A comprehensive approach to reforming the microfinance related legal framework Armenia as a case stu

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(No Transcript)
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A comprehensive approach to reforming the
microfinance related legal framework Armenia as
a case study
7th Annual Conference of Microfinance
Institutions Warsaw, Poland May 27 29, 2004
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Overview of the session

• What do we mean by comprehensive what does
  this mean for
• the range of reforms sought?
• the content of the reforms sought?
• the approach taken to seeking them?
• Developing and applying global best practice

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Overview of the session (cont.)

• Range of reforms yes, the legal status of MFIs,
  but what other topics are hot and what about
  the clients?
• Content of reforms a microfinance-specific
  framework versus creating a suitable space for
  microfinance within the mainstream financial
  sector laws and normative acts
• What approach to seeking reform giving the
  sector an appropriate voice and a seat at the
  table with key policymakers

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Overview of the session (cont.)

• Well present our experience in Armenia, but the
  goal is to extract ideas that can be applied more
  broadly in countries throughout the region
• We plan to talk for 45 an hour, but we want
  your questions and comments as we go along
• We should have half an hour 45 minutes to
  broaden the discussion to other countries and
  others experience with microfinance-related
  reform initiatives

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Who we are

• Chrys Miliaras
• Worked with ACCION in Latin America
• Ran EBRD onlending program with banks in Georgia
• Chief of Party for Armenia MEDI
• Monica Harutyunyan
• Former Head of HSBC Legal Department in Armenia
• Legal Advisor, USAID Banking Supervision Project
  in Armenia
• Legal Advisor, Armenia MEDI
• Tim Lyman
• DBH Foundation President and Executive Director
• MFCs International Legal Issues Advisor
• CGAP Policy Advisor
• International Legal Issues Advisor to Armenia MEDI

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Background on Armenia MEDI

• USAID-financed initiative, implemented by
  Chemonics
• Component parts
• Increased Access to MSE Finance
• Increased Access to MSE Business Development
  Services
• Improved MSE Enabling Environment
• Centerpiece of Enabling Environment Component
  is comprehensive approach to reforming the
  microfinance related legal framework

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Context a few key facts about Armenia and about
microfinance in Armenia

• Microloan portfolio outstanding 32 million USD
• 21 million through German Armenian Fund
  commercial bank programs (primarily ACBA bank).
• 11 million through MFIs (including one
  commercial microlender)
• Microloan portfolio outstanding represents
  approximately 25 of total portfolio outstanding
  of entire banking sector
• 17 banks
• 9 microlenders
• 125 million USD banking sector portfolio
  outstanding

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Context a few key facts about Armenia and about
microfinance in Armenia (cont.)

• Overall microfinance sector has grown rapidly in
  past 2 years (2001 - 2003)
• For top five MFIs
• Portfolio outstanding has nearly doubled from
  approximately 5 million to 9 million 82
  increase
• of active clients has grown from 18,790 to
  28,516 52 increase
• Three main legal forms are carrying out
  microfinance
• NGO microlenders formed as foundations
• Commercial microlenders formed as LLCs and
  licensed as credit organizations
• Licensed commercial banks (including one
  specialized agricultural bank)

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Developing and applyingglobal best practice

• In July 2003, CGAP published Guiding Principles
  in the Regulation and Supervision of
  Microfinance
• Represent consensus on best practice principles
  based on global experience developed over the
  past 30 years
• But further development of our knowledge and
  understanding of these topics comes through
  practice
• The Armenia MEDI project represents a laboratory
  for applying the CGAP Guiding Principles in
  practice

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Developing and applyingglobal best practice

• Two of the topics well discuss today in our
  Armenian case study issues of the range and
  content of reforms pursued are addressed in the
  CGAP Guiding Principles
• On the third topic the approach taken to the
  reform process were hoping that Armenia MEDI
  will contribute to the development of new global
  best practice standards and concepts

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Range of reforms yes, the legal status of MFIs,
but what other topics are hot and what about
the clients?

• Legal status of MFIs
• Credit bureaus
• Legal status of clients

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Range of reforms yes, the legal status of MFIs,
but what other topics are hot and what about
the clients? (cont.)

• In countries throughout CEE and the NIS, various
  issues related to legal status of MFIs remain the
  most critical targets for microfinance-related
  reform
• Armenia is no exception
• Armenia MEDIs 2003 Survey updating a 2001
  diagnostic assessment supported by MFC identified
  significant issues for all three legal forms of
  institution presently carrying out microfinance
  in Armenia
• Microlending foundations
• Microlending companies
• Commercial banks involved downscaling

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Range of reforms yes, the legal status of MFIs,
but what other topics are hot and what about
the clients? (cont.)

• For microlending foundations
• In a legal limbo since adoption of Armenias
  Credit Organizations Law (which neither
  explicitly provides a space for them nor exempts
  them from its provisions)
• Unworkable 20 cap on administrative expenses
  (including all salaries) since the adoption of
  Armenias Law on Foundations
• In 2003, subjected to VAT (though exemption was
  restored beginning in 2004)
• Unavailability of profit tax deductions available
  to licensed financial institutions
• All are problems typical of those faced by NGO
  MFIs in other countries in the region

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Range of reforms yes, the legal status of MFIs,
but what other topics are hot and what about
the clients? (cont.)

• For microlending companies (which exist already
  in Armenia)
• Situation was clarified by the adoption of the
  Credit Organizations Law (which clearly covers
  them) BUT
• Now they are subject to inappropriate prudential
  type (i.e., banking type) reporting and capital
  requirements
• For banks engaged in downscaling
• Significant practical obstacles in required
  procedures for uncollateralized lending (to avoid
  prohibitive reserve requirements)

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Range of reforms yes, the legal status of MFIs,
but what other topics are hot and what about
the clients? (cont.)

• As in many other countries in the region, legal
  issues related to credit information services
  (credit bureaus) have surfaced as an important
  new hot topic of interest to microfinance in
  Armenia
• Armenia already has a public sector credit
  registry, but only licensed institutions are
  included and access is subject to a strict Law on
  Bank Secrecy
• But a private sector credit bureau modeled on
  the European and North American credit and
  payment information services markets is a very
  different undertaking

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Range of reforms yes, the legal status of MFIs,
but what other topics are hot and what about
the clients? (cont.)

• Armenia MEDI is taking the lead for the whole
  financial sector in researching the legal changes
  that will be needed or advisable for the
  development of a private sector credit bureau
• Our recommendations aim at a balance between
• The interests of credit bureau operators, those
  who supply information to them and those who
  purchase their credit reports
• The interests of individuals and businesses whose
  data are collected and disseminated, especially
  their privacy and data accuracy interests

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Range of reforms yes, the legal status of MFIs,
but what other topics are hot and what about
the clients? (cont.)

• Client-focused reform business registration of
  MSEs
• Armenia MEDI research proved that the real
  obstacle to business registration was not the
  legal framework itself (more or less acceptable)
  but implementation and a lack of readily
  available information to MSEs on how to register
  their businesses
• Proves the point that a proper legal and
  regulatory environment is necessary but not
  sufficient in ensuring a favorable enabling
  environment for MSEs
• Effective implementation of the legal framework
  and dissemination of information about the law
  are equally important
• Toward these ends, Armenia MEDI has created the
  Entrepreneur Road Map, a user friendly guide to
  business registration
• The Road Map is the first in a series of Armenia
  MEDI publications to help educate MSEs on the law

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Content of reforms a microfinance-specific
framework versus creating a suitable space for
microfinance within the mainstream financial
sector laws and normative acts

• In some countries in the region, often for
  pragmatic reasons, a separate microfinance-specifi
  c legal framework has been created along side the
  existing legal framework for the mainstream
  financial sector
• Example Kyrgyzstan
• In other countries, the Western European and
  North American approach is being followed, where
  MFIs operate under the same rules as the
  mainstream financial sector
• Example Russia

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Content of reforms a microfinance-specific
framework versus creating a suitable space for
microfinance within the mainstream financial
sector laws and normative acts (cont.)

• In some countries, a middle ground is being
  found, where a suitable space for different types
  of microfinance is being created by adding some
  specialized rules and even categories of
  institutions within the mainstream framework
• Example Kazakhstan
• In Armenia, were following this third approach

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Content of reforms a microfinance-specific
framework versus creating a suitable space for
microfinance within the mainstream financial
sector laws and normative acts (cont.)

• But the most important question is not whether
  separate rules are developed that use the words
  microlending or microfinance, but rather the
  content of the rules
• This means, among other things, making sure that
  MFIs are not subject prudential regulation (i.e.,
  banking type regulation) unless they truly pose
  a risk of losses to depositors or of causing
  instability in the wider financial sector if they
  fail

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Content of reforms a microfinance-specific
framework versus creating a suitable space for
microfinance within the mainstream financial
sector laws and normative acts (cont.)

• In Armenia, therefore, were working towards the
  creation of a suitable non-prudentially regulated
  space for two different MFI types
• Microlending foundations
• Microlending companies
• Were also working to assure that there is a
  smooth path for organizations to transform
• From microlending foundation to microlending
  company
• From microlending company to licensed commercial
  bank

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Content of reforms a microfinance-specific
framework versus creating a suitable space for
microfinance within the mainstream financial
sector laws and normative acts (cont.)

• What about the content of credit-bureau related
  reform should MFIs have their own credit
  bureaus and does this require separate
  microfinance related credit bureau legislation?
• Generally speaking, microfinance specific credit
  bureaus are a bad idea, because
• The more data in the system, the more useful and
  reliable the credit reports
• Credit bureaus are expensive, and there are no
  economies of scale if only MFIs report into the
  data base
• In many legal systems the needed legislation for
  MFI-specific credit bureaus would be the same as
  for credit bureaus serving the whole financial
  sector

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Content of reforms a microfinance-specific
framework versus creating a suitable space for
microfinance within the mainstream financial
sector laws and normative acts (cont.)

• Armenia MEDIs research shows that legislation
  for a microfinance specific credit bureau in
  Armenia would be as much trouble as legislation
  for credit bureaus serving the whole financial
  sector
• Main reason is meeting the E.U. standards on
  protection of personal data (and since most CEE
  and NIS countries either must or want to have
  E.U. compliant legislation, this will hold true
  in many countries in the region)

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What approach to seeking reform giving the
sector an appropriate voice and a seat at the
table with key policymakers

• NOT a straightforward question!
• Practitioner-led reform initiatives mixed
  results previously in Armenia
• Disaster of credit organizations law enactment
  without a space for noncommercial microlenders or
  an exception for them
• Big win of inclusion in roll-back of VAT on
  unlicensed lenders

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What approach to seeking reform giving the
sector an appropriate voice and a seat at the
table with key policymakers (cont.)

• Typical shortcomings of practitioner-led reforms
• Practitioners are not themselves financial sector
  regulatory experts, and technical expertise is
  essential
• Practitioners are focused on the interests of
  their organization rather than the sector as a
  whole and the clients
• Practitioners have too short term a focus
  (usually just the problem in front of them)
• Practitioners dont understand the regulators
  point of view (and often dont understand or take
  seriously the very important purposes of
  financial sector regulation)
• Practitioners have difficulty getting the
  attention of key policymakers

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What approach to seeking reform giving the
sector an appropriate voice and a seat at the
table with key policymakers (cont.)

• Another typical problem the policymakers
  themselves
• Regulators usually dont microfinance and tend to
  think of it as something very marginal
• They think of financial services for low-income
  people as inherently risky
• They dont understand the special risks that are
  involved in a portfolio with a large volume of
  small loans
• Financial sector policymakers come in two basic
  flavors financial sector protection-focused and
  financial sector development focused, but the
  protection-focused policymakers usually have a
  dominant voice in CEE the NIS

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What approach to seeking reform giving the
sector an appropriate voice and a seat at the
table with key policymakers (cont.)

• The Armenia MEDI approach
• Educate practitioners re global best practices.
• Legal and Regulatory Survey
• Stakeholder Policy Forum
• Suggest reforms that anticipate future sector
  problems, not just those facing the sector today
• Transformation
• Commercial debt (and equity for commercial legal
  forms)
• Moderate an exchange of viewpoints between
  practitioners and policymakers
• Stakeholder Policy Forum
• Working Group to develop legislation

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Replicable experience what reform issues may be
relevant in other countries?

• Most basic issue - legal and regulatory
  feasibility to form and operate MFIS - is
  becoming more certain in many countries
• Now MFIs are focusing on access to new sources of
  funding and capacity to transform into other
  legal forms
• In some markets, competition is increasing, and
  over-indebtedness may soon be a real concern (so
  legally and practically feasible credit
  information services credit bureaus - are
  becoming more important)

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Replicable experience what reform issues may be
relevant in other countries? (cont.)

• Consumer protection
• Threat of interest rate caps?
• Is transparent loan cost disclosure an
  alternative?
• And what about the clients?
• Greater practical feasibility to operate
  informally?
• Better prospects for successful clients to
  register their businesses?
• What are clients most pressing legal and
  regulatory concerns?
• In some countries basic legal rules are certainly
  still a concern
• But in many countries the rules have improved,
  and MSEs face worse problems with lack of
  awareness of the rules and poor or exploitative
  implementation practices

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Replicable experience How best to approach
policymakers? What role for practitioners? What
role for experts?

• The Armenia MEDI approach
• Pragmatic Not looking for the perfect solution,
  but providing policymakers with a range of
  options that will result the most realistic
  solution based on global best practices but
  consistent with Armenias political realities
• Education MEDI has methodically educated both
  policymakers and practitioners as to global best
  practices for the regulation and supervision of
  microfinance (Gaining buy-in on how microfinance
  should be regulated increases the likelihood that
  rules adopted will be acceptable regardless of
  who ends up being the regulator(s))

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Replicable experience How best to approach
policymakers? What role for practitioners? What
role for experts? (cont.)

• The Armenia MEDI approach
• Expertise Armenia MEDI offers both policymakers
  and practitioners access to the best available
  local, regional and international technical
  expertise, so that policy reform isnt improvised

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Replicable experience How best to approach
policymakers? What role for practitioners? What
role for experts? (cont.)

• The Armenia MEDI Approach (cont.)
• Timing The time is right to push the sector to
  another level
• MFIs are well-established, but there is
  tremendous room for improvement and growth
• Policymakers have acknowledged the importance of
  microfinance to the Armenian economy
• See it as an asset rather than a nuisance
• Previous education efforts are paying off (such
  as MFCs USAID- and OSI-sponsored NIS Policy
  Forum)

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Replicable experience How best to approach
policymakers? What role for practitioners? What
role for experts? (cont.)

• The Armenia MEDI Approach (cont.)
• Donor Coordination Armenia MEDI has gone out of
  its way to inform other donors as to its goals
  and activities so as to
• Ensure that all players are on the same page and,
  to the extent possible, that they speak with one
  voice
• Leverage other resources
• Armenia MEDIs MFI due diligence provides a means
  to broker future MFI investments by donors and
  socially responsible investors
• Getting donors, such as the World Bank, to fine
  tune their policy to support common goals
• Examples (1) cooperating on credit bureau
  enabling research and (2) pursuing
  microfinance-related policy conditionality on
  future World Bank credit

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Replicable experience How best to approach
policymakers? What role for practitioners? What
role for experts? (cont.)

• The Armenia MEDI Approach (cont.)
• Respect Armenia MEDI is acutely aware that no
  one has to listen to its advice
• It treats all of its counterparts with respect
  and works hard to show them that it has something
  worthwhile to offer (not just money) that can
  benefit them.
• This has paid off in the form of regulators, such
  as the Central Bank, soliciting input from MEDI
  on changes to normative acts that have a big
  impact on the microfinance sector

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Questions and answers - discussion