In 2009, the United Nations Commission on International Trade Law (UNCITRAL) commissioned its first study regarding the need for a regulatory and legal framework that would protect and nurture development of the microfinance sector.
To further this query, in January 2011, UNCITRAL gathered microfinance specialists from governments, international organizations, NGOs, the private sector, and academia from around the world for a colloquium on the topic. Participants recognized the lack of, and need for, globally common industry practices and principles which can respond to legal, regulatory and market gaps preventing the industry from operating optimally; the increasing role of investors; and the advent of direct cross-border contacts between lenders and borrowers. In April 2011, the UNCITRAL Secretariat issued its Colloquium findings (A/CN.9/727), which are briefly summarised below.
Financial inclusion aims past microbusiness to all population segments through flexible services, various provider types, and reliable delivery mechanisms. Related regulatory regimes must balance regulation and supervision cost against the risks of non-regulation and correspond proportionately to the type and size of the transactions they govern. Microfinance invites more prudential regulation (which protects the integrity of financial systems, usually through a special agency) than non-prudential regulation (which governs the conduct of the business itself). While various bodies set governing standards, greater international clarity would encourage cross-border microfinancing, a matter within UNCITRAL's mandate.
International and Regional Contributions
To date, notable work by agencies interested in promoting microfinance, include:
The United Nations system.
The United Nations focuses on assisting the Secretary-General's Special Advocate and providing technical assistance to member States. The U.N. proper could pursue the enhancement of:
(a) Cooperation among world-wide policymakers, regulators, and standard-setting bodies that address economic inclusion, stability, and integrity;
(b) Competent inclusive financial systems that serve a spectrum from individuals to medium-sized ventures;
(c) National fiscal infrastructures, especially concerning payment services;
(d) Safeguards against potential customer abuses, by means of industry standards, self-regulation, external regulation oversight, product transparency, and improved customer efficacy in choosing financial products and managing money.
Basel Committee on Banking Supervision.
The BCBS reported on the application of its Core Principles to depository microfinance institutions and their prudential regulation (August 2010). The report highlights the key differences in applying each Principle to microfinance as compared to traditional banking. It aims to assist States in creating a paradigm that competently apportions supervisory resources, producing particularized information within its supervisory bodies to capably gauge risk, and acknowledging tested control and management methods.
G-20 Financial Inclusion Experts Group/Access through Innovation Sub-Group.
The G-20's Nine Principles (June 2010) facilitate policy and regulatory paths that incorporate:
(a) Secure employment of creative, sufficient, inexpensive financial service distribution modes;
(b) A system of incentives for the various microfinance providers that also ensures fair conditions of competition among them; and
(c) Affordable and quality financial services that respond to various client needs
The Principles presume that innovations and the participation of international funders make more pertinent the need for global standard setting and advisory bodies to improve microfinance transparency and efficacy.
Global Partnership for Financial Inclusion.
GPFI is the primary implement for the November 2010 financial inclusion strategy devised at the Seoul G-20 Summit and has created a squad concentrating on the G-20 Principles and employing standard setting bodies. GPFI seeks to develop a financial inclusion data and measurement task force to improve the amount and calibre of pertinent information for borrowers and to furnish means and methods for countries to establish goals.
Consultative Group to Assist the Poor.
An autonomous policy and research centre located at the World Bank, CGAP adopted 2002 Consensus Guidelines (being updated this year) for regulation and supervision principles, written by microfinance professionals. CGAP believes that for microfinance to maximize its potential, governments must create a regulatory scheme that licenses microfinance institutions (MFIs) as prudentially supervised market participants. CGAP's Smart Campaign includes the fundamental expectations a customer should be entitled to have when doing business with an MFI; these include the aversion of excessive debt, straightforward and sensible pricing, fitting methods of collection, principled personnel, complaint recourse procedures, and security of customer information.
The World Bank stresses the necessity of an adept fiscal infrastructure, particularly systems for actions against collateral (such as registries and secured transactions processes) that will encourage creditors to accept movable property as security. A modern system can expand credit and reduce its cost.
The European Commission launched a 2007 initiative to better the credit supply to microbusinesses. It encouraged EU States to accommodate microcredit offerings by banks and non-banks through various ways; ease interest rate caps for microcredit providers; adapt microfinance-specific national regulation and supervision; and step up the institutional framework for self-employment and microenterprises. Member States should establish measures to assist the unemployed and welfare recipients to transition to self-employment and improve the likelihood of success for upstart microbusinesses.
Association of Supervisors of Banks of the Americas/Inter-American Development Bank.
ASBA issued 2010 guidelines for successful microfinance regulation and supervision, championing wider use of the Basel Principles to create a microfinance regulatory and legal framework. The Guidelines apply to all MFIs and speak to:
(a) Prerequisites for productive regulation and supervision, including policies on interest rates, information access for customers, customer protection, customer rights and duties, clarity of cost, and deposit insurance;
(b) Actual regulation and supervision of MFIs; and
(c) Regulation of defined microcredit operations
The Guidelines also extol the necessity for a reliable foundation that facilitates debt collection, sureness in the resolution of guarantees, and swift settlement of smaller disagreements between clients and MFIs. The duties of financial supervisors should be unambiguous; the legal framework should provide for MFI licensure commensurate with commercial institutions; and the regulatory framework should integrate risk management concepts, debt limits, and anti-money-laundering and counter terrorism mechanisms. Governments should plainly define "micro" words and their attendant customer traits and credit practices.
Legal and Regulatory Issues in Microfinance.
Self-regulation alone is no longer sufficient, and consensus-oriented legal instruments would be extremely helpful for lawmakers and policymakers, particularly in developing and transitioning countries. UNCITRAL notes the following matters for consideration:
Issue 1 - Nature and quality of the regulatory environment.
Microfinance services are provided by a wide range of institutions, formal, semi-formal and informal entities; non-profit and for-profit; overseen, if at all, by different regulators; deposit-taking and not; all complicating policymaking and supervision.
Issue 2 - Interest Rates.
Interest rates in microfinance are higher because operating costs are higher than mainstream lending (small amounts, short terms, many borrowers and wide geography). Should States intervene?
Issue 3 - Over-indebtedness.
Providers should monitor and prevent over-indebtedness, which sometimes occurs when available credit is abundant and competition is high, A glut of willing lenders sometimes disincentivizes borrowers to repay. States need a competent framework for the evolution and regulation of credit bureaus. Reliable borrower data to lenders helps reduce default and facilitates less expensive credit.
Issue 4 - Use of collateral.
Employing collateral without a suitable legislation can lead to abusive collection methods by some MFIs. Regulation is vital. Borrowers must be aware of the consequences of potential default before entering into a secured transaction. States may consider limiting use of collateral to assets having market value and tailor related law for microfinance to reduce costs and time.
Issue 5 - Foreign exchange risk and international capital markets.
Institutions in developing countries are often indisposed to or lawfully prohibited from lending to MFIs, and international capital markets are a dominant source of needed funds (especially for nondepository MFIs). MFIs may obtain these funds through collateralized debt obligations and microloan securitizations. MFIs can incur loss when they borrow capital abroad in foreign currency and convert it to their home currency, but few have alternatives due to the cost and complexity of transforming to a deposit-taking institution and the insufficient legal frameworks for cross-border funding or complex securitization transactions.
Quick and inexpensive exchange of remittances is essential. Some MFIs use their branch network as remittance payment points for money transfer operators. Perhaps States can license MFIs to handle international remittances of funds on a wider basis.
Issue 8 - Electronic money.
Mobile money technology is a hot topic requiring international standardsetting and an international legal regime. M-banking is evolving rapidly and has the potential to ensure financial inclusion, but partner banks must ensure compliance with anti-money-laundering and consumer protection regulations. Unresolved legal issues regarding e-money include
(a) Should governments treat e-money as savings, thereby accruing interest;
(b) Are e-money issuers engaged in banking and thus subject to banking regulation; and
(c) Should governments subject e-money to deposit insurance schemes
With no guidance among the spectrum of pure payments, stored value instruments, and deposits, countries have a variety of approaches with concomitant inconsistent operating environments for account providers, sometimes restricting the services they can provide. UNCITRAL deems communication via mobile devices as a possible subset of electronic communications for purposes of its relevant legislative standards. The embracing of such standards would make the legal status of mobile transactions predictable.
Issue 9 - Agent Banking.
UNCITRAL advocates agent banking, an aspect of branchless banking, whereby correspondents who are widely scattered geographically provide services at the local level. States should consider whether banks might use non-bank agents to take deposits, open accounts, accommodate bank transfers, and distribute loans. Non-bank agents are a low cost distribution channel. Per Basel, such new delivery channels require specialized operational risk standards that do not restrict invention but guarantee the reliability of institutions and the security of customer funds. Supervisory personnel must have an incisive apprehension of how new business models operate and create tailored methods for recognizing enhanced operational risk.
Issue 10 - Client protection and financial literacy.
States must ensure client protection, including by preventing unscrupulous practices and building financial literacy in the community. "Bundling" different financial services can mean clients engage obligations and expenses they do not truly comprehend. High client illiteracy means MFIs should be more accountable than commercial banks, and States should contemplate making financial literacy integral to their development agendas. States need to
(a) Restrict over-collateralisation and the requirement that borrowers deposit of a portion of their loan monies with their lenders
(b) Enhance transparency (e.g. regarding interest rates; charges and fees; conditions and costs of products and services; the true cost of borrowing; complaint procedures; and debtor rights when repayment is enforced)
(c) Regulate sales and marketing methods, including prohibitions on deceptive advertisement
(d) Protect client confidentiality, and
(e) Establish mechanisms for client redress.
Issue 11 - Alternative Dispute resolution.
Access to fair, rapid, transparent, and inexpensive dispute resolution is integral to client protection. Court is lengthy, expensive, and subject to geographic, linguistic, and cultural barriers, and borrowers do not know their rights. For lenders, high delinquency and ineffective recovery through court contribute to higher interest rates and reduced credit access. Regulators must ensure recourse mechanisms under MFI internal procedures as well as thirdparty dispute resolution.
Issue 12 - Secured financing.
As microenterprises grow, secured financing becomes increasingly important to their progress. Borrowers have productive assets that could serve as collateral, but domestic legislation often precludes their use as security. Legal frameworks that permit secured transactions using movable property and fixtures would increase available credit, enhance lending terms, and correspondingly benefit MFIs.
To stay within its mandate and not duplicate efforts of other agencies, at its July meeting, UNCITRAL determined it will explore four of the identified issues for possible work:
Dispute resolution, and
To keep current on its progress, visit www.uncitral.org.
Julee L Milham
Business, Intellectual Property, and Entertainment Attorney
Specialties: Copyright and Trademark Licensing and Counsel, Contract Negotiation and Drafting, Commercial Arbitration, General Business Counsel, Microfinance, Quasi-Judicial/Government Services. Board Certified in Intellectual Property Law, the Florida Bar; 1 of 9 members of the Bar's Intellectual Property Certification Committee. American Arbitration Association arbitrator and mediator - Commercial, Intellectual Property, and Consumer panels Co-founder/co-chair, New York State Bar Association, International Section, International Committee on Microfinance and Financial Inclusion (now known as International Committee on Social Finance and Enterprise). Executive Committee member, NYSBA International Section. Entertainment, Arts & Sports Law Section of the Florida Bar, member and Chair Emeritus; Executive Council member 1997-2007, 2009-2017 The Practice of Music Law in Florida (1st, 2nd Editions), Florida Bar CLE Fastrain/Lexis-Nexis Publishing, Author (2003, 2006) Arts Law in Florida: A Guide for Artists and Arts Organizations, Volunteer Lawyers for the Arts, Author (2005) Entertainment Law, Stetson University College of Law, Adjunct Professor (2004, 2005, 2007, 2009)