Rationale for Assessing the Regulatory Framework for Rural Finance and Microfinance Institutions

The core objectives for the regulatory framework are the same for microfinance activities and institutions as for other components and segments of the overall financial system. However, the key principles and standards for the design of a regulatory framework for
institutions providing financial services to the rural finance and microfinance sector are likely to be different from those for formal banking and finance institutions, because the design must consider the operational, market, and client characteristics of the rural finance and microfinance sector. This section focuses on the regulatory framework issues that have an important influence on access to financial services for low-income rural households.

image052The term financial services extends beyond the traditional credit products and savings deposits facilities provided to varying degrees by different types of rural finance and micro­finance institutions. See section 7.3 and table 7.1 in that section for a listing and discus­sion of various types of MFIs, including those linked to nongovernmental organizations (NGOs) and various non-bank institutions). The term includes payments, money transfer and remittance services, and insurance and contractual savings products. It is important to focus on access to payments and savings products by different segments of the popula­tion and the supply of those products by different institutions. Payment and savings prod­ucts are often the most important financial services for low-income households. Improved access to savings product can help households achieve higher returns on their savings and smoother cash flows, and can reduce vulnerability to external shocks.

The degree and quality of access to financial services available to low-income rural households and their small businesses is influenced by the quality of the legal and regulatory framework. This framework should be guided by the following core principles of good micro­finance: (a) to provide a level playing field among participants in the provision of a range of financial services beyond credit and savings facilities; (b) to allow the institutional trans­formation of nontraditional and non-regulated MFIs (such as multipurpose and microcredit NGOs) into specialized, regulated, or licensed rural finance and microfinance intermediar­ies; (c) to promote and reward transparency in financial accounting and transaction report­ing; and (d) to foster the exchange and sharing of credit histories of borrowing clients.

Available data and information show that deeper, more-efficient financial markets can contribute to accelerated agricultural growth and better food security. Scaling-up access in rural markets to a wider array of financial services through a varied range of financial intermediaries becomes critical to help low-income rural households smooth consumption and enhance labor productivity, which is the most important production factor controlled by the poor. Also, agriculture has strong forward and backward multi­plier effects for the overall economy. Economic growth in agriculture is a key precondition for overall economic growth and poverty reduction, given that most of the world’s poor still live in rural areas (Robinson 2001; Zeller 2003)

There are examples of agricultural development banks, MFIs, and credit unions devel­oping strong rural portfolios, while commercial banks do not generally seem to fit this market niche as readily. Some MFIs have tried to transform from nongovernmental status to a regulated, supervised financial institution; however, with notable exceptions, this has not proven to be a reliable route to improved rural outreach of financial services. In general, commercial banks have not entered the rural and agricultural credit markets on a substantial scale in most developing countries, despite incentives designed to encourage downscaling and rural market penetration.

In a few countries, agricultural development banks have succeeded in transforming themselves into more-sustainable institutions by offering demand-driven financial ser­
vices, building credible lending contracts, and using full-cost recovery interest rates. The experiences of Thailand’s Bank for Agriculture and Agricultural Cooperatives (BAAC, Bank Rakyat Indonesia’s (BRI) village units in its microbanking system (Yaron and Charitonenko 1999; Zeller 2003), and the revival and restructuring for privatization of Mongolia’s Agricultural Bank (Boomgard, Boyer, and Dyer 2003) and of Tanzania’s National Microfinance Bank demonstrate that state-owned banks can be transformed into dynamic, profitable, and successful rural-oriented financial intermediaries with busi­ness-oriented management reforms. Of course, such transformation of state owned banks can be achieved only with firm political commitment, ownership of reforms, management autonomy, and incentives (Zeller 2003).

image053Group-based models have built impressive portfolios in rural markets; savings and loan cooperatives and credit unions have grown rapidly in diverse settings.1 Emphasis on the importance of large-scale operations, internal systems, attractive products, and portfolio quality has contributed to improvements in performance. In addition, the village banking methodology2 pioneered by FINCA International has shown, in many cases, that rural community-based and self-managed financial entities can become self-sustaining. This model was later adapted with changes by CARE, Catholic Relief Services, World Vision, and even a few commercial banks.

Several MFIs have shown that they can profitably serve large numbers of relatively poor households, microenterprises, and small businesses. Although the client base is typi­cally in peri-urban markets or in off-farm business activities in rural markets, those expe­riences have renewed interest in the feasibility of reorienting rural finance and microfi­nance institutions. There is a growing list of MFIs that have moved beyond their initial urban client base to tailor their products to rural clients, including the Equity Building Society in Kenya, CrediAmigo, a bank-affiliated MFI in Brazil and the Development Bank of Brazil (BNDES), MiBanco in Peru, Financiera Calpia in El Salvador, and Basix India Ltd, a micro-credit institution serving the rural poor in India. The experiences of these MFIs point toward the possibilities of adaptation and replication by other MFIs operating in predominantly rural markets.

The rural finance and microfinance sector is small relative to the commercial financial sector, with limited effect on the overall stability of the financial system. In a large number of developing countries, the total loans outstanding in the rural finance and microfinance sector was about 1 percent of broad money supply (M2), with this sector reaching fewer than 1 percent of the population as clients. A handful of countries stand out from the rest with higher levels of microfinance outreach and penetration, especially in Indonesia (6.5 percent); Thailand (6.2 percent); Vietnam and Sri Lanka (4.5 percent); Bangladesh and Cambodia (3.0 percent); Malawi (2.5 percent); and Bolivia, El Salvador, Honduras, India, and Nicaragua (at 1.0 percent or slightly more) (Honohan 2004).3

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