1. Presentation for the roundtable discussion on regulatory and supervisory framework in microfinance 18-19 March 2014 Sudan University of Sciences and Technology, Khartoum,Sudan Presented by : Abdelrahman Elzahi Saaid Ali (PhD.) Islamic Training Research Institute/ Islamic Development Bank

2. Introduction Most of the literature in the area of regulation and supervision of MFIs confirms that The microfinance sector has to be regulated in order to achieve massive and sustainable delivery of financial services to the lower income section of the population. The issue of prudential regulation and supervision of MFIs is therefore key to its success yet it is also a complex matter that keeps evolving. The objective of this paper is to use the Kenyan context to determine an appropriate Model capable of tackling the challenges and constraints of the country’s current regulatory and supervisory framework.

3. Problem statement Kenyan MFIs continue to evolve rapidly by creating new and localized ways to service the increasing demand for their services. This rapid development seems to have generally overtaken taken policy formulation by the government. The regulation of MFIs in Kenya is complicated because the institutions involved in providing microfinance services exist under different legal structures. The challenge therefore is the identification of an appropriate overarching regulatory approach that is conducive and flexible enough for all the players and the development of this sector.

4. Objectives of the study This general objective of this study is to examine how Kenya’s regulatory and supervisory framework impacts on the clients, operations and institutional development of microfinance institutions (MFIs). Specifically the study will  Examine the performance of the microfinance sector since the implementation of the Microfinance regulatory and supervisory framework of 1996 to date;  Critically review, identify and analyze the basic regulatory and supervisory weaknesses, constraints and challenges that are obstacles to the efficient performance of the microfinance sector.  Suggest a course of action to enhance the regulatory and supervisory framework of MFIs in Kenya.

5. Scope  This study will discuss the need to regulate and supervise microfinance institutions with various practitioners.  It will also review Kenya’s regulatory system; its historical development and its application of various principles, approaches and instruments.  It will highlight major weaknesses and challenges of this regulatory framework.  In making its recommendations it will review various literatures, books and theoretical papers to draw from lessons learnt in Uganda’s and Tanzania’s regulatory and supervisory frameworks.

6. The history of microfinance in Kenya  The earliest cases of micro-finance and microcredit development in Kenya were church-based lending programs that arose in the 1980s whose primary function was to provide credit to members of its congregations.  In the 1990s NGOs started developing functioning systems to facilitate the administration of the credit delivery initially not as outright business ventures but as they received considerable funding they began to change into full commercial entities assuming various formal structures registered under different statutes.  While small donor funded Islamic microcredit programs exist in Kenya,Islamic microfinance remains to be a relatively unexplored market niche.

7. Categories of microfinance institutions in Kenya The Central Bank of Kenya(CBK) broadly categorises MFIs into non- deposit taking (credit only) and deposit-taking Microfinance(DTM) institutions.  DTMs are licensed and regulated by the CBK. They are permitted to mobilize and intermediate (or lend) deposits from the general public. However unlike commercial banks DTMs can only engage in a limited range of products. The DTMs are categorised into nationwide MFIs (operating countrywide) with a minimum core capital of KES 60M (USD 860,000) and Community MFIs (operating within a specific administrative region) with minimum core capital is KES 20M (USD 300,000).  Non-deposit taking microfinance institutions are regulated by the Ministy of Finance.They are not allowed to mobilize public funds and as such can only lend their own funds or borrowed funds.

8. Kenya’s MFI landscape

9. Registration of MFIs MFIs in Kenya can be registered under eight different Acts of Parliament namely:  The Non Governmental Organizations (NGO) Co-ordination Act,  The Building Societies Act,  The Trustee Act,  The Societies Act,  The Co-operative Societies Act,  The Companies Act,  The Banking Act  The Kenya Post Office Savings Bank (KPOSB) Act. Some of these forms or registrations do not address issues regarding ownership, governance and management capacities, unhealthy competition, access to funds and accountability simply because they lack the appropriate regulatory oversight machinery that can enforce compliance.

10. Kenya’s MFI financials  According to Association of Microfinance Institutions Kenya (AMFI) 2012 annual report on MFI sector the total assets for the sector maintained a steady growth and are worth over KES 220bn (USD 2.59bn).  It also indicates that the sector reaches out to nearly 1.5 million borrowers with values of the outstanding loan book standing at KES 138.4bn (USD 1.6 bn) and total liabilities of KES 178.4bn (USD 2.2bn).

11. Kenya’s regulatory architecture 1.The Microfinance Act 2006 The main objective of the Microfinance Act 2006 is to provide the legal, regulatory and supervisory framework for the Deposit Taking Microfinance Institutions(DTMS). 2.The Microfinance Amendment Bill 2013 Increased the range of financial services that the DTMs can offer to include issuance of third party cheques, operation of current accounts and transacting in foreign trade operations. 3.The Deposit Taking Microfinance Bill This Bill inter alia, specifies three different tiers of micro finance institutions : First tier — Formally Constituted Deposit-taking MFIs which the CBK is empowered to regulate and supervise. This group of MFIs are members of the Deposit Protection Fund Board (a deposit insurance scheme) that protects depositors’ deposit up to KES. 100,000. Second tier — Formally Constituted Credit-Only MFIs that are regulated and supervised by the envisaged Micro Finance Unit in the Ministry of Finance. Third tier — Informally Constituted MFIs like ROSCAs, club pools, and financial services associations (FSAs) supervised by donors, commercial banks, and government agencies from which they obtain funds.

12. Kenya’s regulatory architecture (Contd…..) 4.Financial Institutions Department and Rural Finance Department The Financial Institutions Department, a division in CBKs Bank Supervision Department participated in the drafting of the Microfinance Bill and prudential guidelines/regulations. The Rural Finance Department was set up to address various policy issues concerning rural finance, including microfinance. These two together are now involved in developing capacity to regulate and supervise those microfinance institutions that are being licensed under the DTM Bill. 5. Microfinance Unit The microfinance unit based at the Ministry of Finance (the Treasury) is expected to build a database and to formulate policies and procedures to address the challenges faced by rural microfinance institutions not supervised by CBK. 6. The Association of MFIs in Kenya The Association of Microfinance Institutions (AMFI) is a member-based institution, registered in 1999 under the Societies Act by the leading MFIs in Kenya. The main reasons for its establishment is the need for MFIs to have a common voice in lobbying the government for favorable policies; to share information and experiences and to link up and network with both local and international actors. AMFI currently has 59 member institutions serving more than 6,500,000 poor and middle class families with financial services throughout the country. Interestingly no Islamic Microfinance institution is grouped under tier 1 or even a member of AMFI.

13. Kenya’s regulatory framework (Cont’d..) 7. Financial Reporting Centre The Financial Reporting Centre is established under the Proceeds of Crime and Anti-Money Laundering Act, 2009 (the “AML Act”) became fully operational in 2012. The centre’s principal role is to assist in the identification of the proceeds of crime and the combating of money laundering. All banks, financial institutions, non-bank financial institutions, mortgage finance companies and forex bureaux are obliged to monitor and report suspected money-laundering activities to the Centre. 8.The Prudential Guidelines Prudential guidelines deal with a wide range of issues including licensing requirements, corporate governance, board composition, remuneration of directors, capital adequacy requirements, liquidity management, stress testing, foreign exchange exposure limits, prohibited business, anti-money laundering, consumer protection, enforcement of banking laws and regulations, agent banking, and representative offices.

14. Kenya’s regulatory framework (Cont’d..) 9.Retail Transfers Regulation As part of Kenya’s recent move to bring in adequate measures for consumer protection and to prevent money laundering, the CBK has published the draft Retail Transfers Regulation 2013 (the “Regulation”) for provision and regulation of electronic retail transfers and e-money. Stakeholders have been invited to review and comment on this draft Regulation before it is brought into force. The Regulation will apply to all retail transfers utilizing an electronic payment method, and to all payment service providers that are not licensed as banks or financial institutions. Such payment service providers will be required to hold core capital of not less than KES 10m (approximately US$119,000). 10.Islamic banking There are currently two fully-fledged Shariah-compliant banks and a few conventional banks that have an Islamic Banking arm and one shariah compliant MFI whose operations are restricted to Mombasa. A few small donor funded Islamic microcredit projects exist. None of these are regulated by CBK or are members of AMFI. The challenge for offering Islamic financing remains to be the lack of a proper legal framework, which prevents financial institutions from providing certain products. In addition, there is ambiguity in respect of the tax treatment of Shariah-compliant financial instruments.

15. Recent regulatory themes and developments  A credit information-sharing mechanism was launched in July 2010. Through this mechanism, the CBK has ensured that banks have strengthened credit appraisal standards by their incorporating credit reference reports in the credit risk appraisal. However regulation has yet to be amended to allow MFIs to incorporate this process into their credit appraisal system.  The Kenya Deposit Insurance Act, 2012 (the “KDI Act”) has been assented to but is yet to commence, provides for the establishment of an autonomous body called the Kenya Deposit Insurance Corporation which will replace the current Deposit Protection Fund Board, a department of the CBK. The KDI Act provides for the setting up of a deposit insurance system, and the receivership and liquidation of deposit-taking institutions.  There is increased interest in Islamic MFI and non-deposit-taking microfinance business in Kenya. However areas are not covered by specific legislation as yet.

16. Discussion