Impacts of the Regulatory Framework on Development of Sustainable Microfinance: Survey of Global Experience & Best Practices Tuesday, 26 June 2001 Joselito Gallardo Financial Sector Department The World Bank

 Informal sector (moneylenders, pawnbrokers, suppliers, friends and family, ROSCAs)  Semi-formal (NGOs, village banks)  Formal financial institutions -- commercial and savings banks; state banks; cooperative financial institutitions [credit unions, savings and credit cooperative associations] Continuum of Financial Intermediaries:

11 Subsidy dependence (Interest and fee income does not cover operational costs) Operational self-sufficiency (Interest and fee income covers cash costs) Breakeven cash flow Breakeven after adjustment Profitability ( full financial self-sufficiency ) (Interest and fee income cover all costs, including inflation and subsidy adjustment)

Impact of Legal and Regulatory Framework on Microfinance Microfinance Institutions Small & Micro Enterprises Transactions: Loans Deposits Collateral interest Donors, Banks & General Public Transactions: Grants Borrowings Deposits Establishment Procedures Regulations on Financial Institutions & Operations Accounting Standards & Procedures Tax Laws & Regulations Securities Law Legal Framework for Ownership & Security Interests Establishment Procedures Regulations on Financial Institutions & Operations Accounting Standards & Procedures Tax Laws & Regulations Securities Law Legal Framework for Ownership & Security Interests

1. Licensing of MFIs is important for long run  Massive, sustainable financial services to the poor  Only financially sustainable MFIs should be licensed 2. Informal & small member-based MFIs should be exempt from regulation Consensus on Microfinance Regulation

3. Any regulation of non-bank MFIs should be:  Tailored to specialized characteristics of MFIs  Tiered: - Prudential (external supervision of compliance, soundness) - Non-prudential (registration, other requirements) - Exemptions (informal, beyond reach) Consensus on Microfinance Regulation

1. Timing: regulate sooner, or later?  Establish general framework, or wait for large MFIs that demand regulation? 2. Comprehensive or phased?  Issue regulations for entire MFI sector, or gradually extend to different tiers? 3. Rigidity or flexibility? 4. Capacity to implement  Risk of overcommitment, ineffective application  Affects response to timing and comprehensiveness Issues of Application

Establish rules to foster orderly development of microfinance industry Banking Superintendent:  Stability of financial system  Protect deposits of the public MicroFinance Institutions:  Legitimacy; access to savings, commercial credit  Build confidence of clients and financiers  Protection from government interference Why Demand Regulation in Africa?

Why Postpone Regulation in Africa? Avoid excessive rigidity and costs when few MFIs would qualify for prudential regulation Bank Superintendent:  Inadequate experience, capacity to supervise  High cost of supervision relative to benefits (1-5% of assets)  Avoid responsibility for NGOs, informal agents beyond reach MicroFinance Institutions:  Rigid regulations may stifle innovation, some types of MFIs  High cost of compliance (1-5% of portfolio)  Risk of interest rate restrictions being imposed