> Posted by the Platform for Inclusive Finance (NpM)
How has the microfinance industry leveraged regulation and supervision to safeguard client wellbeing? In priority areas like over-indebtedness, acceptable pricing, and transparency, what progress has been made to ensure that institutions are operating responsibly? And in cases where regulatory actions have been taken, how have they been implemented? A recent research project conducted by EY and the Platform for Inclusive Finance (NpM) investigates these questions across 12 country markets and assesses the current state of client protection regulation in microfinance.
The growth of the inclusive finance sector has helped create significant opportunities for low-income people around the world. However, when not done correctly, access to financial products also has the potential to bring harm. Of the increasing importance of client protection and sound regulation, EY Senior Manager and one of the report’s authors, Justina Alders-Sheya remarked: “The sector is growing and to do so responsibly, it is necessary that supervisory authorities perform their role.”
Drawing on questionnaires completed by local stakeholders, the study examined whether laws and regulations on client protection have been implemented in any way in the 12 studied countries: Azerbaijan, Bolivia, Cambodia, Ghana, India, Kenya, Peru, the Philippines, Rwanda, Russia, Tanzania, and Uganda. The study also examined the regulatory and supervisory landscape for client protection in each country. It investigated who is creating the regulations, how they’re being enforced, and the role of industry players like microfinance associations and credit bureaus.
Key players in the microfinance sector launched the Smart Campaign to improve protection of clients throughout the industry. This international initiative for responsible microfinance has seven Client Protection Principles. This study focused on three of those principles: prevention of over-indebtedness, responsible pricing, and transparency.
What did the research uncover?
In large part, the legal and regulatory landscape for microfinance is still developing. Not all countries have specific law or regulations for the microfinance sector, but seven of the 12 studied countries (Bolivia, Cambodia, Ghana, India, Kenya, Russia, and Uganda) do. However, these specific measures do not necessarily include provisions on client protection, as most are focused on financial requirements for microfinance institutions.
In terms of over-indebtedness, the research shows that less than half of the studied countries have rules for adequate care during all steps in the credit process. Only five countries have specific microfinance regulation aimed at preventing over-indebtedness, despite the fact that research participants perceive over-indebtedness as a big issue across the global industry. Many MFIs are non-deposit-taking (NBFC-MFIs) and thus don’t fall within the regulatory framework for commercial banking, which may address over-indebtedness more explicitly. In Cambodia, for example, NBFC-MFIs are excluded from the obligation of monitoring total loan exposure to single beneficiaries. A bright spot in this space is Tanzania, which through the Microcredit Activities Regulations (2004), requires all institutions engaged in offering microcredit to conduct an appraisal of the character, payment history, and payment capacity of each client. Credit-reporting bureaus are still developing, making the availability of information on borrower indebtedness and repayment history, especially for smaller microfinance institutions, a concern.
On responsible pricing, seven countries do not have applicable regulations, referring instead to transparency and the sales process, with price-setting being left to the market. As for the five countries with such regulation, in Peru, Russia, and the Philippines microfinance institutions are covered by regular financial law and regulation concerning price-setting, and Cambodia and India have specific price-setting rules for the microfinance sector.
Laws and regulations on transparency in microfinance are the most well-developed of the three targeted client protection areas. Nine countries have regulations on the communication and dissemination of information between microfinance institutions and their clients. Beyond rules on clearly outlining the pricing, costs, and expenses, some countries extend their transparency regulations to other areas, like advertising, in Peru’s case.
Across the surveyed countries central banks are the most important law and regulation enforcement entities (in 11 countries). The study indicated that in countries where MFIs are under supervision, regular oversight visits to institutions occurred. Microfinance associations and special microfinance authorities also get involved in the monitoring and auditing of MFIs in some cases. In instances where there is no specific microfinance regulation, NBFC-MFIs are not always audited. Consumer protection agencies also sometimes contribute to addressing client protection in microfinance. On the whole, many different types of authorities are involved in law and regulation, with varying levels of monitoring and audit scrutiny.
Beyond these areas, Josien Sluijs, Director of NpM points out the role of empowered clients in client protection: “In addition to regulation and enforcement, attention to financial literacy of clients is as important to develop and implement.” Enhancing financial literacy among clients is a necessary step in the movement to ensure that microfinance best serves its clients.
A logical step for follow-up of the study would be to research how to improve law and regulation in a practical way and to even develop a ranking of countries so that investors have good insight on the current status on law and regulation in different countries. This knowledge might even be included in investors’ due diligence. Points to consider for further research on this topic may be obtained from the report, which can be read by clicking here. To learn more about NpM, the Platform for Inclusive Finance, click here.
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Regulatory Complexity and Financial Inclusion
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March 30, 2015 at 3:15 pm
MFHeretic
Interestingly the report, EY and NpM seem to ignore one crucial aspect of client protection: are clients engaged in legal activities? Countries have laws beyond microfinance-specific laws designed to protect their citizens. For example, health and safety, child labour, preventing money-laundering, payment of taxes etc. Presumably one over-arching responsibility of any MFI is to lend only to clients who adhere to the laws of that country, and yet I saw no mention of this in the report. EY above all should be aware that financial institutions, particularly those that are at least nominally regulated, have an obligation to finance only legal activities, and yet we can safely assume that many such activities are ultimately illegal. In the case ot tax avoidance the MF sector seems to turn a blind eye, justifying this as normal in the informal economy (albeit illegal in countries such as the US or in Europe). Various papers have documented the uncomfortable link between microfinance and child labour, which clearly has a negative impact upon children and their education, and yet we willingly finance such enterprises. Child labour does not even get a mention in the Smart Campaign principles of client protection.
This may seem pedantic, but there are further implications. If MFIs make minimal effort to ensure that the businesses they finance are legal, it is questionable whether investors in the US or Europe (in particular the investment funds) may themselves invest in such MFIs. If a regulated investment vehicle (such as Deutsche Bank, Citibank, or the specialised funds such as Triple Jump or responsAbility) are funding MFIs that are in turn funding illegal activities, this may itself be illegal. Were such funds to lend to drug-dealers there would be an uproar. But if they lend to MFIs that chose to turn a blind eye to child labour, this is apparently acceptable? What do EY think of this? Or do they believe that microfinance only finances legal activities?