COMMENTARY: The microfinance industry - Building quality through self-regulation
As microfinance institutions become increasingly important as providers of credit in the micro business landscape, the matter of their operational policy and practices is even more pressing.
The matter of self-regulation for the micro-finance industry is receiving international attention.
The SEEP Network, for example, which is an association of microfinance organisations from different countries, has brought focus to the matter of the effectiveness of these organisations as a means of self-regulation of the industry.
One strategy now in operation, the SMART Campaign, promotes 'smart' microfinance as being fully transparent in pricing and in the terms and conditions of financial products.
SMART finance works with borrowers so that they do not borrow more money than they can repay or purchase products that they do not need.
In countries like India, Mexico and Pakistan that have a mature microfinancing sector microfinancing associations have taken on the responsibility of ensuring client protection through introducing best practices in the sector.
In the case of India, self-regulation emerged as a strategy in response to a crisis within the microfinancing sector which came to international attention in 2010.
The crisis developed after several years of rapid growth, during which MFIs grew over 100 per cent per year. This rapid growth had several unintended consequences for borrowers, including multiple borrowing and over leverage.
The problem soon spread to other parts of India, with the result that government bodies took swift and heavy-handed action to restrain the MFI sector making it almost impossible for many MFIs to sustain their operations.
The central government of India also became involved in the response by passing a microfinance bill and creating a central regulator for the industry in 2011.
In Pakistan, warning signs of trouble in the microfinance sector began to appear in 2006; this was largely a result of the co-location of branches for competing lenders which resulted in multiple borrowing. The situation deteriorated until there was a borrowers' revolt in 2009 when bad debts began to climb.
Interestingly, a study of markets in four countries - Nicaragua, Morocco, Bosnia/Herzegovina - that have had recent problems in their microfinancing sector, due
to client overindebtedness and client movements against payment, revealed that the crisis occurred after a period of intense growth, such as the microfinancing sector in Jamaica is currently experiencing.
The global economic recession was not found to be a primary cause of the repayment crisis. Three primary vulnerabilities existed in the national microfinance industry in each country, they were: concentrated market competition, multiple borrowing and overstretched MFI system.
Experience has shown that government regulation of the sector is not enough to change the culture that leads to these problems; in fact, too-stringent government regulations may have the negative impact of driving operators underground, with a resultant boom in the informal sector.
code of conduct
What is emerging is that the role of microfinance institutions as a self-regulatory mechanism is a growing one.
In India, the premier industry association, Microfinance Institutions Network (MFIN), after its esta-blishment in 2009, moved imme-diately to develop a code of conduct for its members.
The Pakistan Microfinance Network determined that the informational asymmetries between clients and MFIs, as well as increasing competition among MFIs has resulted in overindebtedness and increased client risk, increased transaction costs and weakened lender-borrower relationships.
In the face of these difficulties, the association took action among which was to develop a code of conduct and coordinate consumer-protection strategies.
What is clear is that industry associations have a critical role in maintaining the stability of the sector and ensuring long-term growth.
In Jamaica, the sector has taken the first steps in organising itself. There are two associations currently: Jamaica Micro Financing Association (JaMFA) and Jamaica Association for Micro Financing (JAMFIN).
The establishment of these associations is timely as the Government of Jamaica seeks to regulate the sector through the proposed Micro Credit Act. The associations need to act swiftly, on the one hand, to protect their membership from the passing of potentially injurious restrictions, as was the case in India, and, on the other hand, to preserve healthy lender-borrower relationships.
Promulgating a code of conduct for the sector is an important strategy in mitigating risks for the industry. It is for this reason that JAMFIN has developed a code that outlines best practices as well as offering guidance on how to adhere to these to these tenets, the ultimate aim being client protection and the preservation of the sector. It speaks to integrity and ethical behaviour, transparency, client protection, governance, client selection, client education, data sharing and client redress mechanisms.
The introduction of a code of conduct is not without its challenges. Enforcement may prove to be difficult and its promulgation will bring increased administrative costs to the association, while members who refuse to adhere to the code may form a significant subset pursuing bad and damaging practices.
Self-regulation will have its best chance of success if the regulatory environment favours similar objectives and is sensitive to the specific needs of microfinance institutions.
Jamaica will have its best chance of being a model of best practices in the microfinance industry where there is cooperation between the industry associations and the policymakers in the interest of the growth of micro-enterprises as key contributors to national economic growth.
• Blossom O'Meally-Nelson is chairman of the Jamaica Association for Micro Financing.