Building a regulatory architecture for microfinance
The best panel I went to at Davos this year—and I got the impression that most of the other people there would say the same thing—was a lunch session today on going “beyond microfinance” when it comes to providing financial services to the unbanked around the world. The implosion of the microfinance sector in Andhra Pradesh has clearly had a sobering effect on much of the well-intentioned professionals here in Davos, and it’s clear that a lot of the hope that surrounded microfinance is now moving on to other things, especially mobile banking.
If there was one big running theme to the lunch, it was that of regulation—a very tough nut to crack. On the one hand, there are lots of organizations devoted to delivering financial services to the poor which are severely hobbled by the regulatory regimes under which they’re working. A big bank CEO at the lunch said that all of his company’s initiatives in the sector essentially had to be ring-fenced from the bank itself, or outsourced entirely to other organizations, for regulatory reasons. The cost of effective anti-money-laudering architecture, he said, is so high per bank account that no account for tiny depositors could ever make economic sense. And at the other end of the size spectrum, a tiny non-profit in Haiti was saying that the regulatory obstacles to providing basic banking services were so high as to be practically insurmountable.
On top of that, many of the success stories in banking the poor, from Grameen in Bangladesh to MPesa in Kenya, grew to be large and highly successful precisely because they had little or no regulatory oversight. And there was an impassioned plea from one speaker that the concerns of banks catering to the poor be an important part of the Basel rules, since so many of those rules are designed for big, rich banks with big, rich clients, and are almost impossible to apply to this very different world.
On the other hand, lack of regulation is the main reason why microcredit, in particular, grew so quickly and out of control, with pretty disastrous outcomes not only in Andhra Pradesh but in many other countries too, from Bosnia to Nicaragua. A profusion of microlenders can easily result in borrowers taking too many loans from too many people, eventually getting far out of their depth, and a lack of regulation can mean usurious interest rates. Far too much commentary on microlending seems to be based on the premise that more lending is ipso facto a good thing, but attempts to demonstrate that empirically have often failed or have generated very unclear results.
Meanwhile, the emphasis on small individual borrowers has meant a certain deficit of attention on small businesses in developing nations, where by some estimates the credit gap is well over $2 trillion. And the amount of money and talent being devoted to setting up lending operations does seem in many cases to have short-changed other, even more important financial services, such as payments, savings, and insurance.
My feeling is that what’s needed here is some kind of platform, or architecture, into which all financial service organizations can plug themselves without being stifled by regulation or needing to bypass or arbitrage it. Lending needs to be regulated more than it is, because although the main victims when a lender collapses are generally its rich shareholders rather than its poor borrowers, the collapse of major lending institutions can cause great damage when it comes to trust in financial-services companies more generally.
Some private-sector initiatives, like Fino, are quite exciting on this front, but they obviously can’t provide much help when it comes to regulation, which is crucial. It needs to exist, across the financial-services spectrum; it needs to be helpful and constructive rather than simply saying no to anything which doesn’t look like a big traditional bank; and it needs to be able to protect end users through deposit insurance and other mechanisms which require full state backing.
This is going to be extremely difficult. Central bankers and other regulators, for many reasons, have very little interest in regulating or licensing mobile-phone operators and other new entrants into the financial-services space. And the existing players in that space, banks foremost among them, have similarly little interest in seeing competitors spring up with lighter regulation. Already they’re at a serious competitive disadvantage: one attendee at the lunch said that a bank employee in India costs $10,000 a year, while a microlending employee costs only $1,000 per year. Given the politics of bank regulation, large existing regulated institutions are likely to be calling the shots when it comes to allowing smaller banks and insurers into the club.
For the time being, then, I fear that microfinance is going to continue to evolve most interestingly and vibrantly in the unregulated space, with all the dangers that naturally means. I hope that a well-thought-through system of microfinance and microinsurance regulation does begin to evolve, but I’m pessimistic, and I suspect that one of the greatest hopes for the educated youth of countries like Egypt and Tunisia—that they will be able to get loans to start companies and develop their economies—will remain out of reach for the foreseeable future.