Financial Sector Assessment
. Some Cross-Cutting Issues Affecting Rural Finance and Microfinance Institutions
Tax issues may present obstacles to rural finance and microfinance institutions from more effectively providing access to financial services. The legal and nonprofit status of nonbank NGO MFIs may sometimes be questioned by tax authorities on the grounds that the credit services they are providing to their clientele are priced at commercial rates, rather than at “charitable” levels, as in the case of NGO MFIs in India. In other instances, licensed specialized banks and non-bank finance institutions may not be permitted by tax accounting laws and regulations to expense provisions for possible loan losses, in spite of prudential regulations issued by the central supervisory authority, as in Tanzania, which creates an unnecessary real economic burden to such specialized banks and non-bank finance institutions. A related problem stems from the requirement by tax authorities that delinquent loans may be written off only when the sale and disposition of collateral securing such a defaulted loan results in recovering a monetary value that is less than the value of the collateral, as in the case of Kenya.
Credit registries allow borrowers to build up a credit history and can assist lenders in assessing risk, thereby reducing the cost of lending and improving access. Credit registries that give easy and reliable access to a client’s credit history can dramatically reduce the time and costs of obtaining such information from individual sources and, therefore, can reduce the total costs of financial intermediation. Credit reporting makes borrower quality much more transparent, which benefits good borrowers and increases the cost of defaulting on obligations. It helps borrowers build up a credit history and eases access to
credit. Credit registries are especially important for SMEs, because their creditworthiness is more difficult to evaluate and because they have less visibility and transparency relative to large enterprises.
Often, current regulations may provide for the sharing of only negative information (i. e., information on nonperforming loans). It is preferable that regulations allow for sharing of both positive and negative information to improve reliability of credit risk evaluation and to increase competition.6 Reporting positive information significantly increases the predictability of rating and scoring models used by lenders, thereby translating into lower loss rates, higher acceptance rates of credit applicants, or both (see Staten 2001). Sharing positive information will also allow borrowers to build their credit history, which can especially benefit small borrowers, because it will allow them to establish a good borrowing reputation and to improve their chances to increase borrowings as their business grows. Regulations governing information sharing should also allow for adequate consumer and data protection mechanisms. Allowing all finance providers to share both positive and negative information on their borrowers will allow small business to participate in
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In an assessment of the prudential regulatory and supervisory framework for microfinance, the following key questions need to be addressed:
• Are the prudential standards applied to specialized banks and financial institutions in the rural finance and microfinance sector consistent with and adapted to the nature and characteristics of the market clientele they service (e. g., microfinance loans are short term, repeating, and unsecured with group guarantees being widespread practice), or are the prudential standards used the same as those that apply to regular commercial banks?
• Does the central bank or supervisory authority have rural finance - or microfinance-dedicated staff members assigned to the supervision and examination of the specialized banks and financial institutions in the rural finance and microfinance sector? In a number of countries, including Kenya, Pakistan, the Philippines, and Tanzania, the supervisory authority has a separate specialized microfinance section that deals with policy issues (including appropriate standards), but actual examination and supervision of all licensed banks and financial institutions are carried out by technical staff members from the banking supervision department. In other countries, including Ghana, Indonesia, and the Philippines, rural and community banks are examined and supervised by staff members in the
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rural banking department of the supervisory authority.
• What is the comparative workload (number of licensed institutions, or number of days needed to complete onsite examination or supervision) of supervisory staff members assigned to commercial banks versus that of members assigned to specialized banks and financial institutions in the rural finance and microfinance sector?
• What is the judgmental assessment of the technical capability of staff members and the quality of their examination and supervision of specialized banks and financial institutions in the rural finance and microfinance sector in comparison with technical staff members responsible for commercial banks? Is this a fair comparison?
• Is it possible to estimate and compare the costs associated with the examination and supervision of specialized banks and financial institutions in the rural finance and microfinance sector in comparison with the costs for the examination and supervision of commercial banks? Is this a fair comparison?
• Does the central bank or monetary authority require the commercial banks and the specialized banks and financial institutions in the rural finance and microfinance sector to pay for or to defray the costs associated with examination and supervision? If so, what charges are imposed?
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Key Issues
Access to financial services through microcredit programs is primarily through microfinance institutions (MFIs) and credit cooperative organizations (CCOs) registered with and licensed by the central bank. The microfinance sector is small in terms of total credit volume and number of households and enterprises reached. The most critical issues for development of the microfinance sector are (a) diversification of funding sources, as authorization for mobilizing deposits does not come automatically with licensing, even for CCO members’ deposits; and (b) striking a balance between developing a safe and sustainable sector and imposing unreasonable burdens on both the regulated institutions and the regulatory authority.
Policy Recommendations
• MFIs and CCOs should be allowed to take deposits from their members or borrowers, provided they meet established prudential norms related to expected financial and operational risks.
• The legal and regulatory environment for MFIs or CCOs that do not take deposits should be reviewed and simplified commensurate to their risk profile.
• Improvement of the regulatory and supervisory framework through better prudential reporting standards and more-effective sanctions could make supervision more effective.
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Key Issues
The regulatory regime for microfinance is uneven and tilted toward overregulation. The policy direction is unclear as to whether the provision of microfinance and small-scale finance services will depend more on formally licensed banks and institutions reaching down, or will depend on developing the scaling-up of community - or nongovernmental organization (NGO)-based MFIs, including savings and credit cooperative organizations (SACCOs).
Policy Recommendations
• The move toward a more systematic and thorough regulatory regime for the few MFIs to be taking more than a specified amount of deposits is commendable, but smaller NGO MFIs and SACCOs able to reach remote rural areas should not be suppressed by excessive regulation.
• The development and strengthening of umbrella organizations and the greater reliance by MFIs on funding from local banks rather than external donors should be encouraged.
• A specialized agency for cooperative financial institutions should be considered for focusing on capacity building and financial infrastructure.
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the process of reputation building and generation of credit history. It would help facilitate the process of borrowers’ graduating from microfinance to bank finance as their business develops. Information sharing among all finance providers could contribute significantly to reducing segmentation and increasing competition.
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