Recommendations for a Legal and Regulatory - PowerPoint Presentation

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Recommendations for a Legal and Regulatory

Framework for Microfinance in Serbia

Small and medium enterprises (SMEs) are

critical

to increasing employment and economic growth and decreasing poverty in Serbia

Two-thirds of SMEs in Serbia report problems getting creditAvailable loan products are poorly suited for SMEs in terms of loan size, collateral requirements, and physical accessMicrocredit provides an alternative, market-based approach to providing financing better suited to the needs of SMEs However, legal and regulatory framework prevents existence of “real” microfinance industry in Serbia

Access to finance a problem for SMEs

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High demand/unmet need

Estimated potential portfolio for microcredit is EUR 267M

Only 2-7% of current demand being met

“Missing” middle between current microcredit (EUR 960-1,600) and bank loans (> EUR 10,000)

Strong investor interest

Investors actively looking

for

investment opportunities given saturation in other markets in region

Numerous investors already expressed interest in investing ~EUR 40M

in existing providers

With an enabling legal framework, it is estimated that loan portfolios could expand by 50% at existing providers alone

Microfinance has real potential in Serbia

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Overindebtedness

and Financial Crimes

Harmonization with Existing

Regulatory FrameworkLaw on Microcredit Companies (MCCs)Components of microcredit regulatory framework

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Strike

appropriate balance

between providing minimum requirements for key legal components while not overregulating

Overburdening non-deposit-taking institutions with excessive regulation increases compliance costs, ultimately decreasing access to financeA risk-based approach is recommended by the EU

Key components of MCC law

Definition of “microcredit”

Registration of MCCs

Ownership and governance

Permissible activities

Prudential regulation, loan loss provisioning, and risk management

SupervisionReporting and auditing requirements

Others…Guiding principles for MCC law

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Definition of “microcredit”

Considerations

Recommendations

Type of Client & Use of Funds

Loan Size Limits

Two-pronged approach allows MCCs to serve some clients with larger loans, while majority of clientele remain low-income clients

Look to current microcredit operations as starting point, consider how portfolio may evolve with MCC law

If included, use general language to convey policy intentions

Goal of microfinance to “alleviate poverty, increase employment, assist in the development of social entrepreneurship” in Kyrgyz Republic

Helps prevent regulatory arbitrage by institutions with different objectives

However, limits flexibility of MCCs to serve necessary range of clients

Difficult to determine where to draw the line

Recommended as more concrete method to maintain policy focus

Two-pronged approach:

Higher single loan size limit, plus

Lower average outstanding loan balance

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Registration of MCCs

Initial minimum capital requirement: low enough to allow entry of new MCCs, high enough to bar entry of unprofessional institutions

Risk-based

approach recommended, with less extensive registration requirements than for banks“Licensing” vs. “registering”May require registrants submit:Ownership structureDirectors and senior managementEvidence of minimum capital paidInitial operating plansLink requirements to confirming compliance with regulatory objectives

Case Studies

Microcredit agencies (MCAs) and microcredit companies (MCCs) obtain certificate (not license) from National Bank of Kyrgyz Republic

Documents required:

Application

Establishment documents

State registration certificate

List of members of management bodyConfirmation of funds as charter capitalMinimum capital for NBFIs in Romania is EUR 200,000

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Ownership and governance and permissible activities

Permissible activities

Permission to lend

Consider: financial leasing, guarantees, factoring, insurance intermediaries, payment and transferAllow secondary, related activities (i.e. training)Ban deposit-taking, though clarify regarding cash collateral

Ownership and governance

Ensure requirements don’t impede foreign equity holders or foreign investorsInclude “fit and proper” requirements for directors and

officers, adapted for microfinance

Other corporate governance rules should be limited and not overly prescriptive

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In general,

prudential regulation not warranted for MCCs

as they do not pose systemic risk or put public savings at risk

Imposes unnecessarily high compliance costs on supervisors and MCCs alikeIf standards issued for certain topics such as client documentation, leverage ratios, or risk management, should be adapted for microlending  simplified and allow room for innovationMCCs need ability to create loan loss reserves and write-off such serves for tax purposesAny guidelines for loan classification should be adapted for microcredit (i.e. more aggressive provisioning for delinquent microloans)

Prudential regulation and loan loss provisioning

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The supervision question

Option 1: Delegated supervision (recommended)

Option 2: Self-regulation

Supervision

by

industry association

Has traditionally achieved mixed results with respect to prudential supervision

May still be beneficial for consumer protection purposes, and least costly option

Association could take on responsibilities listed above

Industry association serves as agent for

MoFE

or NBS

Provides formal link to financial regulator and allows

MoFE

or NBS to monitor and control association’s work

Association could collect registration info, collect data and reports, recommend sanctions, and provide consumer protection oversight

Responsibilities could include:

Maintain public register of approved MCCs

Serve as repository of periodic reports by MCCs

Develop and promote sound financial performance and consumer protection standards

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Critical that

financial consumer protection rules

apply to MCCs and microcredit clients

Typical microfinance clients have low-literacy, low-numeracy, and less familiarity with formal financial sectorAll providers of similar financial services should be held to same consumer protection standards, to provide level playing field and comprehensive protection to consumersHowever, existing consumer protection rules in Serbia limited to natural persons or banks, resulting in gaps in coverage Recommendation: Revise rules to cover microenterprises and MCCs, and consider what body will be responsible for monitoringAlso harmonize: tax, accounting, payments, bank laws and regulations

Harmonize with existing regulatory framework

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Addressing

overindebtedness

and financial crimes

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Financial crimes

Non-depository microcredit providers

not

historically part of pyramid schemes or similar abuses

Regardless, MCCs should be subject to existing controls to prevent AML/CFT, fraud and financial crimes, and identity fraud

Financial Action Task Force (FATF) recommends

risk-based approach, adapting rules for characteristics of microfinance (i.e. customer due diligence)Overindebtedness

Microfinance not inherently riskier than bank lendingRisk factors: irresponsible provider behavior, poor borrowing decisions by consumers, oversaturation of microcredit marketTools to address risk:

Credit bureaus (mandate participation by MCCs) and assessment of creditworthinessDisclosure and transparency

Financial literacy and educationMarket monitoring

Complementary policy initiatives and long-term financial inclusion strategy

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New MCC legal framework should be accompanied by

well-targeted, complementary policy initiatives

Guarantee programs to domestic banks for wholesale funding to MCCs

Targeting of development funds

Reaching out to and encouraging investments from international investors, including shifting target of existing internationally-funded credit lines for SMEs to smaller loans/clients

Long-term financial inclusion strategy

needs to be developed, addressing issue from multiple angles

When to transition to deposit-taking microfinance institutions (MFIs)Strategic adjustments to prudential framework that encourage banks to move down market, balancing with need for financial stability and management of risk

Next steps to consider

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Assess the potential impact of microcredit in Serbia

Assess the potential for investment in microcredit in Serbia

Convene stakeholders and form an official working group

Begin process of drafting MCC law