Many development practitioners and financial institutions believe that we are in the midst of a paradigm shift from microfinance to inclusive finance — from supporting discrete microfinance institutions (MFIs) and initiatives to building inclusive financial sectors . Inclusive finance recognizes that a continuum of financial services providers work within their comparative advantages to serve poor and low-income people and micro and small enterprises. Building inclusive financial sectors includes but is not limited to strengthening microfinance and MFIs.
Existing terminology that developed over many years to describe microfinance initiatives no longer serves well when we shift to discussing inclusive financial sectors. Microfinance has been defined as the provision of diverse financial services (credit, savings, insurance, remittances, money transfers, leasing) to poor and low-income people. Retail financial service providers that serve this market segment are increasingly more difficult to define with one common term. They include NGOs, private commercial banks, state-owned and postal banks, non-bank financial institutions (such as finance companies and insurance companies) credit unions and credit and savings cooperatives. Many of these institutions are quite large; many are quite old; and many have large numbers of clients and highly diverse products and services. As a result, the term MFI is often not descriptive or adequate to refer to this diverse group of financial institutions. While each of them plays an important role in inclusive finance, many of them could not be considered MFIs in the technical sense.
• Third, the financial sector provides safe savings facilities and a range of risk/return tradeoffs for savers. In so doing, it mobilizes savings into a formalized system. It helps households accumulate financial assets, which can provide a cushion against untoward events (“shocks”), and provides resources to respond to economic opportunities.
• Fourth, the financial sector provides additional means beyond privately accumulated savings to help absorb shocks through insurance and credit. When people have these products and services to draw upon they are better able to undertake a modicum of risk in their activities. Risk-taking is a prerequisite for being entrepreneurial and thus for economic dynamism.
There needs to be a continuum of financial services available to households as they increase their standards of living and for enterprises as they grow into the business mainstream. This is a critical issue for the development of financial sectors. It involves adequate financial services for small and medium-sized enterprises (SMEs), often called the “missing middle,” as well as the smallest microentrepreneurs. It involves financial infrastructure, such as credit bureaux and property registries, and financial institutions that serve poor and low-income households and their enterprises. Working to extend financial services on adequate terms to all population groups should be a central focus of financial sector development.
Too often, financial services for poor people have been treated exclusively as part of social policy, distinct from the rest of the financial sector. Extending financial services to poor people is also part of policy for economic growth and financial sector development. Expanding and deepening financial services for poor people should simultaneously be a concern of poverty reduction and financial sector strategies. Indeed, these should come together in comprehensive national development strategies to achieve the Millennium Development Goals, as the world’s Heads of State and Government pledged at the 2005 World Summit (United Nations, 2005, paragraph 22a). They should equally inform the poverty reduction strategies that countries discuss with the Bretton Woods institutions and donor governments.
In many countries, a change in attitudes of government and other stakeholders may be required, along with a greater appreciation of what inclusive financial sectors can deliver for development. The views of Fouad Abdelmoumni, Executive Director of Association Al Amana, a leading microfinance institution (MFI) in Morocco, are instructive on this point. To him, inclusive financial sector development means nothing less than reversing the current state of exclusion, turning minority access to finance into majority access in a limited time period. As he said:
“The evidence is clear. Financial sectors today exclude the vast majority of the population. We have learned, however, that the financial exclusion is not congenital, but rather attributable to cultural factors, the stigmatization of the poor, along with the lack of capacity to deliver sustainable financial services to them. Today, we operate from a different mindset, tools in hand, whereby it is considered reasonable to achieve a massive expansion of banking services over the medium term, or at least something closer to the medium term than to the long term.”
There is, in short, a compelling case and pressing need in developing countries to look at financial sector development inclusively, placing greater emphasis on access by poor households and enterprises to financial services. In this regard, policymakers can take important steps towards achieving global development goals by adopting policies that promote access to financial services for poor and low-income people and assuring that these policies are integrated into overall financial sector development strategies.
The central question asked by this book is how to bring access to these fundamental services to all people in developing countries, and thus to accelerate their economic development and that of their countries. Inclusive finance — safe savings, appropriately designed loans for poor and low-income households and for micro, small and medium-sized enterprises, and appropriate insurance and payments services — can help people help themselves to increase incomes, acquire capital, manage risk, and work their way out of poverty. Access to the financial system facilitates making and receiving financial payments and reduces their cost. This is increasingly important in the globalized labour market and in view of the homeward foreign remittances that result. Moreover, access to financial services serves to increase production and social protection, as the financial sector — through stored savings, credit and insurance — serves as a cushion in times of crisis. Increasing the inclusiveness of financial sectors, fuelled by domestic savings to the greatest extent possible, will, over time, bolster the poorer segments of the population as well as those segments of the economy that most affect the lives of poor people.
A vision of inclusive finance
While appreciating the variety of approaches, the richness of diverse experiences, and the differing policies among countries, one may discern a vision of inclusive finance that can be widely shared. The ensuing chapters will elaborate on that vision. But it may also help orient the reader to try to describe it at this point.
The vision begins with a goal: supported by a sound policy, legal and regulatory framework, each developing country should have a continuum of financial institutions that, together, offer appropriate products and services to all segments of the population. This would be characterized by:
(a) Access at a reasonable cost of all households and enterprises to the range of financial services for which they are “bankable,” including savings, short and long-term credit, leasing and factoring, mortgages, insurance, pensions, payments, local money transfers and international remittances;
(b) Sound institutions, guided by appropriate internal management systems, industry performance standards, and performance monitoring by the market, as well as by sound prudential regulation where required;
(c) Financial and institutional sustainability as a means of providing access to financial services over time;
(d) Multiple providers of financial services, wherever feasible, so as to bring cost-effective and a wide variety of alternatives to customers (which could include any number of combinations of sound private, non-profit and public providers).
To achieve this goal, financial services for poor and low-income people should be seen as an important and integral component of the financial sector and various types of financial institutions, based on their own comparative advantages, should see it as an emerging business opportunity. Inclusive finance should be part of any financial sector development strategy.
A number of other important considerations need to be taken into account to accomplish this vision.
First, the individual in his or her society must enjoy the right to fair treatment. This requires financial policies and practices that do not tolerate discrimination by gender, ethnicity, or other characteristics that should be seen as irrelevant to financial services availability. It requires protection of customers’ rights and enforcement of that protection, recognizing that financial market abuses of customers have been common.
Second, the vision also recognizes that the ability of customers to do business with financial institutions depends on their degree of financial literacy. Especially in communities in which people are not used to handling debt, education about the dangers as well as opportunities of borrowing are essential, not to mention counselling for the over-indebted and appropriate personal bankruptcy legislation. Promoting financial literacy increases access as well as the ability of customers to get the financial services they need on appropriate terms.
Third, the vision must be cognizant that historically some civic or government intervention has typically been required to open access to appropriate financial services for poor and low-income people on sustainable terms, in particular by setting in place the systems of incentives for a broad range of financial services providers to step in. Policymakers have accommodated a variety of legal models for financial institutions and allow different sizes, forms and methods for institutions that seek to provide financial services to poor people. Multiple types of financial service providers (private, non-profit, and public) may very well coexist in competitive economies. Public/private partnerships are also possible.
Fourth, while some financial policy interventions may be necessary, they should not be prisoner to short-run exigencies. Policy should take a long-run view on access. This means that financial services should be provided on a sustainable basis. In this regard, governments can decide to give subsidies or special tax benefits, but they should take into account the lessons of many countries over many years, and they should be sure to aspire to sound practice. Whether in the form of providing incentives or removing disincentives, these measures can be adopted as conscious policy. Incentives should find transparent expression in annual government budgets, where they may be judged against alternative uses of public funds. Choices will differ from country to country, but they should all be aimed at efficient, effective and sustained access to the most services by the widest share of the population. The goal should be that no one is excluded from accessing appropriate financial services.
Finally, the vision is dynamic and eclectic. It sees the possibility of new forms of service provision arising through technological and financial innovation. Indeed, it welcomes them, especially when they hold out the promise of further breaking down the impediments to access to financial services of underserved populations. It follows that regulation and supervision of financial institutions should make room for financial service providers to innovate to enhance access, as long as this does not impede the fundamental imperatives of financial institution soundness and financial sector stability. Some individual countries will find greater interest than others in different institutional forms and regulatory interventions, but they should all be alert to changing opportunities and constraints. What the vision requires, in other words, is being open to progress.
What services are profitable enough?
The concept of “inclusive finance” is one for special consideration because serving the low-income end of the market is often not perceived as a major profit opportunity when compared to other lines of business. In discussing why more commercial banks are not more involved, a senior manager of a credit union association suggested that:
“Ample experience demonstrates that microfinance services can be profitable if appropriate rates are charged, but there is the perception and possible truth is that they are not as profitable as other ways that capital can be deployed.”
A wide variety of retail financial institutions have found that micro and small scale lending is profitable enough. They have also found that microsavings combined with broader savings mobilization initiatives decreases the blended cost of funds. Credit unions have been particularly adept at intermediating members’ savings, including very small account balances, to support loan products for their members. “By serving a diverse group of people from different social and economic strata, credit unions can help more poor people than if they only focused on the poorest of the poor” (Lennon and Richardson, 2002, p. 98).
“The Guatemalan credit union movement was one of the first to discover this important principle. In 1987, the entire movement of more than 20 credit unions had mobilized only US$ 2.8 million of savings deposits and member share accounts. By offering convenient service, market returns and institutional security, 11 credit unions with a user base of 199,332 people, were servicing more than US$80 million in 345,000 accounts at year end 2000, resulting in an average savings account balance of US$233. Of that amount almost 302,000 accounts had an average balance of US$37. It is interesting to note that while the credit unions provided a very valuable service to the poorest…they also provided a valuable service to other groups of poor and low-middle class people. Even though lower middle class accounted for only 16,064 accounts, they provided more than US$55 million, or 69 per cent of the total volume of savings and share accounts. Were it not for this group of people, the Guatemalan credit unions would never have had the necessary liquidity for onlending purposes” (ibid., pp. 98-99).
By 2004, 26 Guatemalan credit unions had 550,000 members, US$279 million in savings deposits, and a combined portfolio of US$207 million (WOCCU, 2005, p. 3).
While some savings banks, such as postal savings banks, are restricted to providing savings and fee-based services, many also have loan portfolios that serve poor and low-income people. The weight of microloans in their portfolios ranges from modest to significant. Savings banks are often the major providers of small savings accounts in countries where they operate (WSBI, 2004, p. 19). Savings banks, because of their “proximity services,” often dominate the payments market, including combining social welfare benefits with savings accounts (ibid., p. 16).13
Commercial banks have traditionally discouraged small-scale savers by setting high minimum balances or transaction fees. This is often cited as a major challenge for commercial banks to provide savings services to poor and low-income people. Yet innovation in product design, such as South Africa’s Mzansi_accounts, limit cost by restricting the number of transactions per month. Savings banks within the WSBI network also offer a range of products that limit administrative costs for the institution and offer savings services to the lower segment of the market.
Increasingly banks that extend microcredit to poor clients — regardless of ownership or mandate
— have sought to raise net income from their client relationship by providing additional services on which they earn fees. These services include bill-paying, debit and stored-value cards, and money transfer services. As noted in Chapter II, this can take the shape of specially designed product offerings or partnering with other financial services providers, as for insurance and remittances, or forming alliances with NGOs and community-based entrepreneurs, such as the ICICI experience in India (see box III.1).
Public policy, politics and inclusive finance
The existence of a politically endorsed and nationally owned strategy for inclusive financial sector development increases the likelihood of follow-through on implementation. The politics of pro-poor financial sector development is as much about identifying and solving technical problems within the financial system as it is about the political process of framing and implementing policy to address them. That is, policymaking is not only about whether a particular intervention will work as expected under stated conditions, but also whether the intervention will win broad support or at least acceptance by the population at large. It is also about whether policy is respected and applied consistently. The question of political economy has been framed as follows:
“In the case of technical problems in financial service provision, once fixed, they normally stay fixed. The financial technicians move on to new problems and further frontiers of efficiency. But in the world of development finance, problems of political economy are hardly ever finally fixed” (Special_Consultant,_Foundation_for_Development_ Cooperation,_Australia).
While good policy and a participatory political process is thus at the centre of pro-poor financial sector development, the improper politicization of financial sector development provoked passionate responses during the consultations for this book.
Stakeholders referred to the persistent misuse of microfinance for narrow political gain, either through targeted credit to powerful interest groups or debt forgiveness to appeal to the general voting public. The political focus on short-term expediency can undo the years of development efforts of numerous stakeholders, creating frustration, and dampening support for development efforts. This is contrary to a vision of inclusive finance whereby microfinance is seen and treated as part of the financial sector.
A major challenge for public policy is to avoid treating microfinance as a charitable activity and not as “real” financial services. In such a situation, the generally accepted rules of the game for the mainstream financial sector are not applied. This can lead to ill-targeted subsidies and the undermining of a culture of credit discipline. Moreover, a lack of credit discipline (i.e., willingness to default on debt obligations) usually accompanies a perception by the debtors that the funds borrowed and not repaid are “free” money and not their own or their neighbours’ savings.
Accepted financial sector proposals may be undone by successor regimes for a range of well-intentioned and ill-intentioned reasons. One reason is that these proposals may not produce expected results. Another is that the results may not come fast enough. A third reason is that entrenched interests do not want to relinquish prerogatives regarding control of financial assets. A truly participatory political process, including full engagement by major stakeholders, can often help avoid some of these problems. Monitoring by stakeholders can also provide an important feedback mechanism about when policies are not working as anticipated and thus need to be rethought.
Given the political imperative to do so, how can governments best define the nature and extent of their support to inclusive financial sector development? The most controversial issues raised during the consultations related to the appropriate role for government in establishing interest rate levels, the direct provision of credit and the organization of public subsidies.
Experience in Bangladesh in lowering costs
Evidence from Bangladesh suggests that both the questions of efficiency and competition require a closer look . A 2003 Palli Karma-Sahayak Foundation (PKSF) study (‘Current Interest Rate and Financial Sustainability of PKSF’s Partner Organisations’) concluded that there was no scope to reduce the interest rate of 29% APR, but that this was due to inefficiency in the microcredit operations of the partner organizations and that with greater efficiency the breakeven point could be reduced to 18% and the interest rate reduced to 25% .
Interestingly enough, interest rates have not been used as a weapon of competition . The large NGO-MFIs set the price and the others followed . The ability of the larger institutions to lower rates could result in the demise of many of the smaller organizations . Instead, MFIs compete on the basis of qualitative factors: larger loan size, shorter waiting period, flexibility, ease of access to general savings, local flavour and additional services .
Consideration needs to be given to a range of measures that lead to the lowering of interest rates over time. Some measures are regulatory, particularly with respect to market entry and costs of maintaining uncompensated mandatory reserves. Some are macroeconomic, particularly with regard to inflation and currency devaluation. And some are dependent on the operating environment where poor infrastructure leads to high operating costs. Yet, the greatest challenges are at the institutional level. At this level, the key to lowering decontrolled interest rates is to seek to lower costs on every front and pass these increased efficiencies on to customers. The measures to consider include:
• facilitating market entry for new financial service providers;
• requiring increased transparency with regard to interest rates, fees and other obligations;
• requiring transparency with regard to institutional efficiency;
• lowering the costs of operations through increases in efficiency;
• lowering the cost of provisions against loan loss by maintaining very low portfolio at risk;
• lowering the cost of funding to MFIs that show strong performance and low portfolio at risk;
• lowering the costs of operations through increases in investment in human and physical infrastructure in the country; and
• increasing the use of performance-based contracts with greater transparency in order to strengthen incentives to lower costs of operation.
In terms of political economy, there is also the question of whether within the context of a nationally owned national strategy, with commitments to build the supply response, and apply all needed measures, decisions based on short-term political expediencies could be avoided.
LEGAL MODELS, REGULATION AND SUPERVISION IN THE CONTEXT OF INCLUSIVE FINANCE
”Don’t_fix_problems_that_do_not_exist;_don’t_ignore_problems_that_do.”
CEO, microfinance regulatory body
he range of financial institutions that participate in the provision of financial services and the regulatory and supervisory regimes that oversee them are critical elements of financial sector development. They determine the development and the direction of an inclusive financial sector. As retail institutions grow, they develop more sophisticated financial products and services and become more adept in accessing resources to fuel the growth of their portfolios. The legal, regulatory and supervisory framework is challenged to not only keep up, but to lead the way for the development of inclusive finance. In many countries, this framework is underdeveloped. Retail financial institutions are often frustrated by the incompatibility of the existing framework with their growth trajectory. Policymakers and regulators are challenged as well as they seek to redefine the opportunities for inclusion and to respect the fundamental principles of protecting the customer and the financial system. It is not surprising that numerous issues are raised in this context.This chapter looks at legal, regulatory and supervisory issues from the perspective of the public policy goal of increasing access. It treats the questions of access as an objective of regulation and supervision, the importance of various institutional models, the issues of when and how to regulate, and a selection of concerns in the area of regulation and supervision of building inclusive financial sectors.
How to fashion financial infrastructure for inclusive finance?
The “financial infrastructure,” as the name implies, is the set of ancillary services on which any country’s financial system relies to hold itself together. It helps the financial institutions to talk efficiently with each other through the information and communication systems; it also allows them to pass money and financial instruments safely and quickly through the payments and settlement system. It reduces the risks from lending to the non-financial sector through credit bureaux, property registries and bankruptcy processes, and from lending to each other through external audits and institutional credit ratings. It also works to reduce the risk to the system as a whole from financial difficulties in individual members through prudential regulations and supervision, with central banks serving as “lenders of last resort” in national financial emergencies. Finally, research and development on numerous aspects of financial operations and innovations are a shared interest and concern for the entire financial sector, as is ensuring a continuing stream of well-trained professionals in different aspects of financial service delivery.
Building a strong and efficient financial infrastructure is thus an essential part of financial sector development in developing countries, and it applies ipso_facto to those parts of the financial sector providing services to poor and low-income households and to micro, small and medium-sized enterprises.
How should governments be organized to promote financial inclusion?
Whether national stakeholders opt for a more or less interventionist approach, governments have an important role to play in building inclusive financial sectors. This is true even in those cases where MFIs developed successfully without much government intervention. With the maturity of many MFIs, the increase in savings mobilization, and the mainstreaming of microfinance into local and global financial markets, the policy agenda and corresponding roles for governments and other national stakeholders in this sector are changing rapidly.
Governments influence financial sector development in significant ways. They can be organized more or less effectively to ensure that their roles, policies, and actions are coherent, effective, and efficient. A government comprises a diverse set of ministries and authorities. How should their collective effort to enable, strengthen and advance more inclusive financial sectors best be organized?
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