMACs was introduced in a December 1996 law.What privatization actually means, however, remains unclear and will be defined in the coming year.

Cajas Rurales

Cajas Rurales de Ahorro y Crédito (CRAC) were created in August 1992 to fill the vacuum left bythe liquidation of the Peruvian Agricultural Bank.78 Initiated by the SBS and the PeruvianAgricultural Ministry, CRACs were designed as a network of financial institutions that in the longterm would meet the demand for financial services of small and micro rural enterprises.

Like CMACs and EDPYMEs, the minimum capital requirement for CRACs is US$256,000. The firstCRAC was authorized in the end of 1993. By the end of 1994, nine CRACs were in operation. Todate, the total has reached sixteen.79 CRACs are authorized to mobilize deposits using passbooksavings and term deposits, but are prohibited from offering current accounts. In order to offer demanddeposits services, a Caja Rural must have a capital base of US$2.8 million. Additional sources offunds for the CRACs are provided by COFIDE, the Fondo Revolvente del Sector Agrario (FRASA),and private commercial banks. With the authorization of the SBS, COFIDE can extend a line ofcredit to an individual CRAC for up to three times its net equity level.

Preliminary analyses of the CRACs have reflected several problems: (i) issues related to paid-in equityare present in many of the CRACs; (ii) ownership structure of the CRACs is not adequately dispersedamong many investors; (iii) numerous loans have been made to private companies with ties toprincipal investors; (iv) there has been progressive deterioration of portfolio quality, for whichadequate provisions have not been made; and (v) many of the CRACs have elevated operationalcosts.80

EDPYMEs

Though originally outlined by legislative decree in October 1993, EDPYMEs were created by an SBSResolution in December 1994, which detailed the norms for the regulations and the operations of thesenon-bank financial institutions. EDPYMEs were specifically designed to provide non-governmentalorganizations involved in microfinance an opportunity to become regulated financial institutions. The1991 General Law on Banks prohibits the development of parallel banking activities outside of theregulated system. This was intended to avoid unregulated deposit mobilization, but in fact the Lawblocked access to capital by NGO microfinance institutions. EDPYMEs were designed to fill themicroenterprise credit vacuum resulting from a mismatch between the services provided by traditionalbanks and the needs of microentrepreneurs.

COFIDE is considered the main promoter of the EDPYME framework. As previously mentioned,COFIDE perceived a constraint in its ability to channel available funds to the microenterprise sector

78 1992 Legislative Decree No. 25612.79 More than thirteen additional CRACs are in the process of approval by the SBS.80 IDB, 1995.


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using the existing Cajas Municipales. Moreover, the existence of a large number of NGOs providingcredit to the microenterprise sector without regulation prompted the SBS to create a mechanism tobring these NGOs into the formal financial system. It took close to two years to get the EDPYMElegislation approved. Because of a lack of wide-spread support among the Peruvian Congress, theSBS leveraged its powers under the law to ensure the EDPYME creation.

Operational Parameters and Financial StructureCurrently, there is one established EDPYME, known as CREDINPET. More than 13 applications arein process with the SBS and represent a wide range of objectives. These efforts include: a consultingfirm that provides financial packaging services to smaller businesses; a pharmaceuticals company thatwill use the EDPYME to finance their retail outlets; and several business groups of indigenouspopulations. The SBS and COFIDE expected that many more NGO microfinance institutions wouldquickly become EDPYMEs. The process has been slowed in part by a lack of support necessary forsuch institutions to provide the financial performance information required for application.

COFIDE regards the corporate structure of the EDPYME as an essential element. It regards anEDPYME as a permanent institutional actor, unlike NGOs which tend to have less staying power.Moreover, though EDPYMEs will access subsidized funding through COFIDE (from sources such asthe Inter-American Development Bank), it is hoped that the regulated nature of the framework willincrease private funding for microfinance. In addition, the low minimum capital requirements allowfor many institutions to enter the regulated sector. This will promote competition and possiblyimprove the quality and quantity of financial services provided to low-income markets.

Those involved in the process of developing regulations for the EDPYMEs attempted to ensure thatthe supervisory requirements reinforce operational efficiency while taking into account thecharacteristics that distinguish microcredit programs from traditional banking. The following are themost significant areas of regulation as currently incorporated into the EDPYME structure:

• Minimum capital requirement to establish an EDPYME is US$256,000.

• EDPYME’s are not required to risk-weight their assets. Instead, their capital adequacyrequirement is set by allowing them a leverage ratio in which total liabilities are limited to nomore than 10 times the institution’s regulatory capital.

• No single loan may exceed five percent net equity.

• Total amount of guarantees or bonds may not exceed three times net equity.

• Total value of fixed assets may not exceed fifty percent of net equity.

• The loan loss reserve requirement is equivalent to 25 percent of capital. At least 10 percent ofafter-tax profits must be transferred to this reserve annually.

• EDPYMEs are subject to a 30 percent tax on income.

• EDPYMEs are required to submit various reports to the Superintendency, including dailytreasury reports indicating liquidity levels, weekly statements of the balances carried forward,monthly financial statements, and portfolio quality reports every four months.

• The EDPYME is subject to regular annual inspections and special inspections according tocriteria determined by the Superintendency.


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• Provisioning requirements are listed in Table 17. The Superintendency considers themicrocredit of an EDPYME as consumer credit.

Table 17: EDPYME Provisioning Requirements

Classification Days Delinquent Provisioning1. Normal Loans 9 days or less 0%

2. Potential Problem Loans 9-30 3%

3. Deficient Loans 31-60 30%

4. Doubtful Loans 61-120 60%

5. Lost Loans 120 days or more 100%

Operational AuthorityThe institutional objective of the EDPYME framework is to provide persons engaged in small ormicro businesses with access to financing. The law defines small businesses as having assets less thanor equal to US$300,000 and/or annual sales less than or equal to US$750,000; microbusinesses haveassets less than or equal to US$20,000 and/or annual sales less than or equal to US$40,000. Areas ofauthorized operations include:

• Short, medium, and long-term credit

• Promissory notes, bonds, and other guarantees

• Discounted letters of credit and notes

• Allowed to receive direct financing from donated or concessional sources, multilateralinstitutions, or as rediscounted through COFIDE

• May engage in all foreign exchange operations allowed under current law

• Factoring

In the long-term, COFIDE and the SBS hope that a federation similar to the one created for the CajasMunicipales will be developed for the EDPYMEs. This coordinating entity plays a key role in theeffective supervision of microfinance by installing management and methodological capacity withinindividual institutions, and by gathering the requisite financial performance information for use by theSBS as well as potential investors. This might mitigate NGO concerns that the EDPYME frameworkwill be penalized in the capital markets because it is an unknown legal entity servicing what isconsidered a high-risk market.

While EDPYMEs were designed to channel credit to the microenterprise sector, the authorization tocapture savings was not contemplated in the Law. However, if an EDPYME increases its capital baseto US$1.4 million, it may capture public savings. In the meantime, EDPYMEs are able to accessloans from other regulated financial institutions to increase their loanable funds.


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Since the EDPYME framework does not allow for the mobilizing of public savings – and is thereforeheavily dependent on COFIDE – it is widely perceived as merely a window for COFIDE transactions.Others argue that EDPYMEs provide an intermediate institutional framework for NGO microfinanceinstitutions interested in entering the regulated sector. By allowing both NGO managers and SBSregulators time to understand the process of supervising microfinance, the effort will be strengthenedwithout risking the deposits of microentrepreneurs. With only a single EDPYME in operation, there istoo little experience to make a sound judgment about the longer term success of this institutionalframework.

Conclusion

In the context of worldwide regulated microfinance, Peru is among those countries leading the effort.By maintaining a well-defined prudential framework for the CMACs, Peru serves as a good exampleof the detailed process of regulating microfinance portfolios. Perhaps most importantly, the SBS hasrecognized the value of establishing working relationships with microfinance institutions to improvethe effectiveness of overall supervision. In this way, the SBS is able to obtain the necessaryinformation from experienced individuals who are working in the trenches to evaluate microfinanceactivities. Regulating microfinance is not just a matter of making minor adjustments to the inspectionprograms used for commercial banks. Rather, a fundamentally different approach and mechanismmust be created to recognize the weaknesses that may exist in an institution which is wholly distinctfrom the traditional financial sector.

In a matter of time, increased experience with the regulation of the CRACs and EDPYMEs will yieldmore lessons and information about how to, and how not to, supervise microfinance. Will effectivefederations emerge for these newer legal frameworks? If not, will the SBS establish the adequatecapacity in-house to supervise them? What Peru does have in its favor is historical experience toserve as a guide in the coming years. In any case, that the Peruvian financial sector has threeregulated legal frameworks for microfinance is a significant fact for what is becoming a worldwideeffort to bring low-income entrepreneurs into the mainstream.


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87

ÐÐ

KENYAÓÓ

Janney Carpenter, Kimanthi Mutua, and Henry Oloo Oketch

In 1997, the largest micro credit organization in Kenya is converting its credit operations into acommercial bank, K-Rep Bank Ltd.81 K-Rep the non-governmental organization is making this moveto gain the power to accept deposits, to use them as a source of lending capital, and to providefinancial services to a broader market, though still focusing on low-income communities. K-Rep BankLtd. will be a formally chartered financial institution in compliance with all the rules and regulationsregarding most banks. The Central Bank of Kenya (CBK) has supported this initiative in principle,and has invested time and resources to understand microcredit institutions. As a result of K-Rep’stransition process, the central bank is now considering whether some form of oversight andsupervision for non-bank microfinance institutions may be appropriate.

This chapter focuses on (i) the design of K-Rep Bank Ltd. and how it fits into the existing bankingregulation and supervision framework, and (ii) the issues and challenges facing K-Rep as it plans andexecutes this transition into a commercial bank.

Context: The Formal And Semi-Formal Financial Sectors in Kenya

The Kenyan financial system has undergone significant reform since 1990 as part of the transitionfrom a planned to a market-economy.82 In that process, the central bank has become politicallyindependent of government and the regulatory and supervisory frameworks for bank and non-bankfinancial institutions were revised to reflect international banking standards.83

The Formal SectorSeveral recent milestones in banking reform have reinforced Kenya’s commitment to a marketeconomy and the independence of the CBK from the Ministry of Finance and the Government. In1991, interest rate controls were abolished. In 1993, foreign exchange controls and regulations wererepealed. In 1994 and 1995, new rules were introduced regarding the legal forms of bankinginstitutions and the criteria for establishing them. These new rules focus on preventive and protectiveregulation, including higher standards for the financial condition of an institution, management quality,capital adequacy, and earnings prospects, as well as the convenience and needs of the geographic areato be served.

81 This case study was completed with assistance from Mengistu Alemayehu of the International Finance Corporation.

As of July 1997, K-Rep Limited was an incorporated legal entity and had applied for a banking license; K-Repexpects the bank to be operational in the second half of 1997.

82 As of June 1997, the 90-day government Treasury Bill Rate was 19.5%, inflation was 8.8% per annum, and the USdollar exchange rate was 56 Kenyan shillings.

83 Including the Basle Accords which specified minimum risk-weighted assets to capital ratios.


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The Regulators: Central Bank of Kenya and Ministry of FinanceWhile the Ministry of Finance has the legal authority to license banks, the Central Bank of Kenya istechnically responsible for recommending the approval or decline of those applications. The profile ofthe CBK has become more prominent since 1993 with the transition from a predominantlygovernment-regulated and controlled regime to a private-sector, market-driven economy. According tothe Central Bank of Kenya Act, its objectives are:

to assist in the development and maintenance of a sound monetary, credit, and banking systemin Kenya conducive to the orderly and balanced economic development of the country and theexternal stability of the currency, and to serve as banker and financial advisor togovernment.84

In addition, the Central Bank’s supervisory and regulatory responsibilities include the oversight of“commercial banks and non-bank institutions and other deposit-taking institutions to safeguardcustomers and the payments system.”

With the shift to market-based regulatory instruments, the CBK relies on open market operations toinfluence monetary conditions, such as the buying and selling of Treasury bills. Like many centralbanks, one of its tools is the requirement that banks maintain cash balances with the central bankequal to a percentage of their total assets. The “cash ratio” effectively takes those funds out ofcirculation and therefore reduces the money supply. Because these cash reserves earn no interest, thisrequirement is a direct cost for the banks.

Alternative Forms of Financial Institutions in KenyaThere are four alternatives for legal status as a financial institution in Kenya:

Commercial Bank: A commercial bank can engage in a wide range of financial services. Minimumcapital requirements for creating a bank are US$1.34 million if incorporated locally, and US$3.57million if incorporated externally. Paid-up capital and unimpaired reserves must equal 7.5 percent ofrisk-weighted assets.

Non-Bank Financial Institution (NBFIs): Until 1996, the only differences between NBFIs andcommercial banks were that non-bank financial institutions had lower minimum share capitalrequirements and liquidity ratios, a narrower range of loans and services, and less extensive reportingrequirements. Recent amendments to the 1995 Banking Act have raised the minimum capitalrequirement of NBFIs to the level of commercial banks. Liquidity ratios were also brought to thecommercial bank level. As a result, 95 percent of NBFIs have received a banking license and formallyconverted to commercial banks as of June 1997.85

Housing/Mortgage Finance Company/Building Society: Although formal financial institutions, thelending of these institutions is limited to long-term loans and advances for the financing of housing andhousing-related projects.

84 Excerpt: “Function of the Central Bank of Kenya.”85 Prior to the amendment of the 1995 Banking Act, K-Rep intended to register as an NBFI because of the lower

capital requirements and the less extensive reporting requirements.


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Savings and Credit Cooperative Society: While Savings and Credit Cooperatives (SACCOs) canmobilize savings and use such savings to make loans and advances, their services are restricted to themembership of the society. SACCOs are neither licensed nor regulated by the Central Bank of Kenya,but they are subject to restrictive regulatory oversight from the Commissioner of Cooperatives.

None of the more than 100 formal financial institutions in Kenya effectively serve micro and smallenterprises. According to a 1993 survey of this sector by K-Rep and GEMINI,86 there were over910,000 micro and small enterprises in Kenya. The existing financial services targeting this marketwere estimated to reach only about 30,000 enterprises, or 3 percent of the total microenterprisemarket. Only six of the 100 plus formal financial institutions have established credit facilitiesintended for this market segment, and those are serving less than 3,000 borrowers. From this study,K-Rep concluded that existing formal financial institutions are unlikely to reach microbusinesses on ameaningful scale because of organizational, structural, and orientation constraints that limit theirability to provide affordable banking services.

The Semi-Formal SectorThe majority of institutional credit provided to microenterprises in Kenya comes from non-governmental organizations. About 35 NGOs provide microenterprise promotion schemes that includecredit. The average portfolio size is about 1,000 borrowers. Most of these organizations have limitedgrowth potential because of their limited financial resources; many are funded by just one donororganization, and few have the systems and organizational infrastructure to support a largerorganization. Accordingly, few of these are financially viable without continuing operating supportfrom donors. Only a few NGOs include savings mobilization in their program design.

K-Rep is the largest micro credit organization in Kenya. As of June 1996, its portfolio included15,000 borrowers and totaled US$5 million in outstanding loans.

There is no current regulation or oversight specifically for microfinance institutions in Kenya.Through the process of establishing K-Rep Bank, Ltd., however, K-Rep has helped the central bankbecome more familiar with microfinance institutions and more aware of their similarities with anddifferences from conventional financial institutions.

K-Rep Bank Limited

BackgroundK-Rep is a microenterprise development organization with a mission to serve as a catalyst for low-income people to participate in economic development and enhance their quality of life through self-employment and income generating activities. Established in 1984, K-Rep began as a supportorganization for other NGOs with funding from USAID. It expanded into direct service provision andbroadened its support base among international donors, becoming a recognized leader inmicroenterprise finance in Africa and around the world.

86 GEMINI was a microenterprise study and information-sharing project funded by USAID and managed by

Development Alternatives, Inc. of Maryland. The project ended in September of 1996.


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K-Rep has four principal areas of business activity: (i) microcredit; (ii) training and capacity-buildingfor MFIs; (iii) consulting, including research and evaluation; and (iv) information dissemination.

Microcredit: K-Rep provides financing to microentrepreneurs primarily through two direct lendingprograms, popularly known as the Juhudi and Chikola Credit Schemes. As of December 1996, theprograms had made over 45,000 loans since inception, of which 15,000 were currently active. Juhudiis a group-based lending scheme modeled after Grameen Bank. It uses cross-guaranties among themember of small groups (5 persons), weekly repayment schedules, and stepped loan amounts toreplace traditional collateral and loan terms. Chikolas are existing, grassroots savings and creditorganizations of 12-18 members that use rotating savings and credit associations to deliver credit toindividual members. Repayment rates average 96 percent for both credit schemes.

Training: K-Rep provides training for its staff as well as for other NGOs in Africa. Between 1991and 1994, K-Rep trained more than 4,000 individuals in microenterprise development.

Consulting: K-Rep provides a wide range of consulting services including research and programevaluations. K-Rep has conducted assessments of other microcredit organizations on behalf ofinternational funders, in addition to conducting routine assessments of its own programs. K-Rep hasalso completed several studies of microenterprise activities in Kenya that have provided valuable base-line and comparative data to funders, including a review of Kenya’s informal financial markets, andthe legal and policy constraints facing Kenyan microentrepreneurs.

Information Dissemination: K-Rep management is active in the microenterprise field and theapplication of technology and new methods to improve cost-effectiveness and impact. Through itsextensive resource center and its publications, K-Rep is a leading educator in the field. Theorganization also regularly hosts visitors from other African microfinance institutions and activelyparticipates in regional meetings and conferences.

Over the past five years, K-Rep has increased its scale of impact and its operating efficiencies. As thedemand for credit threatened to outstrip the organization’s sources of below-market loan capital,management began looking for alternatives to expand K-Rep’s funding sources and provide financialservices to a higher proportion of Kenya’s low-income communities. This led to the conclusion tolaunch the K-Rep Bank.

Description and Rationale for K-Rep Bank, Ltd.

DescriptionK-Rep is transferring its credit operations to a newly formed, private commercial company called K-Rep Limited. Once that entity receives its banking charter, it will change its name to K-Rep Bank,Ltd. K-Rep the NGO is selling its entire financial services operations to the new bank, including thecredit portfolio, staff, and management information systems. The bank is expected to continue to usethe tested microlending methodologies of K-Rep, while expanding and refining that product line toprovide financial services to a broader range of customers. The surviving NGO will continue itstraining, consulting, and information dissemination activities, funded by consulting fee revenues anddonor agency grants. Donors have agreed to continue their support of the NGO since its research anddevelopment, training, and consulting services are valuable resources for microenterprise developmentorganizations throughout Africa.


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The bank and the NGO will function as completely separate institutions. The NGO may provideservices to the bank on a contractual basis. For example, the NGO may conduct market research, afeasibility study for a new loan products, or staff training for bank employees. However, there is norequirement for the bank to use the NGO for such services. The only link between the two will bethrough K-Rep Holdings, a holding company that effectively owns the NGO and will own 25 percentof K-Rep Bank, Ltd.87

RationaleK-Rep decided to create a bank for four primary reasons. By late 1992, K-Rep realized that donor-subsidized capital could no longer satisfy its funding requirements for growing loan volumes. K-Repwould need to find alternative ways to fund its expanding portfolio. If K-Rep established a bank,client savings could form one source of funds. A 1993 report on the amount of savings indirectlymobilized by the institution highlighted that the savings of most K-Rep clients were going tocommercial banks at low interest rates. These savings were being effectively transformed into aresource for well-off bank customers, since banks were unlikely to lend to low-incomemicroentrepreneurs. As a financial institution, K-Rep could capture some of those savings andconvert them into loans extended back to microentrepreneurs.

Second, K-Rep saw an increasingly important market need for full-scale financial services for thismarket segment, not just microlending. In other parts of the world, the provision of savingsmechanisms as well as access to credit had proven to help microenterprise clients develop personalliquidity, reducing their need for short-term borrowing during seasonal periods. As an NGO, K-Rep’sactivities were limited to the provision of credit – it could not accept deposits.

Third, the NGO recognized the need for financial services for low-income communities in general, notjust the microenterprise sector. As reflected in the study by K-Rep and GEMINI, no formal financialinstitution was targeting this market. Combined with K-Rep’s low-cost branch network, a market-driven institution with the ability to collect savings and disburse credit could develop a strong marketniche with limited competition. K-Rep believes that a micro-friendly financial institution can grow itsdeposit base more quickly if it does not limit itself to microentrepreneur savings as the sole source ofdeposits.

Fourth, the experiences of BRI in Indonesia and BancoSol in Bolivia have shown that commercialbanks with a focus on microfinancial services are not only viable, but profitable as well. Withadequate capitalization, a well-designed structure, and professional management with bankingexperience, an NGO can create a formal financial institution.

Besides offering savings and other financial services, the bank structure will permit K-Rep to providelarger amounts of credit to those borrowers that grow beyond the standard microcredit loan productsand whose credit history with the Juhudi and Chikola lending schemes is strong. After careful reviewof its strategic options, K-Rep determined that converting its financial services division into a bankwould maximize the efficiency of its operations.

87 While an NGO technically has no shareholders and cannot be owned, the management influence of the holding

company and the clear coordination between the two will make the NGO perceived as “under the control of” K-RepHoldings.


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Structure and OwnershipK-Rep Bank Ltd. will be a private commercial bank with private investors, and a board of directorsthat is separate from, but linked to, the NGO and the holding company. It will have an initialcapitalization of US$5.98 million and a conservative capital/asset ratio of about 60 percent upon itsformation. The bank will have seven private investors, including a 25 percent ownership interest byK-Rep Holdings, the parent entity of the surviving NGO. The ownership structure is summarized inTable 18.

Table 18: K-Rep Bank Ltd. Shareholders

Investor Ownership % US$ AmountK-Rep Holdings Ltd. 25.0% 1,496,000

Shorebank Corporation 18.0% 1,077,000

KWA Multipurpose 10.0% 598,000

International Finance Corporation (IFC) 16.7% 1,000,000

Netherlands Development Finance Company (FMO) 5.0% 299,000

Triodos Doen 6.8% 513,000

African Development Bank (AfDB) 16.7% 1,000,000

Totals 100% US$5,982,000

K-Rep Holdings Ltd. will be the largest shareholder of the bank. It will purchase shares with theproceeds from the sale of assets to the bank. In addition, K-Rep Holdings will receive a long-term,low-interest loan from the Ford Foundation, which it will in turn lend to the bank. The second largestshareholder will be Shorebank Corporation, a development bank based in the United States with nearly25 years of operating experience. At nearly the same level of ownership will be the AfricanDevelopment Bank and the International Finance Corporation. The IFC has been an influential andlong-term supporter of this initiative. The AfDB is seeking to support viable development strategies inAfrica, and it provides K-Rep with access to other types of regional funding.

KWA is the K-Rep employee association currently registered as a cooperative society. It will own 10percent of the bank as a way to facilitate the ownership of among employees. This arrangement servesas a reward for their performance to date, as well as a mechanism to establish a performance-basedincentive system for future bank employees. KWA has applied to CGAP at the World Bank for agrant to purchase its shares.

The Netherlands Development Finance Company (FMO) and Triodos Doen are both Dutch agenciesthat strongly support the privatization and formalization of microcredit delivery and have invested inother institutions. While all investors are expecting some dividends and a decent rate of return on theirinvestment, they are not anticipating short or medium-term liquidity for their investment.

K-Rep Bank Ltd. will be governed by a seven-person board of directors, of which the investors willappoint four seats. The IFC, AfDB, Shorebank, and FMO/Triodos will appoint one representativeeach. The fifth seat will be a local financial sector representative to be appointed by the board, andthe remaining two will be K-Rep representatives, one of which will be the bank’s managing director.


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Coordination of Mission with K-Rep, the NGOAs noted above, K-Rep Bank will be 25 percent owned – the maximum percentage permitted by law –by K-Rep Holdings, the parent holding company of K-Rep the NGO. This structure allowscompletely independent operation of the two organizations, with some coordination of strategicdirection at the highest level. In addition, this structure permits the formation of a strong bank boardof directors with the experience to manage a financial institution. The board of the bank will includetwo board seats for K-Rep Holdings to ensure a balancing voice for the mission of the organizationand the best interest of all stakeholders, including shareholders, staff and clients.

Regulation and Supervision IssuesWhen K-Rep first approached the central bank about establishing the bank, the CBK indicated that nofavorable treatment would occur for a microfinance bank. As an overall philosophy, the Central Bankof Kenya operates under the assumption that prudent bank supervision is undertaken by several agentsrepresenting the interests of shareholders, management, and the public at large. The primary agentsfor that oversight are the internal audit and control systems within an organization, a strong board ofdirectors, external auditors, and the supervision of the central bank. While the previous sectiondescribes the board of directors and the management of the institution, this section describes theregulatory and supervisory framework used by the central bank and discusses the major issues andchallenges faced by both K-Rep and the CBK.

The Central Bank’s Regulatory ApproachThe CBK has the authority for both prudential regulation to limit the risks undertaken by banks intheir quest for profits and growth, and protective regulation, which gives it the power to providedeposit insurance, grant and revoke banking licenses, and the ability to assume control of amismanaged financial institution.

Regulation begins in the licensing stage and continues through ongoing supervision and monitoring,including:

• Restricting entry into banking through strict licensing procedures and minimum standards;

• Capital adequacy requirements for both minimum amount as a financial cushion and on risk-adjusted gearing ratios that assess capital relative to risks undertaken;

• Limits on ownership by any one party (no one institution can own more than 25 percent);

• Liquidity and cash reserves requirements;

• Restrictions on permitted business activities and limitations on certain risks (e.g., credit andforeign exchange risks); and

• Thorough information disclosure through periodic reporting to the CBK.

The Banking Act now requires the CBK to assess the quality of management, the board of directors,the adequacy of the capital structure, earnings prospects, and the needs of the geographic marketbefore issuing new banking licenses. Ongoing supervision includes a combination of both off-sitefinancial reporting and on-site examination and verification.


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On-Going SupervisionFor off-site monitoring and surveillance of the institution’s financial condition, the Central Bank ofKenya requires frequent reports to assess the health of financial institution and its ability to honor itsobligations to depositors. The off-site monitoring reports required by the Central Bank include:

1. Liquidity Ratio, reported every 10 days; the minimum liquidity ratio is 23 percent.88

2. A monthly Income Statement and Balance Sheet, due 15 days after the end of each month.

3. Quarterly Capital/Asset ratio reports, which show core and supplementary capital as apercentage of total risk-weighted assets. The minimum is 7.5 percent for total capital, or 4percent for core capital.

4. Quarterly audited financial statements need to be provided within three months of the end ofeach period. The central bank provides guidelines on the presentation of accounts for banksand requires submission of the following reports with the audited accounts:

• Risk classification for advances and discounts• Advances performance report• Credit and/or commitments to any person or group that exceed more than 100 percent of

capital• Any advances or facilities to shareholders, directors, or their associates• Twenty largest credit exposures

In addition the CBK performs periodic on-site examinations that focus on a qualitative assessmentsimilar to the CAMEL scoring used by international banking regulators:

Capital Adequacy: This measures the extent to which an institution’s capital base can absorbunexpected losses and the risks inherent in its business activities. It is measured by three parameters:(i) an absolute minimum amount for new institutions (US$1.34 million for locally incorporatedcommercial banks);89 (ii) banks and financial institutions are expected to maintain a gearing ratio of7.5 percent between their capital base and their deposit liabilities; and (iii) capital cannot fall below 8percent of risk-adjusted assets.

Asset Quality: Examiners classify bank loans into Satisfactory, Watch, Sub-standard, Doubtful, andLoss categories, with higher risk categories assigned minimum reserve levels to anticipate loan lossesproperly.

Management: For the purposes of bank supervision, management comprises the senior executivesand the board of directors. The objective is to assess the effectiveness of management, managementdepth, and the board’s ability to set policy and then ensure that those policies are being followed.

88 Defined as the ratio between total holdings in cash, placements with other financial institutions, and Treasury Bills

maturing in 90 days or less (minus deposits held from other financial institutions) divided by customer deposits(liabilities).

89 Based on an exchange rate of 56 Kenyan Shillings to the US dollar. The levels are Ksh 75 million and Ksh 200million respectively for locally-incorporated commercial banks and foreign-incorporated banks. Levels for non-bankfinancial institutions used to be half those amounts, but were raised to commercial bank levels in 1997.


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Earnings strength: The quality and reliability of earnings are crucial to an organization’s ability toabsorb loan losses without eroding capital, and to finance capital growth to support growth in assets.

Liquidity. A minimum level of liquidity is needed to ensure that the institution can honor maturingobligations and withdrawals, and to ensure that sufficient funds are available to make new loans.

The intent of both the central bank and the investors in K-Rep Bank was to ensure that the new bankcomplies with all the terms and conditions for formal commercial banks. As the CBK has becomemore familiar with the microfinance field and the experiences of other institutions, however, certainaspects of the existing regulation and supervision framework need to be adapted to reflect the businessrisks and mitigating factors associated with K-Rep’s group loan methodology and the uniquecharacteristics of its target market. As a result of this education process, the CBK is apparently nowconsidering whether some form of regulation and supervision for non-bank MFIs may be appropriate.

Transition Issues and ChallengesK-Rep involved the Central Bank of Kenya at a very early stage in the process, even before it begandeveloping a business plan for K-Rep Bank Ltd. The NGO also assembled a six-person advisoryteam to advise K-Rep on the business plan for the new bank. This group included the former head ofsupervision at the central bank, two experienced bankers, and a former senior executive of Deloitte &Touche, a major accounting firm. This advisory team allowed K-Rep to become familiar with theregulatory environment and the potential concerns of the central bank. The following issues have beenthe most significant to K-Rep, the central bank, and investors:

1. Ownership challenges for an NGO: The legal form of an NGO and its relationship to a corporateentity posed specific challenges in creating a bank. The primary obstacle was the central bank’sreluctance to accept an NGO as a legitimate owner because (i) NGOs themselves have no ownersor accountability to investors, and (ii) there would be no legal entity with a direct financial stake,and therefore no one responsible in the case of a crisis. This argument reasons that an NGO doesnot have outside stakeholders or investors who will impose the discipline to hold managementaccountable for financial performance. K-Rep had to convince the central bank that the NGOparent of the bank could be a responsible shareholder. In addition, because Kenyan law requiresthat no single investor can own more than 25 percent of a bank, K-Rep had to assemble a group ofinvestors that would respect the unique mission and long-term goals of the microfinanceinstitution. The central bank eventually agreed to allow K-Rep Holdings (an NGO) become ashareholder of the bank as long as it did not hold more than 25 percent of the shares.

To address the anticipated concerns of the Central Bank of Kenya and the board of the future K-Rep Bank, the NGO and the advisory team considered the following issues as they formed theshareholder group:

(a) Value-added: K-Rep was very careful to identify investors who could add value to theorganization. K-Rep secured political cover and global credibility from the IFC, an affiliateof the World Bank Group that works in 160 countries. It secured access to development bankmanagement experience and international banking expertise from Shorebank Corporation.FMO and Triodos Doen brought to the table committed, long-term funds as well asconsiderable experience in governing commercial banks. The AfDB provides access to


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funding sources in Africa and potential linkages to other countries in the region. It alsobrought extensive expertise in organizing and governing financial institutions in Africa.

(b) Patient: It was necessary to find investors that were large enough to take a long-term view ofthe investment and not demand short-term liquidity. Institutional investors can usually bearthe risk of this type of investment and not require short-term liquidity because they have astrategic interest in the region or project and want to leverage other development investments.The Shareholders Agreement restricts investors from selling their stock within the first fouryears. At which point, K-Rep Bank intends to become publicly traded, which will promotemore widely held ownership and better liquidity for large and small investors. K-RepHoldings and other mission-driven investors would most likely retain voting control.

(c) Deep pockets: K-Rep also made sure that it identified investors with deep pockets or theability to invest in a second round, if necessary. While not a stated goal, K-Rep knew that thecentral bank would gain some comfort from investors with the financial resources to helpavert or solve a financial crisis.

2. Management and Governance: The Superintendency was concerned that the board of directorsand management team of the proposed bank have the experience to run a regulated bank. Thecomposition of the board addresses this concern through the inclusion of a local financialexecutive, a representative of a commercial bank holding company (Shorebank), andrepresentatives from other shareholders with financial operations. The board will meet monthly toremain well informed of the bank’s activities, particularly during the first year of operations.Regarding management, the Superintendency recommended that K-Rep Bank hire experiencedbankers for key management positions, particularly treasury management and generalmanagement functions related to interfacing with the central bank. K-Rep plans to hire at leasttwo experienced bankers in those positions.

3. Relationship Between the Continuing NGO and the Bank: Drawing on the experiences of othermicrofinance institutions that have made a transition into a commercial bank, K-Rep decided tolocate all financial services under one organization, and to operate the bank and the NGO ascompletely independent organizations. This will ensure the greatest efficiency in operations,transparency in financial reporting, and clear accountability for performance to each set ofmanagers. All transactions between the two will be on an “arm’s length” basis with writtencontractual agreements.

4. Balancing Mission and Financial Performance Goals: One of the greatest challenges inmanaging a self-sufficient development institution is to maintain a balance between thedevelopment impact goals and the financial performance goals. Financial performance isimportant for long-term viability and organizational permanence, but can easily overshadow theless quantifiable development results the organization achieves. To address this challenge, K-Repwill have two independent entities with the same overall mission, which work with differentstrategies and tools. The financial tools will be housed in the bank, with the appropriateperformance measures, standards, staffing, and governance. The NGO will house thedevelopment tools, with a different set of performance measures, staff skills, and governance. Asthe parent company, K-Rep Holdings will be responsible for coordinating the missions andstrategies of the two institutions, with accountability to all stakeholders. It will accomplish thisthrough board participation in both organizations, and an ownership interest in the bank. The K-


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Rep Holdings Board will serve as the board of the NGO, and it will have two of the seven seats onthe board of the K-Rep Bank.

5. Adapting Central Bank standards to fit a MFI mission: The central bank and K-Rep have had tonegotiate mutually agreeable solutions to several routine bank regulatory and supervisory issuesthat affect an MFI in different ways than they would affect a standard bank. For example, as inmany countries, the central bank must approve all new bank branches for commercial banks basedon economic viability and community need. The Central Bank of Kenya is cautious aboutlocating branches in the low-income and potentially dangerous neighborhoods, which is where K-Rep’s target market lives and works. Another issue is the value of collateral underlying grouploans in relation to risk-weighted assets. The current practice by the central bank would discountsuch assets since group guarantees are not considered tangible collateral.

Conclusions and Lessons

The experience of K-Rep through this transition process suggests that several factors will be importantto the success of the new K-Rep Bank Ltd. and its affiliated NGO:

Management, Management, Management: K-Rep has attracted and cultivated an experiencedmanagement team that has assembled the core components of a strong organization. The currentleadership has recruited a capable group of directors that complement management, and hasimplemented internal policies, procedures, and controls that will make compliance with bank financialand performance reporting requirements less onerous. According to one investor, the managementteam is smart, willing to learn, and very flexible. Their ability to identify and clearly articulate issueshas allowed them to use outside expertise effectively and enabled others to help them find specializedassistance when needed. In addition, their ability to communicate with and mobilize staff support willbe an important part of managing the organization’s “culture” during the transition from an NGO to afor-profit bank.

The professionalism of K-Rep staff in managing the regulatory process: Management and staffresearched the regulatory and business issues thoroughly before approaching investors. K-Repassembled a dedicated and capable advisory group to advise on the business plan for the new bank.K-Rep understood what knowledge and expertise they did not have in-house and invested time andeffort in a very thorough business planning process.

An upfront investment to educate key decision-makers about microfinance: K-Rep educated thebanking superintendent about MFIs to counter wariness of microcredit and its roots in the NGOcommunity. From the beginning, the central bank was very clear that K-Rep Bank Ltd. would need tocomply with everything in the banking laws, so it was important for the central bank to becomefamiliar with successful examples of MFIs that were banks. K-Rep arranged a trip to Bolivia for K-Rep management and the senior CBK official to meet with Bolivian bank regulators and to seeBancoSol. This visit helped the bank superintendent understand how microcredit is similar totraditional banking, the risks that are unique to microcredit, and the practical approaches to mitigatethose risks. As the central bankers learned more about microfinance, they developed a better pictureof how a micro bank could fit within the existing bank regulatory structure.

Assembling a credible pool of investors with a commitment to establishing a solid base for theinstitution’s growth: Each investor has a long-term commitment to the organization and to themicrofinance mission, and brings a particular area of expertise that complements the skills of K-Rep’s


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management. The cooperation between its investors so far has helped K-Rep design an appropriatelegal structure and ownership arrangement to achieve the organization’s long-term objectives.

In conclusion, the transition to a formal financial institution appears to have many benefits for K-Repand few costs. The organization will benefit from introducing a new set of stakeholders into thegovernance and oversight structure – investor owners – since they will bring a new focus on thebottom line and cost-effectiveness. The holding company relationship between the surviving NGO andthe new bank will create two separate, well-managed institutions each focused on its own activitiesand with its own performance measures and accountability, yet with some coordination through thelinked boards of directors. Compliance with outside regulators appears to impose minimal ongoingcost to K-Rep Bank for two reasons: first, the supervision requirements appear to be well planned; andsecond, K-Rep already has the MIS and loan management systems in place to meet the central bank’sreporting requirements. The K-Rep model will need to stand the test of time, but it appears to be welldesigned and on the right track for reaping the benefits of formal financial institution status.


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ÐÐ

WEST AFRICA

ÓÓ

Anne-Marie Chidzero and Gilles Galludec

In June 1992, the Central Bank of West African States (BCEAO)90 launched a support program forthe regulation of savings and credit mutuals called PARMEC,91 with the financial assistance of theCanadian International Development Agency (CIDA) and technical support of Société deDéveloppment International Desjardin (SDID), a Canadian credit union organization from Quebec.The objective of PARMEC was to define an appropriate legal and regulatory framework formicrofinance institutions in the Economic and Monetary Union of West Africa (UEMOA).92 Thetechnical assistance project lasted four years and resulted in the “PARMEC Law” presented andadopted by the Council of Ministers of the UEMOA in December 17, 1993.

This chapter describes how the law came into existence, and gives details of its main features. It alsoexplains the development impact of the Law and highlights some key issues, including the adequacy ofthe law for credit unions, the regulation of non-credit union MFIs, and the implications for the Law onUsury.

History of the Law

The initial objective of PARMEC was to provide the seven UEMOA member-countries with a legaland regulatory framework for non-bank savings and/or credit mutuals to protect the vast number oflow-income people that were placing their savings in informal non-regulated institutions. Theseunregulated institutions reach over 3 million low-income people in the region. BCEAO was concernedthat these institutions were mobilizing vast amounts of savings from low-income persons withoutprotection for savers in the event of insolvency. As an illustration on their scale, one of the largercredit unions in Benin, FECECAM, had savings deposits amounting to US$26 million as at December31, 1996, with over 200,000 members.

Besides protecting small depositors, BCEAO had a second and equally important objective. It wasconcerned that these informal institutions, ranging from tontines (ROSCAs) to more structuredinstitutions such as credit unions, were capturing vast sums of money that were not accounted for inthe coffers of the central bank. A survey of tontines in Senegal in 1992 estimated that the volume of

90 Banque Central des Etats de l’Afrique de L’Ouest. Member countries include Benin, Burkina Faso, Ivory Coast,

Mali, Niger, Senegal, and Togo. Guinea Bissau is in the process of joining.91 Prôjet d’Appui à la Réglementation des Mutuelles d’Epargne et de Credit.92 Union Economique et Monetaire d’Ouest Afrique; the Economic and Monetary Union includes all members noted in

footnote 90.


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funds channeled through tontines nationally amounted to US$125 million.93 Usually these funds arekept in cash and do not enter the formal financial system.

To achieve these two objectives, BCEAO decided to create a law for savings and credit mutualsbecause this was the dominant institutional structure among microfinance intermediaries in the regionbased on the number of institutions and members. It is estimated that 60 percent of the informalfinancial institutions in the UEMOA are savings and credit cooperatives or mutuals. The eight majormutualist institutions in the UEMOA have over 620,000 members and US$64 million in savings.These mutualist institutions exist at various levels including local savings and credit cooperatives(SCCs), unions of SCCs, federations, and confederations. Most of these institutions startedoperations in the early 1980s. They are reaching the low-income market mainly in rural areas withaverage savings balances of less than US$150 and average loan sizes of US$100-500. The creditunion model has proliferated in West Africa for two primary reasons:

• Some institutions were developed from the grassroots tontine models that are widespread inWest Africa, and which exhibit many of the principles of membership that exist in a creditunion. Therefore, there was a cultural proclivity toward the mutual model. An example isCMGT94 in Benin where the grassroots groups formed associations to expand theiroperations.

• Other credit unions were started and financed with donor funds from France, Canada, andSwitzerland. The credit union movements in these countries are very strong and assisted indeveloping similar models in West Africa.95

Though originally designed for mutual institutions, as a result of consultations with microfinanceinstitutions and donors, the coverage of the Law was modified to encompass other types ofinstitutional structures that were emerging during the early 1990s. These included village bankingmodels (or caisse villageoise as they are commonly known in West Africa), and the solidarity groupand individual lending models. These modifications, however, do not adequately address the legal andregulatory requirements of non-mutual institutions.

Status of Implementation of the Law

Once the UEMOA Council of Ministers adopts a law, the signatory countries must ratify it byapproval of the national assemblies. The PARMEC Law was adopted in December 1993, and as ofMay 1997, it has been ratified by all countries except Benin. The decrees of application that definethe implementation modalities of the Law have also been approved by those countries that haveratified the Law.

The Law designates each country’s Ministry of Finance as the supervisory agent and charges themwith creating special units for this purpose called CAS/SMEC.96 The follow-up to PARMEC is a 93 World Bank. 1993. “Senegal: Le Secteur financier informel et ses implications pour le développement du secteur

financier.” Report 11749-SE. Industry and Energy Division, Western Africa Department, World Bank, Washington,D.C.

94 CMGT: Credit Mutuel Gibirila Taoffic.95 Some examples are Société De Développement Desjardins (SDID) from Quebec, Centre International de Credit

Mutuel (CICM) in France.


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US$3.75 million, CIDA-funded project designed to provide assistance to the CAS/SMEC toimplement the law, and to harmonize practices of credit and savings unions.97 The project will rununtil June 2000 and will provide: equipment; technical assistance in developing procedures, manuals,systems; staff training; and workshops on the law. A series of training courses has already beenorganized through BCEAO offices in the seven countries. In addition, a number of round tablemeetings and seminars involving donors, practitioners and the monetary authorities have beenorganized to discuss certain aspects of the law, such as it subjecting institutions to the Usury Law andon the fate of non-mutuals. The International Labor Office has assisted BCEAO on a database ofmicrofinance institutions in the region.98 The World Bank is exploring assistance to CAS/SMEC inMali, particularly to look at the regulation of non-mutual institutions.

Features of the Law and the Decrees of Application

The PARMEC Law covers five areas: (i) scope; (ii) the smallest unit of a mutualist structure; (iii)apex and federations; and (iv) supervision.

Scope (Articles 1-15): The Law classifies all microfinance institutions into the following threecategories and states how the articles of the law apply to each category:

• Category 1 – Mutualist institutions: The articles of the law apply to these institutions thatmust seek recognition and approval from the Ministry of Finance to operate. The Law statesthat mutualist institutions should fully adhere to the mutualist principles and structure asoutlined in Article 11, including: (i) membership must be voluntary and not limited; (ii) thegovernance structure must be democratic and based on one vote per member; (iii) votes byproxy are not authorized except under exceptional circumstances; (iv) dividends on shares arelimited; (v) the creation of a general reserve is obligatory and cannot be shared amongmembers; and (vi) priority should be given to actions aimed at the economic and socialeducation of members.

• Category 2 – Savings and credit associations: Institutions designated as cooperatives ormutuals, but do not fully adhere to the principles outlined in Article 11, are not governed bythe Law, and have no legal status. These institutions must legalize their operations by seekingrecognition from the Ministry of Finance under the conditions set forth by the Decrees ofApplication. However, the Decrees of Application do not mention these conditions. Theseinstitutions can also opt to fall under the articles of the Law by converting into a mutualistinstitution. The law stipulates sanctions for those institutions that do not abide by theseinstructions, including penalty fees and imprisonment.

96 Cellule d’Appui et de Suivi des Structures Mutualistes ou Coopératives d’Epargne et de Crédit, or support and

monitoring unit for savings and credit mutual and cooperative structures.97 This project is known as Prôjet d’Appui à l’Application de la Réglementation sur les Mutualistes d’Epargne et de

Crédit dans les pays de l’UEMOA, or the support project for the application of PARMEC.98 This project is called PASMEC, Prôjet d’Appui aux Structure Mutualiste d’Epargne et de Credit, or support

program for savings and credit mutuals.


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• Category 3 – Other institutions: All other institutions that conduct savings and/or creditactivities must either register under the Banking Law or obtain approval to operate through aspecial convention – “Convention Cadre” – from the Ministry of Finance, which is discussedin more detail below.

The Law establishes a distinction between “pure” mutual systems and other types of structures. Itdefines the principles and structures of the mutualist institutions that must be adopted by anyinstitution seeking recognition and approval from the Ministry of Finance. Institutions that are notstructured along these lines are given the choice either to modify their operating bylaws and beregulated as a credit union or to operate without any legal protection by obtaining a license from theMinistry of Finance. Falling under the banking law is not a real option since most institutions do nothave the minimum capital requirement of US$2.0 million in Benin, Burkina-Faso, Mali, Niger, andTogo; and US$6.0 million in the Ivory Coast and Senegal.

Smallest unit of a mutualist structure (Articles 15-37): The Law prescribes the organizational set-up for the smallest unit of a mutualist organization, as well as its operational functions, credit policies,and modalities for fusion and liquidation. Limits are also placed on the type of financial instrumentsthese units can use by prohibiting the use of cheques or transfers except within a credit union network.It articulates the provisions for exempting institutions and its members from taxes on savings and loantransactions. It states that mutualist institutions are exempted from all forms of taxes linked with theirsavings and credit activities. Members of these institutions also benefit from tax exemptions onincome earned from shares and savings. This exemption does not apply for non-mutualist institutions.

Apex and federations (Articles 38-56): The Law defines the modalities for the integration of thesmallest unit into a union, the union into a federation, and the federation into a confederation. Foreach level it defines the recognition and approval procedures, as well as their operational roles withinthe network. It also states that a network can create a financial organization that would be registeredunder the banking law and whose function is to “centralize and manage” the surplus funds of thenetwork.

Supervision (Articles 57-72): The Law provides for three levels of control:

• Internal audit/inspections (not to be confused with internal controls) to be conducted annuallyby the union, federation, and confederation according to central bank standards.

• Institutions must submit an annual external audit to the Minister of Finance for unions,federations and confederations, and the smallest unit that is not within a network.Confederations, federations and financial organizations must also submit reports to the centralbank.

• The Minister of Finance can at any time conduct an audit of any financial institution,including the central bank. The Minister of Finance can take control of any institution at therequest of one of the units within the network or when it is being financial mismanaged andthe interests of the members are at risk.


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The Decrees of Application: The application decrees provide details and specificity to the applicationof the Law, but they only apply to mutualist institutions in Category 1 described above. The decreescover the following:

• Provisions relating to the organizational structure of credit unions. The decrees defineconstitution procedures, capitalization, and contents of the institutions' statutes. They definethe organizational structure and require the existence of four bodies: a general assembly, aboard of directors, a credit committee, and a control body. Prototype statutes and internalrules for the smallest unit, the union, and federation are also provided in the decrees.

• Provisions related to approval, recognition, affiliation with the apex institution. Thesedecrees define the type of information to be submitted, procedures for approval andcancellation of licenses, as well as the procedures for recognition status for the smallest unit.

• Rules permitting savings mobilization. The application decrees allow these institutions tomobilize deposits by giving them exemptions on minimum capital requirements (presumablyfrom the Banking Law, although this is not stated).

Prudential Ratios: The Law and accompanying decrees present the following prudential ratios:

• Risk exposure associated with equity investments limits these investments to 5 percent of theinstitution’s loan portfolio. Exemptions for ratios above 5 percent can be sought through theMinister of Finance.

• Maximum risk exposure limits the outstanding credit portfolio to twice the amount ofmembers’ savings excluding resources available from donors.

• Allocations to general reserves where institutions must allocate 15 percent of net surplus atthe end of each fiscal year to a general reserve fund.

• Loans to directors must not exceed 20 percent of the value of members’ deposits.

• Loans to one member cannot exceed 10 percent of the value of members’ deposits.

• Liquidity where short-term assets must equal 80 percent of short-term liabilities at all times.

The Law on Usury: The Law subjects all three categories of institutions to the Law on Usury. TheLaw on Usury places a ceiling on interest rates of twice the discount rate. The discount rate currentlystands at 7 percent thus limiting interest that institutions can charge on loans to a per annum rate of 14percent. However, the monetary authorities are aware of the potential devastating impact this ceilingwill have on the financial viability of microfinance institutions. As a result of a commitment made bythe Governor of BCEAO during the “West Africa High Level Policy Forum on Microfinance” held inBamako, Mali in 1996, monetary authorities intend to change the definition of usury for microfinanceinstitutions.

The Convention Cadre: As mentioned above, non-mutualist institutions can register their operationsby obtaining a license from the Ministry of Finance. A “Convention Cadre” provides the prototypeagreement for this purpose. It was adopted by the UEMOA Council of Ministers on July 4, 1996,and is now ready to be adopted by each country.

The Convention Cadre clarifies the conditions under which a non-mutualist can operate. The text andits 18 articles are largely open to interpretation or negotiation between a given institution and the


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Minister. The Convention Cadre does not give any clear legal status to non-mutuals, nor particularadvantages or rights. It does not provide any protection to savers, and neither does it elaborate onprudential ratios. Institutions are however obliged to send an annual report to the Ministry of Financeand Central Bank and are subjected to the Law on Usury.

Developmental Impact

The PARMEC Law represents a bold step by BCEAO to regulate institutions mobilizing large sumsof savings from low-income clients. It is worth mentioning some of the developmental impact the Lawhas had on the microfinance industry in West Africa.

Capacity building and internal control: Since 1994, BCEAO has been running a training programfor savings and credit cooperatives and for staff from the Ministries of Finance of the UEMOA. Thepurpose of the training is to educate key individuals on the implementation of the law. This hasresulted in the promotion of improved financial management tools among microfinance institutions,including internal controls, bookkeeping, the preparation of financial statements.

Homogeneity within the industry: By imposing a common chart of accounts the Law effectivelystandardizes financial statements and reports. This will bring much needed homogeneity on financialreporting within the industry. If this objective is reached, it will bring greater transparency andprovide better information on the activities and performance of microfinance institutions in theUEMOA. However, it is unclear why BCEAO opted for a new chart of accounts instead of adaptingexisting charts, thus achieving more efficiency and harmony with the financial sector.

Networking and associations: The consultative process applied by BCEAO in the drafting of theLaw has accelerated the creation of networks of MFIs or Consultative Forums. This phenomenon iswelcome as it provides a platform for MFIs to enter into a dialogue with the regulatory bodies. Thisplatform has been used to explain the contents of the Law and its application procedures, and hasallowed practitioners to voice their opinion on the inadequate coverage of non-mutuals.

Issues

While the PARMEC Law makes important headway toward regulating informal finance in WestAfrica, it raises some issues regarding the treatment of non-mutuals, the capacity of authorities toimplement the Law, as well as some regulatory aspects that may effect the performance of creditunions.

Scope: The Law is adequate in its treatment of mutualist institutions with some areas of concernnoted below. The primary weakness of the law lies in its coverage of non-mutual institutions. First,the law is too vague on the treatment of non-mutuals in Category 2. The Law states that institutionsproviding credit and savings services that are not pure credit and savings unions, as defined by thelaw, must seek recognition. However, these institutions are not given any legal status (personalitémoral), and are not legally covered by the law. They must comply nevertheless with the procedures ofrecognition as defined by the decrees of application. It appears this would mean they would have tocomply to the requirements of the Law. Unfortunately, the articles in the decrees of applicationconcerning recognition procedures do not make any reference to Category 2 institutions. This has ledto a considerable amount of confusion on the legal status of these institutions.


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Second, as stated above, the treatment of non-mutuals in Category 3 that opt for the Convention Cadreinadequately addresses their legal and regulatory requirements. The application of the Law to thiscategory of institutions will need to be monitored to identify a regulatory framework that wouldadequately regulate their activities.

Degree of specificity on mutualist principles: The Law is rather rigid in its application of mutualistprinciples at the risk of stifling innovation and restricting the ability of institutions to adapt proceduresand products to market conditions. The experience in West Africa shows that mutualist institutionsare changing and adapting these principles, for example opening services to non-members and seekingother financial investors besides members.

Prudential ratios: To a certain extent the prudential ratios correspond to those applied by bankingregulators. However, the prudential ratio on credit risk exposure is a concern because it is a functionof savings. This ratio could limit an institution’s ability to develop its loan portfolio if it savings baseis small. This is a particular issue for mutuals that use external resources to finance their operations.Examples of external resources include lines of credit from commercial banks and non-membersavings, as is the case for some larger mutuals like FECECAM. The limit set on individual loanscould also constrain the ability of the institution to serve its clients adequately. These ratios may bemore effective if equity rather than savings is used. The other ratios regarding the 15 percent annualreserve, investments, and liquidity are appropriate.

Supervision: The PARMEC Law advocates for direct supervision of MFIs by the Ministry ofFinance. This is an enormous task for the Ministry given the shear numbers of institutions that needto comply to the Law, and the number of required reports. In addition to financial statements, the Lawrequires institutions to provide notices of meetings, minutes of sessions of the organizational bodies,lists of members, lists of loans to directors, and copies of insurance policies. The Ministries ofFinance do not have the capacity to handle this volume of work. A further analysis is required todetermine if some of these supervision functions, particularly of the smallest units can be delegated tothe Federation or Union, so the Ministry of Finance would only need to supervise the top level of thenetwork. Even then, the volumes of data are excessive and could be streamlined. For the MFI, thereports required by the Ministry of Finance are extremely detailed and will prove burdensome andcostly for smaller institutions, particularly the smallest unit of the credit union structure.

Usury law: The Law on Usury could severely limit the ability of MFIs to recover their costs and movetowards financial sustainability. Though it is important to encourage management of MFIs to holdbudgets within reasonable limits, the high operating costs of providing financial services to smallcustomers in rural areas require flexibility on product pricing. The monetary authorities have beenvery sensitive to this issue and are in the process of modifying the definition of the usury rate.

In conclusion, PARMEC has been an enormous effort to design a comprehensive regulatoryframework to protect low-income savers in West Africa. BCEAO has taken an important step tointegrate informal financial intermediaries reaching vast numbers of low-income people and mobilizingsignificant sums of savings into the formal financial system. The process of defining andimplementing the Law has raised awareness among MFIs and the monetary authorities on the financialnature of the operations of these institutions, as well as the diversity and wealth of experience ofmicrofinance in West Africa.

The Law is well suited for savings and credit cooperatives or mutuals. The capacity of thesupervisory authorities to implement the Law will be an important element to address as professional


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expertise, efficient operational systems and streamlined supervisory procedures are developed.Monitoring of the Law’s implementation will also be important to address some of the concerns raisedabove. Careful attention will need to be paid to the treatment of non-mutuals with a view of using theConvention Cadre mechanism as a temporary step towards the development of a more comprehensivelegislative and regulatory system for these types of structures.


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ÐÐ

SOUTH AFRICA

ÓÓ

Rudolph Wilhemse and Steven Goldblatt

The change to a democratically elected government in South Africa in 1994 has resulted in, amongother things, a complete review of the country’s banking policy. Laws in South Africa have beenhistorically instruments of state coercion, designed to promote the racist policies of the illegitimategovernment. Today, the new Constitutional laws are designed to allow individuals and communitiesthe freedom to improve their lives. One of the key obstacles to creating new banking policies in SouthAfrica is to change the mindset of civil servants and the general public so that they view laws asenabling rather than coercive.

The major challenge for South Africa’s financial sector is to meet the needs of the previouslyunbanked population profitably. It is a struggle to match the financial services demands of low-income communities with the risks and costs of providing these services.

Microentrepreneurs and Access to Finance

It is estimated that forty-five percent of the economically active population in South Africa is eitherunemployed or works outside the formal sector. The vast majority of these people are Africans. Thisfigure is likely to increase because less than ten percent of the new entrants to the labor force is able tofind formal sector employment. Many who are unable to find formal sector employment resort to self-employment in the informal sector. Informal sector businesses, particularly those that are able togrow and create jobs, have the potential to play a critical role in the economy of the new South Africa.One of the main constraints inhibiting the growth potential of microenterprises is their access tofinance.

There is a chasm between the financing needs of microentrepreneurs and the requirements ofcommercial banks. South African banking has evolved to offer some of the most sophisticatedfinancial services in the world, but very few financial institutions are designed to meet the diverseneeds of the informal sector. South African banks have never regarded small, African-ownedenterprises as an attractive market. Banks view loans to microentrepreneurs as extremely risky whenthere is no collateral, credit history, business plan, or business records. Because of the Usury Act andthe high transaction costs of administering small loans, banks do not feel it is cost-effective to lend tothis market. In South Africa’s polarized racial atmosphere, as a pillar of the minority establishment,banks have shunned the predominantly African informal sector. South Africa’s banking infrastructureis also segregated geographically so that many township residents do not have convenient access tofinancial services.

The lack of affection between banks and microentrepreneurs is reciprocal. Small-scale businessowners are disinclined to borrow from banks because of the arduous application process and aminimum loan size that usually exceeds the borrowers’ needs and capacity to repay.


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Microentrepreneurs generally want small loans for working capital without long loan applications thatdemand a certain level of education and extensive collateral. In South Africa, where formal andinformal demarcation falls primarily along racial lines, real or imagined discrimination further restrictsaccess to bank loans. Low-income Africans often consider financial institutions unapproachable andidentify banks with the discriminatory machinery of the apartheid establishment.

Financial liquidity for low-income households is at least as important as access to credit. Responsiblesaving activity is evidence of creditworthiness and serves as a useful collateral substitute. Savingsservices allow households to engage in consumption smoothing to manage uneven flows of income andexpenditures. The key to serving people at the lower ends of the socioeconomic ladder effectively isaccess to both lending and savings services through efficient financial intermediaries.

A challenge for the new South Africa is to encourage the private sector to provide financial services todisadvantaged communities. This “democratizing” of financial services would help integrate thepreviously disenfranchised population into the formal economy and fulfill important political andeconomic objectives. Reforming the financial regulatory regime is a critical step towards expandingaccess to financial services in African communities. This chapter reviews the current banking lawsand the proposed reforms that are being discussed to extend financial access in South Africa.

Financial System Institutions

South African Reserve Bank: The Reserve Bank is the central bank of South Africa, entrusted withthe responsibility of protecting the internal and external values of the currency in the interests ofbalanced and sustainable economic growth. To achieve these goals, the Reserve Bank influences thetotal monetary demand in the economy by controlling the South African monetary supply and theavailability of credit. It is important to note the independence of the South African Reserve Bank. Itsability to make practical and policy decisions independently of the government is guaranteed by theconstitution. The Reserve Bank is responsible for holding a minimum reserve balance for all banksand for supervising banking institutions.

The Registrar of Banks, an official of the Reserve Bank, heads the Department of BankingSupervision in the Reserve Bank and reports to the Minister of Finance. Extensive powers ofsupervision and inspection vest in the Registrar who may call upon the auditors of a bank to furnishnotices and other information. Moreover, auditors must inform the Registrar of any matter relating tothe affairs of a bank which, in their opinion, may endanger the bank’s ability to continue operating,may impair the protection of the funds of the bank’s deposits, may be contrary to the principles ofsound management, or amounts to inadequate maintenance of internal controls.

Policy Board for Financial Services and Regulation: The Policy Board was established in 1993 toadvise the Minister of Finance on matters relating to financial services and regulation, either of its ownaccord or by the Minister’s request. The Board’s scope of advice includes laws that affect financialregulation, policy considerations that impact from the regulation, and any matter referred to the Boardby the Minister. The Policy Board also facilitates communication between the Reserve Bank and theFinancial Services Board (see below) to ensure the efficiency of financial regulation and the stabilityof the financial system.


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Financial Services Board: The Financial Services Board was created in 1990 to serve as a watchdogover the non-banking financial services industry. The Financial Services Board regulates insurers,pension funds, financial exchange members, unit trusts, portfolio managers, investment firms,securities firms (including stockbrokers, fund managers, and the securities trading division of banks),and non-securities firms (such as trust companies, insurance brokers, and investment advisors).

Retail Financial Institutions in South Africa: Table 19 outlines the range of retail financialinstitutions in South Africa. Besides the institutions outlined below, South Africa also has severaldevelopment financial institutions that provide a range of wholesale and retail financial services.Under apartheid, the development finance system was used to pursue the racist political objectives ofthe illegitimate government and was therefore largely discredited, particularly in African communities.In the new South Africa, the government is attempting to re-create these development financialinstitutions to correct for the failure of markets to allocate resources at socio-economically optimumlevels.

Table 19: Financial Institutions in South Africa

Type PurposeMinimumCapital

DepositTaking?

ApproximateNumber

Commercial Banks General banking services US$11.1 million99 Yes Around 40

Finance Companies Retail Lending None No Many

Mortgage Companies100 - - - -

Credit Cooperatives Small scale savings andcredit services

None Yes Many

Mutual Banks General banking services US$2.2 million Yes Less than 5

Khula Enterprise Finance Limited and the National Housing Finance Corporation (NHFC) are twonew development financial institutions designated to provide services to retail financial institutions.Khula provides a mixture of loans, guarantees, and grants to approved financial retailers that serve thesmall and microenterprise market, particularly the informal sector. Retail financial intermediaries areassessed based on developmental criteria such as outreach to targeted groups and job creation, andinstitutional criteria such as portfolio performance and sustainability. NHFC serves a similar functionwith retailers that provide housing finance.

In addition to the formal financial sector, unregulated NGOs provide financial services, primarilycredit, in market niches poorly served by government or commercial institutions. Generally offeringmicroloans up to US$1,330 in disadvantaged communities, the NGOs tend to operate on a smallscale.101 One explanation for their small outreach is their limited access to funding sources, asdictated by the regulatory environment described below.

99 Based on an exchange rate of R4.50 to US$1.100 Mortgage companies in South Africa took the form of building societies. However, these institutions no longer

exist, having now converted into either banks or mutual banks or having seen their functions assumed by commercialbanks.

101 This loan size cap for NGO microloans is because of the exemption to the Usury Act for loans below R6,000.


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Banking Laws and Regulations

The Banks ActThe Banks Act (1990) consolidated the provisions of previous South African banking legislation todeal with banks, building societies, and all deposit-taking institutions in the same manner. The mainobjective of the Act is to create a common regulatory framework for deposit-taking to safeguard theinvestments of depositors and protect the integrity of the banking system.

The approach of the Banks Act is functional, not institutional. It addresses the function of deposit-taking rather than the institutions accepting deposits. The advantage of this approach is that variousgroups of banks are regulated by a single act, creating a more level playing field by eliminating pastdiscrepancies in the regulation of these groups. The disadvantage is that the current regulatoryconditions create high barriers to entry that has led to the emergence of a few powerful banking groupswho dominate the industry. In 1996, the four banking groups controlled approximately seventy-sevenpercent of all assets of deposit-taking institutions. The financial institutions operating under the BanksAct generally do not cater to the demands of low-income communities for financial services.

Deposit-taking Prohibition. The Banks Act introduced a general prohibition on taking deposits fromthe general public unless the entity was registered as a bank. Under the current banking regulations,besides not mobilizing savings from the general public, retail lenders are prohibited from accepting“deposits” from the investment community, except for loans from equity banks. This provision has adramatic impact on the ability of nontraditional lenders to obtain wholesale funding.

Exceptions. Certain “common bond” institutions are exempt from the provisions of the Banks Act.These include stokvels102 and credit unions on the condition that they are members of a self-governingumbrella body – such as the Savings and Credit League of South Africa or the National Associationof Stokvels of South Africa – and have less than US$2.2 million in assets. The common bondexemption assumes that the members of a stokvel or credit union know each other well, therebyreducing the asymmetric information problem. In living or working closely together, members areable to monitor peer behavior. It is further assumed that the local association receives sufficientsupervision by falling under the aegis of an umbrella body. In addition, since each local association isa closed system, a failure at the local level will not affect the broader financial system.

Cooperatives also circumvent the Banks Act. In describing the “business of a bank,” the Act does notinclude the cooperative’s borrowing money from its members. This allows members of a cooperativeto make deposits with it in the form of a loan, subject to certain conditions. The loan from a memberto a cooperative must be at least US$222 and the repayment period is usually twelve months or more.The cooperative must issue an acknowledgment of debt, and the loan is repayable either at a fixed dateor upon thirty days’ notice by the cooperative to the member.

Risk Management. The Banks Act is based on international banking criteria and principles, asindicated by its risk management requirements, which are in accordance with the Basle Concordat.These requirements rely on the risk management capacity of directors and senior management ofbanking institutions, and on capital adequacy and liquidity requirements.

102 A stokvel is a South African rotating savings and credit association or burial society.


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A bank is required to maintain total-share capital and unimpaired reserve funds of at least US$11.1million or up to eight percent of its risk exposure, whichever is greater. The current bankinglegislation does not encourage the provision of credit to potential borrowers with low incomes andwithout security. Only loans fully secured by mortgages on urban residential dwellings qualify for afifty percent risk weighting for capital adequacy purposes; all other assets qualify for one hundredpercent risk weighting.

A bank must also hold liquid assets, which must not be encumbered without an exemption by theRegistrar, amounting to not less than five percent of the bank’s short-term liabilities. It may not makea single investment for an amount exceeding a prescribed percentage of the institution’s capital andreserves without permission from its board and specific reporting to the registrar. It must alsomaintain a reserve balance with the Reserve Bank between one and two percent of its liabilities.

The Mutual Banks ActThe Mutual Banks Act of 1993 was an attempt to add depth to South Africa’s financial system bycreating a banking category that had less stringent capital adequacy prerequisites but similar risk-management requirements. It also attempted to involve communities in banking by including aprovision for local boards for branches of mutual banks, the organization of which must be mutually-based rather than equity-based. The primary share capital of mutual banks is in the form ofpermanent interest-bearing shares that are not redeemable but may be transferred at the discretion ofthe board of directors. It is expected that over time the members of the community in which a mutualbank operates will acquire shares in the financial institution. The Act provides that a mutual bankmay accept deposits and grant loans, advances, or other credit.

The prudential requirements for mutual banks are similar to equity banks that fall under the BanksAct. A mutual bank is obliged:

• To meet capital adequacy requirements by maintaining unimpaired reserve funds in theamount of at least US$2.2 million or up to eight percent of its risk exposures;

• To maintain a minimum reserve balance with the reserve bank equal to five percent of itsshort-term liabilities;

• To avoid portfolio concentrations in excess of a certain percentage without making a specificreport to the Registrar; and

• To give detailed monthly and quarterly returns, showing its various risk exposures and themanner in which it complies with capital adequacy and liquidity requirements.

The Act provides that the Registrar may require applicants for mutual banks to establish a relationshipwith an equity bank (referred to as a “guardian bank”) to assist the applicant with technologicalinfrastructure, management, and advice.

The capital and reporting requirements are so stringent and inflexible that mutual banks have noteffectively increased access to financial services in South Africa. According to the StraussCommission (1996), the majority of non-traditional institutions have not converted to mutual banksfor a number of reasons. First, registration is believed to compromise their independence. As soon anentity registers, it comes under the supervision of the Registrar of Banks. This can be seen asinterventionist given the political environment out of which these entities have grown. Second, low-


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income persons do not perceive banks as customer-friendly. Therefore, registration may diminish theperceived legitimacy of non-traditional lending institutions in the communities in which they operate.Third, there are staffing, reporting, and other cost implications in becoming registered. The Registrarneeds to be satisfied with the directors and senior management. In most cases, this requires theemployment of high-paid staff, which could endanger the viability of the institution. Fourth, thecapital adequacy requirement of US$2.2 million is perceived by some as too high. And finally, thepeople who are the driving force behind the success of non-traditional lending institutions in SouthAfrica generally come from an NGO background and would not feel comfortable in a formal bankingculture.

Strauss Commission Recommendations for New Banking CategoriesIn January 1995, President Mandela appointed a commission to study the provision of rural financialservices. Chaired by Conrad Strauss, the former Chairman of Standard Bank of South Africa, thiscommission introduced several recommendations designed to add depth to the financial system. Theserecommendations are now being considered by the Reserve Bank, the Minister of Finance, theDepartment of Trade and Industry, development finance institutions, and practitioners in the field.

The current regulatory environment provides two primary categories of financial institutions. Thefirst tier consists of commercial banks and mutual banks. Apart from the minimum capitalrequirement, the primary differences between the two are in the nature of their investment instrumentsand the fact that mutual banks are perceived as having a development focus. Since the prudentialrequirements for banks and mutual banks are effectively the same, and since mutual banks have noteffectively diversified the banking system, they should not be considered as separate tiers of banking.

The other category of financial services in South Africa includes the unregulated institutions andassociations that fall under the common bond exclusion. With this exemption, the Reserve Bank hasabrogated responsibility for supervising financial institutions that cater to African clients, providedthat the level of deposits is less than US$2.2 million. The Commission believes that this exceptioncreates too much flexibility and exposes the lowest-income segments of South African society tounnecessary risks. The commission suggests that there is a need for more appropriate regulation andcontrol over umbrella organizations. This implies a supervision function that would have a capacity-building component. It may be inappropriate to house this function under the Registrar of Banks, asthis function requires a qualitatively different focus and set of skills.

The Strauss Commission recommends the creation of a new category of financial institution to allowretail lenders to mobilize savings, including village banks and NGOs. For this tier of banking to berecognized through legislation, it requires that the registration be accepted as a legal entity. Minimumcapital adequacy will have to be determined by an appropriate regulator with reference to the riskprofile of the institution. It is possible to reduce capital requirements for this type of financialinstitution. However, liquidity problems are the cause of most bank failures. Accordingly, theliquidity requirements of banks and mutual banks should apply to this alternative banking tier as well.Liquidity requirements in the form of a minimum reserve balance (five percent of total liabilities)could be held in a commercial bank, serving a capacity similar to the guardian bank arrangementprescribed in the mutual bank legislation.

If authorities move to establish this new category, it is important to consider the commission’sexplanations why alternative lending institutions have not transformed into mutual banks. The mostbasic principle is that the benefits of formalization should exceed the costs of reporting and


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supervising for practitioners, the Registrar, and the target market. It is also important thatformalization does not alienate the customer base. From the perspective of commercial banks, thiscategory of financial institution may be an opportunity to improve their relationship withdisadvantaged communities and consequently they may consider creating microbank subsidiaries.

Other Laws Affecting Access to Financial ServicesUsury Act (1968). The Usury Act regulates consumer transactions including moneylending,commercial credit, and leasing. It states that no moneylender may receive finance charges at anannual rate greater than the maximum rate determined by the Registrar. Currently, the maximumeffective interest rate (including all fees) on loans more than US$1,330 cannot exceed twenty-sixpercent and for loans below US$1,330, twenty-nine percent. The Registrar of Banks is responsible forenforcing the Usury Act.

In 1992, to facilitate lending to low-income borrowers, the previous government issued a regulationexempting loans of US$1,330 or less from the provisions of the Act, provided that:

• The loan amount and finance charges owed by the borrower are paid within three years;

• The lender does not advance the loan until after a “cooling off” period of three days, duringwhich time the borrower may terminate the transaction; and

• The lender must furnish to the borrower, in writing, the amount in Rands and cents of the loanamount and the sum of the finance charges and other costs payable (the interest rate does notneed to be disclosed).

In 1994, the new government announced that it intended to remove the exemption to the Usury Act onthe ground that it allowed lenders to charge interest rates that exploited low-income communities.This rationale for limiting interest rates is in the interests of consumer protection. Yet borrowers whodo not have access to loans under a controlled interest rate, have no choice but to be exploited bymoneylenders that operate outside the regulated financial system. The removal of the exemptionwould make it impossible for microfinance institutions to achieve full-cost recovery, therefore causingthe adverse effect of limiting the access to financial services in low-income communities. The removalof the exemption is being protested by most key players in South Africa’s microfinance community,including the broad-based Alliance of Micro Enterprise Development Practitioners (AMEDP).103

Land Reform. The process of land reform currently taking place in South Africa has a profoundimpact on access to financial services. The current subdivision legislation provides that agriculturalland may not be subdivided into smaller holdings without the consent of the Minister of Agriculture.This policy was implemented in a period when government policy promoted the ownership of largerfarms and is no longer appropriate, except for the zoning function that may be viewed asenvironmentally protective.

103 The AMEDP is a South African association consisting of NGOs, government institutions, formal financial

institutions, and other private and parastatal entities, which provide financial services to the micro market.


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Land tenure is another contentious issue. Freehold tenure is regarded by many financial retailers asthe only credible tenure basis for lending. This requires a tenure system with the followingcharacteristics:

• Certainty as to the boundaries of the property;

• An identifiable entity that holds the liability for the repayment of the loan;

• The ability to repossess the property free of any encumbrances; and

• The ability to sell the property to recoup the loan.

Few low-income people are able to provide such security. African farmers often live on land ownedby the state. Communities in these areas gain access to land through communal tenure and otherinformal land tenure systems. While these tenure systems may provide a basis for structuringcommunal ownership of land, they do not provide a system of tenure that acts as a basis forcommercial financing.

Access to Financial Services for Women. While not banking law per se, the customary law that hashistorically been applied to Africans treats all married women as minors, rendering them unable toenter into legal contracts. Consequently, women married under customary law must get their spousesto sign loan agreements. There is also gender discrimination by institutions dealing with small-scaleentrepreneurs. While African women are major loan recipients of NGO retailers, other institutionsthat serve African borrowers, including development corporations and commercial banks, deal mostlywith men.

Collateral. The use of movables as collateral for microloans is problematic. Although legallypossible, the costs involved in complying with the stipulations of “The Security by Means of MovableProperty Act” preclude its application to microlending.

Self-Regulation for Microfinance Institutions

Besides advocating for some of the regulatory reforms discussed above, some members of the Alliancehave been working with the two new development finance institutions (Khula and NHFC) to develop acode of conduct that could serve as the framework for self-regulating the South African microfinanceindustry. To that end, the microfinance community established a committee to create “Statements ofSound Practice,” outlining best practice standards for practitioners and forming the basis for aregulatory framework for the microfinance institutions.

The committee consists of ten members, including five microfinance practitioners. The Registrar ofBanks, representatives from Khula and the NHFC, a representative from the formal bankingcommunity, and a representative from the Institute of Chartered Accountants fill the last five seats.This committee will:

• Approve an initial draft of “Statements of Sound Practice” based on a submission made by atechnical task team;

• Consider submission from practitioners to whom the Statements would apply for changesand/or additions;

• Advise development financial institutions on trends in the microfinance industry; and


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• Develop proposals for a long-term regulatory framework for microfinance retailers.

This effort may result in the self-regulation of microfinance institutions; alternatively, it may shape theperspective of the Registrar regarding the creation of a new category of microbanks.

Some members of the South African microfinance community believe that successful microcreditprograms should evolve into deposit-taking institutions. This is based on two primary arguments.First, sustainable microcredit programs, having the trust and respect of the communities in which theyoperate, will be able to provide the target population with a broader range of financial services if theyare permitted to mobilize deposits. Second, these programs will strengthen the institutions and createstable financial intermediaries that will more effectively reach low-income communities than ifincentives are designed to encourage commercial banks to target the micro sector. The other camp ofmicrolenders believes that there is widespread availability of savings services, through commercialbanks and the Post Office Savings Bank. These MFIs are more concerned with expanding the scaleand quality of their lending activities than with offering savings services.

The microfinance community is wary of allowing unregulated institutions to mobilize deposits,particularly the hard-earned savings of low-income persons. The logical conclusion to this concern isthe creation of a new category of regulated financial institution for micro-intermediaries. Thecommittee may reach this conclusion. They also may recommend a strategy for supervisingmicrofinance institutions that delegates some responsibilities to the new development financeinstitutions, as they are already monitoring the performance of the retail microlenders. However, thedevolving supervisory responsibilities to Khula or the NHFC might create a conflict of interest sincethese institutions have a commercial relationship with the retailers.

In South Africa there are two competing forces battling to institute banking reforms. Thedemocratization of South Africa has created extensive political will to deepen and broaden financialservices for the unbanked population. However, South Africa has a very sophisticated “first world”formal financial system that does not have the flexibility to accommodate non-traditional approachesto provide financial services in “third world” communities. These two factors create tension that maydelay the reform process, but once a solution is reached, it is likely to be well crafted and may serve asa model for other countries.

The South African reform process stands out because it is participatory effort to enhance theregulatory environment for microfinance. This case illustrates two important points about the processof creating regulations for MFIs. First, South African regulators are not in a hurry to licensemicrofinance institutions because they do not mobilize savings. This cautious approach toward thepossibility of integrating informal lenders into the formal financial system is laudatory since bothparties have much to learn about the intentions and the procedures of the other. The second point isthat the Advisory Panel initiative was led by government-owned wholesalers, Khula and the NHFC.They have involved the Reserve Bank in the discussions in an advisory capacity, but a possibleoutcome is some form of self-regulation. In contrast to the Peruvian example described above, if self-regulation based on industry standards is adopted, it will give the wholesale funders confidence as theyextend public resources to MFIs, and yet it will not burden the Reserve Bank with the responsibility ofsupervising credit-only institutions.


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PUBLICATIONS FROM THE MICROFINANCE NETWORK:

CONFERENCE PAPERS:• Current Governance Practices of Microfinance Institutions• Moving Microfinance Forward 1998*• Establishing a Microfinance Industry 1997*• Key Issues in Microfinance 1996*

OCCASIONAL PAPERS:• The Regulation and Supervision of Microfinance Institutions: Experience from

Latin America, Asia and Africa by Shari Berenbach and Craig Churchill,1997.**

• The Regulation and Supervision of Microfinance Institutions: Case Studiesedited by Craig Churchill, 1997.*

*Also available in Spanish.

**Also available in French and Spanish.

The MicroFinance Network

The MicroFinance Network is a global association of leading microfinance practitioners. Networkmembers are committed to improving the lives of low-income people through the provision ofcredit, savings and other financial services. The Network believes that this sector should beserved by sustainable microfinance institutions. The MicroFinance Network is a vehicle foraccomplished institutions to provide each other with technical assistance and to learn from eachothers’ experiences.

Non-governmental Organizations Support Institutions Regulated Financial InstitutionsASA, Bangladesh ACCION International, USA ACEP, SenegalABA, Egypt CALMEADOW, Canada BancoSol, BoliviaBRAC, Bangladesh Banco del Desarrollo, ChileCHISPA, Nicaragua BRI Unit Desa, IndonesiaEmprender, Argentina CERUDEB, UgandaFED, Ecuador Citi Savings and Loans, GhanaFundusz Mikro, Poland Cooperativa-Emprender, ColombiaGet Ahead, South Africa FINAMERICA S.A., ColombiaPRODEM, Bolivia K-Rep Bank, KenyaTSPI, Philippines Mibanco, formerly ACP, Peru

SEWA Bank, India

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