summary of the last lecture private equity for microfinance tiaa-cref and procredit. sequoia and sks

Summary of the Last Lecture

• Private Equity for Microfinance

• TIAA-CREF and ProCredit.

• Sequoia and SKS.

THE EMERGING INDUSTRYOF INCLUSIVE FINANCE

BUILDING THEINFRASTRUCTURE FORINCLUSIVE FINANCE:

• Poor financial infrastructure has historically been one of the biggest barriers to inclusive finance in less developed countries. As enabling conditions appear, however, far-reaching initiatives suddenly become feasible and financial institutions start new projects.


• Within six years after the introduction of regulations allowing retailers to become banking agents in Brazil, the number of Brazilians with bank accounts nearly doubled.


• Financial infrastructure means different things to different people. We think of it as the shared building blocks that allow institutions to deliver services. The building blocks include operating platforms such as ATM networks, smart card systems, and financial software.


• They also include institutional arrangements, such as credit reporting bureaus, clearing and settlement systems, rating agencies, and collateral registries.


• Many of the most important arrangements are devoted to getting information about clients, transactions, and institutions into the right places at the right times. Other arrangements raise confidence about agreements between people or institutions.


• The public and private sectors have distinct roles in building strong financial infrastructure, and the best environments come from a well-functioning partnership between both. While the public sector determines the regulatory framework— the rules of the game—


• the private sector builds market mechanisms like credit information and technology. In the lecture that follow we will examine portions of this shared infrastructure that are especially important for financial inclusion: credit bureaus, payments systems, and the market infrastructure for investments.


• In these areas the private sector takes the lead. This Lecture departs, however, from the course’s otherwise exclusive focus on private opportunities for a brief digression on the role of government.

Financial Sector Liberalization

• The good news is that in many countries governments have improved the enabling environment and are still making reforms. When financial sector liberalization swept across the globe during the 1980s and 1990s, the enabling environment for financial inclusion improved dramatically.


• With liberalization, governments got out of the business of providing services and soaking up financial-sector liquidity to fund themselves. The tenets of liberalization focused instead on creating a competitive marketplace with many different providers.


• In countries as different as Bolivia (starting in 1985) and India (starting in the late 1990s), financial-sector liberalization triggered the takeoff of the microfinance industry because it opened the way for competition.

• In both countries, liberalization created the incentives for new entrants to come into the financial sector, find their niches, and expand their reach.


• In practice, the relationship between government and private sector is not always harmonious, and conflicts create obstacles to reaching previously unserved clients. In some countries liberalization has been politically challenged, and politicians seize on inclusive finance as a political tool. Providers of BOP finance count political interference as one of the biggest risks they face.

What Makes a Good Enabling Environment?

• The best environment for inclusive finance starts with the broad conditions that support financial institutions of all kinds. At the most basic level, we start with a business environment that includes investor-friendly policies, contract enforcement, low corruption, and the like. Macroeconomic and political stability are musts. To that foundation are added features especially important for inclusion. A laissez-faire approach may contain hidden barriers to BOP finance.


• One macroeconomic factor particularly important for financial inclusion is low inflation. Across all of Latin America in the 1970s and 1980s, inflation was a scourge that kept financial sectors small.


• Millions of wealthy Latin Americans sent their money to Miami to maintain its value, while poor people stocked up on assets like animals or construction materials. The legacy of high inflation lingers in the belief among many low-income Latin Americans that it is risky to save money in banks.


• When inflation was finally tamed, financial institutions started reaching out, first to the wealthy, but ultimately (now and in the future) to the lower-income segments of the population.


• In Africa, the financial sectors in a number of countries have been shortchanged by the lack of a good basic business foundation, with the least successful countries plagued by political instability, armed conflict, or corruption.


• In such countries inclusive finance remains small and fragmented, often involving only the NGO and cooperative sectors. Fortunately, an increasing number of emerging economies, including many in Latin America and Africa, now have the basic market necessities.

The Architecture for Inclusion

• Let’s assume that a country has mastered the basic economic environment and wants to encourage financial inclusion. What then?

• The foundation for inclusive finance rests on the same elements needed for a competitive mainstream financial sector: a competitive market with a level playing field for all qualified entrants.

The Architecture for Inclusion

• But in several areas of regulation special attention is needed to ensure inclusion. In countries that are getting the following elements right, like Peru, Uganda, and many others, inclusive finance is growing rapidly.

Licensing Rules.

• Rules to encourage inclusion should be tough enough to ensure that market entrants are qualified and have sufficient financial resources, but not so restrictive that they turn banking into a cabal. Inclusion requires countries to create effective pathways for the entry of qualified smaller institutions like credit unions and microfinance banks that specialize in serving lower-income people.

Licensing Rules.

• On the other hand, rules should not restrict inclusive finance to the smaller entities; larger banks have a role, too. Ownership of inclusive finance institutions often involves unusual partnerships with social investors and even NGOs. Regulators need to recognize the important role such unconventional players can provide in an ownership mix.

Market-Determined Interest Rates.

• Financial institutions need to set their own interest rates if they are to survive, and so the importance of market-determined interest rates can hardly be overstated. Paradoxically, the very interest-rate caps intended to protect the poor have historically confined credit to large borrowers.

Market-Determined Interest Rates.

• Under the banner of fairness to the poor, interest rate caps prevent businesses from charging the generally higher rates needed to make small loans profitable and hence sustainable. In countries with caps, such as Ecuador and Venezuela, new investments in financial inclusion dry up fast, with predictable consequences for the poor.

Strong Regulation and Supervision.

• Politically independent regulators should be armed with ample supervisory capacity and prudential norms that promote safety and soundness. For financial inclusion, it is especially important that regulators understand the unique characteristics of BOP finance and work closely with its providers to accommodate those characteristics in their norms and procedures.


• For example, when regulators in Bolivia first heard about the microfinance group loan guarantees used by their newest bank, BancoSol, they regarded those loans as unsecured, a designation relegating them to a small part of the bank’s total portfolio.

• Pointing out its near-perfect repayment recorded in five years as a microfinance NGO, BancoSol argued that the group guarantee produced outstanding portfolio quality.


• Regulators agreed to allow BancoSol to operate provisionally with group loans. This was a daring step for regulators. It took banking authorities prepared to work with providers to allow careful experimentation.

• After a few years of close tracking, Bolivia’s bank supervisors recognized the solidarity guarantee in new regulations as a legitimate way to secure loans.

Agreement That Government Is Not a Provider.

• Government’s best role is to create a functioning market, not to provide financial services, particularly credit. When government-run institutions compete with private institutions, it is tempting for governments to favor their banks at the expense of private providers.


• In Andhra Pradesh, India, for example, state-government shutdown of microfinance institution offices in 2006 was ostensibly justified by inappropriate collections and interest-rate policies at the MFIs. Behind the scenes, however, the action was prompted in part by managers of the state government’s microfinance program, who were angry over losing clients to private providers.


• More generally, India’s regulatory environment favors public-sector banks as the preferred providers of inclusive finance, to the detriment of private actors, both mainstream banks and MFIs.

Legal Underpinnings.

• A legal framework that supports financial system operation will include secured transactions laws and collateral registries, land titling, ID systems, and consumer protection legislation.

Legal Underpinnings.

• South Africa, for example, has a regulatory body, the National Credit Regulator, dedicated to protecting consumers from unscrupulous practices. Born in response to abuses in the consumer loan industry, the National Credit Regulator now ensures that responsible providers are supported and preserves the reputation of the sector as a whole.

Access vs. Stability

• Is there a trade-off between access and stability in the financial system? Some regulators have acted as if they thought so. Traditionally, the mandate of regulatory authorities has been to preserve stability, a task that appears easier in a financial system with fewer participants.


• Inclusive finance requires regulators to pay attention to institutions that serve many people even though monetary amounts may be insignificant. Regulators usually think the other way around, on the theory that the large players determine the health of the financial system as a whole, measured by volume of funds, not people served. Dedication to access with stability requires investment in supervisory capacity so smaller institutions still receive adequate scrutiny.


• A number of past experiments with opening too wide did not go well because they allowed unqualified players. Too many players entered for supervisors to keep up with. This was the case with rural banks in the Philippines and Ghana, community banks in Nigeria and Tanzania, and consumer finance companies in South Africa, India, and numerous other countries.


• In most of these cases supervisors have had to backtrack, overhaul small institutions, close weaker ones, tighten regulations, and seek new partners to shore up the survivors.

Openness to Different Means of Risk Management

• The informality of BOP clients requires regulators to be flexible in their rules for risk management. Regulators do not generally feel comfortable with informality, however. For example, inclusive finance requires banks to accommodate clients lacking standard documentation, but efforts to move toward flexibility have been stopped cold by the rise of antiterrorism and related concerns.

Regulating for Inclusion: Branchless Banking

• Examples from Banco Bradesco and its agents at Brazilian post offices, to the cell phone banking offered by Globe Telecoms, to Visa’s card systems, show the potential of technology to make microfinance much more inclusive very quickly. Unfortunately, regulations do not move as quickly. Work is proceeding in different countries at different rates to allow these technologies to reach their full potential.

Political Risks

• Because it reaches so many people, inclusive finance can be a very attractive political target, and the bigger it gets, the more attractive it becomes. Attention to the political dynamics of inclusive finance is especially important for high-profile corporations getting into the sector.

Political Risks

• High-level political support has sometimes given a major boost to inclusive finance. At various times presidents of Mexico, Colombia, and Bolivia each signaled their interest in microfinance, helping to ensure the essential policy changes that created conditions for rapid growth. The results of this kind of attention from responsible politicians can be incentives to encourage bank entry into inclusive finance.

Political Risks

• Among such efforts, the subsidy auction program in Chile stands out as particularly well-structured. Banks in Chile bid for temporary subsidies to serve low-income clients. The subsidies help the banks move up the early learning curve, and when banks no longer need them, they phase out.

Summary

• BUILDING THE INFRASTRUCTURE FORINCLUSIVE FINANCE:

summary of the last lecture private equity for microfinance tiaa-cref and procredit. sequoia and sks

Documents

financial institutions

financialsector liquidity

financial inclusion

financial software

poor financial infrastructure

public sector

shared building blocks

market infrastructure