> Posted by Dave Grace, Managing Partner, Dave Grace & Associates
Several months ago I attended a seven hour annual general meeting (AGM) of a client-owned microfinance institution where I heard a long stream of angry and sad members recount stories of the potential loss of their life savings. The primary purpose of the AGM was for the regulator of this intervened institution to hear from the thousands of clients whether they wanted to collectively pay US$14.6 million to recapitalize their institution or to liquidate it and lose their money. This was not an insignificant question for the country as the defunct institution held deposits equal to 12 percent of the country’s GDP. The AGM went so late that most of elderly couples, who are the largest depositors, had long since left before the critical vote was taken to recapitalize the entity.
Although there was ample disclosure and discussion of the 30+ pages of financial statements distributed in advance and prepared by a top-notch big five accounting firm, few, if any, of the clients understood them. What every member did understand was that the regulator and its advisors (including myself) were offering two bad choices. Their raw emotions were a testament to that.
As we look at improving the consumer protection environment for institutions that serve the base of the pyramid (BoP) and try to define what “quality” financial services means, we need to give deeper thought to how savers are affected. At this intervened institution clients were required to save US$20 each month. If they did not save this amount their accounts became “delinquent.” Clients who had rejected or just couldn’t afford the mandatory savings were some of the hardest hit. They agreed to convert part of their savings to capital in the institution with the hope of better days and the ability to sell or withdraw their shares in the future.
While consumer protection issues are important for borrowers, they can loom even larger for savers. Yes, I’ve witnessed microfinance borrowers in an African country getting a raw deal when they are sold an interest rate of 18 percent but actually charged flat rates plus fees and prepayment penalties so that the lender appears competitive with commercial banks’ 19 percent declining balance rate. Not that anyone should have to, but if I had to choose between having unclear (or deceptive) loan rates on the one hand and on the other losing access to my savings for up to 24 months in an intervened institution and being forced to convert US$375 plus 10 percent of my savings to long-term capital for the institution, the shock to savings would be a lot worse.
Survey results released last week at the Alliance for Financial Inclusion’s Global Policy Forum showed that only 50 percent of deposit-taking MFIs and 26 percent of financial cooperatives are prudentially supervised (the intervened institution referenced above was not prudentially supervised). AFI’s survey also showed that deposit-taking MFIs and financial cooperatives are much less likely than commercial banks to have deposit insurance or access to central bank borrowing to get them through a liquidity crisis (neither of which was available to protect clients in the intervened institution). It isn’t just that we need better prudential supervision, but rather market conduct supervision and prudential supervision need to complement each other and be buttressed by a sound financial infrastructure.
Small BoP oriented institutions are often the only source of access to financial services for millions of people. We need to put in place the financial infrastructure components to provide consumer protections for their savers as well as borrowers.
Dave Grace is the Managing Partner of Dave Grace & Associates, an international boutique consulting firm which focuses on financial cooperatives, supervision, deposit insurance and financial sector strengthening. Its clients include the World Bank, International Monetary Fund, the Alliance for Financial Inclusion, United Nations, the Center for Financial Inclusion, Filene Research Institution, financial cooperative associations, and central banks. Prior to launching his firm Mr. Grace was Senior Vice President for the World Council of Credit Unions, Inc. (WOCCU) for 14 years.
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September 16, 2013 at 10:05 am
Y P Issar
While one agrees with the consumer protection being of high import to savers in BOP institutions, one wonders how this type of options are allowed at the first place where deposit contribution per month is mandatory and if one fails, balance is allowed to be transferred to capital of MFIs. No amount of regulation can save savers if basically faulty schemes are allowed to start. Then the institution also created systemic risk for the country concerned. International institutions working in BOP financial services space must divert more resources to make countries aware of this type of failures so that savings of poor are absolutely protected.
Indian regulator- Reserve Bank (RBI) has not allowed MFIs to collect savings despite all the clamour for the same.
Above example simply confirms the need to follow RBI’s approach as what can not be controlled must not be allowed in financial services.
September 16, 2013 at 3:25 pm
Dave Grace
YP – Thanks for the comments. Once an institution takes deposits it (should) enter a new level of oversight. It is difficult to informal groups that pool savings but when they self liquidate in 12 months as planned there is limited risk. Unfortunately big numbers of financial cooperatives and postal savings banks remain with no prudential or market conduct oversight.
September 18, 2013 at 11:21 am
John Gitau
Hi Dave! Your post is good and reveals some of the new challenges that come with serving the poor in the financial inclusion sphere.
Oversight is sometimes a generic placebo, a roll of opium that keeps people high on pseudo-protection feeling and at best a house on quick sand. It doesn’t totally remove systemic financial risk. The 2008 US sub-prime debacle is an example of what can go wrong even under the very nose of oversight-it almost brought the globe on its financial knees.
Upon a close reading of the book “Savings Group in the Frontier” edited by Candace Nelson( I thank Dr. Susan Johnson for giving me a copy), it is tempting to agree with YP that the poor are better of left to manage their savings informally. It may represent slow growth and a drag on financial inclusion but if we think about it, deposit taking MFI are managed by people who are not poor and may not understand the potential pain of losing a lifetime saving.
Saving and credit are two different products. While profit based MFIs lend their money to the poor at interest rates above 10% per year and make good profits( high risk on their capital,for high returns) the little interest the poor get from their savings( on average below 5% per annum) is not worth the risk if we consider the additional manipulative exposure that comes along as demonstrated by Dave.
If through savings the poor get exposed; credit they get over-indebted and insurance they get deceived, yet these are the pillars of financial inclusion, which way do they go? Perhaps they should just be supported to do what they know best the best way they know how. I know this sounds pessimistic knowing that MFIs have done a good job for the poor within the three pillars and they continue to do so, but we have a duty to address any risk we foresee and Dave’s suggestion on tighter oversight is still a good idea.