COMMERCIAL BANKS AND SPECIALIZED MICROFINANCE BANKS

1
COMMERCIAL BANKS AND SPECIALIZED MICROFINANCE
BANKS
2
Commercial Banks and Specialized Microfinance
Banks

• deposit-taking institutions (from the public)
• regulated
• supervised
• privately-owned, profit motivated, commercial
  orientation

3
Banks have entered the field of microfinance in
three ways

• microfinance programs or NGOs have transformed
  into banks
• microfinance practitioners have created banks and
  specialized microfinance banks
• commercial banks have expanded their business to
  reach out to the poorer groups

4
Reasons why NGOs have transformed into banks

• to access capital through deposit-taking
• to raise capital through equity investments by
  shareholders
• to increase borrowing capability
• to offer a wider range of services to clients (in
  addition to deposit taking)

5
Reasons why commercial banks have entered the
field of microfinance

• diversification (given competitive environment)
• profits of successful microfinance banks
• public image
• access to lines of credit from international
  financial institutions for onlending to
  microentrepreneurs
• technical assistance
• government requirements

6
Distinguish between different types of banks

• full service private commercial banks
• state-owned banks
• specialized banks and finance companies

7
Three primary ways in which commercial banks are
involved in microfinance

• lending directly to microentrepreneurs
• lending to microfinance institutions which onlend
  to poor
• lending to self-help groups of rural poor

8
Some of the structural aspects of banks are
beneficial for microfinance

• requirements of being a regulated entity help
  ensure prudent management
• private ownership
• physical infrastructure (branches)
• independent of donor resources
• wide range of financial products
• administrative and accounting systems

9
Drawbacks to commercial bank structure and status

• lack of commitment to microfinance and clientele
  (poor)
• reporting and regulatory requirements are
  burdensome and often not appropriate for
  microfinance
• hierarchical structure
• different financial methodology
• difference in staff training
• overhead

10
Issues To Be Discussed Related To Banks Involved
in Microfinance

• 1. Whom do the banks serve and with what
  services?
• 2. What is their ownership and governance
  structure?
• 3. What are their sources of capital?
• 4. What regulation -- prudential and
  non-prudential -- should apply to banks involved
  in microfinance?
• 5. What current legal and regulatory limitations
  challenge banks involved in microfinance?

11
Who is Served and With What Services?

• Generally larger clients
• due to cost and lack of access to poor
• Services
• loans
• deposits
• checking accounts
• payment transactions
• smart cards/debit cards
• issuing and accepting liability on letters of
  credit

12

• pawn brokerage services
• payment guarantees
• issuing negotiable debt securities (certificates
  of deposit, bonds, promissory notes)
• financial leasing transactions
• foreign currency transactions

13

• And
• trust management services
• brokerage services (purchase and sale of
  securities)
• underwriting securities

14
Legal Form

• Joint stock company (open or closed)
• Limited Liability Company
• Cooperatives

15

• Ownership
• Maximum ownership interest
• Limitations on foreign ownership
• Limitations on NGOs

16
Governance

• General Assembly
• Approves the annual financial plan and report on
  performance
• Approves annual results of banks activities
• Elects the council of directors/supervisors,
  audit committee, external auditor
• Determines remuneration of members of council of
  directors and external auditor

17
Governance (contd.)

• Board of Supervisors/Council of Directors
• Determines strategic goals of the bank and its
  policy
• Approves/discharges members of management
• Supervises management
• Determines internal policy
• Reports to shareholders at annual meeting
• Approves internal auditor
• Determines remuneration of management
• Decides on establishment/liquidation of branches

18
Governance (contd.)

• Management/Management Board
• Governs day-to-day activity of bank in accordance
  with established policy
• Managing Director
• Plus Audit Committee
• Tests compliance with policy

19
Sources Of Funding/Capital

• Share capital
• Borrowings
• Deposits
• (Donor funds)

20
Prudential Regulation

• a. Minimum capital
• b. Capital Adequacy Ratio
• c. Asset quality indicators/Loan classification
  and provisioning
• d. Unsecured loan limits
• e. Reserves requirements ( deposits)
• f. Reporting requirements
• g. Supervision
• h. Camel rating (capital adequacy, asset
  quality, management, earnings, liquidity)

21
Non-Prudential Regulation

• a. Interest rates
• b. Disclosure of ownership
• c. Registration
• d. Reporting/publication of financial statements

22
What Current Legal and Regulatory Limitations
Challenge Banks Involved in Microfinance?
23
Prudential Requirements

• Minimum capital
• Should be lower minimum for microfinance banks
• Capital Adequacy Ratio
• Basel Accord recommends at least 8 of risk
  weighted assets
• Advocate higher (20) for small and microfinance
  banks
• less diversified and higher risk portfolios than
  other banks
• relatively high costs and high interest rates on
  loans
• Banking regulators have little experience with
  microfinance
• for banks established by NGOs, capital may come
  from investors not primarily motivated by
  commercial concerns

24
Prudential Requirements (contd.)

• Asset quality indicators/Loan classification and
  provisioning
• although microfinance portfolios show lower
  delinquency than commercial bank portfolios,
  delinquency tends to be more volatile
• microfinance banks should provision overdue loans
  (based on time overdue) more aggressively than
  commercial banks
• regulations for loan provisioning usually require
  high provisions for unsecured loans, even where
  such loans are not overdue -- inappropriate for
  microfinance banks

25
Prudential Requirements (contd.)

• regulators should consider accepting additional
  indicators of asset quality such as historical
  performance of portfolios, statistical sampling
  of arrears and adequacy of management information
  systems
• check for concentration of sectors, insider
  lending
• Unsecured loan limits
• microloans are generally unsecured
• use alternates (group guarantee)

26
Prudential Requirements (contd.)

• Reserves requirements ( deposits)
• limits monetary expansion in the banking system
  and thereby controls inflation
• the higher the requirement, the less deposit base
  available for on-lending (and therefore less
  opportunity to lend for microfinance)

27
Prudential Requirements (contd.)

• Reporting requirements
• reporting format used for large commercial banks
  may not be appropriate
• typically banks are concerned with fewer, larger
  transactions
• microfinance banks are more concerned with
  aggregate indicators

28
Prudential Requirements (contd.)

• Supervision
• bank examiners' typical review (30 of a bank's
  loans) is not feasible for microfinance
  portfolios
• guidelines for documentation for loans are not
  appropriate for microloans
• increase in administrative controls (in response
  to delinquencies and management weakness) is
  probably not appropriate for microfinance banks

29
Prudential Requirements (contd.)

• supervision should carefully examine how
  microfinance banks manage risk, taking into
  account
• diversification of loan portfolio
• lending technology and products
• loan tracking systems
• qualifications of staff

30
Prudential Requirements (contd.)

• CAMEL rating (capital adequacy, asset quality,
  management, earnings, liquidity)
• regulators should compare banks with large
  microfinance portfolios with other microfinance
  banks (instead of commercial banks) because banks
  with large microfinance portfolios will have
  higher ratios of operational costs to average
  portfolio than other banks

31
Non- Prudential Requirements

• Interest rate caps
• one of the greatest deterrents to banks entering
  into microfinance is an inability to charge
  commercial rate of interest
• yet cost of microfinance is higher because (i)
  smaller loans for work, (ii) high level of
  involvement with clients