1. Microfinance regulation and supervision
microcredit microloans Yunus CGAP
reglamentation de la microfinance
Access to finance: policy, legal, and
regulatory frameworks
Amman, June 9-10, 2009
IDLO TW-373E
Simone di Castri, Policy Analyst
CGAP / World Bank Group

2. Presentation outline
Part I Part III
• What is CGAP • Terminology
Set the context: • Institutional Framework
• Microfinance by the numbers • Policies
• Diversity of financial services • Regulation and supervision
• Diversity of formal providers
• Context matters Part IV
• Regulation matters • National Frameworks
Part II
• Regional Context Sharia-Compliant Financial Services
Ala’a Abbassi will be analyzed on Sunday

3. Goals
• To find agreement on basic legal and economic
concepts related to access to finance
• To discuss policy and regulatory approaches
• To compare frameworks in a number countries

4. CGAP: Who we are
CGAP is an independent policy and research center dedicated to
advancing financial access for the world's poor.
It is supported by 33 development agencies and private foundations who
share a common mission to alleviate poverty.
CGAP provides market intelligence, promotes standards, develops
innovative solutions and offers advisory services to governments,
microfinance providers, donors, and investors.
At a glance:
• 7 locations: offices in Washington DC, Paris and Bruxelles, with 4 regional
representatives based in Abidjan, Dhaka, Moscow and Jerusalem
• 28 million dollar annual budget
• 18 European based members
• 60 staff
• 70 countries with CGAP activities
• 150,000+ copies of CGAP publications distributed globally in 2008

5. CGAP: What We Do
PARTNERS OBJECTIVES KEY ACTIVITIES
Donors & Increased funding • Market surveys
Investors effectiveness • Standards and norms
MACRO
• Advisory services
Governments More supportive policy • Advisory services
environments • Awareness building
• Research, policy
analysis and standards
Financial Market Improved systems, • Information platforms
MESO Infrastructure information and technology • Reporting standards
• Recognition of model
practices
Financial Service Diverse Institutions &
• New business models
MICRO Providers Delivery Channels (technology and
graduation)
GOAL: Financial access for the world’s poor

6. Microfinance by the Numbers (1/2)
• Over 2.7 billion people in the world live on $2 or less a day
• More than 2.5 billion potential clients have no access to financial
services
• Estimates for total number of MFIs worldwide range from 7,000 to
12,000

7. Microfinance by the Numbers (2/2)
• Around 750 million savings and loan accounts in double-bottom line
financial institutions
• Specialized MFIs account for about only 18 % of these accounts

8. Finance for All?
access to finance poverty
inequality growth
• Informational Asymmetries
▫ Moral hazard
▫ Adverse selection
• Transaction Costs

9. Diversity of financial services
• Poor people need a wide array of flexible financial services
• A demand driven approach will encourage portfolio diversity by
offering the poor a variety of financial services:
 deposit services
 a variety of loan products
 insurance
 transfer
 payments
 remittance services Secure
Convenient
Flexible

10. Diversity of formal providers
• NGOs (various forms)
• Commercial finance (and leasing) companies
• Financial cooperatives
• Commercial banks
• A variety of government-run and/or government-owned
financial service entities
• New players on the scene:
▫ Nonbank retail agents supporting ‘branchless banking’ models
▫ Mobile phone operators and nonbank prepaid card issuers

11. Bank Downscaling Model
• Definition: Downscaling is all about enticing mainstream
commercial banks to provide microfinance services.
Downscaling is not a consumer lending to lower income clients
• Advantages: already has the infrastructure and the banking
knowledge
• Challenges: few bank managers have the vision or the desire to
“downscale” (conservatism)
• Examples: Kazakhstan Small Business program (7 banks), Russia
Small Business Fund (17 banks), China Delelopment Bank Program
(12 banks), Egypt Banque du Caire, Brazil Banco do Nordeste

12. Greenfield Model
• Definition: Greenfield banks are new institutions specialized in
microfinance usually set up as corporations by a microfinance
investment company in cooperation with a consulting firm and
supported by a funder (mostly DFIs).
• Advantages: Greenfields have a banking license from the beginning
and can offer a diversity of financial services. They focus on poor
clients and reach new market segments.
• Challenges: High start-up costs, possible hidden subsidies => exit
strategies for public funders
• Examples: ProCredit Banks in ECA; Advans in Cameroun;
Opportunity Banks, BRAC in Afghanistan, ACLEDA in Laos
• Funders: KfW, IFC, FMO, EBRD, World Bank, DOEN Foundation

13. NGO Transformation Model
• Definition: a microfinance non governmental organization
transforms itself into a licensed institution to raise deposits from the
public
• Advantages: NGOs usually serve lower segments of the population
and have a double bottom line (social responsibility). It enables the
NGO to expand its services and outreach and poor people to
access much needed voluntary deposit services.
• Challenges: transformation is painful for “non-bankers type”. The
reporting requirements are expensive.
• Examples: Card Bank in the Philippines, EMT in Cambodia, BRAC
in Bangladesh

14. Cooperative Model
• Definition: developing member-owned saving and credit institutions
which are registered as cooperative
• Advantages: relatively low cost and enable members to have a say
in the way the organization is run.
Financial cooperatives have emerged in 19th century – long
experience
• Challenges: governance is often an issue as well as the
supervision of cooperatives because cooperatives often fall under
supervision authorities that lack financial knowledge
• Examples: Desjardin replications, Woccu members and saving and
credit cooperatives in Africa

15. Branchless Banking: Agent Model and M-Banking
Traditional Branch ATM Agent with POS terminal Agent No agent
branch within with (cashless)
store mobile

16. M-Banking: M-Pesa
ownership legal structure e-money equivalent of e-money

17. Successful business models: context
matters
EACH COUNTRY IS DIFFERENT
DIFFERENT FACTORS MATTER
Political economy
Existing regulation
Strength of existing institutions
Stage of financial sector development
Existence of market infrastructures
Availability of technologies
Population density
Levels of poverty
Competition

18. Expanding access to finance: regulation
matters (1/2)
“When we take savings in India, it is actually in violation of the law. I have a
structure with eight entities in order to sidestep enough of the law that
it stays below the radar.”
Vikram Akula - McKinsey Consultant and Founder and Chair of SKS India
“Think of the financial sector as a three-legged stool; if the law is the seat of a
three-legged stool, regulations are the legs. One leg is safety and
soundness. One is profitability and innovation, and one is consumer
protection. All these virtual legs are equally strong and supportive and
each is essential to maintaining balance. It is through effective and balanced
regulations and rules that the system has retained its integrity, its edge and
its ability to deliver capital where it is needed. Regulations should allow this
more risky activity to be profitable.”
Diana Taylor - New York State Banking Superintendent

19. Expanding access to finance: regulation
matters (2/2)
“Financial regulation around the world was designed to prevent fraud and to
insure stability of the financial system, how did it evolve into an
instrument that prevents innovation in financial services and broad
access to credit? Unfortunately, it is no accident. Many intermediaries benefit from
restrictions to competition and may see universal access as a threat. For this reason,
the struggle to reform regulation in favor of microfinance is not an easy one.”
Luigi Zingales - Robert C. McCormack Professor of Entrepreneurship and Finance at the University of Chicago
“Governments, including central banks, must balance the responsibilities they have
been given related to their banking and financial systems. We have the
responsibility to prevent major financial market disruptions through
development and enforcement of prudent regulatory standards and, if necessary, in
rare circumstances, through direct interventions in market events. But we also have
the responsibility to ensure that the regulatory framework permits private
sector institutions to take prudent and appropriate risks, even though such
risks will sometimes result in unanticipated bank losses or even bank failures.”
Alan Greenspan - former Chairman of the Federal Reserve of the United States

20. Terminological Confusion
• Different countries use same terms differently
• Different countries use different terms to mean the same thing
• Non-lawyers use terms differently from lawyers and regulators
• MFI and microfinance
▫ are not regulatory terms, except in a small number of countries
where they have been added recently
▫ could mean many different things, depending on the country
e.g. proposed regulation in Egypt permits a loan of up to US$100,000
to be considered a microcredit loan, while in Lebanon the cap is
placed at approximately US$6,000

21. Microfinance is the provision of a broad range of financial services such as
deposits, loans, payment services, money transfers and insurance products to the
poor and low-income households and their microenterprises.
By definition, microfinance is not subsidized credit, not a dole-out, not salary or
consumption loans, and a cure-all for poverty.
Bangko Sentral ng Pilipinas (BSP)
21

22. Frameworks
• Institutional
• Policy
• Legal and Regulatory

23. Institutional Framework (e.g.)
refers to the implementation of bodies, policies and tools to support and
promote the legal framework and the regulatory framework, but also a
sector or an activity, such as the provision of financial services to the poor.
• Authority in charge of Banks/Coop/MFI/others
licensing
• Authority in charge of Banks/Coop/MFI/others
supervision
• Public administration in charge of financial sector
support
• Public guarantee fund
• APEX institution
• Role of MFIs national/regional network

24. Policy Framework (e.g.)
• National Strategy and/or Policy of which Micro-Finance is a part
▫ National Poverty Alleviation
▫ Economic and Monetary
▫ Financial Sector
▫ Agriculture
▫ SME
▫ Microenterprises
▫ Unemployment
▫ Youth & Women
• Wholescale debt relief initiatives (generally in agricultural loans; ie
India)
Directed Lending / Priority Sector Lending In India, public and private domestic banks
• are required to lend 40% of ANBC to priority
sector, of which 18% to agriculture sector,
and a major stake to micro and small
enterprises. In Brazil, private banks must
assign their mandated 25% of deposits to
any agricultural clients, and 2% towards
microfinance operations.

25. Access to Finance and Regulation
• Jordan No MF Regulation
• Syria MF Decree (2007)
• Lebanon No MF Regulation
• Egypt Single Regulator Act / General Rules for Microfinance
Companies
Not only financial/banking regulation, but a multitude of laws and regulations
affects financial inclusion, the provision of microfinance services and the access!
Regulation
Laws Set of rules adopted by a legislative body
Regulations Set of rules adopted by an executive body
Supervision External oversight aimed at determining and enforcing
compliance with regulation.
Do not regulate what cannot be supervised!
25

26. Basel Committee for Bank Supervision at BIS
BCBS
• Established by G-10 in 1974
• 13 Member countries, industrialized nations, represented
by central bank
• Forum for cooperation on bank supervisory matters
• Encourages convergence toward common approaches
and standards
▫ no detailed harmonization
▫ No supranational authority, legal force
▫ Implementation of broad standards, guidelines tailored to
country context

27. Basel Capital Accords
• 1970s oil and debt crises highlighted need to better
supervise internationally active banks
• Basel Capital Accord (1988) attempts to reduce bank
failures by tying bank’s CAR to riskiness of loans
• Aligns capital standard with basic credit risk
measurement framework
• Introduced in virtually all countries with internationally
active banks

28. Basel II
• In process of implementation
• Greater role played by bank management and market
• Better align capital to underlying risk
• Incentive to improve RM
• Comprehensive coverage of risks
▫ Applicable to wider range of banks (more options)
• Proposed: largest internationally active banks (eg Citi, HSBC)
• Reality: estimated 100 countries (and counting) plan to implement
Basel II
▫ Should not apply to MF banks based on BCBS parameters (eg
asset size, international activity, supervisory capacity)
▫ Mix data: 7% MFIs are banks, but extend 57% of microloans
▫ Borrowing costs may increase, most MFIs will be subinvestment
quality

29. Basel Core Principles for Effective Bank
Supervision (BCPs)
▫ 25 principles cover range of supervisory and risk
management topics and issues
▫ Core Principles Methodology - facilitates
implementation and assessment
Gold standard, benchmark for regulation and
supervision of deposit takers

30. BCBS subgroups and MF: ILG and CPSS
• International Liaison Group – ILG
▫ Forum to deepen BCBS engagement with
nonmember countries on range of issues
• BCBS members (8) and nonmembers (16), EC, IMF, WB,
FSI, ASBA, Islamic FSB
• Working groups: Capital (ILGC) and AML/CFT (AML/CFT
EG)
• Main entity working on prudential MF issues
• No explicit access/inclusion mandate in BCBS
• The Committee on Payment and Settlement
Systems - CPSS

31. Why to regulate? Hypotheses
• to reduce the level of risk bank creditors are exposed to (i.e. depositors)
• to protect clients, and investigate complaints (i.e. representation of interest
rates)
• to reduce systemic risk resulting from adverse trading conditions for banks
causing multiple or major bank failures
• to avoid misuse of MFIs and banks for criminal purposes (i.e. laundering the
proceeds of crime)
• to prosecute cases of market misconduct
• to protect banking confidentiality
• to direct credit to favored sectors or borrowers
• to license providers of financial services
• to maintain confidence in the financial system
• to attract investments
• in general, to reduce the moral hazard of the actors
• to increase financial inclusion (i.e. reducing adverse selection)
• to promote the development of the sector and access to finance

32. How to regulate?
Prudential and Non-Prudential Regulation
for
• Some rules have both functions
• Soft regulation
• Self-regulation
Should these norms differ from those applied to commercial banks that offer
more typical financial products?
32

33. The Costs of Regulation
• Compliance
• Supervision
• Enforcement
• Direct/Indirect/Hidden
Substitution effect

34. What to regulate?
o Institution/s? o Activities?
Syria (pending)
o Deposit-taking? o Credit providers?
institutions

35. Capitalization requirements and risk
management
• Minimum capital
• Initial reserve requirements Jordan For-profit entities (commercial
companies) and NGOs are allowed to
• Liquidity requirements engage in microlending with NO
Capital adequacy / gearing ratios license & NO minimum capital
• requirements)
• Risk-weighting of assets
• Loan loss provisioning
• Loan loss provisioning fiscal treatment
• Concentration of risk
• Unsecured lending limits
• Restrictions on use of funds

36. Ownership and Governance
• Standards for ownership officers
• Restriction on foreign ownership
• Other restrictions on ownership
• Standards for managers
• Possibility to create stock-options or other incentive tools
for management by the shareholders
• Restrictions on managers
• Other governance standards and restriction
• Prohibited sources of funds

37. Accounting, auditing and reporting
requirements and operational concerns
• Accounting norms
▫ Estimated cost of auditing requirements
▫ Estimated cost of reporting requirements
• Loan contract registration
• Collateral registration
• Loan recovering enforcement legal tools
• Connected/insider business
• Involuntary and voluntary liquidation procedures
• Corrective action powers

38. Fiscal Concerns
• Tax breaks Jordan Tax exemption for all MFIs (Cabinet
decree 2004)
• Taxes on income Syria NGOs: exempted
SFBIs: corporate tax
• Taxes on transactions Lebanon NGOs & Coops: exempted
• Taxes on payroll Financial Institutions: corporate tax
Egypt NGOs: exempted
• Double taxation treaty MFCs: corporate tax
• Others

39. Intermediation

40. Regulating Credit Only Financial Institutions
• Registration with authorities
• Tax benefits
• Annual financial statements/audits (perhaps only relevant if MFI is
borrowing from commercial banks)
• Limited reporting of activities/business for statistical purposes
• KYC (Know your customer)
• Anti-money laundering/combat financing of terrorists (AML/CFT)
• Consumer protection (particular attention to overindebtedness)
• Interest rate regulation/usury
• Consider possible abuses:
▫ across variety of products (not just credit);
▫ over life cycle of product (marketing, delivery, collection)

41. Consumer Protection
Critical issues in the contractual relationship
Transparency
Suitability
Fair treatment
Privacy
Before sale
At the Sales practices
moment of Information and **
sale disclosure
Design of products
*** Collection Customers’
During the and contracts
practices data
execution *
**** ******
Redress and recourse
After the
mechanisms
execution
******
* e.g. terms and conditions, rights and obligations, right to withdraw from the contract, to change product or switch
provider, repayment breaks; unilateral changes and automatic adjustments; prevention of overindebtedness
** e.g. of rates, terms, and conditions, of rights and obligations, of the characteristics of the product or service, of
redress and recourse, of changes in rates, terms, and conditions; what information and disclosure (type) and
how (language, format, timing, location) are provided; transparency (standardization, comparability, public availability)
*** e.g. advertising and marketing, affordability, incentives for the agents, prevention of overindebtedness
**** e.g. delinquency and privacy, incentives for the agents
***** e.g. personal and financial; re: prevent overindebtedness
****** e.g. procedures to detect and respond to mistreatment or abuse

42. Interest Rates (1/2)
JORDAN EGYPT LEBANON SYRIA
Interest rate cap 9% (Civil Procedural Law) Interest rate cap 7% No interest rate cap on Interest rate cap 9%
Financial Institutions are exempted (Civil Code) commercial (Civil Code)
(Banking Law) Only banks are transactions (including SFBIs: set by CMC
What is the legal status of current MFIs? exempted (Banking Law) “Small Loans” (like banks)
A Financial Institutions is a company Cap on Civil
whose objectives include financial activities transactions 12%
with the exception of accepting
unconditional deposits.
Microcredit rates have been dropping by 2.3 percentage points each year since 2003, much more steeply
than the decline of bank loan rates. In the MENA region, interest yields declined by 3.9 percent between
2003 and 2006. (CGAP, 2008)
400 sustainable MFIs
reporting to the MIX in 2006,
the median borrower paid
bout 31% per year.

43. Interest Rates (2/2)
CGAP 2004: IRs caps in 40 developing countries
• 20 interest rates control
• 13 usury limits
• 7 de facto controls

44. Regulatory Issues for Foreign Financing
• Equality of treatment of foreign investors with local investors in case
of crisis
• Relevant procedure of conflict resolution in case of commercial
disagreements with the public, private local and private foreign
partners.
• Possibility to cash dividend from equity investments
• Tax treatment of foreign investment
• Foreign ownership restrictions and governance matters
• Availability of hedging instruments and cost of hedging
• Sequestering foreign direct investments for long periods of time
(Argentina, Brazil and Venzuela)
• (in)Ability to repatriate profits

45. References
• Finance for All? Policies and Pitfalls in Expanding Access (The
World Bank, 2008)
• The Portfolio of the Poor (Collins et al., 2009)
• Consensus Guidelines: Guiding principles on regulation and
supervision of microfinance (CGAP, 2003)
• Rethinking Banking Regulation (Caprio et al., 2008)
• Islamic Microfinance, a Market Niche (CGAP, 2008)
• Microfinance Regulation Curtail Profitability and Outreach? (Cull et
al., 2008)
• cgap.org (MENA Update - April 2009)
• microfinancegateway.org
• microfinanceregulationcenter.org
• themix.org

46. Advancing Financial Systems
for the World’s Poor
Thank you!