In developing countries, financial services to the unbanked are no longer exclusively provided by microfinance institutions, particularly NGOs or savings and credit cooperatives, that have shown signs of weaknesses (in terms of governance, undercapitalization, technological investment, etc.). Hence, some of these traditional actors have left part of their clients to new players (limited companies, mobile phone operators, etc.), which today define the scope of financial inclusion. In this new context, regulators have had to adapt their practices and to change their approach to the legislation and supervision of microfinance.
In a previous article published on the iD4D blog, we had exposed the role of microfinance supervisors.
Everything we wrote in this post in 2015 still holds true, and we continue to believe that the solution to a healthy development of microfinance lies in improving supervision. Indeed, while further improvements in legislation and regulations are still required, in order to increase and secure the flows of investments made by players – whether cooperative or commercial –, the bulk of efforts need to focus on establishing effective supervision based on risk mitigation.
Regulations gradually being adjusted to market realities
The first thing to note is that a number of regulations have, to varying degrees, been adapted to recent changes in the financial inclusion sector, in particular to the very rapid development of mobile banking. For example, some countries have already launched second generation regulations on electronic money and digital financial services.
However, the market entry conditions (such as capital requirements) set by regulators for financial institutions in the microfinance space in the WAEMU and CEMAC zones are probably too permissive, which can partly explain the presence of several weak players in the market. For example, many individual microfinance licenses are given to savings and credit cooperatives, whereas it would be more efficient in terms of supervisory costs and market security and stability to give licenses exclusively to those cooperatives affiliated to structured and efficient large networks (such as FUCEC in Togo, RCPB in Burkina Faso, the MUCODECs in Congo and CECAM in Madagascar). This is how some regulators (Madagascar, Guinea…) have decided to grant collective licenses to networks whereas others (such as the Central Bank for Central Africa or BEAC in French) are strictly tightening their requirements in terms of professionalism of the members of cooperatives’ governing bodies (Boards of Directors, Supervisory Boards, etc.).
Stricter market entry conditions should also be applied to limited companies: requirements in terms of capital requirement, reference shareholders, rigor of business plans, and efficiency of the information system sometimes fall short in ensuring that the licensed company is viable. Yet the sector does not need a large number of fragmented institutions, but a small number of strong and competitive institutions.
Conversely, the same regulators do sometimes appear to have irrational fears over the “new risks” brought about by technology-intensive remote banking, particularly in terms of technological flaws in the operator’s payment system, or over money laundering using electronic payment systems in real time. This sometimes leads to unwarranted regulatory barriers in view of the intrinsic benefits of these new financial services, particularly their capacity to control information flows in real time.
Microfinance supervisors need a strong institutional culture
The effectiveness of the supervisor is just as important as the quality of regulations. Its institutional culture is a critical factor for the success of its mission: firstly, a supervisor should be independent from the executive, as its mission entails an hybrid role between a policeman and a legislator.
Secondly, its prevailing mission should be clear: although central banks serve a bigger mission of financial inclusion and financial market development, financial sector promotion and development falls under the responsibility of the Government and not of supervisors. For supervisors, financial integrity and the security of deposits should always prevail over market promotion issues that can be very vague.
Finally, supervisors need to assume their “duty to displease” (to take up the title of the book by a former prosecutor, Mr. Éric de Montgolfier), with no qualms, but with the gut conviction that achieving the objectives of their mission prevails over all other considerations, including humanist or human considerations, and that the best course of action is often to liquidate an institution in order to minimize losses for its creditors, and first and foremost for its savers.
More pragmatic supervision of microfinance…
Supervisors rarely fail to detect major fraud or shortcomings, at least during inspection missions. Leaving aside the low frequency of inspection missions (related to the large number of licensed players, see above), supervisors do have the information required for their mission. Yet, it comes as a surprise to see that supervisors are capable of detecting and listing a vast array of infringements but are unable to take the couple of vigorous and priority measures required by the situation.
To reduce this gap, supervisors should move from a supervision of microfinance based on compliance to a risk-based supervision, which is both a cultural and methodological change. This requires both:
- questioning the relative importance of the infringement in the framework of systemic risks;
- moving from a dual analysis (compliant/non-compliant) to gauging the depth of the problem.
For example, when a MFI is required to comply with a capitalization ratio of 15% (equity/assets ≥ 15%), being at +14.9%, +1% or -20% is a totally different ball game! In the first case, the capital requirements are minimal, in the second a restructuration is required, combined with a massive recapitalization… If the third assumption has been reached, there is a need to question the failure of the supervision itself, as the insolvent institution should have been liquidated a long time ago.
…based on risk measurement and mitigation
A tool has gradually been developed to measure the risk of failure in banking supervision. It has now become an international prudential standard: CAMELS (acronym for Capital, Assets, Management, Earnings, Liquidity, Sensitivity to market risks). I have made a version for the supervision of microfinance, called “CAMELI” (with an “I” for financial Information, a recurrent problem in microfinance).
The CAMELI tool comprises some 60 items classified into six thematic pillars, with weightings reflecting the level of the control point. The institution is given a rating between A+ (excellent) and E (deficient). The tool provides an overall graphic result for each pillar, showing the strengths and weaknesses.
Here are the overall results:
The diagram on the left shows the overall rating (in figures, from 1 to 5 and in letters, from A+ to E). Here, the rating in figures is 3.00, meaning a letter C rating = unsatisfactory).
The diagram on the right shows details of the composition of the rating, by pillar, which allows a more detailed analysis of the strengths and weaknesses.
Then for each pillar:
The diagram on the left shows the rating of the pillar (3.067, i.e. a C rating). The diagram on the right shows details of the composition of the rating, by control point (from M01 to M20), which shows the strengths and weaknesses by item.
Results from the first MFI supervisions using CAMELI: what lessons can be drawn?
Some supervisors have started to use this tool, which allows us to highlight three initial results.
Firstly, we have an overall picture of everything! The CAMELS approach is effective in measuring the risk of failure in microfinance, provided an in-depth dive into the institutions’ risks and their origin is made by the supervisor. This needs a good understanding of the financial and technical risks of a financial institution but also a bit of microfinance psychology and general culture to understand the organizational and human considerations that are at stake in a microfinance institution.
Secondly, most failures are caused by serious shortcomings in terms of governance (pillar M), which have an impact on the other pillars. Furthermore, some problems seem to be shared by a large number of MFIs in distinct countries, especially by those that have benefited from technical assistance provided by the same organization. In these MFIs, the institutional culture, the management system, the rigor of the organization and of the internal control and the risk management culture often share common features and can either be considered as strengths or weaknesses, depending on the way in which they have been addressed and transferred by the technical assistance organization to the MFIs.
Finally, no “institutional model” (cooperatives, limited companies, etc.) can claim to be the best in terms of prudential risk. Well and badly managed players are to be found in both cooperatives and limited companies for example, although cooperative networks face specific challenges in terms of governance. Each supervisor seeks to address these governance issues in their own way, by requiring elected leaders of cooperatives to be microfinance professionals or by opening up the capital of umbrella organizations to external investors, as it is the case for the Crédit Rural in Guinea, Crédit Agricole in France, or Banques Populaires/Banque Chaabi in Morocco.
To find out more, consult the new edition of the “Précis de réglementation en microfinance” by Laurent Lhériau.
 Financial inclusion means that households and businesses have access to and can effectively use appropriate financial services. These services must be provided in a responsible and sustainable manner, in a well-regulated environment. Source: CGAP, Strategic Plan 2014-2018.
 In this post, the term regulation comprises both legislation, i.e. all the laws governing financial inclusion activities, and supervision, i.e. the enforcement of these laws.
 Supervisors are the entities responsible for ensuring that legislation and its objectives are enforced, i.e. mainly bankruptcy prevention and the protection of the public’s savings. Supervision is generally entrusted to central banks and banking commissions, when they exist. In certain countries (mainly in the WAMU), the Ministries of Finance play a major role in microfinance supervision, in conjunction with the other supervisors.
 Mobile banking makes it possible to access financial services outside the traditional circuit of bank branches by using technologies such as mobile phones, smart cards and biometric applications. It is the most advanced form of remote banking.
 An “umbrella” organization is the entity, generally established in the form of a cooperative company or public limited company, at the top of the pyramid of a mutual network. All, or at least a significant proportion, of its capital is held by the network of local savings and credit cooperatives (directly or via regional Unions). An umbrella organization provides technical assistance to its members, but also has a mission for their prudential supervision, in accordance with a mission conferred by law (in the context of what the Basel Committee calls “auxiliary control” – see Basel Committee, September 2016 mentioned above, pp. 51-52).
The opinions expressed on this website are those of the authors and do not necessarily reflect the official position of their institutions or of AFD.