A robust microfinance sector: For lowering poverty

Increasing degree of professionalization, the employment of new technologies in the industry and the higher involvement of banks in microfinance indicate a rethink of the rationale of microfinance regulation and the supervisory practices

By providing small loans and savings facilities to people who are excluded from commercial financial services, microfinance has become a strategy for lowering poverty. It is a means to render poor women and men with opportunities to take an active role in their respective areas through entrepreneurship and building income, bargaining power, and social empowerment.

In the past few years, with rapid changes in information technology, microfinance has been evolving, and MFIs are broadening their services in innovative ways. A classic example is the delivery of microfinance products using mobile phones where MFIs are leveraging this striking penetration of mobile technology and mobile payments to improve delivery of microfinance services and products to their clients. In the case of Nepal, the history of microfinance goes back to the inception of Small Farmers’ Development Project in 1975 when the Agriculture Development Bank of Nepal began a collateral free group-based lending program to the poor in the Terai and hilly areas of the country. It was only in the country’s Sixth Plan (1980/81-1984/85) that microfinance was acknowledged as an official poverty alleviation mechanism.

In the SAARC region, Nepal was the first country to introduce specific regulations for the microfinance sector when the Development Banks Act got through by the Parliament in 1996 after which the first Financial Intermediary Societies Act (FISA) was passed in 1999. Microfinance regulation evolved from official attempts to promote a poverty agenda through the Nepal Rastra Bank’s sponsorship of the five Regional Rural Development Banks (RRDBs).

The RRDBs were set up beginning in 1992, initially under the Commercial Banks Act, and had majority share of NRB as well as significant contributions from the commercial banking sector. The success of Grameen Bank of Bangladesh was replicated in Nepal by the establishment of these rural development banks. Each year Nepal Rastra Bank (NRB) announces a number of policy measures in its annual monetary policy for enhancing access to banking services by unbanked people. The National Microfinance Policy, 2010, whose principal objective was to facilitate the mitigation of poverty through sustained, simplified and accessible micro-finance services, has already been implemented. Proposal to establish a separate microfinance authority has also been put forward to regulate and supervise these institutions.

Likewise, as announced in its Monetary Policy 2015/16, steps are to be initiated to avoid the duplication of micro-finance services by providing licenses to new MFIs only in the financial service deficient areas. The Monetary Policy has also mentioned about the increase in the paid-up capital by the MFIs while according due emphasis to merger and acquisition. Similarly, NRB has recently instructed the MFIs to develop a separate Client Protection Fund for the institutional development and welfare of the borrowers. Under the directive, the MFIs are required to allocate 1 percent of their net profits to the fund and are also required to allocate another 25 percent of the dividends if the dividend distribution exceeds 20 percent of their profit.

The NRB has also directed banks to support microfinance institutions by extending credit under deprived sector. Under the deprived sector lending policy, commercial banks are required to lend at present 5 percent of their total loan portfolio to the deprived sector, while development banks and finance companies need to allocate 4.5 percent and 4 percent of their credit respectively to the deprived sector, which in turn provides resources for the microfinance institutions for on-lending to the poor.

Nepal faces an array of challenges with respect to the microfinance sector. There is a general complaint that lending rates are exorbitant, that the margin between the cost of fund and lending rate is extremely high and that some of the poor borrowers have problems in borrowing at such a high rate. This aspect must be addressed if a clear distinction is to be made between the MFIs and the local moneylenders.

It is also crucial to link microfinance services to complementary pro-poor interventions that help people in extreme poverty to become economically active and creditworthy. Likewise, technology-based solutions, such as mobile phone and internet banking, payment cards, and electronic money, can facilitate MFIs in reducing operating costs and extending the reach of their services.

Analogously, the microfinance sector has to develop appropriate products that are compatible with the requirements of the poor and low income groups, affordable and financially viable as there still exists a gap in understanding the poor people’s needs and demands.

The increasing degree of professionalization, the employment of new technologies in the industry and the higher involvement of banks in microfinance indicate a rethink of the rationale of microfinance regulation and the supervisory practices. Any new regulatory and supervisory framework for microfinance has to balance the need for financial stability, resilience, integrity and consumer protection with the need to preserve financial inclusion and healthy competition.

Dr. Pant is Director at Nepal Rastra Bank