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The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010


FACOLTÀ DI ECONOMIA Corso di Laurea in MASTER IN MICROFINANCE Classe n. 2009 / 2010

The Role of Regulation and Supervision of Microfinance Institutions: evidence From South Africa and its Implications For The Development of Non-Deposit Taking Microfinance Regulation In Kenya

Presidente di commissione: Prof. Laura Viganò Prova finale di Muganga Denis


Matricola n.



The Role of Regulation and Supervision of Microfinance Institutions: Evidence From South Africa, and Its Implications For The Development of Non-Deposit Taking Microfinance Regulation In Kenya.

By Denis Lewa Muganga UNIBG ID - 1013853 2010

Submitted To The State University Of Bergamo, Italy, In Partial Fulfillment Of The Requirements For The Degree Of Master Of Science In Microfinance Management In The School Of Economics And Business Studies

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DECLARATION No portion of the work referred to in this Research Paper has been submitted in support of an application for another degree or qualification of this or any other university or other institution of learning.

ACKNOWLEDGEMENT Though I will not be able to list all those who were of help to me during the process of my studies and research, I would like to acknowledge with appreciation, the following people who made this research possible, but above all, I thank the Almighty God for His favour and blessings throughout my studies, and in my entire life. Thank you Lord.

Luciano Bonomo, Contract Professor at The State University of Bergamo, and my research supervisor who provided great insight and guidance throughout the research process. It was a great learning experience that will enhance by technical capabilities in my professional life.

Mehdi Dutheil, the Executive Director of PlaNet Finance - South Africa Regional Office (PFSA), where I did my research, for your warm reception, guidance and links to your vast network of experts.

Bezant Chongo, Microfinance expert at PFSA and my research supervisor in the field, for your leadership and day to day oversight of my progress and development of my research paper.

Lauren King, the Human Resources and Administration Manager at PlaNet Finance, for your kind reception and ensuring my pleasant stay in South Africa.

Justus B. Nyamunga, Director, Economic Affairs, Ministry of Finance, Kenya, for your wisdom, sound judgment and inspirational leadership through creating opportunities for young people to upgrade their skills and capacities.

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George Omino, Deputy Director, Economic Affairs, Ministry of Finance, Kenya, for being my mentor in the field of Microfinance, and for the guidance and direction throughout my training and work experience.

Josephine Kanyi, Chief Economist, Ministry of Finance, for teaching me and showing me the right path in career growth and professionalism.

Evans Maturu, Consultant ­ Economic Division, Japan International Co-operation Agency (JICA), Kenya. For your useful guidance towards improving my paper.

Ezra Anyango, Senior Microfinance Expert, Ministry of Finance, for your valuable advice and direction.

Rashid Ahmed, Private consultant and my key advisor on the South African regulatory framework, for bringing me up to speed on the reality of the situation on the ground.

Professor Wolfgang Thomas, of The University of Stellenbosch, for your guidance and oversight of my research work throughout my field work.

Doreen Mnyazi Muganga, my wife, who persevered the loneliness caused by my absence yet encouraged and believed in me all the way.

Daniel and Beatrice Muganga, my parents, who have shaped my life and supported my decisions.

Joseph and Linah Janga, my parents in ­ law, for your trust, love and sharing in my successes.

My siblings and siblings in-law, for your love, care and prayers all through my studies.

To all my colleagues and friends, for your understanding, support and confidence in me.

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ABSTRACT This paper looked at the model and contribution of the South African Regulatory Framework to the Microfinance sector's development, in an attempt to find out whether Regulation enables or creates barriers to increasing access to financial services and reaching the unbanked population in South Africa. It tried to determine whether benefits of Regulation outweighed costs and if this would make a case for Non-deposit taking microfinance regulation in Kenya.

The methodology of this study was purely qualitative. Information was collected mostly through primary data sources by means of face to face interviews guided by questionnaires administered to a selected sample of MFIs, Microfinance banks and key Regulators; as well as through secondary research in the form of literature reviews, telephonic and written submissions. A light Regulatory Impact Analysis and Cost Benefit Analysis was also employed.

It was found that while regulation is definitely not the sole factor responsible for the state of development of the South African microfinance market (macroeconomic reforms have also played a key role) it constituted a facilitator to enhance growth of the industry, by setting standards, increasing efficiency and promoting fair competition while strongly protecting consumers.

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Table of Contents

DECLARATION .......................................................................................................................... 2 ACKNOWLEDGEMENT ............................................................................................................ 2 ABSTRACT.................................................................................................................................. 4 LIST OF ABBREVIATIONS ....................................................................................................... 7 CHAPTER 1 .............................................................................................................................. 10 1.1. 1.2. 1.3. Introduction.................................................................................................................... 10 Objective and Scope of the research .............................................................................. 14 Methodology and Research Structure ............................................................................ 15

CHAPTER 2 .............................................................................................................................. 18 2.1 Economic Rationale for Financial Regulation.............................................................. 18 Preserving Financial Sector Soundness...................................................18 Ensuring Institutional Soundness ............................................................................ 19 Information Sharing................................................................................................. 21 Responsible Lending and Service Provision..............................................22 Consumer Protection ............................................................................................... 22 Interest Rate Controls........................................................................23 2.2 Financial Regulation of MFIs......................................................................................... 24 Prudential regulation................................................................................................ 28 Non-Prudential regulation...................................................................28 Non-prudential standards......................................................................................... 29 2.3 Financial Inclussion......................................................................................................... 29 2.4 International Evidence of MFI Regulation and Supervision ...................................... 30 Bolivia ..................................................................................................................................... 31 Cameroun ................................................................................................................................ 33 Ethiopia ................................................................................................................................... 34 Uganda .................................................................................................................................... 34 Morocco .................................................................................................................................. 35 ASIA ....................................................................................................................................... 37 CHAPTER 3 .............................................................................................................................. 38 3.1 Background Information: South Africa versus Kenya................................................ 38 South Africa's Economic Performance....................................................38

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Kenya's Economic Performance............................................................40 Microfinance Industry in South Africa.................................................................... 41 Microfinance Industry in Kenya...............................................................................42 Kenya's Medium to Long Term Microfinance Agenda...........................................46 3.2 Evolution of the RSA Regulatory Framework ............................................................. 47 (a). Market Structure ............................................................................................................... 50 (b). Prices ................................................................................................................................ 54 3.3 Building a Case for Financial Inclusion ........................................................................ 49 3.4 Findings on the SA Financial Sector Regulatory & Supervisory Framework........... 57 3.4.1 The National Credit Act No. 34 of 2005:..................................................................... 58 The Experience of the NCR in Regulating Credit only institutions ........................................ 62 A) Development of an accessible credit market ....................................................... 62 B) Registration functions of the NCR ...................................................................... 62 C) Enforcement Function ......................................................................................... 63 D) Compliance and Monitoring Functions of the NCR............................................ 63 E) Other functions of the NCR................................................................................. 64 3.4.2 Cooperative Banks Act:............................................................................................... 65 CHAPTER 4 .............................................................................................................................. 67 4.1 Regulatory Challenges In South Africa............................................................................. 67 4.2 Responses To The Four Key Research Questions............................................................. 70 4.3 Lessons learnt: Implications for Kenya and Proposals for the Development of Nondeposit Taking MFI Regulations............................................................................................. 72 4.4 Summary and Conclusions................................................................................................ 77 BIBLIOGRAPHY ................................................................................................................. 81 LIST OF WEBSITES.................................................................................................................. 86 LIST OF PEOPLE INTERVIEWED .......................................................................................... 87 LIST OF FIGURES, GRAPHS & TABLES............................................................................... 87

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AMFI AMFIU APR ASCAS BankSeta BBBEE BCEAO CAA CAR CRB CBA CBDA CBK CBO CENFRI CGAP CIO CMA CMF CPA CU DAFF DBSA DFID U.K. DFIs DTI DTM EAD FAIS FIA FI FNB FSC Association of Microfinance Institutions ­ Kenya Association of Microfinance Institutions of Uganda Annualized Percentage Rate Accumulating Savings and Credit Associations Banking Sector Education and Training Authority Broad Based Black Economic Empowerment Banque Centrale des Etats de l'Afrique de l'Ouest Credit Agreements Act Capital Adequacy Ratio Credit Reference Bureaus Cooperative Banks Act Cooperative Banks Development Agency Central Bank of Kenya Community Based Organisations Centre for Financial Regulation and Inclusion Consultative Group for Assisting the Poor Credit Information Ombudsman Capital Markets Authority Centre for Microfinance Credit Providers Association Credit Union Department of Agriculture, Forestry & Fisheries Development Bank of South Africa Department for International Development ­ United Kingdom Development Finance Institutions Department of Trade and Industry Deposit Taking Microfinance Institutions Economic Affairs Department Financial Advisory and Intermediary Services Financial Institutions Act Financial Intermediaries First National Bank Financial Sector Charter

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Financial Services Cooperative Financial Services Measure Financial Self Sufficiency Financial Year Gross Domestic Product Gross National Income Industrial Development Corporation Insurance Regulatory Authority Information Technology Kenya Bankers Association Kenya Credit Information Sharing Initiative Kenya Post Office Savings Bank Kenya Rural Enterprise Program Know Your Customer Living Standards Measure Microfinance Depository Institutions Micro Enterprise Alliance Microfinance Institutions Network Micro Finance Regulatory Council Micro Finance South Africa Management Information System Ministry of Finance, Kenya Micro and Small Enterprises Micro, Small and Medium Enterprises Non Bank Financial Institutions National Credit Act National Credit Regulator National Credit Tribunal National Debt Mediation Association National Housing Finance Corporation National Loans Register National Youth Development Agency Other Deposit Taking Institutions Operational Self Sufficiency Payments Association of South Africa

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Pawn-Broking Companies Private Financial Funds Quarterly Economic and Budget Review Rand Retirements Benefit Authority Rural Finance Facility Retail Financial Intermediaries Rural Housing Loan Fund Regulatory Impact Assessment Rotating Savings and Credit Association Republic of South Africa Savings and Credit Co-operative Savings and Credit Co-operative League of South Africa South African Microfinance Apex Fund South African Reserve Bank SACCO Societies Regulatory Authority Small Enterprise Development Agency Small Enterprise Foundation Sector Education and Training Authorities Self Help Group Small and Medium sized Enterprises Small Micro and Medium sized Enterprises Usury Act United Kingdom United States Agency for International Development University of Stellenbosch Women's Development Business

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1.1. Introduction Microfinance1 - "the provision of financial services to low-income individuals and households, as well as micro, small and medium enterprises (MSMEs), using specially designed methodologies that will ensure sustainability for the lenders, and lead to improvement in the standard of life for the consumers, while ensuring a triple bottomline of "developing the person; positively impacting lives; and leading to economic development of the region" as it facilitates large numbers of clients with relevant financial services at affordable prices" - provides an enormous potential to support the economic activities of the low income alleviation. people and thus contributes to poverty

Widespread experiences and research have shown the importance of savings and credit facilities for the low income people and MSMEs. This puts emphasis on the sound development of MFIs as vital ingredients for investment, employment and economic growth. There is therefore, need for new, innovative, and pro-poor modes of financing low-income households and MSMEs based on sound operating principles. Implying that, an appropriate policy, legal and regulatory framework to promote viable and sustainable systems of microfinance in a country must be developed (Omino. G., 2005).

As in most developing countries, there are policy and regulatory shortcomings in the Kenyan financial sector in general, and the microfinance industry in particular, especially for Non-deposit taking MFIs. This research identifies the existing regulatory gaps in the microfinance sector in Kenya and tries to borrow from the findings of the RSA MFI regulation, to see how it can be deployed to the Kenyan scenario.

The existing microfinance regulation in Kenya, (Microfinance Act 2006), while putting regulation and supervision of Deposit Taking Microfinance Institutions (DTIs) under Central Bank of Kenya (CBK), has, through Section 3(2) of the Act, empowered the


Defined in the author's own words in an attempt to be as broad as possible for the purpose of this study.

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Minister for Finance to make regulations specifying the Non-deposit taking microfinance business and prescribe measures for the conduct of the specified business (MF Act, 2006).

In this regard, the Ministry of Finance has been conducting initial studies and also sought assistance from the Consultative Group to Assist the Poor (CGAP) to carry out some consultations with various stakeholders in the industry to determine the way forward. The outcomes of these initial discussions clearly reveal legitimate concerns with some practices and a desire for orderly development of the sector through policy changes, regulations and consumer protection measures.

It is therefore imperative that MFIs be provided with an enabling regulatory environment to reach their full potential. This is also in tandem with the Economic Pillar of Kenya's Vision 20302 objective of enhancing deposit mobilization, increasing savings levels (Kenya intends to raise the gross national savings to 27.7 per cent of GDP and expand the level of investment to 32.6 per cent of GDP by 2012) and improving the general quality of life for all citizens (MoF Strategic Plan, 2009-2012).

It is noted that lack of a clear regulatory framework for MFIs will expose these institutions to uncertainties and risks in terms of costs, unhealthy competition, operational challenges, limited funding sources, sustainability and other challenges that individual institutions may not be able to address. This, in my view, boils down to the need for an efficient policy and regulatory environment within the borders of a country, that seals the financial system from both internal and external macroeconomic turbulence.

According to Amha, (2001 pg.7) the Ethiopian "Microcredit initiative in pre 1990 had the following characteristics: poor project concept, highly subsidized, very high default rates, absence of financial discipline, concentration on loans and giving less attention to

Kenya Vision 2030, is the country's long term development agenda which aims at transforming Kenya into a globally competitive and prosperous nation with a high quality of life by the year 2030, by raising the rate of annual economic growth to 10 per cent per annum by 2012 and sustaining it at that level to the year 2030. The Vision identifies 6 key sectors namely tourism, agriculture, wholesale and retailing, manufacturing, business process off-shoring and financial services.


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savings mobilization, donors considered as the source of loan fund, and it was not a real financial intermediation. As a result of the above problems, there was need to change the direction and move towards building sustainable financial service delivery systems. This made a regulatory framework necessary. Thus, prudential regulation and supervision of microfinance institutions was a critical issue in promoting sustainable MFIs".

According to the CGAP Update on Regulation of Branchless Banking (2010c, pg.2) "South Africa has a vibrant and sophisticated financial sector, the strength and stability of which have provided the foundation for over 10 years of uninterrupted economic expansion." The Africa Competitiveness Report (2009, pg.38) further notes that "South Africa, ranked 1st in the region and 24th globally, has highly sophisticated financial markets, on a par with Belgium and France, with relatively easy access to capital from various sources, sound banks, and a well-regulated securities market." This therefore provides important lessons for other countries to emulate, and formed the basis for my research focus on the RSA.

The special characteristics of microfinance, make it such that a range of legal and regulatory norms may challenge the sector to scale up and professionalize, or may simply stifle and impede its development. Effort must therefore be made to tailor financial licenses, prudential and non-prudential norms, supervision systems, and other rules affecting microfinance operations in order to ensure orderly growth (Meagher, 2006).

According to Staschen, (1999, pg.1) "the issue of regulating and supervising microfinance institutions (MFIs) is attracting growing interest. So far though, no clear agreement has been reached on who and how to regulate. At issue are questions like: should MFIs be subjected to government regulation at all? If so, all or only some with certain features (e.g. those engaged in retail deposit-taking)? What adjustments need to be made to regulations for traditional financial institutions to do justice to the specific features of MFIs? Are other regulatory approaches (e.g. self-regulation) perhaps superior to statutory regulation via legal provisions?"

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The author however believes that the government has an important role to play in MFI regulation and supervision, especially as a facilitator and creator of an enabling environment for them to thrive. It should therefore develop rules and regulations that are appropriate and relevant. During the 3rd African Microfinance Conference held in August 2007 in Kampala Uganda, Prof. Harper, in his presentation entitled, "What is wrong with Microfinance?" painted Microfinance as "promoting debt and not thrift, as it forces clients into perpetual dependence on debt, based on lending and not savings and use of inappropriate Asian models to promote indebtedness in Africa. It encourages groups, which are time consuming and oppressive social set-ups, offers unsafe savings facilities mainly dominated by women, who employ themselves and cannot create jobs." Giving examples from India, he cited that microfinance had driven families to abject poverty and caused some to commit suicide. He however went further to concede that microfinance has evolved to become a new asset class, urging that it should be seen as a means and not an end to alleviating poverty in Africa.

For the above mentioned reasons therefore, it is important to carry out studies on the relevance of regulatory frameworks for MFIs and verify their ability to increase access to finance and reach the unbanked. In most countries, a majority of low income people are served by the informal, unregulated financial markets, that seem to be flexible (in terms of their contractual conditions such as oral agreements, flexible interest rates, negotiable collateral, readily available services) and therefore satisfactory to them because of this convenience. It is however important to note that such informal markets3, may not necessarily be reliable and sustainable in the long term, and thus expose their clients to higher risks because of, among other reasons, lack of a recourse mechanism mainly arising from operating outside the formal regulated mechanism. They also have low average transaction amounts and often short-term average maturity. Further, they do not allow

These include the money shacks, money keepers, landlords, loans from friends and relatives, pawn brokers, merchants, tontines, group associations, and others.


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the implementation of substantial measures for the promotion of economic growth and development for the economy in the short-run. Vigano4 (2010) also observes that when informal intermediaries reach a certain level of formalization, they lose their positive features. 1.2. Objective and Scope of the research

This Research Paper has sought to study the model and contribution of the RSA Regulatory Framework on the development of the microfinance sector, through an analysis of whether it enables or creates barriers to increasing access to financial services and reaching the unbanked population. The main focus is however, on the regulation of Non-deposit taking MFIs, in order to inform the Kenyan Ministry of Finance on the development of regulations as directed under section 3(2) of the Kenyan Microfinance Act, 2006.

Towards this end, this study seeks to find answers to the following key questions:

1. What is the model specification of the RSA Regulatory Framework applied on the MFIs for the sector's development? 2. Does regulation enable or create barriers to increasing access to financial services and reaching the unbanked population in RSA? 3. Do the benefits of regulation outweigh the costs? and; 4. Can the results be generalized and make a case for good regulation for Nondeposit taking MFIs in Kenya? This study progresses as a build up to my initial study tour of 12th ­ 17th October 2009, to the RSA, to gather information on how to develop appropriate regulations for Nondeposit taking MFIs in Kenya. In this initial visit, I sampled several institutions and held comprehensive interviews together with 3 of my colleagues as a government delegation from the Kenyan Ministry of Finance.


Laura Vigano (2010) class lecturers on the role of financial intermediaries on economic development, Module 4 ­ Master in Microfinance, University of Bergamo, Italy.

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The delegation comprised of the following officers: 1. Ezra Anyango ­ Senior Microfinance Expert (Head of delegation) 2. Julius Mutua ­ Senior Economist (Microfinance Division, EAD) 3. Denis Muganga ­ Economist (Financial Sector Division, EAD) ­ Secretary In this regard, the following institutions were visited, in Johannesburg, Midrand and Pretoria: 1. National Credit Regulator (NCR); 2. Credit Information Ombudsman (CIO); 3. Department of Trade & Industry (The DTI); 4. Trans Union Credit Bureau; and 5. Microfinance South Africa.

The scope is now limited to interviews with a sample of MFIs and Microfinance Banks, specifically in the Western Cape Province, mostly those partnering with the PlaNet Finance Advisory Services ­ South Africa Regional office (PFSA)5, that are duly registered and answerable to the National Credit Regulator. 1.3. Methodology and Research Structure The methodology of this study was mainly qualitative. Information was collected mostly through primary data sources by means of face to face interviews guided by questionnaires administered to a selected sample of MFIs, Microfinance banks and key Regulators; as well as through secondary research in the form of literature reviews, telephonic and written submissions. To make the information more reliable and easy to track, the questionnaires were designed to include quantitative questions.

The research methodology was implemented in 4 main phases: meetings with the attachment supervisors to clarify the objectives and scope of the study; literature reviews; stakeholder interviews; and analysis and report writing.

PFSA is part of the PlaNet Finance Group based in Paris-France, active in more than 60 countries, advising microfinance actors on various financial sector issues, and was my host organization for the field work and research towards writing this Research Paper.


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Also adopted, albeit partially, in the research is the methodology called, Regulatory Impact Analysis (RIA), which according to Kirkpatrick and Parker (2003, pg ii), "involves a systematic appraisal of the costs and benefits associated with a proposed new regulation and evaluation of the performance of existing regulations with the aim of improving the quality of regulatory policy".

A RIA is usually helpful in assisting governments and regulators to; assess the costs and benefits of intended regulations; encourage a structured study of the objectives and gains of regulations; link impacts of change in one law or introduction of a new law, to other laws; improve transparency by enhancing stakeholder consultations and exchange of views; and enhance accountability. Importantly, however, in this case, the conventional RIA has been adjusted for the ex-post assessment of the impact of the National Credit Act. This means that issues of regulatory efficiency, compliance costs and other costs to society, which are usually included in RIAs, are not explicitly assessed in this study (Calvin and Coetzee, 2010).

The analysis includes how the positive and negative impacts are distributed among different stakeholders (Lee, 2002). This is because regulation normally entails trade-offs in which some gain and others lose as a result of its implementation (Kirkpatrick and Parker, 2003; FSA, 2000a).

To ensure total objectivity to qualitative research, data triangulation could be used, ensuring a variety of data sources in a study, such as different timeframes, different geographies and subjects. Triangulation research approach was therefore used in order to enhance the credibility and validity of the qualitative analysis (Tucker et al, 1995).

In-line with this Cost Benefit Analysis will be partially applied as an additional technique. This has been the most commonly applied method in the assessment of financial regulation (FSA 2000a).

All approaches intended to be used here, have their weaknesses. An FSA (2000a, pg. 39) study notes, concerning RIA approach that, "it can be very difficult to distinguish

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between changes in a market that were occasioned by a regulatory initiative and changes that would have arisen in any event." On the other hand, cost benefit analysis usually presupposes the existence of a non-regulated control group with identical characteristics to the regulated one, so as to be able to isolate the effects of regulation.

RIA usually strives for an overall regulation that is transparent, appropriate, accountable, fair and efficient, thus providing a strong platform for policymaking. To assess the impact of a regulatory program, the best option is through evaluation using experimental designs. However, this approach to assessing the impact of the NCA is difficult to implement at this stage and would also have been quite expensive, thus was not fully adopted.

Diverse studies have been done on regulation of MFIs, such as Gallardo (2002) and Calvin et, al. (2010), etc, but most of them could only extrapolate and/or make assumptions on actual costs and benefits of regulation, due to lack of sufficient data for trend analysis. Appropriate data collection is a significant element of this study yet there is no sufficient data on, for instance, actual costs of compliance to regulatory requirements, time value of reporting and complying to regulatory provisions, etc. The paper will therefore be restricted from conducting a comprehensive econometric analysis of costs and benefits, or outreach and profitability, against compliance to regulation. This will therefore result in a more qualitative than quantitative study.

The author however believes that the methods selected for this study are sufficient enough to bring some useful conclusions and support the arguments to answer the research questions and support my analysis.

The paper will be structured as follows: the second chapter reviews literature on regulation and supervision of MFIs in RSA as well as in other parts of the world, identifying their main findings, attitudes towards various regulatory approaches and how they have impacted on the performance and development of MFIs. Chapter three, the heart of the paper, will provide a background of the economic and microfinance situation in both RSA and Kenya, highlighting the trends and key issues in both

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countries, review the evolution of the regulatory frameworks in both countries, build a case for financial inclusion and look at the techniques applied in regulation and

supervision, and how this has impacted on the microfinance market.

Chapter four looks at the key challenges and shortcomings of the RSA regulatory framework, presenting an assessment of the research based on a light RIA in order to discuss the financial and economic impacts for the different microfinance stakeholders. It will also respond to the four key questions and clearly indicate the benefits versus the costs of regulation in the case of RSA regulatory framework. It then highlights the key lessons and their implications for Kenya and finally summarises the main arguments of the paper, presents the conclusions and introduces some guiding measures necessary to be taken towards building a comprehensive regulatory framework for the Non-deposit taking MFIs in the Republic of Kenya.


It has been noted extensively that there is need for a comprehensive analysis of whether regulation actually encourages or discourages the growth of MFIs and in-turn promotes or deters access to financial services. The literature about microfinance regulation has mostly focused on analyzing benefits and drawbacks of different regulatory options through a comparative analysis of regulatory frameworks (Gallardo, 2002). However, any potential impact should not be taken for granted (Staschen, 2003). 2.1 Economic Rationale for Financial Regulation Preserving Financial Sector Soundness The core objectives of financial regulation are to preserve the stability and soundness of the financial system and to protect the deposits of the public (Llewellyn, 1999). A primary reason for regulating and supervising traditional financial institutions is consumer protection for public depositors in financial institutions.

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There are two main approaches to financial regulation: firstly, to impose limits or constraints on the supervisees so as to deter them from engaging in certain activities that entail excessive risk, and secondly, to provide financial firms with a set of incentives that would induce them to align their private objectives to social goals. Thus, regulation is meant to define the rules and incentives by which market participants must behave, but without constituting a barrier for the natural development of the industry. It was further stated by Stiglitz (2001, pg.16-17) that "the challenge of financial regulation is to enhance competition, openness, and innovation in the financial sector while maintaining sound prudential oversight, appropriate incentives, and needed constraints"

Ensuring Institutional Soundness Regulation should help in setting standards that when followed to the latter, will enhance financial institutions' soundness and thus enable their growth and sustainability, leading to economic development in the country.

According to the Banana Skins report (2009, pg 28), "the concern most frequently cited by respondents is that many countries still lack specific MF Regulation, which means that MFIs are either unregulated, or forced to conform to other, mainly commercial banking regulation. This is a particular issue for deposit taking, an activity that more MFIs want to get into. The wrong regulation can affect the viability of the business model, undermine depositor and investor confidence and expose MFIs to political interference".

Moral hazard issues sometimes arise because the interests of financial institutions vis-àvis the interests of consumers per se are not necessarily compatible. Depositors and investors may not be in a position to judge the soundness of a financial institution (the issue of asymmetric information) much less to influence the institution's management (Stiglizt, 2001).

In one among four studies on Microfinance Tradeoffs, conducted by Robert Cull, Asli Demirgüç-Kunt and Jonathan Morduch in September 2009, which looked at Regulation, Competition, and Financing, using an updated MIX Market dataset, they examined the

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effect of regulatory supervision on the profitability of microfinance institutions (Cull et al. 2009). In particular, they investigated how regulated institutions manage the financial and administrative burdens of complying with regulation, looking at profits, business orientation, outreach, and the share of employees who work in the field.

They also looked for evidence that regulation provides benefits by improving loan quality. They conducted econometric analyses of the dataset described above, and of a subset, the 154 institutions that both reported detailed financial information and were subject to regulatory supervision (Cull et al. 2009). They estimated the impact of prudential regulation on profitability and financial self-sufficiency, using, for the key regressors, three dummy variables that summarize whether an institution faces prudential supervision and the intensity of that supervision.

These dummy variables measured whether; (1) an MFI faces a regular reporting requirement to a regulatory authority; (2) the MFI faces onsite supervision; and (3) onsite supervision occurs at regular intervals. They controlled for the same variables as in an earlier 2007 study on contracts and added a measure of staff concentration and Premium6. They found that onsite supervision of microfinance institutions varies, even within the same country and among profit-oriented institutions. Whether an institution faces onsite supervision depends on its ownership structure, funding sources, activities, and organizational charter. In terms of trade-offs, they found that microfinance institutions subjected to more rigorous and regular supervision are as profitable as others, despite facing higher costs of supervision (Cull et al. 2009).

This finding may in part reflect the fact that being regulated often permits institutions to collect deposits and thus gain a cheaper and/or more stable source of capital. For example, Ledgerwood and White (2006, pg. 174), as quoted in (Cull et al. 2009) draw on four to six years of data for nine MFIs to report that "experience to date has shown that as transformed institutions mature, deposits as a percentage of funding liabilities increases."


Defined as the difference between the interest rate an institution charges its borrowers and the "market" rate for capital.

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This therefore demonstrates the desire for more MFIs to grow into the regulatory realm, where they will have access to increased funding sources, one of which is through mobilization of voluntary deposits, as a cheaper and more reliable source of funding.

Mersland and Strøm (2009) also conducted an econometric analysis of the impact of regulation with cross-institution data. In line with the above findings on regulation and profitability, they found that regulation does not have a significant impact on financial performance. They did not find evidence for the trade-off with outreach, however.

Hartarska and Nadolynk (2007) also show that regulation does not directly affect the performance of microfinance institutions, either in terms of operational selfsustainability (OSS) or outreach. They find that deposit-taking institutions have broader outreach, though, suggesting that regulation may offer an indirect benefit by permitting institutions to expand.

Information Sharing The existence of information asymmetries defines the special nature of the financial industry and explains its heavier regulation compared to other industries (Arun, 2005; Stiglitz, 2001). In fact, the asymmetric distribution of information among the different stakeholders (shareholders, debtors, and depositors) raises the need to counterbalance their particular interests through regulation, and especially, to protect the interests of small depositors (Vogel et al, 2000; Jansson, 1997). According to Reille (2010)7 "Few countries boasted as strong and as vibrant a microfinance sector as Morocco, where MFIs saw the size of their combined loan portfolio multiply 11 times between 2004 and 2007. But the last two years have shown that this growth came at the cost of asset quality, which ­ combined with clients borrowing from multiple MFIs ­ have spurred write-offs and falling returns". Morocco was thus hit by a repayment crisis, that sent one of the largest MFIs, Zakoura, almost collapsing and had to merge. To hasten recovery, Reille (2009, pg.3) found that "Moroccan MFIs are, among other remedies, sharing timely credit information to curb


Article on Morocco MFIs confront crisis and strive for a brighter 2010 (February 2010). Available at Last visited 23rd September 2010 at 14.18hrs.

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the practice of multiple MFIs lending to the same client, prompting a decrease in the share of clients with multiple loans from 39% in October 2008 down to 29% in September 2009. MFIs are also now exchanging credit information weekly to control cross-lending".

The National Loans Register (NLR) According to Rashid Ahmed8, "the NLR was developed during the time of the MFRC as a public registry intended to keep information specific to the micro-lending industry. It included information on loans - enquiries, total granted and payments. It does not house other credit bureau information such as judgments and there are no rules about what loans may or may not be made. The decision to grant loans rests with the lenders based on their risk and credit policies. The MFRC owned and took overall responsibility to ensure that the rules on making inquiries on the register were complied with, while the private sector, running credit bureaus also ran this register".

Responsible Lending and Service Provision Regulations help to define the legal status of institutions, outlining the allowable and prohibited activities, as well as the scope of offering those services. This helps in creating an environment of responsible lending, for lending institutions, and other services. Consumer Protection In stressing the importance of consumer protection in microfinance, it has been noted that financial services can help poor people transform their lives. And if not designed and implemented properly, they can, in some cases do more harm than good, especially micro credit (McKee et, al. 2010).

To help guard against this, the Smart Campaign (formerly known as the Campaign for Client Protection in Microfinance) is bringing together a broad range of players in microfinance: practitioners, networks, donors, investors, fund managers, and policy makers. Launched in March 2009, its goal is to make sure financial service providers

Rashid Ahmed is a consultant on Financial Sector Regulation, who was key in development of the Regulatory framework in South Africa, while working with the Finmark Trust.


22 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

treat customers fairly, and avoid offering financial products that could harm or expose clients to unnecessary risks (McKee, 2010). The Campaign is working to establish standards for the appropriate treatment of low-income clients based on six Client Protection Principles: Avoidance of over-indebtedness; Transparent pricing;

Appropriate collections practices; Ethical staff behavior; Mechanisms for redress of grievances and Privacy of client data. Interest Rate Controls Regulation is intended to guard against exorbitant interest rates and pricing of MFI services that would exploit the poor. It is usually the case that when faced with an interest rate ceiling, companies and NGOs providing financial services to poor people will often retreat from the market, grow more slowly, and/or reduce their work in rural areas, or other, more costly market segments because they cannot cover their operating costs.

According to Goodwin-Groen (2006, pg.26) "the interest rate ceilings discourage commercial banks from expanding into higher-cost rural or microcredit markets. For example, evidence of market contraction was seen in Nicaragua after the national Parliament introduced an interest rate ceiling for specific types of lenders, including NGO-MFIs, in 2001. Annual portfolio growth of these MFIs fell from 30% to less than 2%. The imposition of interest rate ceilings also caused several microfinance institutions to leave rural areas, where risks and operational costs are higher."

According to Gonzalez-Vega and Villafani (2004), quoted in Goodwin-Groen (2006, pg.27) "recent research in Bolivia asserts that interest rate ceilings have retarded the development of commercial microfinance in that country, primarily by discouraging microfinance NGOs from transforming into licensed financial intermediaries".

It is difficult to substantiate arguments about what specific markets might have looked like without interest rate ceilings. However, a comparison of market penetration rates between twenty three countries with interest rate ceilings and seven countries without ceilings suggests higher penetration rates in the latter (Porteous, 2006).

23 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

Any limitation on the interest rate level usually has counter-productive effects. Low interest rates or Usury laws make institutions concentrate their portfolio on fewer, most profitable and powerful clients (Gonzalez-Vega, 1977). According to Marek Hudon (2007 pg.3), quoting Keynes (1936, pp.378-379) hoped that "pure interest rates could be driven to zero within one generation, to do away with the `rentiers'. In religious, Marxist, and Keynesian understanding, high interest rates are looked upon as either intrinsically unjust or potentially harmful".

According to Von Pischke (1983, pg.176), "low interest rates on loans to rural people end, paradoxically, by restricting their access to financial services". This is further supported by Helmes and Reille (2004, pg.4), who noted that "to compensate for the reluctance of commercial lenders to enter specific market niches, such as rural or agricultural markets, governments have traditionally established specialized rural credit programs and institutions which often hold interest rates at artificially low levels, producing the same effect as an interest rate ceiling. Unfortunately, government and donor-subsidized lending schemes that provide credit for poor people at unsustainably low interest rates have generally been unsuccessful in offering financial services over the long term to their target groups". 2.2 Financial Regulation of MFIs All the arguments that support the application of regulation to banks are naturally extended to non-banks (Stiglitz, 2001; Jansson, 1997). However, as Stiglitz (2001, pg.10) explains "the extent and nature of the regulation may differ markedly between banks and non-banks depending on the role the latter institutions play in the economy".

The Basel Committee on Banking Supervision (2010), released a set of 25 key principles (guidelines) specialized for the supervision of MFIs. The report notes that non-banks that mobilise deposits from the public should be subject to regulation and supervision commensurate to the type and size of their transactions. In general, microfinance oversight, whether over banks or other deposit taking institutions, should weigh the risks posed by this line of business against supervisory

24 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

costs and the role of microfinance in fostering financial inclusion. To assist countries in developing a coherent approach to regulating and supervising microfinance, the Microfinance Work-stream of the Basel Committee on Banking Supervision has developed guidance for the application of the Core Principles9 to microfinance activities conducted by depository institutions in their jurisdictions (BIS, 2010).

In the case of MFIs, the task involves establishing an appropriate and cost-effective regulation that is compatible with the objectives of regulation of the financial system as a whole; and that allows sufficient margins for innovation and flexibility to facilitate the growth of the industry (Arun, 2005).

On the one hand, there are specific arguments that support MFI regulation. Regarding the protection of depositors, Hardy et al (2003, pg.154) argue that "depositors of an MFI are in a less advantaged position compared to other clients, not only because of the small amounts of their individual deposits but because any failure of an MFI would [...] discourage them from participating in the financial system indefinitely". Besides, these authors point out the need for some protection against fraudulent practices like the `pyramid scheme' that can be highly detrimental for small clients.

On the other hand, care should be taken to avoid scenarios of downscaling of MFIs arising from high costs of complying with regulations. The supervision of the National Bank of Romania, for instance, increased the operational costs and forced MFIs to invest in new and more sophisticated Management Information Systems (MIS) and to train their staff in reporting. As a consequence, at the end of 2007 the first Romania MFI handed over the license and stopped the crediting activity (Eurom Consultancy and Studies, 2008).

Tor Jansson, in his (2001, pg.9) article on `Microfinance: from Village to Wall street', noted that MFIs have distinctive features that separate them and their subsequent regulatory requirements from those of conventional banks or credit institutions. "Given


The Core Principles for Effective Banking Supervision are available at

25 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

distinctive features and risk profile of microfinance, some regulatory and supervisory practices have to be adjusted to control risk and protect depositors in MFIs".

Table 1: Distinctive Features of Microfinance

Source: Created by Tor Jansson , using information in Rock and Otero (1996) In an article by Xavier Reille on Wednesday, April 14, 201010 titled "Should big MFIs be prudentially supervised even if they don't take deposits? Are they "too nice to fail"?" It was noted that MFIs usually do not threaten the stability of the financial system, being never "too big to fail," but some governments may regard them as "too nice to fail," in view of the services they provide to the poor. In Morocco, Zakoura MFI was rescued with taxpayer money out of fear that delinquency by its borrowers would spread to other MFIs and push them to the brink. It was taxpayers, not the lenders (mainly local banks), that had to absorb most of Zakoura's losses. This posed questions as to whether even prudential regulation would have saved this crisis.

10 visited on 18th August 2010 at 11.50am.

26 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

In most countries however, regulatory barriers in the financial sector are now being eliminated as part of macroeconomic stabilization and country specific economic development agendas.

There is a common perception that there is no clear justification for prudential regulation of credit-only MFIs, because of their negligible risk in the financial intermediation process. (Kirkpatrick & Maimbo, 2002; Christen el al., 2003). Regulation for these institutions however, is mainly intended to signal the private market and donors about their financial soundness and introduce the possibility of becoming deposit-taking institutions, through up-scaling in a tiered-approach scheme (Christen and Rosenberg, 2000).

Brandsma and Chaouali (1997, pg.35) found that "a country's regulatory approach must be consistent with the financial sector framework and consider the variety of institutional types. Possible responses to microfinance institutions range from no regulation to full regulation:

· No regulation ­ MFIs evolving outside a regulatory framework, are free to develop non-traditional approaches to providing financial services. In some countries, as the local microfinance industry matures, MFIs establish associations or interest groups to define best practices and set industry standards. This was also found to be cost effective (Kirkpatrick and Maimbo, 2002).

· Self-regulation - occurs when the microfinance industry develops its own supervisory and governance bodies. This has occurred primarily through federations of credit unions or cooperatives.

· The hybrid approach - regulatory authorities contract a third party - such as an accounting or consulting firm - to perform some or all supervisory functions.

· Existing law - some countries chose to regulate MFIs within the existing legal and regulatory framework for financial institutions while adapting required ratios and

27 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

supervisory practices to address their unique risk profile. While the regulator faces no major cost with this approach, the process of adequacy to comply with heavy regulatory requirements could involve high costs for the supervisees. · Special laws - establishment of a special regulatory framework tailored to the characteristics and risk profile of MFIs is widely supported by the microfinance industry (Kirkpatrick and Maimbo, 2002). This approach known as the `special window' for microfinance is supposed to contribute to a better insertion of MFIs to a regulatory structure, according to the range of financial services to be provided".

Nonetheless, it is perceived that the most useful approach is to regulate microfinance as an activity rather than focusing on the institutional structure, due to the broad range of institutions that may be involved in the microfinance sector (Christen et al, 2003; Hardy et al, 2003). This has been the approach undertaken by the South African regulatory framework through the National Credit Act, which has provided an equal platform for all credit providers regardless of their institutional types.


Prudential regulation

This intends to protect the soundness, financial health and stability of the financial system. It involves establishing an appropriate framework of norms and incentives by which financial institutions must behave without taking excessive risks that could affect their performance. The goals of prudential regulation are the ones claimed as justifications for regulating the financial system, i.e., preserve the stability and soundness of the financial system and protect the small depositors (Arun, 2005; Christen et al, 2003). Therefore, its oversight should be the responsibility of a public and specialised supervisory body (Llewellyn, 1999).


Non-Prudential regulation

This seeks to promote good behaviour in the system, focusing on the way financial firms conduct their businesses (Llewellyn, 1999; Hardy et al, 2003). It is related to regulations pursuing consumer protection, information disclosure and fair business practices, which are similar to the ones applied to other industries (Arun, 2005; Hardy et

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al, 2003; Christen et al, 2003). It is argued that non-prudential regulation could be selfimposed or controlled by any other authority (Christen et al, 2003). Nonetheless, it is more efficient if the same regulatory agency is in-charge of the design, implementation and oversight of prudential and non-prudential standards because of the economies of scale in information, knowledge and expertise about the members of the market.


Non-prudential standards

Non-prudential regulatory standards comprise a variety of issues related to how the microfinance business must be conducted. Among these, the most significant ones include: protection of consumers; prevention of fraud and financial crimes; implementation of credit bureaus; and transparent disclosure of interest rates to consumers (Christen et al, 2003). By naming these standards as non-prudential, however, it is not meant to qualify them as insignificant, but to describe the fact that they are not required to be enforced by the supervisory agency that is in charge of the soundness of the financial system (Christen and Rosenberg, 2000).

2.3 Financial Inclussion Essentially, the un-banked do not have access to financial services. Financial exclusion may be defined as "The inability to access necessary financial services in an appropriate form" (Kempson and Whyley, 1999). Reasons for exclusion span aspects such as affordability, eligibility and appropriateness of products and services.

A useful taxonomy provided by (Kempson and Whyley, 1999) in FSA (2000b, pg 9(1.17)) identifies:

·Access exclusion - restricted access via the process of risk assessment; ·Condition exclusion or eligibility - occurs where the conditions attached to financial products make them unsuitable for the needs of some people; these conditions imposed by regulators, as well as those imposed by banks, can include proof of address, proof of employment, credit record, etc; ·Price exclusion or affordability - occurs where people perceive access to be unaffordable;

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·Marketing exclusion - where some people are effectively excluded from targeted marketing and sales; and ·Self-exclusion - when people decide there is no point in applying for a financial product because they believe that they would be refused. In this case, they pre-empt the decisions of banks by refusing to apply.

In any study about regulation of the financial sector, it is important to look at these forms of exclusion because they work together to create a complex set of barriers to entry. Internationally, financial exclusion has come under increasing scrutiny, as it is associated with, and is seen to exacerbate, other forms of social exclusion. Financial exclusion also appears to be a growing problem in countries that are deregulating financial systems (Gardener, et, al. 2004).

In RSA, the majority of those who are excluded tend either to earn low incomes or to live in rural areas and Access, Condition and Price exclusion appear to predominate. According to the Financial Sector Charter (FSC), (Preamble, Section 1.3), "in August 2002, at the NEDLAC Financial Sector Summit, the financial sector committed itself to the development of a Broad Based Black Economic Empowerment (BBBEE) Charter". This was aimed at empowering the black community as well as increasing financial access. Key indicators in the FSC include physical access, appropriateness, affordability, fair value, simplicity and non-discrimination.

2.4 International Evidence of MFI Regulation and Supervision Most countries are opting for specific regulations for MFIs, arguing that it is a "special" sector, that needs specific regulation to enhance its quality, development, growth, and to broaden the funding base for those eligible to mobilize and administer deposits, credit facilities and other services, while others argue that when their regulation is aligned to banking regulations, it will integrate microfinance into the broader financial sector, encourage innovation and competition, enable proper harmonization of any regulatory

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changes on the regulatory framework as well as minimize possibilities of regulatory arbitrage11. According to Brandsma and Chaouali (1997, pg.33) "Microfinance activities may be impeded by such legal and regulatory obstacles as interest rate ceilings (Morocco), inability to reward loan officers based on performance (state-owned banks in Egypt), lack of legal status for mobile branches (Lebanon), inability to engage in financial transactions with non-registered (informal) enterprises, minimum deposit or savings requirements that exclude the poor from opening accounts, and loan classification rules. In such cases financial sector legislation should not be immediately overhauled. Rather, exceptions should be allowed on a pilot basis for a transition period".

Specific regulatory practices are discussed below, to provide for a wide and all encompassing comparison of different approaches to this task. These cover 5 countries and 1 continent, selected subjectively but taking into consideration leading regulatory best practices in the 5 inhabited Continents: Americas (South America) ­ Bolivia; Africa ­ (Middle East and North Africa) ­ Morocco; East Africa ­ Ethiopia and Uganda; West Africa ­ Cameroun; and Asia ­ various countries. Others, such as Europe and Australia, were left out because of minimal existence of microfinance activities. Bolivia In a report entitled The KEMCAMP Quarterly Report (2008, pg8), which arose from a study tour of Bolivia by CBK Bank Supervision officers in 2007, it was found that "Bolivia's success in Microfinance is to a large part attributable to the legal and regulatory framework. The Banking Law is applicable also to MFIs with the only microfinance specific modifications being in the regulations. The Superintendence of Banks and Financial Entities (SBEF)12 also applies the law equally to all institutions".

The Banks and Financial Entities Law is the principal legislation for banking and non banking financial entities and is governed by the SBEF. The non-banking entities

Regulatory arbitrage - refers to the fact that some institutions could benefit by following a regulation that was not intended to be applicable to them. This can create negative externalities, market distortions or could leave some institutions inappropriately regulated (Christen et al, 2003). The SBEF is an independent entity from the Central Bank, founded in 1928, that regulates financial institutions and also governs the Banks and Financial Entities Law.

12 11

31 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

covered by the law are; Microfinance Commercial Banks, Savings and Loan Mutuals, Private Financial Funds (PFPs) and Credit Savings Unions (CSUs).

PFPs are the Regulated - DTMs, defined as - public limited companies whose main object is channeling resources to small and micro-sized borrowers whose activities are located either in urban or rural areas. They were brought under the ambit of the SBEF in 1995, while CSU's were brought under regulatory purview in 1996. All banks and nonbank financial entities are subject to the Bank and Financial Entities Law which was updated in 2001. Therefore there are no separate legislation and regulations for MFIs.

To become a licensed PFP, a detailed economic feasibility study has to be carried out and submitted to SBEF, who then embarks on off-site and on-site evaluation of the study submitted. The feasibility study is expected to comprise sections on the economic, legal, and political environment, the financial system, market segments targeted, expected economic impact of financial service provision to these segments and the competition expected. It must also include a description of the financial products demanded by the market segment as well as products to be provided, the prior institutional experience, designated shareholders, organizational structure and managements' qualification. Finally, financial projections that reflect all the above aspects must also be presented (SBEF (1999), as sighted in the KEMCAP Quarterly Report, 2008).

The main success factors for MFI Regulation in Bolivia include: Development policies and strategies, Market and Infrastructure, Legal, Judicial, Regulatory and Institutional framework, Increased number of financial services providers, Enhancement of Self Regulation mechanisms particularly for MFI's not regulated by the SBEF, and Formation of strategic alliances between banks, MFI's and credit unions.

In another study, Villacorta, (2010, pg.4) found that "a new upgrading model is being developed in Bolivian microfinance, which is regarded as one of the world references in the sector. NGO MFIs are going to be considered as financial intermediaries. They will be allowed to offer a wide range of financial services and will

32 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

be allowed to hold deposits and other financial services in areas now excluded from the formal financial system, especially remote and rural areas, while keeping their legal status and, moreover, their non-profit status". Cameroun The CEMAC regulation relates to the conditions governing the exercise and the control of microfinance activities in 6 countries (Cameroon, Central African Republic, Chad, Congo, Equatorial Guinea and Gabon) and categorises MFIs as follows; Article 5 : "MFIs shall be grouped into three categories: 1. Category one shall include institutions which collect their members' savings and use such savings to grant loans exclusively to the said members. 2. Category two shall include institutions which carry out savings collection activities and grant loans to third parties. 3. Category three shall include institutions which grant loans to third parties without carrying out savings collection activities." MFI legal status are, for each category, specified in a regulation issued by the Banking Commission for Central Africa. Article 7 : "The minimum capital of the institutions shall be fixed as follows: · No minimum capital or donation shall be fixed for category one institutions. However, the constituted capital should be represented and enable the respect of all the norms defined by the Banking Commission. · For category two institutions, the minimum capital shall be fixed at 50 million FCFA. · For category three institutions other than projects, the minimum capital shall be fixed at 25 million FCFA. The capital or donations or any other resources serving as such, of the umbrella organ shall not be less than 20% of the constituted capital or donations of its affiliates. "The national authorities shall be authorized to fix a higher minimum capital level as required by the development of the microfinance sector, subject to the approval of the Banking Commission".

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Ethiopia Ethiopia introduced a regulatory framework for MFI licensing and supervision in 1996 (The regulatory framework includes the proclamation 40/1996 and the 17 directives of the National Bank of Ethiopia (NBE)). Since then, the government and NBE have made efforts to gradually improve the regulatory framework. (Gobezie, 2005). The MicroNed - Ethiopia Microfinance Country Strategy, (2008 ­ 2010 pg. 1), further found that "the MFIs are expected to register as limited share companies".

According to Gobezie (2005 pg. 2) "in the proclamation, microfinance business is defined as "an activity of extending credit, in cash or in kind, to peasant farmers or urban small entrepreneurs." The NBE is empowered to license, supervise and regulate the delivery of financial services to the rural and urban poor through microfinance institutions".

Regulation and supervision has helped to create an enabling environment for establishment of specialized formal financial institutions that provide financial services to the un-banked. They have also encouraged MFIs to offer a wide range of products, and promoted standardization and transparency in the sector. Until 1996, donors funded the provision of microfinance services in Ethiopia through NGOs and government institutions, which followed a poverty lending approach that weakened the development of self-sustaining MFIs. Most donor-funded microcredit programs were transformed into regulated institutions (Amha, 2001).

Gobezie, (2005 pg. 4), also found that "MFIs are currently exempted from Income and Sales tax, with a provision in the proclamation that the "Ministry of Finance and Economic Development is responsible for handling and management of such issues". The exemption is quite appropriate, particularly at the initial stage, to protect the "infant industry", and to help it develop with the profit made from operations utilized for capacity development purposes". Uganda According to Caroline, ed. (2008, pg. 5 - 6) "as a result of the policy statement that was issued by Bank of Uganda in 1999 on microfinance supervision and regulation, all

34 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

financial institutions were categorized in 4 tiers; Tier 1 includes commercial banks which offer microfinance services, Tier 2 consists of credit institutions, Tier 3 comprises of Micro Deposit-taking Institutions (MDIs) and Tier 4 comprises of SACCOs, NGOs, and smaller companies which are not under the supervision of the Bank of Uganda (BOU). It is however important to know that there is a proposed bill that has already been presented to parliament to regulate the activities of financial institutions in Tier 4".

These institutions are not regulated under the new Microfinance Deposit Taking Institutions legislation by BOU. BOU regulates microfinance business of Tier 1 and 2 institutions under the Financial Intermediaries Act (FIA) and Tier 3 under the special law, the MDI Act 2003.

The key feature of the regulatory approach adopted by BOU is the "Tiered Approach" which is guided by what is feasible for its own operations and conducive for the development of the financial market. The tiered approach reflects the concept of microfinance as a line of business. It is conducive to the development of a sound microfinance sector. It gives room for more flexibility to microfinance activities, which are still in an experimental stage and also allows for graduation from one tier to another (Caroline, ed. 2008). It incorporates the fact that it may be necessary to regulate different intermediaries in a different manner. This is one important innovation in the regulation of this type of business in Uganda. Morocco According to Reille (2009, pg.1), "Morocco is a recognized microcredit champion, boasting 40 percent of client outreach in the Arab world and host to some of the best performing MFIs in the world". In April 199913, the government passed the Microfinance Act which provides a legal framework for microfinance. The law requires MFIs to register with the Ministry of Finance and, among other stipulations, prohibits MFIs from collecting savings. MFIs are supervised by the Ministry of Finance and are

Reported in a CGAP article written by Dr. Fouzi Mourji of the University of Hassan II, Casablanca. Available at,F


35 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

required to be audited. The Ministry is also supposed to determine interest rates, though this has not yet occurred. According to a USAID brief14, the new Moroccan microfinance law allows micro credit to be carried out by essentially non-profit finance companies. MFIs are not allowed to collect savings and there is a ceiling on loan sizes set at about $3,000. Also, MFIs are prohibited from lending for other than productive activities. Aside from these limitations, MFIs have broad permission to innovate both in mobilizing capital and in lending methodology. USAID is continuing a dialogue with the various MFIs and the government ministries in charge of regulation to encourage the government to reexamine some of the more restrictive aspects of the law. Table 2: Regulation, supervision and main participants in Morocco

Type Supervisory Authority Key player or legislation Description Bank Al Maghrib (Moroccan MFIs must regularly submit outreach Central Bank) information, financial statements, and

funding information to Al Maghrib Bank. Microfinance Law N° 18-97 relating to The 1999 Law No. 18-97 relating to in microcredit requires a specific legal status for MFIs, a lending limit of 50,000 MAD, and financial sustainability after 5 years of existence. Network Fédération Nationale des FNAM, created in 2001, revised its statutes

specific Microcredit 1999



Associations de Microcrédit in 2008. Offers support to restructuring of (FNAM) the sector through the moderation of committees and working groups. Credit bureau Informal credit bureau 8 of 12 MFIs share information. The credit bureau was initiated by the 4 largest MFIs in 2007 and hosted at Al Amana. Formal credit bureau (under A formal credit bureau is being considered implementation) with support from IFC under auspices of the Al Maghrib Bank.


USAID program in Morocco. Available; visited on 19th August 2010 at 14.35hours


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According to a study conducted by Haq, Hoque and Pathan (2008, pg. 421), it was found that in Asia "MFIs are generally regulated under the banking legislation and supervised by central banks. In contrast, semiformal institutions like NGO-MFIs are regulated by either an apex organisation or other government body. Informal MFIs are not regulated but some are of sufficient size to become NGO-MFIs or even banks. The formal MFI regulation seems effective but the internal controls, governance and ownership structure are disappointing for NGO-MFIs, and of course for the informal MFIs". The study divided the sampled Asian countries into: South Asia (Bangladesh, India, Nepal, Pakistan and Sri Lanka) and South-East Asia (China, Indonesia, Philippines, Thailand and Vietnam) and classified MFIs into three major types: Formal, Semi formal and Informal institutions. Haq et, al. (2008, pg. 427) further found that "formal microfinance providers operate under prudential regulation (like commercial banks or microfinance banks) or special regulation (like Grameen Bank in Bangladesh), China's rural credit and cooperatives (RCC), in India the National Bank for Agriculture and Rural Development (NABARD) combines the state and the private commercial banks initiatives in providing microfinance"

Semi-formal MFIs typically have no specific legislation but can register under an existing Act. NGOs are the most common semi formal institutions. In Indonesia however, the range of semiformal institutions is vast - finance and insurance companies, cooperatives and CUs, and NGOs. In India NGO-MFIs are the main semi formal financial intermediary. Informal MFIs are both the most numerous and oldest form of MFI in each country and include both ROSCAs and Self Help Groups (SHG).

This diversity of MFIs obviously suggests a similar variety in their regulation and supervision. Although MFI regulation does vary from country to country, the focal point remains the same (Haq et, al. 2008).

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Haq et, al. (2008, pg. 444) concludes that "direct regulation and supervision under the banking law had some positive outcomes in Bangladesh, China, Nepal, Pakistan, Philippines, and Vietnam. In Indonesia, where Bank Rakyat Indonesia is authorised by Bank Indonesia to supervise branch networks, also proved an effective policy approach. Other regulatory and supervisory authorities include other government bodies or the apex organisations, where Thailand's BAAC has been most successful. However, Pakistan has also formulated special MFI law whereby the central bank plays a vital role. Finally, the NGO-MFIs show a mixed picture of self regulation by their association or apex bodies (like in Philippines) or regulation and supervision run solely by the apex organisation (like in Bangladesh, India and Pakistan)".


3.1 Background Information: South Africa versus Kenya · South Africa's Economic Performance As reported by the Reserve Bank of South Africa (SARB)15, there has been a general economic decline in RSA during the period 2007 - 2009. In 2007, the economy grew by 5.1%, in 2008 the real GDP growth rate was 3.1% - the lowest rate of economic growth since 2003. The recession of 2008/2009 - described as the most serious since the Great Depression of the 1930s - dampened demand for credit and job losses impacted on consumers' ability to repay. In October 2009, the targeted rate of consumer price inflation slowed to 5.9% - the first time it fell within the target range of 3-6% after a period of 30 months in which it continuously exceeded the target.

Figures released in February 2010 show that the RSA economy grew at an annual rate of 3.2% in the last quarter of 2009; growth forecast for 2010 is set at 2.3%, as shown in the GDP Growth figure below. (OECD, 2010).


For more information, see

38 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

Figure 1: Seasonally Adjusted Annual GDP Growth ­ South Africa

The growth in GDP could provide a base for economic empowerment and creation of a class of economically active middle income earners, which is likely to translate into demand for more credit and other MFI services such as remittances, micro-insurance, savings, etc, that will enhance the growth of the microfinance sector and shift policy towards strengthening this sector.

Between 2005 and 2007, RSA continued to have escalated poverty levels, with close to 40% of its population living below a poverty line of R283 per month, according to Van Den Berg (2009), dropping from a peak of 53% in 1996. The Gini coefficient16 estimated by Bhorat (2009) increased marginally from 0.64 in 2002 to 0.68 in 2008, suggesting that the benefits from economic growth have not reached the poorest households.

In the second quarter of 2009, there were an estimated 31 million adults of working age, of which just 13.4 million were employed, or 43%. Out of this group, 60% were employed in the formal sector, 30% were employed in the informal sector, and 10%

The Gini coefficient is a measure of income inequality. A value closer to zero suggests low income inequality (which is favored); while a value closer to one is indicative of high income inequality and a skewed income distribution.


39 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

were employed as domestic workers in private households. This means that just 26% of adults of working age are employed in the formal sector in RSA. It is this group which has fuelled the growth of salary-based micro-lending over the past five years (Calvin et, al. 2010c).

Of all upper middle income countries reporting their unemployment statistics in 2008, RSA had the second highest unemployment rate at 22.9%. Those who are better educated are able to participate in the first economy, while those who did not have access to education are forced to earn a livelihood in the second, informal economy. The history of residential segregation also resulted in forgone work opportunities due to the restrictive costs of travelling to work or to look for a job opportunity. · Kenya's Economic Performance According to the MoF Strategic Plan (2009 ­ 2012, pg. IX), "Kenya made tremendous economic and social progress during the period 2002 to 2007. The annual rate of growth of real GDP increased from 0.5 per cent in 2002 to 7.1 per cent in 2007. This was before the disruption of economic activities occasioned by the 2007 post-election crisis. Since then, performance has been sluggish as witnessed by the decline in growth of GDP to a mere 1.7 percent in 2008".

The August 2010 Quarterly Economic and Budgetary Review (QEBR, pg. IV) released by the Ministry of Finance however notes that "economic activity remained firm during the first quarter of 2010 with real GDP growing by 4.4 percent compared to 5.6 percent in the corresponding quarter of 2009. This expansion was realized against a backdrop of improved weather that boosted agricultural output, interest rate cuts by commercial banks which resulted in increased uptake of loans by businesses and individuals, and stabilizing of local commodity prices. Agriculture and forestry, manufacturing, wholesale and retail trade, transport and communications and financial intermediation sectors were the main growth drivers during the quarter". Real GDP growth for 2010 and 2011 is projected at 4.5 percent and 5.7 percent, respectively or 5.1 percent growth for financial year (FY) 2010/11. Growth in this period will be driven mainly by increased investments in key sectors, including

40 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

agriculture, services, infrastructure, health and education; and targeted strategic development interventions (Ministry of Finance, 2010). The 2009 ­ 2010 Budget speech proposed to amend the Banking Act in order to introduce agency banking, the objective of which was to increase the outreach of the banking sector to the vast under banked and un-banked Kenyan populace. In order to deepen the use of agency banking, the Minister for Finance also proposed to amend the Microfinance Act to facilitate use of third party agents by DTMs. · Microfinance Industry in South Africa Calvin and Coetzee (2010c, pg.2), list the various players in the microfinance industry in RSA. "The industry is identified more by activities and services rendered rather than by type of institution. There are various players in this sector who offer microfinance services to low income people in diverse ways, these include the following; Microenterprise lenders; Financial co-operatives; Salary based micro-lenders; Alternative banks; Primary banks; and Retail development finance institutions. Other special products and services include the Stokvels17, Burial societies, micro-insurance and the Postbank".

Acceptance of deposits, broadly defined, is however limited to banks, unless also registered as a bank with the SARB, a micro lender would not be allowed to take voluntary deposits from the public, retail or wholesale, leaving a restricted role for the few mutuals and other non-banking institutions. The banks also run the National Payments System (NPS) as a joint enterprise, setting rules that discourage non-bank's access to the system. Consumer credit transactions as well as leasing and collateral lending are governed by separate legal regimes. The inefficiencies inherent in this fragmented approach, along with the outdated legislation in some of these areas, further constrain financing options for small firms and low-income households (Meagher, 2005).

Stokvels are defined by Wikipedia as clubs or syndicates serving as rotating credit unions in South Africa where members contribute fixed sums of money to a central fund on a weekly, fortnightly or monthly basis. Each month a different member receives the money in the fund.


41 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

A critical analysis of the micro-credit industry in RSA found that the modern microcredit market began in the 1980's and has been driven by a confluence of forces, with for-profit companies, NGO's and government agencies all playing important roles. The growth of the industry can be separated into four distinct stages18: Pioneer (1980's to 1994), Breakout (1995 to 1999), Consolidation (2000 onwards) and Maturity (not yet reached) (Porteous, 2003).

In order to bring order in the industry, the first MFRC Annual Report of (16 July 1999 to 31 July 2000, pg.7) reported that "the MFRC was established in 1999 (16th July 1999) as a non-profit organization with a board of directors comprising of representatives from government, lenders' associations and consumer representatives. Its purpose was to supervise the operations of those institutions lending under its unrestricted interest rate window to facilitate more effective consumer protection and regularize micro-lender operations in a growing market. The MFRC's powers were defined in the Usury Act Exemption Notice No. 713 of 1 June 1999 ("Exemption Notice") and the Rules of the MFRC exercised in terms of a contract between the MFRC and each registered lender". With a total of 5.6 million deposit accounts, PostBank also plays a critical role in taking savings to the rural areas. PostBank provides critical support to group-based microenterprise lenders operating in rural areas. The potential of PostBank to improve and expand its service is substantial; further professionalization and separation from the post office and conclusion of a full commercial banking licence would be beneficial (Calvin et, al. 2010c). · Microfinance Industry in Kenya The Microfinance industry in Kenya has experienced major transformations over the past twenty years, growing from a fledgling concern dominated by a few donor and church-based NGOs to a vibrant industry increasingly driven by commercial sustainability. Generally, the providers of microfinance services in Kenya can be clustered into three broad categories, notably; formal, semi-formal and informal institutions - with the level of formality defined by the degree of regulation. Under the

These stages exclude the mashonisas, or informal township-based moneylenders, who presumably have existed for much longer.


42 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

formal category are commercial banks and the Post Office Savings Bank. The semiformal category includes SACCOs and Microfinance institutions, while ASCAS and ROSCAs dominate the informal (KEMCAMP, 2008). In addition to traditional forms of microfinance, mobile banking has rapidly expanded access to financial services in Kenya since Safaricom, the Kenyan affiliate of global mobile telecommunications provider Vodaphone, launched its M-PESA service in March 2007. Customers can access an electronic payment and store of value system through their mobile phone, and have cash deposit and withdrawal services at 16,900 Safaricom outlets, nearly half of which are located outside of urban centers. After achieving extraordinary growth since its inception, by January 2010 M-PESA had 9 million active customers (about 40 percent of Kenya's adult population). In May 2010, Safaricom and Equity Bank announced a partnership to allow M-PESA customers to open an "M-KESHO" savings account which they could be able to access through their mobile phones (Mix Market country profiles - Kenya19). Kenya's Microfinance Act, (2006) was signed into Law on December 29, 2006 which brings the Microfinance Institutions that intend to take deposits from the public under CBK supervision and regulation. While specific prudential regulations have been developed for the MFIs that are registered with the CBK as Deposit Taking Microfinance (DTMs) Institutions, the treatment of Non-deposit taking regulation was delegated to the Minister for Finance under section 3(2) of the same Act (CBK, 2008).

According to KEMCAMP Quarterly Report (2008, pg10), "the Microfinance Act has a three tier structure:-

(a) National Deposit Taking MFIs - Have a minimum capital requirement of KShs. 60 million and can operate across the country. (b) Community Deposit Taking MFIs - Have a minimum capital requirement of KShs. 20 million and can only operate in a restricted administrative area.

Available at visited on 23rd September 2010 at 14.10 hours.


43 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

(c) Credit Only MFIs - The Act provides that the Minister for Finance can prescribe regulations for these types of institutions". The Minister for Finance is therefore empowered to make regulations specifying the Non-deposit taking microfinance business and prescribe measures for the conduct of the specified business (MF Act, 2006). Lack of access to financial services, and in particular, of convenient savings and credit products, and payment services, is a major constraint limiting the participation of low income households and micro and small enterprises, both in the rural and urban areas, in the country's economic activity.

Omino (2005, pg.4-5), found that "MFIs in Kenya operate under many legal forms such as; Companies limited by shares or by guarantees, NGOs, Trusts, Cooperatives, Associations or Community Based Organizations (CBOs). Apart from Savings and Credit Cooperative Societies (SACCOS) most of the MFIs are classified as Non-deposit taking20. These entities are governed by their respective Acts as follows;

1. The Non Governmental Organizations Co-ordination Act 2. The Building Societies Act 3. The Trustee Act 4. The Societies Act 5. The Co-operative Societies Act 6. The Companies Act 7. The Banking Act 8. The Kenya Post Office Savings Bank (KPOSB) Act

Because of this diversity of institutional legal forms, it becomes challenging to get accurate and proper information from one source about the status of institutions engaged in provision of micro-finance services and also to determine the extent of their outreach. This gives room for uncoordinated development and growth of the sector as well as creating a potential for abuse".


Some MFIs are currently taking cash collateral and using it as collateral for loans or intermediating it. This has already been addressed in the prudential regulations for MFIs that will register as deposit taking.

44 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

In the recent past MFIs in Kenya have suffered a bad publicity image as a consequence of illegitimate micro lenders running pyramid schemes but posing as legitimate MFIs or SACCOs. Some of them collected cash deposits from the unsuspecting public in the form of advanced collateral for promised loans or for greater return on investments and later collapsed or vanished. The Government of Kenya commissioned a study by CGAP to inform the policy direction on Non-prudential regulations and consumer protection. In their

recommendations, the CGAP team observed that there is need for the Microfinance sector in Kenya to distinguish the "good" and "bad" so that consumers are forewarned of the risks. This risk will be mitigated by the Central Bank regulation for the DTMs that will be registered, but for the unregistered MFIs the risk could still be real (Ministry of Finance, 2010).

Some of the key concerns in the credit market for Kenya can be summarized as follows:

1. Rapid expansion of credit (for consumption and for enterprise) within the unregulated and informal financial sector that may lead to over indebtedness and abuse of consumers; 2. The increase in various forms of unregulated lenders including pyramid schemes that have recently emerged to take advantage of the gaps in the formal sector and the public's demand for simplified forms of financial services; 3. The need for consumer protection against fraudulent financial intermediaries as articulated by policymakers and the society in general on issues relating to transparency in terms and conditions of borrowing, consumer awareness of their rights and obligations and the implications thereof (Sections 44 and 44A of the Banking Act); and 4. Most of the existing MFI's have efficiency and sustainability concerns. They are currently donor funded and thus are not competitive in terms of deposits mobilisation. They lack the necessary human capacity and the I.T systems needed to facilitate effective monitoring and growth of the business. This has led to inefficiencies in their business processes (Omino, 2005).

45 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010


Kenya's Medium to Long Term Microfinance Agenda

As correctly outlined in the First Medium Term Plan of Kenya's Vision 2030 (2008 2012, pg. 38), "MFIs are expected to play a pivotal role in mobilising savings and providing credit to the unbanked Kenyan populace and low income groups. One of the key constraints to the growth of the microfinance sector has been the lack of an effective regulatory framework.

To this end, the following initiatives, under the strategic thrust of increasing access to finance and making finance work for Kenyans, have been and will continue to be undertaken in the medium term (2008-2012) and will be sustained in the long term towards fulfillment of the Kenya Vision 2030: · · · · Increase share of population using formal finance from 27% to 62% Reduce share of population without access to finance from 38% Develop informal finance and extend access to micro-finance Operationalization of the Microfinance Act, empower Central Bank of Kenya to license and supervise Deposit Taking Microfinance Institutions (this was achieved in 2008); · Extension of Credit Information Sharing mechanisms to microfinance institutions (this is underway through January 2010 amendments to the Microfinance Act, 2006); · Formulation of a regulatory oversight framework for non-deposit taking microfinance institutions (this is in the pipeline through this Research Paper as well as various studies being conducted by the Ministry of Finance); and · Promotion of transparency in the pricing of microfinance products and disclosures by microfinance practitioners (market discipline and financial education); and formulation of Consumer Protection Legislative and Regulatory Framework (in progress ­ Ministry of Finance, 2010 (Diagnostic study done in July 2010, on Consumer Protection needs of the Kenyan market))".

In the long term, it is anticipated that the microfinance industry will be mainstreamed into the formal financial system as part of an `inclusive financial system.

46 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

3.2 Evolution of the RSA Regulatory Framework This study has found, from the different methodological approaches applied, including studies such as Calvin and Coetzee (2010a, pg.6), as well as from interviews conducted, that, South Africa faced a growing employment crisis in the early 1990s, but even at present, the nature of the microfinance sector has been largely defined by the dual economy and the presence of structural unemployment21. According to Calvin and Coetzee (2010b, pg1), "despite South Africa's high Gross National Income (GNI) per capita (US$ 9,780 in 2008) and accelerated growth rates, the country is characterized by an unresponsive labour market". The author also found that during the apartheid22 years, much of the South African population was excluded from banking services. Following the post-apartheid transition, the new government placed increasing emphasis on financial inclusion and consumer protection, while maintaining strong policy insistence on financial sector stability. To achieve this, micro lenders had an important role to play. Their operations were however unrestricted and the exposure of consumers to risks of ill-treatment and oppression could be foretold. This therefore called for the development and adoption of a regulatory framework that would govern the operations of money lenders and the micro credit sector in general. As arising from an interview with Professor W. Thomas23, micro lending activities started out in a small and simple way. In villages and townships. Low income people had to find ways to compensate for the lack of, and high cost of financial services from commercial banks in their areas. In some cases they created informal groups among friends, families and neighbors where borrowers and lenders took turns; in other cases

Structural unemployment refers to unemployment caused by the mismatch of skills offered by the workforce and skills required in available vacancies. Defined as one of the most heinous contraptions of exercising political power and enjoying economic privileges by one race over others! By Hon. Professor Anyang' Nyong'o during a media session at the Promulgation of the new Kenyan constitution, at Uhuru Park, Nairobi, on 27th August 2010. Professor Wolfgang Thomas is a professor of development economics, specializing in Doing Business in Africa, at the Stellenbosch University, in the Western Cape Province of South Africa. Interviewed on 20th August 2010 at 1pm.

23 22


47 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

they relied on the flexible but exorbitant terms offered by the local money-lenders (referred to as Mashonisas); in yet other cases they sought out a local credit union or NGO providing basic financial services. All these informal sources were available to the low income populace but at a very expensive price. To make finance available to SMMEs24 was thus seen as one way to address the country's crisis. Lack of access to formal lines of credit created informal communal credit establishments, such as burial societies and stokvels.

In 1992, the need for formal micro credit providers was recognized and microfinance effectively legalized on 31st December 1992. This, in conjunction with an exemption to the Usury Act, was signed into law and the exemption stated the removal of price/interest rate control on small loans (Porteous, 2004).

Before the implementation of the NCA the RSA consumer credit regulatory environment seemed to be fragmented and dysfunctional. The Usury Act (UA) No. 73 of 1968 regulated leasing, credit and money-lending transactions and attempted to protect consumers by setting maximum interest rate charges. However, in terms of section 15a of the Exemption Notice 1407 of 2005 of 8th August 2005, as regulated by the MFRC, all loan amounts below R 10,000 were exempted from the Usury Act no. 73 of 1968 (with the exception of sections 13, 14 and 17a thereof) - as long as (i) the loan is of an amount of less than USD 1,430 and for a shorter than 36 month loan term (ii) the lending entity is registered with the MFRC and (iii) the transaction complies with a simplified set of consumer protection requirements which is contained in the Exemption Notice.

The Credit Agreements Act (CAA) No. 75 of 1980 regulated only specific credit agreements related to movable goods (CAA No. 75, 1980). The hire purchase financing provided by furniture and appliance retailers was governed by this Act. Although the maximum Usury Act interest rates applied to these loans, retailers typically achieved an Annual Percentage Rate (APR) of more than fifty percent on these loans through adding various charges and insurance requirements. This highlighted another deficiency of the

SMMEs refers to Micro, Small and Medium Enterprises in South Africa. In most countries, they are usually initialed as MSMEs.


48 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

Usury Act as it limited interest rates, but neglected to address product fees and charges (Usury Act No. 73, 1968).

The National Payments Systems Act 78 of 1998 regulated the payment processing of credit transactions in conjunction with the Payments Association of South Africa (PASA) which stated that all settlement banks must be members of PASA as governed by the SARB (SARB, 2006).

An Eci Africa and Iris report (2005, pg.13) and background information from my interview with the NCR in October 2009, found that "In 1994, with a new Government in place, the new Minister of Trade and Industry observed that poor and low income South Africans were being charged unreasonably high rates of interest through the burgeoning micro-lending industry that specifically targeted mostly urban, employed individuals, especially those in the public sector, with little or no apparent increase in credit to SMMEs.

On the basis of this perception, the Minister threatened to revoke the 1992 Exemption. This threatened action sparked the five year process of debate and negotiation between the industry and government, which eventually led to the formation of the MFRC in 1999". 3.3 Building a Case for Financial Inclusion

Regulation in South Africa has therefore increased access to financial services, (looking at amounts of credit granted) both for the period 1999 ­ 2004 and 2005 ­ 2009, as shown through various categories of access. It has also created an economic environment leaning towards a credit economy, where utilisation of credit facilities, in addition to several banking and financial services is quite high. Having started broadly in form of consumer credit, facilities are now being expanded towards small business financing, thus encouraging investments, creation of employment, generation of incomes, increasing standards of living and a general improvement in economic growth and development.

49 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

(a). Market Structure Table 3: Composition of micro-lending industry loan book; type of lender 2000 2004.

Adopted from: Evolution of RSA MFI Sector from 1992 ­ 2004 Eci Africa and IRIS Report (2005). Between 1999 and 2004, there was growth in the loan books and number of loan accounts for various players in the financial sector. It can be noted that the commercial banks play a dominant role in serving the market, while micro credit providers (mostly cooperatives and section 21 companies) play a minor role. We however see that most players (except for Public companies, CCs and Trusts) experienced growth in their loan books as well as number of loans granted. This could possibly be linked to reduced government participation in the credit market as well as other economic factors including a possible reaction to the new regulation.

50 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

Graph 1: Growth in Loan Book for Section 21 Companies (2000 ­ 2004)

Source: Author's own illustration, 2010. These are NGOs mostly providing consumer and housing loans, among other MFI related services. The growth is however seen to exhibit upward and downward fluctuations, but picking up a final upward trend, possibly moving in-line with macroeconomic trends and the impact of regulation. It is also clear, from the table 3.0 above, that after MFRC came into place in 1999, loan books for all players dropped drastically except for Cooperatives and Private companies. As suppliers and consumers familiarised more with the regulatory requirements, and appreciated the opportunities available, the loan books picked up. Graph 2: Growth in Loan Book for Banks (2000 ­ 2004)

Source: Author's own illustration, 2010.

51 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

The dominance of the banks in serving the market also shows that they are reaching the lower income market and the previously unbanked population. This is mostly through new entrants into the commercial banking segment of Capitec, African and Teba Banks, as well as major banks moving downstream through the Mzansi25 account, an initiative of the four largest banks and Post bank, targeted at the low income populace. With the entrance of the NCR, the main credit regulator in the country, which has also been recognized worldwide as a leading regulator of credit issuing institutions, and has attracted a lot of attention and interest from the United Kingdom, Canada, Asia and Africa, data was collected in a more rigorous manner, giving more details and more specific information about the market. Below is an illustration by credit type, showing an upward trend for the supply of credit for most types of credit granted. Table 4: Credit granted by credit type

Source: NCR Consumer Credit Report December 2009 Credit granted to consumers increased by R9.71 billion to R63.30 billion for the December 2009 quarter. This represented a significant growth of 18.13% when compared to the previous quarter. This was the strongest rate of growth in credit granted since the NCR started publishing consumer credit statistics. Compared to the total of about more than R17million as at August 2004, we note a significant increase in credit granted over the period 2004 - 2009. The steady growth in total credit, as illustrated below in my own analysis of the data above, shows a favourable credit supply environment, that could probably reflect a facilitating regulatory regime.

The Mzansi account is an entry-level bank account, based on a magnetic stripe debit card platform, developed by the South African banking industry and launched collaboratively by the four largest commercial banks together with the state-owned Postbank in October 2004 (FinMark Trust ­ Mzansi Account Initiative in South Africa Final Report 2009).


52 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

Graph 3: Total credit granted (2008 Q4 ­ 2009 Q4)

Source: Author's own illustration, 2010. More specifically, unsecured credit, mostly provided by MFIs, also displays an upward trend over the 2008 ­ 2009 period, when illustrated graphically, as shown below. This defies the global economic crisis that was at its climax during this period, and shows possible regulatory ability to insulate the MFI market from external shocks. Graph 4: Unsecured credit granted (2008 Q4 ­ 2009 Q4)

Source: Author's own illustration, 2010.

53 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

(b). Prices With the withdrawal of the 1992 exemption notice, all lenders wishing to receive the exemption had to register with the MFRC. Registered microfinance institutions were required to provide the MFRC with quarterly returns. This source of information is very useful in providing information with respect to trends in pricing. Prior to this, however, information on pricing is less accessible (First MFRC Annual Report, 2000).

Table 5: Summary of pricing responses to legislative frame work.

Source: Evolution of the SA MF Sector from 1992 ­ 2004 (Role of MFRC)

From the period 2005 onwards, interest rates have now been prescribed by the NCA Regulations, as provided in Table 6 below. The development credit agreements refer to microcredit. (RR refers to the SARB Repurchase Rate (currently at 6.0%, as from 10th

54 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

September 2010)). This brings the maximum price charged to about 33.2% per annum, for developmental credit agreements and unsecured credit transactions.

Table 6: NCR Maximum Lending Rates and Fees as Prescribed by the NCA

Source: NCA (34/2005) Regulations.

Table 7: South African Banking Status 2005 ­ 2009 2005 Banked (millions) Banked % Previously banked % Never banked % 14.3 46.6 12.3 41.1 2006 15.9 51.0 11.5 37.5 2007 19.0 60.3 9.6 30.1 2008 20.0 62.7 7.5 29.8 2009 19.6 59.8 8.9 31.2

Source: FinScope data, 2009 According to the FinScope26 data, the proportion of the adult population which is utilizing a bank account (referred to as the banked population) grew rapidly from

The FinScope Surveys use the Financial Access Strand to compare financial access across countries. The Financial Access Strand focuses on the financial system of a country in its broadest sense and


55 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

13million to 14.3million, or 47%, in 2005, reaching 20.0million, or 63%, in 2008. Due to the recession and less new entrants into the 16+ age group, this figure dropped back to 19.0million, or 60%, in 2009.

This growth can be partially attributed to introduction of the Mzansi account and other low cost offerings by Capitec and WIZZIT banks, most of which do not have monthly service fees and therefore suit individuals who work as seasonal or casual laborers. The growth in usage of bank accounts can also be attributed to rising levels of crime against businesses and the desire by employers to reduce the amount of cash held on business premises. A final explanation may be the rise in credit accounts over this same period and the requirement by many lenders, for a borrower to hold a deposit account at the same institution.

FinScope RSA Summarised version (2009, pg.4) indicates that "10% of adults rely only on informal products (such as savings clubs or stokvels, mashonisas or informal money lenders, burial societies, etc) to manage their financial lives, while 26% of adults are not being financially served (i.e. are managing their financial lives without the use of financial products albeit formal or informal)".

According to the Preamble of the Financial Sector Charter (FSC) (2000, pg.1), the RSA Government committed itself in the FSC (Charter) to "amend regulations that hinder the extension of financial access by private financial institutions. The government also committed itself at the Financial Sector Summit to prepare new legislation enabling second and third tier deposit-taking financial institutions to provide additional avenues for extending financial services". This approach is in line with the government's preferred policy of restricting any form of deposit-taking to banks only. A position paper27, establishing narrow and core banks and their competitive impact on fully fledged banks in RSA, written for the Policy Board in 2002 was developed,

assumes all adults in the country will fall into one of three segments: formally included, informally served and financially excluded.


For more details, see

56 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

proposing that entry of micro-lenders as core banks28 could solve the multiple challenges facing the microfinance market. It observed that micro-lenders had extended finance to a cohort of borrowers generally excluded by formal banks and developed capability to manage the associated risks. The essence of the proposal in the position paper was that the larger micro-lenders could become core banks, or commence an association with existing banks, so as to offer savings and transmission facilities to a wider range of South Africans. The document also sees a role for retailers and even cellular operators to be involved in offering services to the un-banked. 3.4 Findings on the SA Financial Sector Regulatory & Supervisory Framework

The RSA has a relatively well developed financial system with three main financial sector regulators, namely the South African Reserve Bank, the Financial Services Board (FSB) and the National Credit Regulator (NCR). The Reserve Bank regulates all depository institutions including Commercial banks, Cooperative banks and Mutual banks, but has delegated to Savings and Credit Cooperative League (SACCOL) the regulation and supervision of Credit Unions and village banks. The FSB regulates Insurance, Pensions and Financial/Capital markets. NCR regulates and supervises all credit providers; banks, retailers, MFIs, money lenders, debt collectors and counsellors and CRBs all under the National Credit Act. The NCR's reporting line is to the Ministry of Trade and Industry due to its orientation on consumer protection issues. At a macro level the Ministry of Finance is still responsible for the overall financial sector. Key Government Departments29 All three layers30 of government within RSA recognize the importance of supporting self-employment and entrepreneurship. Within the National Government, five departments in particular play a role in supporting microfinance:


Core banks, as defined in the Dedicated Banks Bill (2004), referred to savings and loan banks engaged in deposit-taking (restricted to individuals and small businesses only, and not from corporations), payments and some categories of loans. 29 Departments refer to Ministries in the South African context 30 3 layers refer to the National, Provincial and Local governments

57 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

1. National Treasury of South Africa ­ financial sector policies. 2. Department of Labour ­ coordinates microfinance support structures. 3. Department of Trade and Industry ­ established the NCR and the NCA 4. Department of Economic Development ­ in-charge of DFIs and other agencies 5. Department of Agriculture, Forestry and Fisheries ­ provides on-lending through the Micro Agricultural Finance Institution.

There are two significant pieces of legislation recently introduced which are expected to create a stronger enabling environment for the provision of microfinance services in South Africa: the National Credit Act (NCA), No. 34 of 2005, and the Cooperative Banks Act (CBA), No. 40 of 2007". 3.4.1 The National Credit Act No. 34 of 2005: It came into effect on 1st June, 2006. The purpose of the Act is ­ "to promote a fair and non-discriminatory market place for access to consumer credit and for that purpose to provide for the general regulation of consumer credit and improved standards of consumer information; to promote black economic empowerment and ownership within the consumer credit industry; to prohibit certain unfair credit and credit-marketing practices; to promote responsible credit granting and use and for that purpose to prohibit reckless credit granting.

To provide for debt re-organisation in cases of over-indebtedness; to regulate credit information; to provide for registration of credit bureaux, credit providers and debt counselling services; to establish national norms and standards relating to consumer credit; to promote a consistent enforcement framework relating to consumer credit; to establish the National Credit Regulator and the National Consumer Tribunal; to repeal the Usury Act, 1968, and the Credit Agreements Act, 1980; and to provide for related incidental matters".

The NCA governs all credit agreements extended to consumers, regardless of loan size. For registered businesses, the Act applies only if assets or turnover of the business are less than R1 million (USD 125,000) and the loan is less than R250 000 (USD 31,250).

58 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

Once a lending institution reaches a portfolio of 100 or more disbursed loans or R500 000 (USD 62,500) or more outstanding loan portfolio, they must register with the NCR and comply with the Act.

Overall, NCA has reduced profitability in micro-lending, while forcing credit providers to become more efficient and professional. On the positive side, it has created a level playing field and credit providers recognize that it provides necessary protection to consumers and should, over time, reduce the proportion of consumers with impaired credit records. The Act limits the rates and fees which can be charged on loans, as set out in Chapter Five of the Regulations (Calvin et, al. 2010).

The Act defines eight loan categories as follows: 1. Incidental credit agreements; 2. Mortgage agreements; 3. Credit facilities; 4. Other credit agreements; 5. Unsecured credit agreements; 6. Short-term credit agreements (loans up to R8 000 and terms up to 6 months); 7. Developmental credit for small business; and 8. Developmental credit for unsecured low income housing.

The microfinance sector is primarily comprised of the last four categories. Allowable interest rates are linked to the Repurchase Rate set by SARB and must be fixed throughout the life of the loan for all loan categories except for credit facilities and mortgage bonds. The allowable APR, which reflects all rates and fees bundled together, drops as the loan gets larger and the term is extended. An interview with Gideon Jones31, confirmed that "new reporting requirements include quarterly statistical returns, annual compliance and assurance reports, and annual financial and operational returns. There is also an expectation that lenders will submit daily records to the National Loans Register in order to have access to this database to


Internal auditor - The Kuyasa Fund. An MFI currently receiving technical assistance from PFSA.

59 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

comply with affordability assessment standards. New record-keeping requirements include, for example, loan applications, declined applications, pre-agreements and quotes, payments made, and collection steps taken. These new requirements have increased costs and require a higher degree of professionalism than was the case in the past; one reason for the micro-lending industry rationalization observed over the past three years.

Provisions in the Act which protect the consumer are far ranging and include items such as: a requirement to provide a refund on interest owed if a loan is settled early; a requirement to provide statements to clients at least every three months; a prohibition against false and misleading advertising; and a requirement for simple language in contracts.

The NCA, more specifically looks at the following consumer credit rights, as outlined in Chapter 4 of the NCA, No. 34 of 2005, sections 60 ­ 68, 72 and 112: · Right to apply for credit (Section 60) · Right to protection against discrimination in respect of credit (Section 61) · Right to reasons for credit being refused (Section 62) · Right to information in official language (Section 63) · Right to information in plain and understandable language (Section 64) · Right to receive documents (Section 65) · Protection of consumer credit rights (Section 66) · Right to confidential treatment (Section 68) · Right to access and challenge credit records and information (Section 72) · Consumer's right to rescind credit agreement (Section 121) Reckless lending and over-indebtedness, are also defined in detail, together with standards for assessment of credit capacity and consequences for the lender if they do not meet these standards. Once again, compliance in these areas requires more costly procedures and a high degree of professionalism. Another area of significant impact on lenders is debt collection and enforcement. Prior to proceeding to legal collections a

60 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

lender must provide certain notices according to specified dates and formats and must refer the client to debt counseling.

Up to March 31, 2009, a total of 3,690 credit providers had registered with the NCR, of which 3,202 or 87% are micro-lenders and 152 credit providers have been granted a supplementary registration as developmental lenders (NCR Annual Report, 2009). Comparatively, as at December 2005, MFRC had registered 2,05632 lenders.

Debt counseling provisions introduced by the NCA became effective from 1 June 2007 and seek to create a mechanism for the rehabilitation of over-indebted consumers through mediation between consumers and credit providers. By end of 2009, over 1,500 debt counselors had been trained and registered throughout the country while more than 150, 000 consumers had applied for debt counseling. Eight training institutions are now accredited to train debt counselors.

Another partner in the process of debt counseling is the National Debt Mediation Association (NDMA), an initiative by credit providers to combat over-indebtedness and assist consumers before they reach formal debt counseling. According to the NDMA March 2009 newsletter, out of 50,000 reported debt counseling cases up to the end of February 2009, only between 1% and 3% were brought to conclusion and sanctioned by a court order. There are obviously gaps in the system and it is these gaps that the NDMA aims to fill by partnering with credit providers, debt counselors, and payment distribution agents.

A Consumer Tribunal was established on 1 September 2006 as an independent adjudicative body. Section 27 of the Act provides that the National Consumer Tribunal may rule on matters arising from any application made to it in terms of the Act, or as a result of allegations of prohibited conduct. The Tribunal hears and decides on applications and referrals involving consumers, credit providers, debt counselors and credit bureaus.


Available on the MFRC website: Visited on 31st August 2010 at 2.09pm.

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The Experience of the NCR in Regulating Credit only institutions As arising from my earlier interview with the NCR in October (12th ­ 17th 2009), it was found that the NCR operates in the following functional areas, as listed in the Act, in Chapter 2, Sections 13 to 18 as detailed below: A) Development of an accessible credit market The NCR is mandated by the Act to promote and support the development of a fair, transparent, competitive, sustainable, responsible, efficient, effective and accessible credit market and industry to serve needs of, especially the historically disadvantaged and low income persons and communities. B) Registration functions of the NCR Under the Act, the NCR is tasked with the responsibility of registration of credit providers, credit bureaus and debt counselors; suspending or cancelling any registration issued under the Act; establishing and maintaining the registers and issuing information to the relevant authorities or regulators. These 3 key institutions are fundamental to the regulatory process of credit in RSA. Registration of Credit Providers Section 40 of the Act provides for registration of all Credit Providers with more than 100 credit agreements or a total Principal debt of R500,000 with the NCR. Credit Providers with a total principal below R500,000 and less than 100 agreements are not regulated by the NCR but must meet the requirements stipulated in the Act.

NCR however, does not have the full mandate to revoke licenses of non-compliant members. In cases of non compliance, NCR can only engage its Investigations department to review the cases, inspect and issue a compliance notice. If after the specified period of 15 business days, the company has not complied, then a recommendation is made to the National Consumer Tribunal for cancellation of the license and the company has to return the license to the NCR.

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Registration of Credit Bureaus NCR also has the mandate of registration of Credit Reference Bureaus (CRBs) to facilitate information gathering and sharing about credit risks in South Africa. There are eleven (11) CRBs licensed by NCR but they are regulated by the Credit Bureaus Association, (CBA) which is responsible for the good conduct and operations of its members. The mandate of licensing and registration are however maintained by the NCR. Registration of Debt Counselors The NCR has a broader mandate of consumer protection. Under this mandate consumers are supposed to be educated, informed and made aware of their rights and obligations when they take credit. The purpose of this mandate is to avoid some of the negative consequences of credit such as over-indebtedness, and loss of assets. In order to execute this mandate NCR runs an in-house call centre and also registers Debt Counselors to counsel and rehabilitate those who are already overburdened by debt. C) Enforcement Function The NCR must enforce this Act by; promoting informal resolution of disputes arising in terms of this Act between consumers on the one hand and a credit provider or credit bureau on the other, receiving complaints concerning alleged contraventions of this Act, without intervening in or adjudicating any such dispute; referring to the Competition Commission any concerns regarding market share, anti-competitive behaviour or conduct that may be prohibited in terms of the Competition Act, 1998 (Act No. 89 of 1998); referring matters to the Tribunal and appearing before the Tribunal, as permitted or required by this Act; and dealing with any other matter referred to it by the Tribunal.

D) Compliance and Monitoring Functions of the NCR Compliance: The NCR is responsible for setting compliance requirements for credit providers; credit bureaus and debt counselors. Compliance issues involve adherence to the following; Conditions of registration - Every registered institution is required to comply with specific and general conditions. These include registration and renewal, reporting obligations etc.

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Language policy - All materials produced by registered institutions must be translated into at least two, out of the 11 official languages of South Africa. These materials include agreements; quotations; operation statements; guidelines, etc Broad Based Black Economic Empowerment (BBBEE) - All institutions with a turn-over of more than R5million are required to comply with BBBEE. This refers to development of programs and creation of special opportunities that will empower the local/natives of South Africa. These programs include consumer education, procurement of supplies, etc Combating over indebtedness - Institutions are required to have policies that will enlighten consumers and guard against over commitment by consumers in debts, to extents that will limit their ability to repay and also attend to personal needs comfortably. Complaints : The NCR has a fully fledged complaints department to handle complaints from consumers of credit services. This department has 10 staff and well developed systems that capture and track information on all complaints. These are then addressed within specific timeframes by issuing a compliance notice to credit providers. In case of nonresponse, the issue is forwarded to investigations and prosecutions department for further action. E) Other functions of the NCR

1. Research and Public information function - The NCR is also responsible to

increase the knowledge of the nature and dynamics of the credit market and industry and to promote public awareness. This is done through research activities in the industry, implementing education and information measures to develop public awareness, providing guidance to the credit market, monitoring socio economic patterns and trends in the consumer credit market, conducting periodic audits of registered providers and overtime reviewing legislation and regulations. In this respect, the NCR published a booklet, that serves as a guide, titled `All you need to know about the NCA as a consumer' Volume 1: 2007. This acts as a summary and guide for all credit consumers, to the NCA.

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2. Relations with other Regulatory Authorities - The NCR engages with other

Provincial regulators on various issues including research information sharing, enforcement and even capacity building of their staff. The NCR may also liaise with other regulatory authorities both local and international on matters of common interest at its own initiation or from the directive of the Minister, or President or any other relevant authority.

3. Reporting requirements of the NCR - The NCR reports to the Ministry of

Trade and Industry and is responsible for advising the Minister on matters of national policy relating to consumer credit and the determination of standards and norms regarding consumer protection in terms of the Act. It reports to the Minister annually on the volume and cost of different types of credit products and the implications for consumer choice and competition and recommends to the Minister changes to bring about uniformity in legislation within the various provinces. 3.4.2 Cooperative Banks Act

According to Calvin et, al. (2010a pg.8), "Cooperative Financial Institutions are regulated by one of four different bodies, depending on the size of the cooperative. The South African Microfinance Apex Fund (SAMAF) and the Savings and Credit Cooperative League of South Africa (SACCOL) are mandated to register and regulate all the smallest financial cooperatives. Once the cooperative reaches 200 or more members and R1 million or more in deposits, the cooperative must apply for registration as a Cooperative Bank to the supervisor within the Cooperative Banks Development Agency (CBDA). Once a cooperative bank reaches deposits exceeding R20 million, they are required to apply for registration with the SARB.

The Cooperative Banks Act, No. 40 of 2007, is intended to improve access to financial services by providing a legislative framework allowing cooperative banks to develop and provide financial services to their members. The Act specifies prudential requirements and CBDA is establishing a supervisory capacity to monitor those who register under the Act. Prudential standards include capital adequacy, reserve requirements, loan loss provision requirements, liquidity requirements, and deposit limits per entity.

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The table 8 below reveals that South Africa had the lowest penetration level of credit union membership of 22 African countries tracked by the World Council of Credit Unions in 2008. Table 8: Credit Union Penetration of Economically Active Populations in Africa

Adopted from Calvin and Coetzee (2010a).

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4.1 Regulatory Challenges In South Africa The current status of RSA regulation is comprehensive and rigid, with any further tightening being likely to `regulate players out of the market'. The original policy intention of the first South African Exemption to the Usury Act in 1992 was to spur growth in lending to SMMEs. What actually emerged was the micro-loans sector, dominated by payroll and cash-based lending mostly to salaried, largely urban individuals. This, therefore left the poor, low income, unemployed rural dwellers, unserved as they were not a lucrative clientele.

It was observed that by many accounts, the 1992 Exemption Notice created a "disaster" by dividing the market and thereby fencing lower income people off from the banking sector and formal credit options. Interest controls were removed without other constraints (such as debt recovery and capital access) being addressed. As a result, full conditions for the development of an efficient market (including regulatory oversight and consumer credit protection) did not exist at a time when the market was growing very quickly (Meagher, 2005).

A further problem, made worse by the Exemption, was the general legislative fragmentation created by the different rules applicable to each form of credit. The Exemption also did not address the restrictive framework that impeded entry of competitors into the banking sector. This arrangement also seemed to create a small universe of profitable and exploitative informal lending ­ which, in the absence of an incentive framework for developmental lending, seemed to discourage SMME financing.

It has been widely observed that in all countries, enforcement of unrealistically low interest-rate caps can make sustainable micro-lending impossible. MFIs usually need to charge interest rates that are higher than normal bank rates because the administrative

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costs of making small loans are high in relation to the amount lent. At a minimum, interest caps are likely to dissuade MFIs from serving more difficult markets.

From the regulatory point of view, there is a broader issue of the trade-offs between facilitating credit markets to increase inclusion and the need for consumer protection. The lack of access to appropriate credit to the majority of the population is often seen as a bigger policy problem than exploitation that occurs less frequently and when it occurs may affect only a small minority. The burden of stringent protection measures may lead to low access hence adversely affecting the poor as a consequence. It is highly likely that most institutions, especially the smaller players in the market such as micro lending institutions, will be hesitant to lend without proper credit screening, in an attempt to be within the dictates of the law. Regulation has been very stringent in an attempt to enhance consumer protection, probably at the expense of access to finance. In pursuit of guarding against overindebtedness, therefore, MFIs leave most lower income consumers of credit locked out, who then resort to the informal money-lenders, who are unregulated and unregistered. These funds come at a higher cost because of high risk to the lenders. It is this nature of outcome of the tight regulation that is unrecorded yet highly likely to continue to reverse efforts of the RSA in increasing access to finance. It is also evident that the current regulatory dispensation does not create substantial incentives for MFIs to upscale into deposit taking institutions. By their very nature, MFIs do not have sustainable income streams, implying that they either have to be supported by the government or donors, or alternatively, attract voluntary deposits from the public. This provision is however conspicuously lacking in the RSA credit regulation. Unless an institution is licensed to perform the `business of banking', it cannot mobilise deposits. Assuming the MFIs were willing to upscale into deposit taking institutions, they would have to comply and adhere to a more sophisticated and highly rigorous Banking Act which, a good majority would hardly manage to abide by. The next alternative would be to take the form of Co-operative or Mutual banks.

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In terms of the South African Banks Act No. 94 of 1990 (Section 70) "the current requirement for banks and branches of foreign banks is the greater of R250 million (USD 31.25million) or an amount which represents a prescribed percentage of the sum of amounts relating to the different categories of assets and other risk exposures. The prescribed percentage shall be a minimum of 8 per cent, or such higher percentage as may be determined by the Registrar of Banks in consultation with the Governor of the SARB. Mutual banks have to maintain capital adequacy of a minimum of R10 million (USD 1.25million) or 10 per cent of weighted assets and other risk exposures." All forms of banks will also have to comply to specified prudential regulations. The Cooperative Banks Act, allows for the establishment of a reserve fund and deposit of at least 5% of a Co-operatives surplus into such reserve for distribution amongst its members during each financial year of the Co-operative. The capital provision is therefore lower than for commercial banks, but this implies that MFIs would have to make their customers members, as well as be registered either as a primary, secondary or tertiary co-operative under the Co-operatives Act, 2005 and as either a primary savings and loans co-operative bank, secondary co-operative bank or tertiary cooperative bank under the Co-operative Bank Act 2007, if they have 200 or more members and hold more than R 1million in member's deposits, so that they may provide banking services and perform the functions referred to in sections 14 and 15 of the Act (Co-operative Banks Act No. 40 of 2007).

The Mutual Banks, on the other hand, as provided for under the Act, are a juristic person with members/depositors who are shareholders in that juristic person and are entitled to participate in the exercise of control in a general meeting of that juristic person. The institution should also be provisionally or finally registered as a mutual bank in terms of the Mutual Banks Act (Mutual Banks Act No. 124 of 1993).

Apart from the above 3 options, MFIs in RSA cannot upscale into deposit taking institutions.

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4.2 Responses To The Four Key Research Questions

These findings have therefore provided answers to my 4 key research questions whose summary is presented here, as follows; 1. What is the model specification of the RSA Regulatory Framework applied on

the MFIs for the sector's development? It was found that the RSA Regulatory framework is wholistic, incorporating all credit providers, with a provision that covers MFIs under the Development Credit Agreements (NCA, 2005, Section 10) and registration as Development Credit Providers (NCA, 2005 Section 41).

The model is more inclined to consumer protection which is key in non-prudential regulation and supervision of non-deposit taking institutions. However, it is important to note that the consumers seem to have power that can distort an MFIs operation in-case they are fully exercised, especially when applied in bad taste. Any consumer has a right to access credit. The consumer, further has a right to redress under Section 89 (5) of the NCA, which states that "a credit agreement will be unlawful as stipulated in the Act, and as such;

(a) the credit agreement is void as from the date the agreement was entered into; (b) the credit provider must refund to the consumer any money paid by the consumer under that agreement to the credit provider, with interest; (c) all the purported rights of the credit provider under that credit agreement to recover of any money paid or goods delivered to, or on behalf of, the consumer in terms of that agreement are either - (i) cancelled, unless the court concludes that doing so in the circumstances, would unjustly enrich the consumer; or (ii) forfeited to the State, if the court concludes that cancelling those rights in the circumstances will enrich the consumer".


Does regulation enable or create barriers to increasing access to financial

services and reaching the unbanked population in RSA? In the context of the South African market, it is highly likely and evident that although the general unbanked population has reduced compared to the statistical records of two decades ago, it has

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however not reduced by margins that would have been expected. The numbers are most likely to have been much higher, had there been a special window for MFIs. This would have concentrated rules and regulations on MFIs, considering their special nature and funding sources, including favourable options for transformation and up-scaling into deposit mobilizing institutions without having to go through the expensive processes of registering as banks.

Low income people, do not, however, always need credit services, in-fact, more than anything else, they need a platform to accumulate and securely keep their savings. In most developing economies, studies have shown that the ratio of savers to borrowers is about 3:133 respectively. When consumers are already excluded, under the various categories listed in this paper, they are expected to identify more with MFIs than with banks, therefore, when MFIs are unable to meet this demand for voluntary savings, consumers will remain excluded from the financial system, and therefore remain unbanked.


Do the benefits of regulation outweigh the costs? This study has found that costs

will only be lower than benefits in the long run. In the short term, all stakeholders interviewed reported that there are massive costs incurred in compliance and reporting, that can be a barrier to entry into the MFI market, especially for small players. These costs will more often than not, be transferred to consumers in form of limited variety of services and constrained outreach that avoids the deep rural and costly to reach areas, where paradoxically, MFI services are needed even the more.

These costs were however considered negligible in on-going operations when compared to the high returns of the businesses and the intangible positive impacts that a regulatory context has brought to MFIs ­ as expressed by 100% of the respondents interviewed. Supervisory costs also need to be taken into account, as these may vary depending on the specific framework applied. With the NCR, there were no specific additional costs

"This may be because, for any given location, the addressable market of savers is usually larger than the addressable market of credit worthy borrowers" (MBB No.19 ­ Scaling up Micro Savings 2009, pg.4).


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for supervision, but regulators have to develop a workable mechanism of sustaining funding streams that will help to carry out effective onsite and off-sight supervision.


Can the results be generalized and make a case for good regulation for Non-

deposit taking MFIs in Kenya? The RSA regulatory framework cannot be generalized and/or be directly applied to the Kenyan MFI industry, on an as-is basis, at least not in the short run. Kenya has a more robust and highly liquid market for microfinance operations that needs specially designed regulations suited for its suppliers and clients. These should be distinct from those applied to the banks or other financial services sector players. However, in the long run, having a more comprehensive credit law would be ideal, to ensure fair competition in the credit market and set standards across the board.

Even for the deposit taking MFIs currently regulated under CBK regulation and supervision, there is need to review the MFI Act 2006 and ensure that it is appreciative of the real characteristics of microfinance operations and clientele. Kenya can however, borrow heavily from the consumer protection provisions of RSA, with adjustments to match its specific market characteristics. Consumer protection has been noted to be key to non-prudential regulatory guidelines.

4.3 Lessons learnt: Implications for Kenya and Proposals for the Development of Non-deposit Taking MFI Regulations

The study has found important regulatory best practices that will definitely be relevant to the development of Non-deposit taking MFI regulations in Kenya.

As Haq et, al. (2008, pg. 444) found, "It is not simply a matter of creating the legal basis for the proper regulatory environment and then waiting for the regulation to work as expected. It instead requires a constant dialogue among the regulators, the MFIs and the MFIs' borrowing and funding clients. Some may argue that the compliance costs will be just too expensive and work against the public interest. Instead, the reverse may well be true. A poorly developed regulatory system resulting in a suboptimal MFI industry has

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an even higher opportunity cost that of the potential financing opportunities denied to that nation's poor. This opportunity cost is something that a proper and well functioning regulatory system should well control".

A key lesson for Kenya is that registration is an essential part of information gathering and the regulatory process. If all the credit providers are registered under one authority then we would have a one stop shop for all credit providers rather than the current situation where they are registered under different Acts and Authorities.

Consumer protection is also vital, as much as an enabling environment through a facilitatory role of the regulator, for proper growth and development of MFIs in the country.

Just as credit information sharing has facilitated exponential growth in credit access in RSA by lowering the cost of risk assessments to the credit grantors and improving efficiency in credit access for the consumers whose ratings are good, it will be equally important for Kenya to include all MFIs in the current credit information sharing initiative so as to take advantage of its eminent gains.

Consumer education should be prioritized

by all credit providers who should be

required to have policies that provide for debt counselors to enlighten consumers against over commitment in debt to the extent that their ability to repay comfortably as well as attend to their various personal needs is limited.

There is need for a comprehensive legal framework for recourse to consumers of financial services across the whole financial sector as is currently implemented by the NCR. This mandate is currently vested in the various regulatory bodies such as CBK, CMA, IRA, RBA and SASRA. The complaints could be collected and synthesized through the various apex organizations such as Kenya Bankers association (KBA) and Association of Microfinance Institutions (AMFI), and then addressed by a relevant institution specifically established for that purpose.

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One alternative to explore is an expansion and enhancement of the role of the PostBank, together with agreements between the PostBank and microenterprise lenders in which deposits gathered on behalf of their clients would be loaned back to these institutions at discounted lending rates, as is currently successfully taking place in Morocco. The PostBank should take advantage of its wide branch network, high capacity to mobilize savings, facilitate remittances and issue payments, while also considering a full banking license.

Kenya's current Consumer Protection Bill needs to be fast-tracked & enacted, while the Bill for the regulation of the Non-deposit taking MFIs needs to be reviewed and prepared for publishing.

In line with what Jansson 2001 proposed, the author proposes that the Kenyan regulations for Non-deposit taking MFIs therefore take into consideration the following key issues:

Comprehensive definition of what should be regulated - The first step in creating an appropriate regulatory framework for microfinance is to define the objects of "microfinance regulation." In other words, exactly what are supervisory authorities supposed to regulate? In essence, there are two possible objects of regulation: the activity and the institution. To adequately address the distinctive risk profile of microfinance, regulations have to cover both objects. We should therefore enlist and license all institutions engaging in Non-deposit taking microfinance business, as well as note their activities, so that crafting of appropriate regulation takes these into consideration.

Use of Definition to Tailor Regulations - Once a definition of microfinance is adopted, supervisory authorities can use it to enact various regulatory modifications that will accommodate microfinance in a responsible manner. A response to why the institutions listed above and their activities, should be regulated, will help to define regulatory parameters. The definition of microfinance should also allow the regulator to

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account for the distinctive features of micro-lending, as well as remain open to accommodate upcoming innovations.

Include Supervision costs and Credit information sharing - Although the regulatory framework is important, it is only half of the story. The other half is supervision. After designing an appropriate regulatory framework for MFIs, effective supervision of the entities must then be ensured. Microfinance supervision spans a range of challenges, from budgetary considerations to the organizational structure of the regulator (in our case proposed in the Microfinance Act 2006, Section 3 (2), to be the Ministry of Finance), to special training for analysts and inspectors.

A way to get around the budgetary challenge would be to let MFIs pay for their own supervision. In most Latin American countries, all financial institutions do in fact contribute all or part of the supervisory authorities' budget. MFIs in Kenya should be treated no differently. An alternative would be to have the supervisory budget partially funded by the Exchequer, with the remainder coming from fees and charges on supervised MFIs.

In the medium to long term, the regulator could develop more innovative ways to raise funds for the same, such as through extensive research and publication of valuable market information that can be sold to players in the market; offer consultancy and advisory services within and without the country; attract external funding from a network of regulators and partners from other countries; etc.

Monitoring and Evaluation framework ­ to be more effective in regulation and supervision, there's need to know how to measure the success rate of the effort being put in regulation and supervision. A comprehensive framework must be in place to help send signals of effectiveness of the process and highlight areas that need modifications towards improvement. Budgetary allocations must always be tracked against value gained in return. As expected, an efficient system of supervision should be reflected in proper adherence to the regulations, while regulatory effectiveness should lead to improvement in operations and sustainability of players in the sector, as well as

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increased economic power of clients being served and ultimately a general growth and development of the economy.

More specifically, looking at the current state of this draft Bill, entitled "Draft Microfinance (Non-Deposit Taking Microcredit Business) Regulations 2007", the author proposes that the following points be taken on board towards improving it: · The title may be recast to reflect microfinance as opposed to microcredit, in appreciation of a more wholistic approach to operations of MFIs in delivering innovative and creative services to low income people, that should go beyond credit facilities and include, but not be limited to; micro-insurance, remittances, mobile payments/mobile banking, business development services, consumer education, etc. · The proposed establishment of a Unit to be known as the Microfinance Unit within the Ministry of Finance, should be fast tracked and preferably set-up as a stand-alone department within the Ministry of Finance, with a director (as the Regulator) empowered to recruit and train supervision staff who will enforce the regulations, and with more specific functions, clear reporting structures, and networks with other regulatory authorities such as the CBK, IRA, RBA, CMA, Kenya Credit Information Sharing Initiative (KCISI), SASRA and others, whose authority may have an impact on MFI activities when they diversify their operations. All these should be developed through a comprehensive process involving stakeholder consultations. · Important also, as has been noted by the Basel Committee for Bank Supervision (2010), is that the types of permissible microfinance activities should be clearly defined and tied to the size of the institution and its ability to manage risks inherent with such products and clients. Permission to engage in sophisticated activities should be substantiated by management's experience and ability to identify, control and mitigate more complex risks. · Borrowing a leaf from the NCA No. 34, 2005 of South Africa, the Kenyan regulations should be more inclined to consumer protection and identify more specific non-prudential guidelines that should include, but not be limited to;

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protection of consumer rights; preserving confidentiality (for personal information and consumer credit records); acceptable marketing practices; prevention of over-indebtedness and reckless lending; law-full and un-law-full agreements; alteration; rescission and termination of agreements; disclosure requirements for all agreements; consumer's liability, interest, charges and fees; collection and repayment practices and dispute resolution. · Management, governance and operations, though usually tightly focused only for DTMs, should also be incorporated in the regulation of non-deposit taking institutions and be emphasized especially for the larger MFIs that intend to upscale into DTMs. · As part of the licensing requirements, and in-line with the norm in Bolivia under the SBEF, MFIs should produce an economic evaluation of the market structure and the value addition that their business adds to the economy in general and the target consumers in particular.

4.4 Summary and Conclusions

While regulation is definitely not the sole factor responsible for the state of development of the RSA microfinance market, the findings of this research suggest that regulation has constituted a facilitator to growth of the industry. Several kinds of interactions among regulators and market participants have been identified and effects of regulation have been theoretically discussed and evidence has been raised to support the arguments.

Effects on competition, quantity, quality and variety of financial services as well as compliance and supervisory costs were highlighted. As a result of the assessment, it can be concluded that regulation has brought more benefits than costs to the industry itself and to all players in the industry. MFIs expressed confidence of strengthening of their financial performance, scale and outreach of their operations, which have benefited themselves by enhancing their capacity and improving their chances of achieving their set targets while being more integrated in the financial system.

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Regulation is a useful tool that has helped MFIs to set foot in the financial sector as an equal player with commercial banks and has also enhanced MFI funding streams, especially external funding, resulting from the recognition of the stringent regulatory regime of the country (even by international standards).

From the side of the supervisor, it was observed that the framework adopted for regulation and supervision did not impose any additional costs that could be singled out by the regulator in supervision and inspections. To achieve the objective of contributing to the development of microfinance as an integral part of the credit industry and the financial system as a whole, the NCR continues to develop better data collection strategies and supervision mechanisms to enhance its efficiency.

Regulation has also impacted positively on the stakeholders, both directly and indirectly. Microfinance clients have benefited from better access to financial services, in terms of quantity, quality and variety of products; while at the same time, have been introduced to a culture of credit discipline. Consumer protection has been at the forefront of the regulatory framework and has built massive confidence in borrowers who would otherwise have refrained from participating in credit transactions. Investors have been more interested in participating in the microfinance market because of more confidence in a regulated system, which has demonstrated so far profitable results on a sustainable basis.

Having noted during an interview with Rashid Ahmed, that - "even though MFIs need to be treated as special entities, with special challenges including but not limited to high operational costs, the recent global financial crisis and the survival of the banking sector in RSA shows that a more wholistic and far reaching regulatory framework for all credit providers is better placed to guard against structural failures in the financial sector, as it applies uniform treatment and standards to be adhered to by all players in the credit economy".

However, the author feels that every country needs to understand its local financial market, i.e. the suppliers and consumers of microfinance services, before setting up any

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regulations; it should think about the wider impact on low income clients. It would be preferable for governments to support the industry as facilitators rather than players; support technology development; inventions and innovations; ensure that rules and regulations are relevant, and test the impact to see whether the envisaged results are realised; ensure emphasis and implementation of consumer financial education; encourage information flow; financial institution registration and reporting;

development of credit registries for information sharing and any market improvement effort. Monitoring and evaluation of the regulatory framework is therefore an important element of the supervisory process.

Regulators have a role to ensure financial inclusion, allow market development, supervise financial institutions and those that they work through, e.g.

telecommunications companies and be flexible enough to create an enabling environment for all actors.

Private sector also has a role in providing services to the low income earners which is not only profitable but also affordable for the client; they should leverage on private sector infrastructure to improve depth and breadth of outreach; broaden private sector participation in the market; engage in the processes towards regulation; provide capital; build infrastructure; develop new products, services and technologies; improve human and institutional capacity.

To conclude, although the study does not penetrate through an extensive financial or econometric analysis (mostly arising from lack of elaborate prudential reporting requirements for MFIs and comprehensive data for trend analysis) the RIA of the South African microfinance regulatory framework could be assigned with a positive valuation, on average, because the findings suggest that benefits outweigh the costs that regulation has imposed on the market players.

Besides, it seems that regulation has acted as a catalyst to enhance growth and development of the entire credit industry and thus, has accomplished its goal of

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promoting the progress of the sector within a financial system approach and increasing financial inclusion and reaching the unbanked in South Africa.

With the promulgation of Kenya's new Constitution by His Excellency the President Mwai Kibaki on 27th August 2010, the regulation and supervisory framework has to take into consideration the proposed governance structure that entails

regional/provincial governments. Supervision may have to be delegated to an institution based in each Province while retaining the oversight at the Treasury. Finally, however, AMFIU (2005, pg.15634) found that regulation is necessary but not sufficient, "development of the regulatory framework should be accompanied by complementary development of other business laws and regulations, especially taxation, contract enforcement, collateral, securities regulation, and consumer protection".


Originally from (Visited on 9th September 2010 at 15.57hrs)

80 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010


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Xavier Reille and Timothy R. Lyman (2005), Diagnostic Report on the Legal and Regulatory Environment for Microfinance in Morocco. CGAP, Washington D.C. Yolanda R. C. (2006), Regulation of microfinance institutions: Impact assessment of the regulatory framework of microfinance institutions in Peru. Dissertation to the University of Manchester. Microfinance Gateway. LIST OF WEBSITES ACCION International: http// (last visited on 17th July 2010, at 4.15pm) Bank for International Settlements: (last visited on 18th August 2010, at 9.30am). Central Bank of Kenya: http// (last visited on 2nd September 2010, 3.30pm). Consultative Group to Assist the Poor: (last visited on 28th August 2010, 10.18am). Ethics and Economics: http// (last visited on 7th September 2010 at 11.40am). Financial Sector Charter: http// (last visited on 18th July 2010 at 3.19pm). Financial Services Authority: (last visited on 30th August 2010 at 4.35pm). Financial Services Authority: http// (last visited on 30th August 2010 at 4.39pm). FinMark Trust: (last visited on 28th July 2010 at 2.05pm). Inter American Development Bank: http// (last visited 7th August 2010 at 8.20am). Microfinance Gateway: (Last visited on 30th August 2010 at 5.05pm). Micro finance Regulation Center: (last visited on 29th August at 9.00am). Mix Market Statistics. (last visited on 26th August at 11.00am) Reserve Bank of South Africa: http//:www.reserve (last visited on 28th August at 2.10pm).

86 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

http// (visited on 4th July 2010). World Bank: http// (last visited on 20th June 2010 at 3.45pm). World Council of Credit Unions: http// (last visited on 6th September 2010 at 4.00pm).


Name Bezant Chongo Gideon Jones

Institution PFSA




29 June [email protected] 2010 Internal Auditor ­ The 14th July 2010 [email protected] Kuyasa Fund Mehdi Dutheil PFSA 20th July 2010 [email protected] Lee Ann Operations Manager ­ The 20th July 2010 [email protected] Lancaster Kuyasa Fund George Omino Ministry of Finance Kenya 13th August [email protected] 2010 Ezra Anyango Ministry of Finance Kenya 13th August [email protected] 2010 Steven Mirero National Youth 17th August [email protected] Development Agency 2010 Rashid Ahmed Independent Consultant 19th August [email protected] 2010 Prof. W. University of Stellenbosch 20th August [email protected] Thomas 2010 Abel Tshimole National Credit Register 12th October [email protected] 2009 th MD - Micro Finance South Africa (14 October 2009) The Credit Ombudsman - South Africa (16th October 2009) Table 10: LIST OF FIGURES, GRAPHS & TABLES Table 1: Table 2: Figure 1: Table 3: Graph 1: Graph 2: Table 4: Graph 3: Graph 4: Distinctive features of microfinance Regulation, supervision and main participants in Morocco Seasonally adjusted annual GDP growth ­ South Africa Composition of micro-lending industry loan book; type of lender 2000 - 2004. Growth in Loan Book for Section 21 Companies (2000 ­ 2004) Growth in Loan Book for Banks (2000 ­ 2004) Credit granted by credit type Total credit granted (2008 Q4 ­ 2009 Q4) Unsecured credit granted (2008 Q4 ­ 2009 Q4)

87 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010

Table 5: Table 6: Table 7: Table 8: Table 9:

Summary of pricing responses to legislative frame work NCR maximum lending rates and fees as prescribed by the NCA Regulations Chapter 5 South African Banking Status 2005 - 2009 Credit union penetration of economically active populations in Africa List of people interviewed

88 The State University of Bergamo ­ Italy. Masters in Microfinance 4th Edition 2009 - 2010



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