Nout Wellink: The significant role of microfinance and supervisory
issues
Speech by Dr Nout Wellink, President of the Netherlands Bank and Chairman of the Basel
Committee on Banking Supervision, at the ING Microfinance Seminar "A billion to gain - the
next phase", Amsterdam, 16 June 2008.
* * *
Introduction
1. I am pleased to be joining you today and to be speaking to so many microfinance experts.
Before starting I would like to commend the conference organisers for putting together such
a comprehensive programme on this important topic. Microfinance is becoming ever more
relevant, and there can therefore be no doubt that we need to keep it on our agendas.
Today, I want to touch upon two issues. I will start with the significant and increasing role of
microfinance to combat poverty in the world. This role cannot be called "micro" anymore.
Then, I will discuss some supervisory issues that follow from the microfinance concept.
Microfinance is booming
2. To start off with: microfinance is booming! It all started in the 1970s with the Nobel price
laureate Mohamed Yunus, who was the first to experiment with the provision of very small -
or micro- loans to people in Bangladesh. He then founded the famous Grameen bank. And
nowadays, it cannot be denied that microfinance has successfully enabled extremely
impoverished people, especially women, to engage in self-employment projects. These
people were previously considered unbankable, as they typically do not meet even minimal
qualifications to gain access to traditional credit, such as steady employment or a verifiable
credit history. Microfinance allows them to generate income and to begin to build wealth and
ultimately exit poverty. The term microfinance is generally used for the provision of financial
services, in most cases micro-loans, to the poor, and many people have begun to realise its
opportunities. Indeed, the concept of microfinance has been accepted as an effective means
to reach out to the poor. And this conviction is not just confined to charitable institutions, but
can beyond doubt be called a worldwide drive. Microfinance institutions have notably
expanded their loan portfolios. Data from The Microfinance Information Exchange show that
over the period 2001-2006, the number of micro credit borrowers each year increased on
average by 19%. Over the same time period, the average loan portfolio grew by an annual
30%. This is huge. For comparison, in the EU-25, the average loan portfolio growth reaches
a mere 6.4%. By the end of 2006, globally more than 1100 MFIs were active, comprising
over 59 million borrowers. Also savings accounts surge, totalling 16 billion US dollars in 2006
and 68 million savers.
3. Meanwhile, also private organisations and investors have found their way to microfinance
and microfinance institutions, and devote ample resources to them. Although exact figures
are not available, it has been estimated that in 2006 worldwide $ 4 to 5 billion was invested in
microfinance institutions. Especially investors with a long-term perspective, such as pension
funds, consider microfinance an attractive investment. This is no wonder: usually returns are
in line with market averages, while risks are relatively low. Moreover, microfinance shows a
low correlation with international financial markets and hence provides diversification
benefits.
4. And on top of this, as we can see here today, microfinance starts to attract increasing
interest from commercial banks, including ING. One element evidencing this interest is the
financial support provided by way of loans to or investments in microfinance institutions. But
in my opinion, a second element is far more important: namely the sharing of expertise in
banking business and the provision of assistance and training. Enhanced cooperation
between existing financial institutions and microfinance institutions contributes to the
development of local financial markets. For example, commercial banks may help
microfinance institutions expand their portfolios with saving services, varied loan products
and insurance, while microfinance institutions in turn may facilitate the development of
commercial banks' customer base. Furthermore, microfinance institutions may build upon the
existing IT and risk management infrastructure of commercial banks.
5. Another reason for the remarkable growth of the microfinance sector is that new
technological developments are quickly being picked up. Recently, I came across an internet
organisation set up to enable private individuals to lend money to poor people in developing
countries. The creditors can actually see and choose the persons to whom they lend. The
money is transferred to the person via a local microfinance institution. Another innovative
feature of this concept is that the loan providers receive regular updates on the borrower.
This brings the benefits of microfinance really at your doorstep! And look, for instance, at the
telecommunication industry. Rapid innovations have made it possible to conduct your
banking operations via mobile phone. For banks, it offers the opportunity to transmit loan
applications and check credit details instantly. For microfinance, this means a real
breakthrough. As you know, a core problem for microfinance institutions is the geographically
wide dispersion of their client base. This makes it difficult to serve clients in very remote
areas and drives up expenditures. Operational costs can be as high as 15 to 20% of loans,
compared to less than 5% for banks in industrialised countries. The introduction of mobile
phone banking now makes it possible to reach millions of people, in a fraction of a second
and without the high costs of establishing an extensive network of offices. Such cost savings
are important for microfinance institutions, as they allow them to reduce interest rate margins
while not impairing profitability.
6. These positive figures are truly good news. As a central banker, I care for economic
growth and the reliable functioning of financial markets. And microfinance clearly contributes
to these goals. For one, microfinance stimulates households to start business activities.
Access to credit allows poor people to take advantage of economic opportunities, thus
contributing to local economic development and job creation. Second, microfinance fills a
gap in the traditional financial infrastructure, which did not provide for lending to the poor.
Indeed, broad access to financial services is a key characteristic of a deep and efficient
financial system. It is encouraging to see that the market is now taking over the role which
was previously only performed by governments or NGOs. And third, more and more
microfinance institutions have become real financial intermediaries and now also offer
deposit facilities to households. As such, microfinance can help households to smoothen
their consumption over time, reducing saving and borrowing constraints. Such constraints
are particularly relevant for poor households because their incomes are often uncertain and
they generally lack collateral. At the same time, deposits form an additional funding base for
microfinance institutions and decrease their dependency on external funding. In these ways,
microfinance enhances economic growth, enriches financial markets and increases welfare
of individual households.
Role for the prudential supervisor
7. But this is only one reason for my interest in microfinance. The other one follows from my
role as prudential supervisor. This brings me to the second remark I want to make today. So
far, the growth of microfinance has, by and large, occurred outside a regulatory framework.
But as a depositor, you expect your bank to be safe and not to take undue risk, so that you
can retrieve your money at all times. If the bank accepts too much risk, it may no longer be
able to meet its obligations to depositors. Therefore, in most countries, only licensed banks
are allowed to attract deposits from the public. Licensed banks are subject to prudential
supervision and have to comply with an extensive and strict set of regulations. The prudential
supervisor requires banks, for example, to have in place an effective risk management
system to screen, price and manage risks. For microfinance institutions, the protection of
depositors is especially important. If a microfinance institution runs into trouble and cannot
repay its depositors, this will affect a very large group of people who do not have the buffers
to cushion such a loss. The effects of such a failure on individual borrowers ́ and their
families ́ lives can be disastrous.
8. The need for depositor protection is underlined by the finding that the quality of the micro
credit portfolio may deteriorate very rapidly. If some debtors are unable to repay their loans,
this may induce other debtors to default on their loans as well. This perverse incentive may
be especially strong in the case of credit provided to a group of persons. Furthermore, micro
credit risks are usually more correlated than those of a traditional bank, since the loan
portfolio generally consists of a relatively homogenous group of people who depend on the
regional economy. Also, as costs are generally higher microfinance institutions may have
smaller financial buffers. At the same time, in many cases it will be difficult for the
microfinance institution to raise additional capital on short notice. For deposit-taking
microfinance institutions, prudential supervision is hence of high relevance.
9. Though most agree that prudential supervision of microfinance institutions is needed, it is
not yet clear what this supervision actually should comprise. Compliance with prudential
rules can be costly to supervised entities and may be especially burdensome for
microfinance institutions. Under circumstances, supervision may even stifle such a valuable
and booming sector as microfinance. In devising a supervisory framework for microfinance
activities, we therefore have to take the unique characteristics of microfinance into account.
Most conspicuous of these characteristics is perhaps the lack of physical collateral. Other
characteristics specific to microfinance institutions that need to be taken into account are a
quick turnover rate, high operational costs and a different lending process. Also
know-yourcustomer requirements are burdensome, as many poor people do not have a passport or
other proof of identity.
10. We also need to be mindful of the large differences between microfinance activities and
microfinance institutions from one country to another. For instance in Brazil, a popular form
of microfinance is the use of correspondent banking, or in other terms "branchless banking".
Due to the sheer size of this country, commercial banks are only located in the main cities
and did not or could not offer financial services to people in distinct villages until 1999. With
the lifting of several regulations in that year, commercial banks were allowed to set up
relationships with non-financial and non-bank firms to provide a wider range of services.
Many banks contracted local chains, for instance grocery stores, pharmacies, etc., which
were allowed to handle simple banking operations on behalf of the financial institution.
However, the financial institution itself is the ultimate provider of financial services and
remains responsible in the end. In India, in the 1999s, microfinance evolved quite
successfully through so-called Self Help Groups. In these groups, 10 to 20 persons pool
savings, collectively obtain loans and lend to each other. And in Bolivia, the most successful
microfinance institution was incorporated as a commercial bank in 1992.
11. But despite these differences, microfinance supervision should not and cannot be a
complete divergent regime. A different supervisory framework for microfinance activities
carries the risk of unbalancing the international level playing field. Moreover, many banking
standards already offer flexibility to allow for the level of complexity and size of institutions,
the level of risks or the existence of international activities. And all the same, supervision of
microfinance institutions need not be harmful per se. Adequate supervision may also
enhance the perceived legitimacy of microfinance institutions and improve their operational
management, due to for instance the higher standards for reporting and financial control.
This may broaden their access to funding, allowing them to expand their financial activities
and serving more clients. Furthermore, there may exist a positive relationship between the
development of supervisory guidance for microfinance activities and for supervision in
general. So taking all this together, we should search for a tailor-made solution within the
scope of existing regulation.
12. One such solution can be found in the Basel Core Principles. To support supervisors
worldwide in building and improving a set of prudential regulations, the Basel Committee for
Banking Supervision has developed this set of minimum standards for sound supervision.
The Core Principles provide a benchmark for a wide range of supervisory aspects, in areas
such as licensing, capital adequacy, risk management, and more. In total there are 25
Principles. But, I stress, these are principles, not rules, and require further specification. The
Basel Committee considers that many of these Principles would also be appropriate for
nonbank financial institutions that offer deposit and lending services similar to those provided by
banks. But the Committee also recognizes that some of these categories of institutions may
be regulated differently from banks as long as they do not hold, collectively, a significant
proportion of deposits in a financial system. However, they need some form of regulation
commensurate to the type and size of their transactions. How should we tailor regulation to
the unique characteristics of microfinance activities? The Basel Committee is currently
working on illustrating what forms regulation can take, keeping in mind the diversity of the
sector. That is why this effort is a collective one, and why the Committee works together with
supervisors from all over the world in the Committee's International Liaison Group, as well as
the IMF, the World Bank, CGAP and regional groups of banking supervisors.
Concluding remarks
13. Ladies and gentlemen, I will conclude. Microfinance is booming. It is now widely
acknowledged as an effective way to reach out to the poor. And, as I said in the beginning,
this belief is not just confined to charitable institutions, but felt the world over. Still, the current
market size forms only a small part of the estimated global demand for microfinance
services. As such, the broadening of financial services offered by microfinance institutions,
specifically the deposit-taking facilities offered by many microfinance institutions, is a
welcome development. In parallel with this, the role of the prudential supervisor will become
ever more relevant. Prudential supervision can contribute to inclusive financial systems by
taking account of the specific characteristics of microfinance while not disturbing the
international level playing field. The efforts of the Basel International Liaison Group will be an
important step forward in this regard. Furthermore, adequate supervision may enhance the
perceived legitimacy of microfinance institutions, improve their operational management and
extend their access to funding.
In this way, microfinance not only contributes to the economic development of a country, but
also enriches the financial system and financial supervision. So maybe, rather than "A billion
to gain", it's a question of "Billions to gain"! Thank you.