Microfinance Institutions and Credit Unions in Albania: Regulatory, Supervisory and Market Development Issues

World Bank 14 April 2008

DRAFT FOR DISCUSSION ONLY

This report has been prepared by a World Bank team from the Private and Financial Sector Department, Europe and Central Asia Region, consisting of Messrs. Lalit Raina (Sector Manager and Team Leader), John Pollner (Lead Financial Officer), Brett Coleman (Financial Economist), and Engin Atcakoca (Consultant). The report draws on existing analytical material, site visits, interviews and discussions with government officials, donors, and market participants. The team expresses its gratitude to the Bank of Albania, the Ministry of Finance, USAID, International Monetary Fund, UNDP, and microfinance providers and commercial banks (the Albanian Savings and Credit Union, the Jehona Credit Union, Besa Foundation, Opportunity Albania, World Vision, Mountain Areas Finance Fund, ProCredit Bank, American Bank, Credins Bank, First Investment Bank, Societe Generale, International Commercial Bank, National Commercial Bank, BIS Banca, and Banka Kombetare Tregtare) which provided information on their activities and generously gave their time to share their knowledge and insights on microfinance in Albania. The findings, interpretations, and conclusions expressed herein are those of the authors and do no necessarily reflect the views of the World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.

Contents List of Acronyms and Abbreviations Executive Summary A. Objective of this Report B. Social and economic context C. Microfinance Institutions in Albania C.1 Savings and Credit Associations and their Unions C.2 Non-Governmental Organizations and Non-bank Finance Institutions D. Legal, Regulatory and Supervisory Framework of Microfinance D.1 International Practice D.2 Legislation in Albania D.3 Prudential Regulations for SCAs and their Unions D.4 Prudential Regulations for NGOs and NBFIs D.5 Non-Prudential Regulations for SCAs, CUs and NBFIs D.6 Taxation E. Future Development Priorities for the SCAs and MFIs Appendix I: Recommended Regulatory Applications for the SCAs and MFIs Appendix II: Comparison of Recommended Regulatory Changes Appendix III: Average Loan Size Per Borrower of MFIs in Different Regions Appendix IV: Pro-Consumer Pledge Appendix V: Comparative Analysis of Tax Exemption Status Appendix VI Country Applications of Profit Tax On Non-Profit NBFIs

2 3 3 10 11 11 14 14 15 15 16 20 25 26 28 32 34 36 37 39 42

List of Acronyms and Abbreviations

ALL ASCU BoA GDP IDA IMF MAFF MFI MFN NBFI NGO SCA USCA “Jehona” TF VCF WOCCU

Albanian Leks Albanian Savings and Credit Union Bank of Albania Gross domestic product International Development Agency International Monetary Fund Mountain Areas Finance Fund Institutions rendering microfinance services Micro Finance Network Non Bank Finance Institution Nongovernmental Organizations Savings and Credit Association Union of Savings and Credit Associations “Jehona” Task Force Village Credit Funds World Council of Credit Unions

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Executive Summary Objective of this Report 1. A Financial Sector Assessment Program (FSAP) was carried out by the World Bank and the International Monetary Fund (IMF) in 2005, one component of which focused on Albania’s credit unions (CUs) and microfinance institutions (MFIs). Following the FSAP, the Bank of Albania (BoA) requested further assistance to conduct an assessment of the current legal, regulatory, and supervisory framework for microfinance, as well as an assessment of MFIs, including the Savings and Credit Associations (SCAs) and their CUs, to identify future development priorities. This study reports on this assessment. Social and economic context 2. In the early 1990s, Albania entered a complex transition period, during which agricultural cooperatives and state farm land were privatized, creating over 400,000 new family farms. Markets for inputs and outputs, as well as financial intermediaries, were either poorly functioning or nonexistent. 3. MFIs entered Albania in the early 1990s and have generally performed well, even during the pyramid savings collapse of 1997, when 50 percent of the population lost their savings. However, the 1997 crisis raised concerns regarding the need to regulate and supervise even small financial institutions, and this concern continues today. 4. In the past decade, structural and institutional reforms have advanced significantly, and sound policies have strengthened macroeconomic stability. Economic growth has averaged around 6 percent annually in recent years. Although poverty has also been reduced, a fifth of the population still live in poverty and about 3 percent live in extreme poverty. 5. One priority of the government has been to promote and encourage sustainable financial intermediaries, including networks of private SCAs, to provide microcredit in urban and rural areas. While MFIs have performed well by many standards, they have been slow to achieve an optimal scale of operations and full sustainability. They are still dependent on donors and subsidies. Albania’s microfinance industry consists primarily of 10 institutions: two non-bank finance institutions (NBFIs), three NGOs, two CUs comprising 127 SCAs, and three commercial banks with microfinance portfolios, serving 2.4 percent of the population. Microfinance Institutions in Albania 6. With the assistance of World Bank in the early 1990s, the government of Albania initiated a series of projects to support the development of a rural market economy. These included provision of small credits through village credit funds (VCFs). In 2000, the VCFs were converted into SCAs, managed by the members themselves. In 2002 these SCAs established the Albanian Savings and Credit Union (ASCU) as their umbrella organization to represent them, provide support, and coordinate their activities. In 2001, the Union of SCAs Jehona (USCA Jehona) was created with assistance from the Irish League of Credit Unions. Today, 127 SCAs in more than 690 villages and 20 urban locations serve more than 29,000 members under two CUs and provide credit and deposit services to their members.

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7. Most SCAs have a very small funding base, with external grants and loans from donors to the CUs as their major funding sources. The borrowings take the form of foreign currency from international donors or creditors, while SCAs’ loans to their members are denominated in local currency. The CUs typically deposit their foreign currency loans in a local bank as cash collateral and borrow a loan denominated in local currency. Once the CU repays the local currency loan, the domestic bank releases the foreign currency, which is then used to repay the original loan. 8. The CU refinances the SCAs at a rate of 11 percent, and the interest rate offered by the SCAs to their members is 15 percent. Compared with the other market players, the interest rates of the SCAs are low. The low funding base, including low capital and low deposits, stem from the historical choice of basing the SCAs on credit lines rather than member contributions and deposits. The low interest rates that SCAs charge their borrowers limit profits, and low interest rates on deposits limits savings mobilization. As a result, outreach and access remains limited. 9. Five other institutions, which all started as NGOs, initiated microcredit activities during the 1990s: Besa Foundation; For Future Foundation (FFF); World Vision ; Opportunity Albania; and Mountain Areas Finance Fund (MAFF). Per the Banking Law of 2006, all non-bank lenders must now register as a commercial company and be licensed by BoA as a non-bank financial institution (NBFI). MAFF and Opportunity Albania have obtained NBFI licenses, while Besa Foundation and World Vision are now in the process of application. FFF’s position is more tenuous. 10. One bank, ProCredit Bank, focuses on microfinance. However, the microfinance market is not clearly segmented from the rest of the financial market, as there is no agreed definition of a microcredit in Albania. Legal, Regulatory and Supervisory Framework of Microfinance International Practice 11. Financial sector regulation aims at overseeing the soundness of financial intermediaries to prevent financial system instability and losses to depositors. Regulation is "prudential" when it focuses on protecting the financial system as a whole as well as protecting the safety of small deposits in individual institutions. Prudential regulation is needed only when there are depositors to protect or when a financial institution is large enough that its failure would endanger the soundness of the financial system. "Nonprudential" regulations are oriented toward business operations and not on protecting the financial system. Non-prudential regulations often apply to non-financial businesses as well as financial institutions (e.g., anti-fraud regulations, fit-and-proper tests for owners and managers), although some are primarily tailored to financial institutions (e.g., truth-in-lending regulations that require complete, accurate disclosure of lending terms in easy-to-understand language). Prudential Regulations for SCAs and their Unions 12. SCAs are permitted to render microcredit services only to their members, who must have a common bond. SCAs are authorized to independently set their own rates of interest, commissions, and fees. Prudential requirements for SCAs are set out in the Regulation on 4

Supervision of SCAs and Their Unions. The deposits of the SCA members are not covered by an insurance scheme. BoA has delegated to the CUs many of the responsibilities to supervise the SCAs. BoA once a year performs on-site supervision of the CUs and about 10 percent of the SCAs, typically the larger ones. Every 6 months, the CUs provide BoA with the financial statements of each SCA and 6 additional reports. On a quarterly basis, the CUs submit their consolidated financial statements and detailed data on SCAs that are in breach of regulations. 13. The regulatory framework should enable a healthy growth of deposits, capital, and the loan portfolios of the SCAs. Strict restrictions and limitations on loan loss provisioning and non-secured lending prevent such growth. The report suggests several changes to the regulations to stimulate capital growth and increase deposits, including authorizing the SCAs and CUs to engage in money transfers to capture remittances, as well as considering the establishment of minimum capital requirements for SCAs. SCAs should also be allowed to increase their maximum loan tenor to 7 years, as well as add other services, such as leasing. 14. The delegated supervision arrangement allows BoA to supervise the SCAs with its limited staff. This arrangement is reasonable, given the small size of the SCAs and their deposits. The CUs are well placed to oversee the activities of their member SCAs since the CUs provide a range of services to them. Alternative methods of saving in the remote locations of SCAs will be riskier than an SCA that is overseen by the CU but not supervised directly by BoA. However, BoA should ensure minimum standards of performance by the CUs and should be strict in periodic testing of the reliability of the CUs’ supervision. A deposit insurance scheme should be considered for the deposits of SCA members. Prudential Regulations for NGOs and NBFIs 15. Since all microfinance NGOs are now required to receive an NBFI license from BoA, they must meet the minimum NBFI capital requirement of approximately $1.2 million (20 percent of what is required for banks). Most of the capital of these institutions consists of the base capital received from donors. Although they are not allowed to collect deposits, NBFIs are prudentially regulated and supervised by BoA under the Regulation on the Granting of Licenses to Non-Bank Financial Subjects. All licensed NBFIs are subject to on-site and offsite BoA supervision. 16. While NGOs are now required to obtain an NBFI license to engage in microfinance activities, there is no definition of “microfinance”, “microcredit”, or “microfinance institution” in the current legal and regulatory framework. Hence, an NGO that wishes to operate as an MFI currently has no choice but to meet the same requirements as any other commercial NBFI, regardless of the nature or scope of its business. In order to establish a sound regulatory and supervisory framework for microfinance in Albania, a common understanding and regulatory definition is needed. The most straightforward way to do this is for BoA to issue a regulation under Law No. 9662 on Banks in the Republic of Albania, which also covers NBFIs engaged in banking activities, defining an MFI as a specialized type of NBFI. NBFIs that conform to the regulation’s definitions of microcredit and MFI would be eligible for an MFI license. MFIs should also be registered as commercial companies. BoA (Legal Department) should prepare a manual or guidelines explaining the principles of transforming from an NGO into a commercial company. 17. Following international guidelines, BoA regulation could define a microcredit either (i) as a percentage of GDP/capita (e.g., 150 percent of GDP/capita, which is currently about 5

$8,550); or (ii) as a fixed amount (e.g., $10,000) which can be changed “from time to time” upon the issuance of new guidelines by BoA. An MFI could be defined, for example as a special type of NBFI (i) whose average loan size is no greater than the defined microcredit size, and (ii) with at least a certain percentage (e.g., 80 percent) of its loans no larger than the defined microcredit size. 18. The current minimum capital requirements for NBFIs would be high by international standards if applied to non-deposit-taking MFIs. In other countries, non-deposit-taking MFIs typically have no minimum capital requirements or low requirements, usually not more than $100,000, and rarely more than $250,000. BoA should also establish light prudential regulations (e.g., minimum capital of $100,000 to $250,000) and supervision (e.g., annual audits and reports). The regulatory focus on these institutions should be non-prudential. In the case of small non-deposit-taking MFIs, prudential supervision should be light, and BoA should focus its limited supervision resources on higher risks. Non-Prudential Regulations for SCAs, CUs and NBFIs 19. Non-prudential regulations for MFIs, SCAs, and CUs should include: (i) internal controls to avoid conflicts of interest and prevent fraud, financial crimes, and money laundering; (ii) simplified loan documentation; (iii) consumer protection, including rules supporting truth-in-lending and rules prohibiting abusive lending and collection practices; and (iv) participation in the credit register recently established in BoA. 20. To strengthen the value of collateral for SCAs and MFIs, amendments should be made in Article 510/d of the Code of Civil Procedure, to enable SCA and MFI loan contracts to be recognized as direct executive title, similar to bank loans. The movable property registries also need to be strengthened to ensure that property pledged as collateral cannot be sold or transferred. Taxation 21. CUs and SCAs are exempt from profit taxes. NGOs engaged in microfinance have also been exempted from profit taxes. However, NBFIs by law must register as commercial companies, theoretically making them subject to taxation. Commercial banks, regardless of the degree to which they are involved in microfinance, are subject to profit tax. 22. There is a consensus in BoA and MOF that MFIs should not be taxed due to their social objectives; moreover, there is clearly no support to lift the SCAs’ exemption. However, this will leave commercial banks focused on microfinance (e.g., ProCredit Bank) taxed and, therefore, treated unequally. Alternatives to level the playing field somewhat in this regard include (i) allowing banks to create wholly owned subsidiaries engaged in microfinance that are tax exempt, and (ii) allowing banks to deduct interest revenue earned from microcredits (as defined in the MFI regulation proposed above) from taxable income. 23. To encourage investment of private, for-profit capital in MFIs, MFIs should be allowed to pay dividends to their shareholders. Tax incentives should be provided on dividend income of microfinance investors for a transitional period of time, such as three years. Hence, all MFIs (whether profit-oriented or not-for-profit) would be exempt from profit taxes, but shareholders would pay reduced dividend taxes during a grace period and pay full dividend taxes afterwards. 6

Future Development Priorities for the SCAs and MFIs 24. The vision of microfinance in Albania should include the development of a sustainable, expanding, market-oriented sector, with privately owned SCAs and MFIs providing demand-driven services and operating under an enabling legal, regulatory, and supervisory framework that ensures the sector’s financial strength and ability to contribute to poverty reduction and economic growth. 25. Thus far in Albania, the only microfinance services offered are loans and savings, and these serve less than 3 percent of the population. Hence, there scope to significantly expand the outreach of MFIs’ existing services and increase the range of services to include insurance, cash transfer services, intermediating workers’ remittances, and providing guarantees. 26. Implementation of an improved legal, regulatory, and supervisory framework will create incentives for SCAs, their Unions, and MFIs to strengthen their operations and governance, operate more commercially, and build up their capital and expand their services. They will also encourage commercial banks to engage in commercial relationships with MFIs and offer microfinance services themselves. 27. Professional and business contacts between banks, MFIs, SCAs, and CUs should be further encouraged to promote exchange of technologies, strategic mergers, and wholesale financing of MFIs by banks. Banks should also be encouraged to partner with MFIs and SCAs where the latter originate loans and deposits but where the loan portfolios are financed and deposits are serviced by banks. An action plan should be prepared to allow the CUs and MFIs to participate in the country’s payment system. 28. The efficiency of MFIs, SCAs, and CUs should be increased, and BoA should coordinate (i) providing them with technical assistance, and (ii) ensuring their access to adequate lending technologies, improved risk management systems, and loan rating and tracking systems. BoA should discuss with MFIs, SCAs, and CUs if there would be demand for the establishment of a Microfinance Resource Center to provide information on the best international practices and funding sources. 29. BoA should coordinate with donors and the CUs to improve the tools the CUs use to monitor the quality of SCA loan portfolios, the financial sustainability of their operations, and their client outreach. A donor-supported project should be implemented on information system enhancement for SCAs and CUs. 30. ASCU expressed some desire to borrow from the World Bank and others to finance an expansion of their lending, reporting a need for EUR 10 million for 2008-2012. The request from ASCU to borrow from the World Bank is worth further exploration. However, such a credit line should be used only if it does not crowd out commercial sources that serve to integrate SCAs into the larger financial sector. Moreover, ASCU should be encouraged to increase its interest rates to build up its capital base and boost its deposits. 31. To increase equity investment in MFIs in Albania, consideration could be given to setting up an autonomous and professionally managed Albanian Microfinance Investment

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Fund, with the contribution of banks, international finance organizations, government, pension funds, insurance companies, domestic, and foreign donors. 32. The growth of SCAs can be ensured by a strategy for their merger. BoA should develop a strategy for consolidating and strengthening the SCAs. To carry out this work, BoA should establish a Task Force comprising the staff of the Supervision Department of BoA and the senior management of the CUs.

Box 1. Main Recommendations Short term (high priorities) 1.

BoA should revise CU and SCA regulations to stimulate capital growth and increase deposits, including: (i) authorizing the CUs and strong SCAs to engage in money transfers to capture remittances, and (ii) establishing minimum capital requirements for SCAs.

2.

The CUs should be encouraged to increase their interest rates to build up their capital base and boost deposits.

3.

BoA should allow SCAs to increase their maximum loan tenor to 7 years and add other services such as leasing.

4.

BoA should (i) ensure minimum standards of performance by the CUs in carrying out their delegated supervision responsibilities; (ii) be strict in periodic testing of the reliability of the CUs’ supervision; and (iii) ensure that CUs have the tools to supervise their SCAs.

5.

A limited deposit insurance scheme should be introduced for the SCAs.

6.

BoA should issue a regulation (under Law No. 9662 on Banks in the Republic of Albania) which (i) defines a “microcredit” and (ii) defines an “MFI” as a specialized type of NBFI that primarily deals in microcredit.

7.

Prudential regulations on MFIs under this new regulation should be light, including minimum capital of $100,000 to $250,000. Supervision resources should focus primarily on deposit-taking financial institutions.

8.

Regulations for MFIs, SCAs, and CUs should be primarily non-prudential, including: (i) internal controls to avoid conflicts of interest and prevent fraud, financial crimes, and money laundering; (ii) simplified loan documentation; (iii) consumer protection, including rules supporting truth-in-lending and prohibiting abusive lending and collection practices; and (iv) participation in the credit register recently established in BoA.

9.

BoA’s Legal Department should prepare a manual or guidelines explaining the principles of transforming from a microfinance NGO into a commercial company.

10. CUs and SCAs should maintain their exemption from profit taxes. MFIs should be exempt from profit taxes, but be required to pay taxes on dividends paid to shareholders (perhaps after a grace period not exceeding 3 years). Banks should be allowed to deduct interest revenue from their taxable earnings and create tax-exempt MFI subsidiaries. 11. BoA should establish a Task Force comprising the staff of the Supervision Department of BoA and the senior management of the CUs to develop a strategy for consolidating and strengthening the SCAs.

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Medium term 12. Significantly expand access to financial services by increasing the outreach of existing services (credit and savings) and increasing the range of services to include insurance, cash transfer services, intermediating workers’ remittances, and providing guarantees. 13. To strengthen the value of collateral for SCAs and MFIs, amendments should be made in Article 510/d of the Code of Civil Procedure, to enable SCA and MFI loan contracts to be recognized as direct executive title, similar to bank loans. 14. The movable property registries should be strengthened to ensure that property pledged as collateral cannot be sold or transferred. 15. Professional and business contacts between banks, MFIs, SCAs, and CUs should be encouraged to promote exchange of technologies, strategic mergers, and wholesale financing of MFIs by banks. 16. CUs and MFIs should be integrated into the country’s payment system. 17. BoA should coordinate with donors to ensure that MFIs, SCAs, and CUs (i) receive technical assistance, and (ii) gain access to adequate lending technologies, improved risk management systems, and loan rating and tracking systems. Consideration should be given to establishing a Microfinance Resource Center for this purpose. 18. To increase equity investment in MFIs in Albania, consideration could be given to setting up an autonomous and professionally managed Albanian Microfinance Investment Fund. 19. Further encourage

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A.

Objective of this Report

An assessment under the Financial Sector Assessment Program (FSAP) was carried out by the World Bank and the IMF in 2005 at the request of the Government of Albania and Bank of Albania (BoA). One component of FSAP focused on Albania’s credit unions (CUs) and microfinance institutions (MFIs) and recommended some consolidation to achieve economies of scale for sustainable growth. The FSAP also recommended that the regulation and supervision framework, currently the responsibility of BoA, be further strengthened to address the risks and responsibilities of microfinance institutions to their members and depositors. 1.

2. In view of the FSAP recommendations and the rapid growth of the microfinance sector in recent years, the Bank of Albania (BoA) requested assistance from the World Bank to conduct an assessment of the current legal, regulatory, and supervisory framework for microfinance and make recommendations for improvements that would support the development of a sustainable, market-oriented sector. BoA also requested an assessment of MFIs, including the Savings and Credit Associations (SCAs) and their CUs, to identify future development priorities, relevant risks, and responsibilities, with a view to developing a sustainable microfinance industry with capacity to render services to a wide range of urban and rural clients and contribute to economic growth and poverty reduction. The objective of this study is to report on this assessment.

B.

Social and economic context

Following the collapse of communism in the early 1990s, Albania entered a transition period that was accompanied by complex social and economic processes. 1 Albania’s agricultural cooperatives and state farm land were rapidly privatized, creating over 400,000 new family farms, most of which lacked inputs and basic tools. Markets for inputs and outputs, as well as financial intermediaries, were either poorly functioning or nonexistent. 3.

To begin filling this gap, MFIs entered Albania in the early 1990s, some as NGOs and some as quasi-governmental agencies, all free of state supervision. By the time state supervision came under discussion in the late 1990s there were a number of MFIs operating in Albania. MFIs have retained high levels of loan repayment, despite a number of social and economic crises, most infamously the pyramid savings schemes collapse of 1997, when up to 50 percent of the population lost their savings. MFIs maintained their small but sound base even when crises in loan repayments led to the collapse of one major state owned bank and, in 1998, a moratorium on lending in another. Nevertheless, the 1997 crisis understandably heightened the concern of BoA and the government regarding the need to regulate and supervise even small financial institutions, and this concern is still apparent today. 4.

5. Following the financial crisis in 1997, the financial sector entered into a phase of dynamic development. Private credits grew by 70, 50 and 56 percent in 2005, 2006, and 2007 respectively. Structural and institutional reforms have advanced significantly, and sound policies have been successful in achieving macroeconomic stability since the late 1990s.

1

World Bank Report No. 34627, page 2. November 22, 2005.

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Economic growth has averaged around 6 percent annually in recent years. Although poverty has also been reduced, a fifth of the population still live in poverty and about 3 percent live in extreme poverty, defined as the inability to meet basic food requirements. 2 Unemployment remains widespread, and is especially high in urban areas. 3

6.

7. One priority of the government has been to promote and encourage sustainable financial intermediaries, including networks of private SCAs, to provide microcredit in urban and rural areas. The Government sets as objectives of these intermediaries (i) in rural areas, to increase farm and off-farm investment and savings services and progressively establish a sustainable CU-SCA network; (ii) in urban areas, to develop self-employment and microenterprises, and to progressively establish sustainable MFIs. 4

BoA, while it is reassured by SCAs’ and MFIs’ consistently high levels of loan repayment, points out that they have been slow to achieve an optimal scale of operations and full sustainability. They are still donor dependent, either through direct subsidies or through access to funds at below-market rates. 5 However, with donor support and with a firm commitment from the government, microfinance has developed into a recognized and established part of the financial market. Today, Albania’s microfinance industry is shaped by 10 institutions: two non-bank finance institutions (NBFIs), three NGOs, two CUs comprising 127 SCAs, and three commercial banks with microfinance portfolios. These institutions serve 2.4 percent of the Albanian population. 8.

Despite the progress made in developing microfinance in Albania, outreach is still limited, particularly in remote mountain areas. The National Strategy for Socioeconomic Development (2004) notes this and calls for an increase in access to markets and credit by farmers and businesses in mountain areas.

9.

C.

Microfinance Institutions in Albania C.1

Savings and Credit Associations and their Unions

10. The government, with the support of the World Bank, initiated the Rural Credit Program in September 1992 to reduce poverty in rural areas and support the transition to a private, market-oriented agriculture sector. In early 1993, also with the financial assistance of the World Bank, the Government launched the Rural Poverty Alleviation Pilot Project (Cr.2461-ALB) and Rural Development Project (Cr. 2680-ALB), aiming to jumpstart a rural market economy by providing small credit through village credit funds (VCFs), and creating employment and improving infrastructure through a community-based infrastructure works program. The Rural Development Fund was established as a foundation, with legal and fiscal autonomy, to implement the project. 6

2

IMF Country Report No.286, page 10. July 2006. World Bank Report No. 29257, page 73. December 27, 2004. 4 Republic of Albania, Council of Ministers, National Strategy for Socio-Economic Development, pp. 20-21. November 2001. 3

5 6

Policy Monitor, January 2006, Regulation and Supervision of Albania’s Microfinance Industry-Michael Gannon, May 2005. World Bank Report No. 34627, page 2. November 2005.

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11. In 1995, the Rural Development Fund was converted into the Albanian Development Fund by expanding its activity in urban areas as well. The Rural Credit Department in this foundation continued successfully to implement the rural microcredit program by developing and expanding credit based on village solidarity. At the end of 1999, the system of VCFs covered 238 villages in 11 districts with more than 20,000 individual loans. 12. In 2000, the VCFs were converted into SCAs which are managed by the members themselves. In 2002 these SCAs established the Albanian Savings and Credit Union (ASCU) as an umbrella organization to represent them, provide support, and coordinate their activities. ASCU has recently been classified as the world’s 15th best MFI by the MIX Market. In 2001, the Union of SCAs Jehona (USCA Jehona), a more traditional urban and profession-based CU providing primarily deposit services, was created with technical assistance and financial support from the Irish League of Credit Unions. Today, some 127 SCAs in more than 690 villages and 20 urban locations serve more than 29,000 members under two CUs and provide only credit and deposit services to their members. 13.

The main duties and responsibilities of the CUs are to: • Represent, protect, and promote the interests of their SCAs. • Coordinate the activity of the SCAs’ network and provide services of common interest. • Carry out on-site inspections. • Refinance the SCAs in a timely manner and according to their needs. • Collect and prudently manage the liquidity of member SCAs. • Control and manage the financial risk of the CU. • Offer training, management consultancy, forms, supplies, insurance, and other support to the member SCAs. • Control, supervise, audit, and report the network activity of the members according to the accounting standards and regulations issued by BoA.

14.

A breakdown of the two CUs is given in the table below. Credit Union 1.

ASCU

2.

USCA “Jehona”

Total Loans $ 37,933,000

(31/12/07)

3,885,000 (31/12/07)

Borrowers 13,460

(31/12/07)

1,762

(31/12/07)

15. Most SCAs have a very small funding base. Most of them start business with around $250 of total member contributions and have a limit of $10 capital contribution per member. Traditionally the CUs have depended on donor money, and until now external grants and loans from donors have been their major funding sources. The borrowings take the form of foreign currency from international donors or creditors. Consequently, the CUs have limited local currency funds that can be used for lending. Although they are permitted to extend loans in foreign currency to member SCAs, they choose not to, so that borrowers do not assume the foreign exchange rate risks. Therefore, SCAs’ loans to their members are denominated in local currency. The CUs try to run the foreign exchange risk within the limits set by the regulations. The CUs prefer foreign debt because of its low interest rate and longer term advantage. For example, ASCU has recently obtained a 10-year loan at 4.25 percent 12

denominated in Euro, while shorter term borrowing in local currency carries an interest rate of about 12.5 percent. Currently, the CUs hedge against devaluation risk by using back-toback lending, wherein the CU takes a foreign currency loan and deposits it in a local bank as cash collateral and borrows a loan denominated in local currency, for which the local bank withholds an amount of about 5 percent. However, the back-to-back loan mechanism exposes the CU to the local bank’s credit risk and does not protect the CU from convertibility and transfer risks. Once the CU repays the local currency loan, the domestic bank releases the foreign currency deposit and the accumulated interest, which is then used to repay the original lender’s foreign currency loan. Although the CUs can use forward contracts, futures, swaps, and options as tools to hedge their foreign exchange risks, the costs of these tools together with their limited availability makes back-to-back loans the most reasonable mechanism. 16. The CU refinances the SCAs at a rate of 11 percent per annum, and the annual interest rate offered by the SCAs to their members is 15 percent. The spread of 4 percent is broken down as: (i) 2 percent to be provisioned by law, (ii) 1.5 percent to cover the operating expenses of the SCA, and (iii) 0.5 percent to provide the expected profit margin to be used for the SCA’s future development. In contrast, the interest rates charged by other MFIs to their borrowers are around 24-27 percent, and the government-owned Mountain Areas Finance Fund (MAFF), is charging 15-19 percent. Commercial bank interest rates in Albania are around 13 percent. 17. Compared with the other market players, the interest rates of the SCAs are on the low side. The low funding base, including low capital and low deposits, stem from the historically unusual choice of basing the SCAs on credit lines rather than member contributions and deposits, which is far more common in CUs. The slow capital buildup is due to the relatively low interest rates that SCAs charge their borrowers, limiting profits, and the slow buildup in deposits is due to the correspondingly low interest rates on deposits. As a result, outreach and access remains limited. Because of this history, most members are net borrowers and therefore do not want to vote in general assembly to increase interest rates. While the effort of both the CUs and the SCAs to keep their lending rates low has had positive effects on the borrowers able to access them, it has slowed the pace of institutional capital development and achieving economies of scale. 18. Some figures related to the SCAs are given below for information and comparison purposes. 7 CU (SCA) number

Members per CU Total Loans (SCA) ($) Worldwide 42,705 3,600 612.2 m Moldova 504 191 648,000 Romania 11 4,442 13.6 m Poland 76 18,421 1.1 b Albania 127 213 18.3 m Source: WOCCU as of December 31, 2005; Albania as of June 30, 2007.

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Loans per CU (SCA) ($) 14,300 1,285 1.2 m 14 m 143,000

Average loan size per member ($) 4 7 278 766 676

In most countries, what Albania refers to as SCAs are referred to as credit unions. Hence, the table refers to the number, etc., of “CU (SCA)” to indicate the comparisons of equivalent organizational levels.

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C.2

Non-Governmental Organizations and Non-bank Finance Institutions

19. Besides the SCAs and their CUs, five other institutions started microcredit activities during the mid to late 1990s: • • • • •

Besa Foundation; NGO, non-profit, tax exempt. For Future Foundation (FFF); NGO, non-profit, tax exempt. World Vision; NGO, non-profit, tax exempt. Opportunity Albania; NBFI, subject to tax. Mountain Areas Finance Fund (MAFF); Government owned, NBFI and NGO, tax exempt.

20. Besa was recently selected by Forbes magazine as one of the world’s top 50 MFIs. There is also one bank (ProCredit Bank) focused almost exclusively on microfinance, while two banks reported having small microfinance portfolios or wholesale lending to MFIs, and some other banks reported that they were considering getting involved as well. However, the microfinance market is not clearly segmented from the rest of the financial market, as there is no specific, shared definition of a microcredit. Therefore, some of these institutions, which consider themselves MFIs, may extend loans up to a few hundred thousand dollars, and many of the banks’ “microcredits” might more appropriately be classified as SME loans. 21. Per the Banking Law of 2006, as well as a BoA regulation of 2003 (“On the Granting of License to Non-Bank Financial Subjects”), no entity (other than banks and SCAs, which are regulated separately) is allowed to lend unless it is registered as a commercial company under the Law on Commercial Companies and is licensed by BoA as a NBFI. Hence, all NGOs currently engaged in microfinance must apply for an NFBI license and register as a company. At the same time, for licensed NBFIs, this regulation foresees a wide variety of potential financial activities such as lending, money transfers, foreign currency transactions, leasing, foreign exchange, safe facilities, and issue of guarantees. NBFIs, however, are not allowed to collect deposits. 22. A brief breakdown of this segment of the market is given in the table below. The number of borrowers from the NGOs and the NBFIs as of June 2007 is approximately 56,000, which corresponds to 1.6 percent of the population. Name

Type Of Institution

1.

Pro Credit

Bank

2.

Besa

Non-Profit NGO

3.

NBFI

4.

Opportunity Albania MAFF

5.

FFF

NBFI & Non-Profit NGO Non-Profit NGO

6.

World Vision

Non-Profit NGO

Total Loans $ 129,614,771 (31/03/07)

37,000,000

(31/12/07)

25,492,087

(31/12/06)

14,509,511

(31/12/06)

-

( n/a )

1,671,326

(30/06/07)

14

Number of Borrowers 29,100

(31/03/07)

9,162

(31/12/07)

10,338

(31/12/06)

5,343

(31/12/06)

229

(30/06/07)

1,776

(30/06/07)

Source: The Mix Market for 1,3,4,5,6; Besa for 2

23. International donors play an active role in developing and funding these institutions. Although two commercial banks are wholesale-lending (to one NGO and one NBFI) against assignment of receivables, alternative domestic sources of funding for the microcredit sector are not sufficiently developed to fill the gap should donor support be reduced. D. Legal, Regulatory and Supervisory Framework of Microfinance D.1

International Practice

24. Financial sector regulation aims to ensure the soundness of financial intermediaries in order to prevent financial system instability and losses to depositors. Supervision is the process of ensuring compliance with those rules, encouraging the soundness and efficiency of the financial system, and enhancing the market disciplines on banks that are naturally present in the financial sector. The most carefully drafted regulations will be useless, or even harmful, if they cannot be enforced by effective supervision. 25. Regulation is "prudential" when it is aimed specifically at protecting the financial system as a whole as well as protecting the safety of small deposits in individual institutions. Prudential regulation is needed only when there are depositors to protect (especially retail deposits of the general public) or when a financial institution is large enough that its failure would endanger the soundness of the financial system, so it is not appropriate for small credit-only MFIs that fund themselves from donors or commercial loans. Prudential supervision is expensive and supervisory authorities have limited resources. There is a tradeoff between the number of institutions licensed and the likely effectiveness of the supervision they will receive. The most common tool for drawing the balance is minimum capital. Some community-based deposit-taking organizations are so small or remote that effective prudential supervision would be too expensive. At the same time, allowing such institutions to take deposits, up to a limit, may be reasonable, as the next best alternative to save (e.g., holding cash at home, buying livestock or gold) is often less safe. Most regulators facing the question have decided to let these small intermediaries operate without prudential regulation and supervision, as long as their assets and number of clients remain below defined size limits. 26. "Non-prudential" rules encompass regulations about the institution’s business operations, and as such do not have the ultimate aim of protecting the financial system. Nonprudential regulations often apply to non-financial businesses as well as financial institutions (e.g., anti-fraud regulations, fit-and-proper tests for owners and managers), although some are primarily tailored to financial institutions (e.g., truth-in-lending regulations that require complete, accurate disclosure of lending terms in easy-to-understand language). These rules tend to be easier to administer because the authorities do not have to take responsibility for the financial soundness of the organization. Therefore the authorities usually avoid using burdensome prudential regulation for non-prudential purposes—that is, purposes other than protecting depositors’ safety and the soundness of the financial sector as a whole. 27. Below, we analyze the current legislation and regulations applicable in Albania. Tables comparing the recommended regulatory framework for SCAs and MFIs to what is being applied for commercial banks in Albania are given in Appendix I and Appendix II. D.2 Legislation in Albania 15

28. The legal, regulatory, and supervisory framework in Albania is based on the following: • • • • • • •

Law on “Credit Savings Associations and Their Unions” (#8782), Law on “Banks in the Republic of Albania” (#9662), BoA Regulation “On the Granting of Licenses to Non-Bank Financial Subjects”, BoA Regulation “On Licensing of SCAs and Their Unions”, BoA Rulebook “For the Licensing of SCAs and Their Unions”, BoA Regulation “On the Supervision of SCAs and Their Unions”, BoA Regulation “On Supervision Norms of Non-Bank Financial Entities”.

29. BoA has also developed a supervisory methodology and drafted inspection and accounting manuals. The legal, regulatory, and supervisory framework, as applied to SCAs, NGOs, and NBFIs, is further discussed below. D.3

Prudential Regulations for SCAs and their Unions

Current Framework 30. SCAs are (i) permitted to render microcredit services only to their members, (ii) managed by their members voluntarily, (iii) not allowed to act for profit or to distribute dividends, and (iv) authorized to independently set their own rates of interest, commissions, and fees. Members are collectively responsible for paying the liabilities which cannot be paid from funds from liquidation, up to an amount equal to the value of their contributions. 31. Membership is limited to people with a common work relation, profession, association, neighborhood, community, or geographic area. An SCA must include at least seven persons, each with equal rights. Members who play a managerial or administrative role perform their duties free of charge. One or more SCA may establish a CU. SCAs and CUs are licensed, regulated, and supervised by BoA. SCAs are exempt from profit tax (currently 10 percent). 32. Prudential requirements for SCAs are set out in the Regulation on Supervision of SCAs and Their Unions. Key features of these include the following: • Classification requirements of loans are stricter than what is applied to commercial banks.(Art.4) • Loan loss provisioning ratios are higher than what is applied to banks.(Art.5) • Two percent of every loan provided by the CU to the member SCA is subject to a reserve fund deduction. (Art.4.8) • The ratio of standard loans to total loans must not be less than 90 percent. (Art.6) • Unsecured lending limits vary over time: (i) for each loan granted during the first two years of lending activity, the portion not guaranteed by deposit blocking must not be more than 100 percent of the SCA capital; (ii) for each loan granted during the third year, the portion not guaranteed by deposit blocking must not be more than 50 percent of the SCA capital; and (iii) for each granted loan after the third year, the portion not guaranteed by deposit blocking must not be more than either 20 percent 16

• • • • •

• • • • •

33.

of the SCA capital or the maximum nominal amount allowed during the third year of the lending activity. (Art.9.1, 9.2, 9.3) Capital/Total Loans must not be less than 5 percent during the first two years of the loan granting activity and 8 percent after the first two years.(Art.7.1) Capital/Net Fixed Assets must not be less than 100 percent. (Art.7.2) Capital/Bad Loans (not cash collateralized) must be more than 100 percent. (Art.7.3) (Cash + Current Accounts + 1 month Time Placements)/(Total Deposits of maximum 6 months maturity) must not be less than 10 percent.(Art.8.1) Loans may be granted with over 3 years maturity and an amount not more than: ƒ 100 percent of the capital, after the fixed assets have been subtracted; or ƒ 10 percent of the total deposits; or ƒ 100 percent of the liabilities with maturity over 3 years (Art. 8.2). No loan may be extended with maturity of more than 5 years. (Art. 8.3) The amount of each loan must not be more than 15 percent of total assets at the time it was granted (Art. 9.4). Routine reporting is done every six months from the member SCAs to the CUs, and from the CUs to BoA. (Art.11) SCAs are required to have in place written manuals and policies that explicitly identify the controls instituted at the various levels of the organization with regard to the analysis, approval, monitoring, and collection of these loans.(Art.13.1) Only the CUs are allowed to maintain a foreign currency open position, within a maximal ratio not more than 30 percent of the total net open position for all currencies to the CU capital, and a maximal ratio not more than 20 percent of the net open position for each currency to the CU capital. (Art.10.2) The deposits of the SCA members are not covered by an insurance scheme.

34. Per the internal rules of the ASCU, no customer of a member SCA is allowed to borrow more than ALL 500,000 (approximately $6,000) unless the loan is secured by a mortgage. 35. Albania has opted for delegated supervision of the SCAs, where the CUs are responsible for on-site and off-site supervision of their SCAs. The supervising bodies and the supervision process of the SCAs consist of the Supervision Committee of the SCAs, the Credit Officer in the Regional Office of the CU, the Credit and Financial Department of the CU, the Internal Audit (on-site inspection) of the SCAs, and the CU’s Supervisory Committee, as well as supervision of the CU and selected SCAs by BoA and external audit of the CU. Reporting from the SCAs to the CUs is similar to the reporting made by the CUs to BoA. The CUs consider their supervisory capacity to be adequate. 36. BoA once a year performs on-site supervision of the CUs and about 10 percent of the SCAs, usually the larger ones. Every six months, the CUs provide BoA with the financial statements of each SCA and six additional reports (loan classification and provisions, loan portfolio quality, liquidity, capital adequacy, risk diversification, and transactions in foreign currency). On a quarterly basis, the CUs submit to BoA their consolidated financial statements and detailed data on SCAs which are in breach of regulations. The on-site supervision reports of the CUs are not forwarded to BoA, but they are referred to by the staff of BoA during on-site supervision of the CUs. BoA is of the opinion that the quality of supervisions of ASCU is better than that of USCA Jehona. 17

Assessment 37. SCAs’ growth has been constrained by their low funding base in terms of both capital and deposits. The regulatory framework should enable a healthy growth of deposits, capital and the loan portfolios of the SCAs. Strict restrictions and limitations on loan loss provisioning and non-secured lending limit such growth. Capitalization requirements for SCAs are low enough to commence activity “from zero”. However, the provisioning requirements for loans are higher than the ones set for the banks (2 percent for standard loans, 30 percent for substandard loans and 75 percent for doubtful loans in SCAs, as against to 1 percent, 20 percent and 50 percent respectively in banks). 38. Adopting direct supervision by BoA on the SCAs is almost impossible, taking into consideration the number of the SCAs and BoA’s capacity constraints with respect to staff size the supervision department. The delegated supervision arrangement allows BoA to supervise the SCAs with its limited staff. Moreover, the CUs are well placed to oversee the activities of their member SCAs since the CUs provide a range of services including training, control, credit, and assistance with reporting. This arrangement is reasonable, given the small size of the SCAs and their deposits. Alternative methods of saving in the remote locations of SCAs will be riskier than an SCA that is overseen by the CU but not supervised directly by BoA, and it would be prohibitively expensive for BoA to supervise all SCAs. On the other hand, consolidation of some SCAs (see below) may be warranted, which would allow BoA to directly supervise a greater share of them. 39. At the same time, SCAs being monitored by the CUs, which are owned by the SCAs, poses some conflict of interest and therefore weakens the power of supervision. Because of the lack of independence of the CUs, which are under control of the boards of directors of the SCAs, delegated supervision may not always be a reliable mechanism. Therefore, BoA should ensure minimum standards of performance by the delegated supervisor and should be strict in periodic testing of the reliability of the CUs’ monitoring, inspection, and reporting activities. BoA should always be aware that the ultimate responsibility of the functioning of the delegated supervisory system rests with BoA. 40. The reporting process from the SCAs to the CUs and from the CUs to BoA is largely satisfactory and contains most of the necessary information needed for off-site evaluation. However, it would be strengthened if a copy of the CU’s on-site supervision reports of the SCAs are also sent to BoA since sanctions arising from non-compliance of the SCAs with the prudential norms and guidelines issued by BoA are to be implemented by BoA. Recommendations 41. It is recommended that Law No. 8782 on “Credit and Savings Associations”, “Regulation on Supervision of Savings and Credit Associations and Their Unions”, and “Regulation on Licensing Of Savings and Loan Associations and Their Unions” are reviewed and the following amendments are considered: • To foster growth of capital and deposits of the SCAs and maintain high loan repayment rates, BoA should (i) permit deduction of the cash collateralized part of loans from the “gross loan portfolio” when calculating the “ratio of capital to gross loan portfolio” (Art.7.1), (ii) redefine the “ratio of each loan granted, except for the 18

portion not guaranteed by deposit blocking, to capital” from 100, 50, and 20 percent during the first two years, the third year, and after the third year of activity respectfully, to 100, 80, 60, 40, and 20 percent for the first, second, third, fourth, and fifth years of activity respectfully, to enable smoother phasing-in (Art.9.1, 9.2, 9.3), (iii) allow preferential treatment for loans collateralized by mortgage or pledge of other acceptable material assets in the above mentioned articles, (iv) limit members’ rights to withdraw share capital if the SCA’s capital adequacy ratio falls below what is permitted by the regulation, and (v) redefine the “maturity” of loans as the “average maturity” where repayments will speed up. • The SCAs and their CUs should be able to invest funds that are not loaned to members. Their Board of Directors should be authorized to invest such funds in some securities, obligations, or other debt instruments issued or guaranteed by the Government. • The SCAs and/or their CUs should be authorized to collect, receive, and disburse monies in connection with the provision of money orders, money transfers, foreign exchange, and travelers’ checks. This would allow the SCAs and their CUs to capture some of the substantial flow of remittances to Albania, thus increasing their deposits and, therefore, funding base for lending. Although the SCAs are currently not allowed to carry a foreign exchange position, this restriction need not be lifted entirely. They can avoid carrying foreign currency positions while accepting foreign currency deposits from members if they are required to place such funds back-to-back with their CUs within a defined (short) period of time (e.g., two days). This should be clarified in the regulations. However, proper operational and accounting infrastructure should be developed before allowing this service. • The SCAs should be authorized to render current account services as well as micro leasing, which can be used to finance machinery, equipment, and sometimes farming land. • Funding of SCAs and the CUs tends to be unpredictable and therefore liquidity standards for the SCAs should be set at higher levels. Current account + one month time placements with banks should not be less than 20 percent of total deposits with 6 months maturity or less. • SCAs in Albania are an important source of agricultural loans, including for vineyards, green houses, and storage facilities, which may require repayment terms longer than the current maximum of 5 years allowed by the regulations. BoA should consider increasing the maximum loan period to 7 years. 42. Establishment of new SCAs should be permitted only when BoA is satisfied that the CU is capable to undertake effective supervision of the SCA in concern. BoA should also require that the CUs provide a copy of their on-site supervision reports on SCAs. On the other hand, the importance of direct supervision and intervention by BoA will surface at times of problem situations. Therefore, BoA is advised to prepare a contingency plan to be acted on at times of distress when intervention is needed. 43. The capital base of SCAs remains low, even after 15 years. As noted above, this is due to the historical decision to finance them primarily from credit lines from the start, as 19

well as their low lending and deposit rates. Minimum capital requirements should be considered to encourage further consolidation of SCAs (on average, each SCA now covers more than 5 villages, and there is no reason that this could not increase further). This would both strengthen the SCAs and simplify their supervision. 44. BoA should also consider ASCU’s request to report on a consolidated basis (SCAs + ASCU) in addition to its current individual reporting. This would improve the image of ASCU and provide more information to potential lenders and donors. 45. BoA should closely monitor the supervision activities of USCA Jehona in order to improve its level of performance and risk analysis. 46. BoA should to take the necessary steps to improve the capacity of the Supervision Department with respect to quantity and quality of personnel employed. This is very important to enable BoA to supervise the CUs and SCAs better, taking into consideration the increased volume of work and new products to be introduced by the CUs and SCAs. 47. A deposit insurance scheme should be considered for the deposits of SCA members. The premium of such insurance should be absorbed by the concerned SCAs. D.4

Prudential Regulations for NGOs and NBFIs

Current Framework 48. As noted previously, with the enacting of the Banking Law in 2006, no institution (other than banks, CUs, and SCAs) is allowed to make loans if not licensed as a NBFI by BoA. 8 MAFF and Opportunity Albania have obtained NBFI licenses under this law, while Besa Foundation and World Vision, under a transition period by BoA, are now in the process of application. FFF’s future is more tenuous. Previously, NGOs which were engaged in microfinance were licensed per the Civil Code. They were not allowed to accept deposits and were not regulated or supervised. These NGOs were only requested to report to BoA quarterly. 49. Since all microfinance NGOs are now required to receive an NBFI license from BoA, they must meet the minimum NBFI capital requirement of approximately $1.2 million (20 percent of what is required for banks). 9 Although they are not allowed to collect deposits, NBFIs are prudentially regulated and supervised by BoA. Key regulatory guidelines include: • Capital/Total Assets ratio must not be less than 10 percent (whereas Capital / Risk Weighted Assets for banks should not be lower than 8 percent). • Capital/Net Tangible and Intangible Fixed Assets should not be lower than 100 percent (Art.4.2). • Capital/Total Problem Loans must not be lower than 100 percent (Art.4.3). 8 9

This law rendered more formal the same restriction from the 2003 regulation “On the Granting of License to Non-Bank Financial Subjects”. Article 2 of the “Regulation on the Granting of License to Non-Bank Financial Subjects” allows for lower capital (as low as $120,000) for NBFIs that do not wish to engage in lending or leasing – e.g., NBFIs wishing to mediate in the conduct of monetary transactions or to act as financial agent or advisor.

20

• Total Problem Loans/Total Loans must not exceed 8 percent (Art.5.1). • Actual Loan Repayment/Loan Repayment Schedule in Loan Agreement must not be below 90 percent (Art.5.2). • Interest Earning Assets/Interest Bearing Liabilities must not be below 100 percent (Art.5.4). • Loans granted to a beneficiary must not exceed 10 percent of total loans (Art.6.2). • Any investments in securities, except for the T-bills of the Albanian government, shall not exceed 5 percent of the capital (Art.6.3). • Total investment in securities, except for the T-bills, shall not exceed 40 percent of capital (Art.6.4). • Assets with one month remaining maturity/Liabilities with one-month remaining maturity shall not be lower than 100 percent (Art.7.1). • Assets with three months remaining maturity/Liabilities with three months remaining maturity shall not be lower than 100 percent (Art.7.2). • 80 percent of loans maturing after two years shall be funded from sources maturing after two years (Art.7.3). • Reporting to BoA is made on quarterly basis, mainly on their lending activities (Art.8.1). • NBFIs are subject to the Supervisory Council’s Decision No.102 “On the minimum technical and security terms of work premises in the entities being licensed by the Bank of Albania”, which includes conditions like implementation of electronic security systems within and outside of the premises , which is composed of closed circuit television and video recording, sensor security and signaling systems. 50. The supervision of the microfinance NGOs has been limited to the analysis of the reports of the three NGOs with formal status with BoA (either through the 2003 regulation or the exemptions issued by BoA). Most of the capital of these institutions consists of the base capital received from donors. All licensed NBFIs are subject to on-site and off-site BoA supervision. In practice, this has meant supervision of MAFF and Opportunity Albania as the only two licensed microfinance NBFIs. Assessment 51. While NGOs are now required to obtain an NBFI license to engage in microfinance activities, there is no definition of “microfinance”, “microcredit”, or “microfinance institution” in the current legal and regulatory framework. Hence, an NGO that wishes to operate as an MFI currently has no choice but to meet the same requirements as any other commercial NBFI, regardless of the nature or scope of its business. 52. The lack of legislation or regulations defining microfinance has therefore blurred the distinction between existing NBFIs and MFIs which are in the process of converting into NBFIs. Moreover, some so-called “MFIs” make loans of $100,000 or more, which are not “micro” in any conventional sense of the term. With no definition of a microcredit, these institutions have become active lenders to all segments of the market, particularly at the SME level. Therefore, in order to establish a sound regulatory and supervisory framework for microfinance in Albania, a common understanding and regulatory definition needs to be agreed.

21

53. The basis for definitions of the terms microfinance, microcredit, and/or MFI are typically: 10 • Defining a microcredit by a maximum loan size. For example, a microcredit might be defined as a loan no larger than X (e.g., $5,000). A common standard is to define a microcredit as a percentage of GDP/capita. • Defining a microfinance institution as a financial institution that deals mainly in microcredits. For example, an MFI might be defined as a financial institution whose loan portfolio must contain no loan above X (e.g., $10,000), with at least 50 percent of the loans no larger than, e.g., $5,000. Alternatively, regulations could state that the average loan size must not exceed, e.g., $7,000. • Alternatively, an MFI can be defined as a financial institution that services primarily “microenterprises” as defined in the law, the norm being to define a microenterprise by the number of employees. • Finally, an MFI could be defined by the poverty status of its clients. For example, an MFI could be defined as a financial institution of which at least 80 percent of its clients were poor as defined by the national poverty line. 54. In practice, defining an MFI according to the characteristics of its clientele (e.g., microenterprises or the poor, per the 3rd and 4th bullet points above) is impractical because of the information requirements to screen and verify the eligibility of clients. Therefore, the most common definitions of MFIs are based on a definition of microcredit (first bullet point) that is appropriate to the particular country, combined with limits on maximum loan size and/or average loan size (second bullet point). In practice, limiting the loan size should act as a proxy to reach the poor as an MFI’s main clientele. 55. Appendix III presents average loan sizes of selected MFIs around the world, including some from Albania. As this appendix shows, average loan per borrower in Albania is above the averages of comparators. However, Albania’s average loan size is well within the international standards suggested by the MIX Market: Loan size per Borrower as percent of GDP per Capita Low end (very poor) clients < 20% Broad end (poor) clients 21 – 150% Higher end (vulnerable non-poor) 151 – 2 50% Small business > 250% Note: In 2006, Albania’s GDP/capita = $5,700

Loan size if applied to Albania ($) 1,140 1,140 – 8,550 8,550 – 14,250 14,250

56. One striking aspect of the current prudential regulations is the high capital requirements for NBFIs. In other countries, non-deposit-taking MFIs typically have no minimum capital requirements or low requirements, usually not more than $100,000, and rarely more than $250,000. Minimum capital of $1.2 million is an unnecessarily steep barrier to entry. Minimum capital requirements of some comparable countries for non-deposit taking NBFIs are as follows:

10

Country

Institution Type

Azerbaijan

Non-banking Credit Organizations

Minimum Capital 0

CGAP/The World Bank Group: Microfinance Consensus Guidelines-Guiding Principles on Regulation and Supervision of Microfinance 2003.

22

Brazil Kazakhstan

Microcredit Companies Micro lending Organizations

Bosnia & Herzegovina

Microcredit Organization

Kyrgyzstan Nigeria

Microfinance Company Financing Companies

South Africa

Microlenders

Tajikistan Zambia

Microfinance Organization Non Deposit Taking MFI

36,000 5,500

0 230,000 155,000

0 10,000 7,500

Source: The Microfinance Gateway

57. The Supervision and Regulation Department of BoA has a total staff of 35, among which 21 are involved in on site supervision of banks, NBFIs, and exchange bureaus. BoA may be prepared to devote an unreasonably large share of its supervisory resources to supervising MFIs licensed as NBFIs. MFIs that are licensed as NBFIs, as noted previously, may not accept deposits. They are also a small part of the financial sector now and will continue to be small for the foreseeable future. As such, the failure of such an MFI jeopardizes only the capital of its owners. BoA’s concerns about supervising such MFIs (and about prudential regulation of MFIs in general) stem from the pyramid schemes of the 1990s, fearing that the failure of any financial institution could cause panics in other financial institutions. However, whether such “panic” would occur in an MFI licensed as an NBFI is questionable since no depositor’s money would be lost – it is not clear who would panic. The failure of MFIs that borrow from commercial banks could, theoretically, impact the health of the financial system. However, as long as commercial banks follow their own prudential requirements (including single borrower limits), there is no reason that default on a loan to an MFI would be any more consequential than default by another borrower. Recommendations 58. Albania needs a formal definition of microfinance around which to structure the legal, regulatory, and supervisory framework. The most straightforward way to do this appears to be for BoA to issue a regulation under Article 126 of the Law No. 9662 on Banks in the Republic of Albania, which also covers NBFIs engaged in banking activities, defining an MFI as a specialized type of NBFI. Such a regulation could be drafted to allow licensed MFIs to engage in banking activities determined by BoA, based on the MFI’s request and capacity, as well as demand for particular services. 59. Per the discussion above, the MFI regulation should define a microcredit either (i) as a percentage of GDP/capita (e.g., based on the MIX Market’s definitions, a standard of 150 percent of GDP/capita could be used, and with Albania’s current GDP/capita of $5,700, this would translate to a current definition of $8,550, which would change yearly as GDP/capita changes); or (ii) as a fixed amount (e.g., $10,000) which can be changed “from time to time” upon the issuance of new guidelines by BoA. 60. Following the establishment of the definition of a microcredit, an MFI should be defined, per the discussion above, as an NBFI (i) whose average loan size is no larger than the microcredit size, and (ii) with at least a certain percentage (e.g., 80 percent) of its loans no larger than the defined microcredit size. 61. NBFIs that conform to these definitions of microcredit and MFI would be eligible for an MFI license. MFIs should also be registered as commercial companies. All existing NGOs 23

and NBFIs currently focused on microfinance, including Besa, World Vision and FFF, should be required to obtain an MFI license and register as a commercial company to continue lending. MAFF, already licensed by BoA as a NBFI, should be required to register itself as a commercial company. BoA (Legal Department) should prepare a manual or guidelines explaining the principles of transforming from an NGO into a commercial company by making attributes and references to the concerned legislation where necessary, to brief and clarify the doubts and reservations of the concerned NGOs. 62. BoA would also need to establish appropriately light prudential regulations (e.g., recommended minimum capital of about $100,000 to $250,000) and supervision (e.g., annual audits and reports). The regulatory focus on these institutions should be non-prudential, e.g., truth in lending and other consumer protection (see more on non-prudential regulations below). As noted above, the primary purposes of prudential regulation and supervision are to protect depositors and the soundness of the financial system. In the case of small non-deposittaking MFIs, these criteria do not apply. 63. Given the history of Albania’s pyramid schemes, however, it is understandable that BoA may be reluctant to apply no prudential regulations and supervision. In this case, BoA may wish to consider some relatively light prudential regulations, based on the following principles and recommendations: 11 ƒ ƒ ƒ ƒ ƒ

ƒ ƒ ƒ ƒ ƒ ƒ

11

Minimum capital of $100,000 to $250,000. In addition to being a prudential requirement, this would also serve to limit the number of institutions to be supervised and to screen potential investors. BoA should not require prudential regulations related to keeping cash collateral and similar obligatory deposits in low-risk securities or in an account with a licensed bank. Borrowing from non-commercial sources, including donors or sponsors should not be subject to prudential regulation. There should be no unsecured lending limits, as most microcredits will not be based on collateral, but rather on client reputation or group guarantees. Loan-loss provisioning requirements may be stricter than for banks because the shorter term of most microcredits will mean that overdue payments indicate a higher probability of losses; however, provisioning should not be so strict that it unreasonably limits the MFI’s ability to leverage its equity to borrow money. Reporting requirements should be simpler for microfinance institutions than for normal commercial bank operations. Fit and proper tests should be applied to keep persons with bad records from owning or controlling MFIs. Minimum capital to assets ratio could be set at 8 percent. Problem loans to total loans need not be set as a prudential ratio since the MFIs would already be required to comply with CAR. Fixed assets 12 months after receiving a license should not exceed 20 percent of total assets. The ratio of loans maturing after 2 years to borrowings maturing after 2 years should not exceed 80 percent.

Microfinance Consensus Guidelines – Guiding Principles on Regulation and Supervision of Microfinance, 2003. CGAP/The World Bank Group.

24

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MFIs should be subject to foreign exchange position limits, similar to what is applied to commercial banks. There should be no limitations for loan repayments to loan repayment schedules. Articles of association of MFIs should include provisions on (i) classes, transfers, transferability, and pre-emptive rights of shares; (ii) prohibition of reduction of capital; (iii) capital increases, subject to BoA approval; (iv) meetings, notices, proceedings, quorum, voting, conflicts of interest, duties and responsibilities of directors, powers of putting the company under obligation, auditors, etc.; and (v) board composition, size, and organizational structure.

64. BoA should always ensure that the staff size, knowledge, and experience, as well as technology mobilized for on-site inspections and off-site analysis are not undermined by the number of supervised institutions and heavy workload. BoA should also provide training, competitive salaries and professional development opportunities to staff specialized in microfinance. It is recommended that BoA establish a separate unit for supervision of the CUs, SCAs, and MFIs. In light of the low risk of non-deposit-taking MFIs as discussed above, BoA should keep its prudential requirements and supervision reasonably light in order not to discourage development of the sector and to focus its limited supervision resources where they are needed most. D.5

Non-Prudential Regulations for SCAs, CUs and NBFIs

65. The following should be considered as part of non-prudential regulations for all MFIs, SCAs, and CUs: •

•

•

•

Avoiding conflict of interest: internal controls should be enforced where no one individual is engaged in approving a loan, disbursing the loan, and collecting repayments; conflicts of interest of the directors and management should be prevented. Loan documentation: given the nature of microfinance loan sizes and customers, it would be excessive or impossible to require SCAs and MFIs to generate the same loan documentation as commercial banks. E.g., the formal documentation required for microcredits should be minimal and focus on information that attests to the client’s identity and place of residence. Consumer protection: rules should be applied to enable truth in lending and prevent abusive lending and collection practices. Although interest rates should be set freely, microcredit borrowers need to be informed in a straightforward manner of the various elements of the loan contract, including how the interest rate is calculated and whether there are any other charges and any other aspects that would reasonably enter in to the decision of the client. Loan contracts should therefore be accompanied by explanatory notes that specify, in simple terms, the rights and obligations of the parties. The regulatory framework should not predefine what type of collateral financial institutions should use in their microcredit transactions. An example of a self-regulation is given in Appendix IV: the Pro-Consumer Pledge, adopted in late 2004 by ACCIÓN International and Micro Finance Network member institutions. The pledge principles address the main categories of consumer protection. Internal control and audit: procedures aimed at preventing fraud, financial crimes and money laundering should be required.

25

• •

Credit information: MFIs should be required to submit and receive information to and from credit bureaus about their borrowers. Physical security of the premises need not be as strict as what is required of the banks.

Enforcement of collateral obtained for loans extended is easier for commercial banks than for SCAs, NBFIs, or NGOs since only bank loan contracts are recognized as direct “executive title” which facilitates foreclosure. Therefore amendments should be made in Article 510/d of the Code of Civil Procedure, to enable SCA, NBFI, and MFI loan contracts to be recognized as direct executive title as well. Moreover, officers of MFIs noted that the country’s bankruptcy law is not efficient and the judicial system does not provide confidence that it is impartial with respect to bankruptcy resolutions. Therefore, improving the enforcement of rights of credit institutions for loan collection and liquidation of collateral should be a priority to ensure prompt and proper action is taken against defaulting borrowers.

66.

67. The microfinance practitioners also expressed their concern about the inefficiencies of the public vehicle registries. Loans disbursed against pledge of moveable property like vehicles and machinery are registered with the Registry Of Securities Charges. However this registration is not enforced, since sale and/or transfer and delivery of such properties to third parties are not required to be checked and cleared by the Registrar, nor are there any sanctions applied for their sale and/or transfer. Amendments in the legislation should be made to protect the rights of the creditors disbursing loans against pledge of all types of moveable property and apply serious sanctions for breach of rules. 68. BoA should consider creating a working group comprised of representatives of MFIs to develop the necessary changes to the legislation in order to solve problems related to executive title, collateral registration, pledge issues, and foreclosures. 69. A credit bureau was recently established within BoA. For the time being banks are the only participants. BoA plans to include the NBFIs and the SCAs into this system starting in July 2008, which will be an important step in integrating MFIs into the financial sector and allowing their clients to build their credit histories. BoA should continue on its current plan to include MFIs, NBFIs, and SCAs in the credit bureau. D.6 Taxation Current Framework 70. CUs and SCAs are exempt from profit taxes. NGOs engaged in microfinance were also exempted from profit taxes. However, NBFIs by law must register as commercial companies, theoretically making them subject to taxation (though the Ministry of Finance [MOF] and BoA agreed that this needs further study). Commercial banks, regardless of the degree to which they are involved in microfinance, are subject to profit tax, which is 10 percent of profits. 71. As of January 2008, MAFF and Opportunity Albania are the only institutions engaged in microfinance licensed by BoA as NBFIs. However, MAFF is also still registered as a NGO because its NBFI license was issued some time ago per the previous legislation. MAFF has, therefore, continued to enjoy an exemption from profit taxes, but it is not clear if it will continue to be tax exempt or not. Besa and World Vision, which were also previously 26

registered as NGOs as per the Civil Code, are in the process of NBFI license applications. Besa is requesting to maintain its tax-exempt status, while World Vision is not. Assessment 72. There appears to be a consensus in BoA and MOF that MFIs should not be taxed due to their social objectives. Moreover, there is clearly no support to lift the SCAs’ exemption. However, this will leave commercial banks focused on microfinance (e.g., ProCredit Bank) taxed and, therefore, treated unequally. Opportunity Albania also wishes to obtain a banking license and focus exclusively on the microfinance market. Given the infeasibility of taxing the SCAs and not taxing commercial banks, there will inevitably be inconsistency across institutions in taxing microfinance, regardless of the decision on taxing NBFIs engaged in microfinance. Alternatives to level the playing field somewhat in this regard include (i) allowing banks to create wholly owned subsidiaries engaged in microfinance that are tax exempt, and (ii) allowing banks to deduct interest revenue earned from microcredits (as defined in the MFI regulation proposed above) from taxable income. 73. Tax exemption enables CUs and SCAs to build up capital through retained earnings. Eliminating their tax exemption would either reduce their capital or require that CUs replace the taxed earnings with other means of capitalization to maintain the same capital reserves. Moreover, their tax-exempt status is consistent with the conditions in the Law for SCAs and their Unions: “not-for-profit”, “no dividend distribution”, “retain all earnings in the business”, “members performing functions voluntarily free of charge”, and “members are collectively responsible for paying the liabilities which cannot be paid from funds from liquidation, up to an amount equal to the value of their contributions.” 74. The same logic largely applies to MFIs. If microfinance is considered to be a driving force of development, particularly in rural areas, and hte government’s main goal is to increase outreach, which is still limited, then establishment of sustainable, market-oriented MFIs and increasing their funding capacity should be encouraged, including tax incentives. At the same time, tax incentives should not be a crutch that allows MFIs to operate unsustainably or keep interest rates too low to build up its capital and expand outreach. Recommendations 75. The SCAs and the CUs should continue to be exempt from profit taxes. Comparative analysis of tax exemption status on CUs across countries and regions is given in Appendix V. 76. In order to encourage local banks and other financial institutions to fund the CUs and MFIs, interest income earned by domestic creditors from their loans to CUs and MFIs, as well as from their own microcredits, should be deducted from the corporate income tax base of the lender. 77. MFIs licensed under the MFI regulation to be developed by BoA should be exempt from profit taxes. However, to encourage investment of private, for-profit capital in MFIs, such MFIs should be allowed to pay dividends to their shareholders. A tax incentive should be provided on dividend income of domestic or international investors that provide capital to any microfinance entity (CU, SCA, MFI) for a transitional period of time, such as three years. In other words, all MFIs (whether profit-oriented or not-for-profit) should be exempt from

27

profit taxes, but shareholders should pay reduced taxes on dividends during a grace period and pay full taxes on dividends afterwards. 78. BoA should work with MOF’s Tax Department to determine the procedure to continue the tax exempt situation of the NGOs that would apply for an MFI license. This may take the form of a letter of authorization from the MOF, or an amendment in the law, which is said to take a month and a half to pass, which should jointly be initiated by BoA and the MoF. The tax issue should be resolved by the time the new MFI regulation comes into force. 79. In case profit tax exemption is not provided for the MFIs, it is recommended that allowances for loan losses of MFIs should be deductable expenses for tax purposes without any limitations as to the maximum amounts, since the MFIs should also be encouraged to provision more than what is required by the regulations. 80. Taxation of non-profit MFIs varies across countries. Examples are presented in Appendix VI. E.

Future Development Priorities for the SCAs and MFIs

81. Reducing poverty and promoting entrepreneurship should be the main goals of microfinance in Albania. The vision of microfinance in Albania should include the development of a sustainable, expanding, market-oriented sector, with privately owned SCAs and MFIs providing demand-driven services and operating under an enabling policy, legal, and regulatory framework that ensures the sector’s financial strength and ability to contribute to poverty reduction and economic growth. 82. The poor and their microenterprises need a diverse range of financial instruments to be able to build assets, generate employment, and manage risks. The efforts of the government, BoA, and MFIs, including CUs and SCAs, should focus on building sustainable, market-oriented financial institutions which (i) are integral parts of the financial sector, (ii) increase access to financial services, and (iii) operate in an appropriate regulatory and supervisory framework. 83. Microfinance by definition consists of financial services for the poor: specifically loans, savings, insurance, transfer services, and other financial products targeted at lowincome clients that do not otherwise have access to formal financial institutions. Microfinance clients in rural areas are usually small farmers. In urban areas, microfinance activities are more diverse and include shopkeepers, service providers, artisans, street vendors, etc. Microfinance clients also include the vulnerable non-poor. To reach its full potential, microfinance should be an integral part of the financial system, with commercial relationships with other financial institutions. 84. Thus far in Albania, the only microfinance services offered are loans and (in SCAs only) savings, and these serve less than 3 percent of the population. Hence, not only is there scope to significantly expand the outreach of MFIs’ existing services, there is also scope to increase the range of services to include insurance, cash transfer services, intermediating workers’ remittances, and providing guarantees. Therefore, in spite of the notable advances already made and the strength of some of Albania’s MFIs, the provision of financial services to the poorer households, especially small farmers and people living in remote areas, still significantly falls short of demand. 28

85. Implementation of the above recommendations on the legal, regulatory, and supervisory framework will create incentives for SCAs, their CUs, and MFIs to strengthen their operations and governance, operate more commercially, and build up their capital and expand their services. They will also encourage commercial banks to engage in commercial relationships with MFIs as well as extend microfinance services themselves. Professional and business contacts between banks, MFIs, SCAs, and CUs should be further encouraged to promote exchange of technologies, strategic mergers, and wholesale financing by banks. Banks should also be encouraged to partner with MFIs and SCAs where the latter originate loans and deposits but where the loan portfolios are financed and deposits are serviced by banks. This could be through banks establishing their own MFIs or it could rely on collaboration of institutions. BoA should also initiate and facilitate the support of the Association of Banks, MFIs, and CUs to conduct research in the area of strategic alliances. 86.

An action plan should be prepared to allow the CUs and MFIs to participate in the country’s payment system. The plan should stipulate the prerequisites with respect to capacities and volumes and permit membership only after full compliance.

87.

88. The efficiency of NBFIs, SCAs, and CUs should be increased in order to improve their cost structure, allowing them to work in areas with low population density and provide small loans. Therefore BoA should coordinate (i) providing them with technical assistance, and (ii) ensuring their access to adequate lending technologies, improved risk management systems, and loan rating and tracking systems.

To achieve this, BoA should discuss with MFIs, SCAs, and CUs if there would be demand for the establishment of a Microfinance Resource Center to provide information on the best international and internal practices, and information on funding sources. If there is sufficient demand, BoA should open a dialogue with donors for its establishment and funding. Such a body would be managed by an independent party and operate at the expense of a donor supported fund. Microfinance institutions could send their requests for specialized technical assistance and training there. Instructors (consultants, trainers, providers of management information systems) would be contracted both domestically and internationally. This center could create a group of qualified microfinance consultants and trainers to provide services to MFIs, NBFIs, and the SCAs (e.g., accounting, auditing, management, marketing), as well as training of loan officers, accountants, auditors, managers, and board members.

89.

Pilot projects should be promoted to introduce financial products oriented at agriculture (e.g., warehouse receipt financing, micro leasing, commodity loans) involving financial institutions, trading and producers’ cooperatives, equipment suppliers, and traders.

90.

91. The SCAs and the CUs need to improve their operational efficiency and effectiveness, track their activities accurately, increase transparency and trustworthiness, produce prompt and correct reporting, and substantially increase the number of new customers by employing appropriate information systems. Therefore, the CUs should select and invest in modern software and hardware. Although small SCAs may manage with manual ledgers or spreadsheets, bigger SCAs need some form of software to track financial transactions and create reports. The information technology should include proper hardware and equipment that would provide communication among staff, the SCAs, and the CU. This may be achieved either through on-line real-time systems or dial-up facilities depending on the 29

communication opportunities. The CU should assume the responsibility of implementing the right information technology for the SCA network, and start the process with defining the strategy and preparing the project and user needs. BoA should coordinate with donors and the CUs to improve the tools (personnel, know-how, technology) of the CUs used for monitoring the quality of SCA loan portfolios, the financial sustainability of their operations, and their client outreach. A donor-supported project should be implemented on information system enhancement for SCAs and CUs. 92.

The ASCU should soften their internal rule of not lending to any borrower more than ALL 500,000, unless securitized by a mortgage, to a higher but reasonable amount like ALL 1,000,000 (not to exceed the maximum to be set for the MFIs) for justified applications in strong SCAs, e.g., with total loans at risk ratio of 0.2 percent or less.

93.

94. ASCU expressed some desire to borrow from the World Bank and others to finance an expansion of their lending, reporting a need for EUR 10 million for 2008-2012. However, it also informed the mission that it has access to commercial sources, and the main advantage of a loan from the World Bank is the lower price. As noted above, ASCU’s SCAs have a low capital base and relatively low deposits (although deposits are increasing, particularly in the oldest SCAs, which have gradually built up trust in their communities). The request from ASCU to borrow from the World Bank is worth further exploration. However, such a credit line should be used only if it does not crowd out commercial sources that serve to integrate SCAs into the larger financial sector. Moreover, ASCU should be encouraged to increase its interest rates to build up its capital base and boost its deposits, and provision of credit lines should not provide a disincentive to make these hard choices. 95. To increase equity investment in MFIs in Albania, consideration could be given to setting up an autonomous and professionally managed Albanian Microfinance Investment Fund, with the contribution of banks, international finance organizations, government, pension funds, insurance companies, domestic, and foreign donors.

The growth of SCAs might be enhanced by a strategy for their merger. Mergers based on joint objectives and bounds can expand the geographical coverage and clientele base, facilitate the increase of cash flows and access to capital, and achieve economies of scale in view of reducing fixed costs. It is also an accepted mechanism to eliminate the relatively smaller, weaker and thus ineffective and inefficient SCAs. Therefore, BoA should develop a strategy for consolidating and strengthening the SCAs. It is advisable for BoA to establish a Task Force to work on SCAs and the CUs, comprising the staff of the Supervision Department of BoA and the senior management of the CUs with the following mandate: 96.

Identify SCAs, which are viable, potentially viable and unviable. In practice a number of SCAs may be weak, inefficient, and be a burden for BoA and the concerned CU regulating and supervising their operations. The legislation provides for license revocation from the SCAs by BoA. However, there may be problems when it comes to actual liquidation. Therefore a contingency plan should be developed by BoA considering all possible outcomes, including liquidation as well as merger of weaker SCAs with stronger SCAs. The proposals recommended by the Task Force should conform to the guidelines issued by BoA in this regard. a.

30

Recommend the various conditions, including the nature and extent of funds required to be infused in each SCA identified as potentially viable, the source thereof, changes in management where necessary and the time frame for achieving viability. In doing so, the task force may assign responsibility to different agencies for facilitating the turn-around.

b.

c.

Establish milestones for evaluation of progress made under the rehabilitation

plan. d.

Recommend the manner and time frame for exit of the unviable SCAs.

Recommend to BoA the management aspects of a SCA which is placed under the rehabilitation plan. e.

Coordinate with the universities and donors to provide training to the SCAs in areas of identified need. f.

g. Draft a manual of accounting principles for the SCAs and the CUs to enable accounting to be carried out in accordance with the Law on Accounting.

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APPENDIX I

Recommended Regulatory Applications for the SCAs and MFIs Compared to Commercial Banks

Institutional Form

LIGHTER REGULATIONS MFIs register as a commercial company; SCAs register as such.

Ownership

Liquidity Limits

Lower licensing requirements for MFIs and SCAs. Simpler for MFIs and SCAs. For MFIs small enough to encourage new entrants; large enough to ease life to supervisor. For SCAs, consider introducing minimum capital to encourage institutional capital build-up Lower for MFIs, since they don’t take deposits. The ratio for MFIs can be set higher than what is being applied to commercial banks. Small size of transactions for MFIs.

Limits on Interest Rates

To be freely set by all three. Should be able to cover high costs.

Licensing Loan Documentation

Minimum Capital

Capital Adequacy Lending Limit/Borrower

AS APPLIED TO COMMERCIAL BANKS

For and SCAs, transparent, fit & proper tests. All three to be licensed by BoA.

For SCAs members only, common bond.

Risk of capital shortage in SCAs in case of emergency. For MFIs, maximum amount defined by law. For SCAs should be tied to capital. Borrowings in short-term; seasonality of demand for SCAs.

Protect customers of all from abusive lending and collection practices. Transparent; fair for all.

Customer Protection Truth in Lending

Stricter for MFIs and SCAs due to shorter terms and volatile loan repayment experience and patterns. MFIs prohibited. SCAs only from members, other SCAs, Government.

Loan Loss Provisioning Deposit collection Reporting to BoA Commercial Borrowings Foreign Currency Position Capital/Fixed Assets

STRICTER REGULATIONS

Should be simpler for all. MFIs

SCAs should be limited. MFIs and CUs.

MFIs

32

No foreign currency position for SCAs. Minimum 100 percent.

LIGHTER REGULATIONS Deposit Insurance Unsecured Lending Limit

AS APPLIED TO COMMERCIAL BANKS SCAs

For MFIs and SCAs

33

STRICTER REGULATIONS

Total Problem Loans / Total Loans Profit Taxes

Interest Earning Assets / Interest Bearing Liabilities

Capital / Total Problem Loans

Capital / Total Assets Capital / Gross Loan Portfolio

Commercial Borrowings/Capital (maturity of 12 months or less)

Maximum 10%. Exempt.

-.-

-.5% during first 2 years; 8%, after. Maximum 100%. (except for loan portions not cash covered).

Maximum 10%. Should be exempt.

-.-

-.Cash pledged portion of the loans to be reduced from gross loans. Maximum 100%. (except for loan portions not cash covered).

Maximum 25%.

Maximum 75%.

-.-.-

Maximum 12%.

a. minimum 30%, b. minimum 75%, c. 100%, d. 1% on standard loans.

Overdue for; a. 31-90 days, b. 91-365 days, c. Over 365 days.

Recommendations Licensed by BoA. -.Free

-.-

a. minimum 30%, b. minimum 75%, c. 100%, d. 2-5% on standard loans.

Provisions

Capital / Deposits + Total Borrowings (from donors, int’l finance institutions for long term + commercial borrowings) Deposits +Total Borrowings /Total Assets

Overdue for; a. 31-90 days, b. 91-365 days, c. Over 365 days.

Applied Licensed by BoA. -.Free

SAVINGS AND CREDIT ASSOCIATIONS

Loan Classification

Licensing Minimum Capital Interest Rates

SUBJECT

Maximum 8%. Subject to tax.

Should be exempt.

-.-

-.Maximum 100%.

-.Maximum 100%. Minimum 100%.

Minimum 8%.

-.-

-.-

-.-

a. minimum 30%, b. minimum 75%, c. 100%. d. 1% on standard loans.

Overdue for; a. 31-90 days, b. 91-365 days, c. Over 365 days

Minimum 10%.

-.-

-.-

Overdue for; a.1-30 days, b.31-90 days, c. 91-180 days, d. Over 181 days. a. 5%, b. minimum 20%, c. minimum 50%, d. 100%, e.1% on standard loans. -.-

Recommendations Licensed by BoA. $100,000-250,000 Free

MICROFINANCE INSTITUTIONS Applied Licensed by BoA. $1,200,000 Free

Comparison of Recommended Regulatory Changes to What Is Being Applied For SCAs and MFIs

APPENDIX II

34

Credit Registry foreign currency Position Limits Conflict of Interests

-.-

Public level infrastructures (roads, bridges, transportation) Community level infrastructures (storage facilities, market centers, -.-.-.-

-.-

-.-

Redeemable Capital

Liquidity

Current Accounts+ Time Deposits with Banks/Total Deposits with 6 months of maturity or less =Minimum 10%.

for

Not to exceed capital.

only

Investments in Fixed Assets

deposits

Loans and members.

Services & Products

Maturity of Loans Excess Funds

100% in first 2 years, 50% in the third year, 20%, after the third year of activity. As in the loan contract.

Applied

ASCU to be in the process of decision making. CUs and SCAs could be permitted within limits to be set as% of capital. Should participate. -.To be avoided

To be limited if CAR of the SCA is below Art.7/1 of Law

100, 80, 60, 40 and 20% in first, second, third, fourth and fifth year of activity. Average maturity Permitted to be invested in Government Securities. Loans, Deposits, Money transfers, money orders, Travelers’ checks, foreign currency, Current Accounts only for members. Not to exceed capital. Exception: Fixed Assets of collective benefit that are funded on one-to-one basis by voluntary capital. Current Accounts+ Time Deposits with Banks/Total Deposits with 6 months of maturity or less =Minimum 20%.

Recommendations

SAVINGS AND CREDIT ASSOCIATIONS

Loan (not cash covered) per Borrower /Capital

SUBJECT

Should participate. -.-.-

N.A.

N.A.

N.A.

Not to exceed capital. After 12 months from receiving license, Net Fixed Assets/Total Assets cannot exceed 10%. Assets/Liabilities, both maturing; -Within 1month = Min.100%, -Within 3months = Min. 100%, -2 years or more = Min.80%.

Average maturity. 5-40% of capital depending on the nature of securities. Permitted in line with the capital.

100% during the first year; 10% of total loans after first year.

Applied

Recommendations

Should participate. Similar to Commercial Banks. To be avoided

N.A.

N.A.

35

Not to exceed capital. After 12 months of receiving a license, Net Fixed Assets/Total Assets should not exceed 20%. Assets/Liabilities, both maturing; -Within 1 month = min.100%, -Within 3 months =min.100%, -Loans maturing after 2 years to Borrowings maturing after 2 years should not exceed 80%. N.A.

Average maturity Permitted to be invested in Government Securities. Loans, money transfers, money orders, travelers’ checks.

$10,000.

MICROFINANCE INSTITUTIONS

APPENDIX III Average Loan Size Per Borrower of MFIs in Different Regions Number of MFIs Surveyed Africa Asia Eastern Europe and Central Asia Latin America and the Caribbean Middle East and North Africa

Number of Active Borrowers

Average Loan Balance per Borrower ($)

Average Loan Balance per Borrower/ GDP per Capita

119 194

9,976 16,168

235 149

0.69 0.22

126

4,690

1,597

0.80

228

10,661

678

0.33

37

13,796

263

0.15

Source : Microfinance Information Exchange Inc. 2006.

Average Loan Size Per Borrower of Some Comparable Companies Company

Country

Besa MAFF Agro Capital KRK Ltd. Micro Invest Opportunity Albania Finca BTFF Banco Sol MiBanco ACLEDA Microserfin Alwatani Normicro Aregak Azercredit VCCL ABA BMM Salta CAFOSA ACFB ASA Dinari

ALBANIA ALBANIA Bolivia Kosovo Moldova ALBANIA Russia Kyrgyzstan Bolivia Peru Cambodia Panama Jordan Azarbaijan Armenia Azarbaijan India Egypt Argentina Mexico Benin Bangladesh Indonesia

Average Loan Per Borrower ( $) 3,990 2,716 2,645 2,576 2,466 2,466 2,235 2,027 1,629 1,445 988 838 736 561 515 500 374 257 220 206 91 71 68

Source. The Mix Market

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APPENDIX IV Pro-Consumer Pledge, Adopted in 2004 by ACCIÓN International and Micro Finance Network Member Institutions By adopting this pledge, the members of the Microfinance Network (MFN) agree to do the following: • • • •

To apply these principles in their own organizations. To promote the widespread application of these principles among microfinance institutions in their countries. To engage with regulatory authorities in their countries where needed to promote effective yet non-burdensome policies or rules. To raise awareness in the global microfinance industry about the importance of pro-consumer principles.

Principles 1. Quality of Service. MFN members will treat every customer with dignity and respect. Members will provide services in as convenient and timely a manner as possible. 2. Transparent Pricing. MFN members will give clients complete and understandable information about the true costs they are paying for loans and transaction services and how much they are receiving for savings. 3. Fair Pricing. MFN members will price their services at a fair rates. Their rates will not provide excessive profits, but will be sufficient to ensure that the business can survive and grow to reach more people. 4. Avoiding Over Indebtedness. In order to avoid customer over-indebtedness, MFN members will not lend any customer more than the customer can afford to repay. 5. Appropriate Debt Collection Practices. While debt collection practices must include energetic pursuit of defaulters, MFN members will treat customers with dignity and will not deprive customers of their basic survival capacity as a result of loan repayment. 6. Privacy of Customer Information. MFN members will protect the private information of customers from reaching others who are not legally authorized to see it. 7. Ethical Behavior of Staff. MFN members will hold their employees to a high standard with respect to conflicts of interest and unethical behavior, especially behavior that harms customers (such as taking kickbacks). Employees who breach these standards will be sanctioned. 8. Feedback Mechanisms. MFN members will provide formal channels of communication with customers through which customers can give feedback on service quality. These channels will include mechanisms for responding to specific customers regarding their personal complaints. 37

9. Integrating Pro-Consumer Policies into Operations. MFN members will make proconsumer orientation a hallmark of the way they conduct business, through efforts such as staff training and incentives, financial education for customers, customer satisfaction programs and the like.

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APPENDIX V

Comparative Analysis of Tax Exemption Status Across Countries and Regions 1. The countries listed below have tax exempt CU movements, and the countries listed in bold have a specific tax exemption Africa

Caribbean

Europe

Botswana Cameroon Cote d’Ivoire Ethiopia Gambia Ghana Malawi Mauritius Senegal Seychelles Swaziland Tanzania Togo Asia Bangladesh Hong Kong Japan ROC Taiwan Thailand

Antigua & Barbuda Bahamas Barbados Belize Cayman Islands Dominica Grenada Guyana Jamaica Montserrat Netherland Antilles St. Christopher & Nevis St. Lucia St. Vincent & the Grenadines Tortola

Ireland Poland Romania Ukraine Latin America Chile Costa Rica Dominican Republic El Salvador Panama Paraguay Peru North America United States South Pacific New Zealand Tonga

Source: Taxation of Financial Cooperatives Background Paper for Cooperative Financial Institutions Workshop Catherine Ford, World Council of Credit Unions, Inc.

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2. Certain countries levy a partial tax on CUs. These are listed below with details regarding the partial taxation. REGION Africa

COUNTRY Zimbabwe

Asia

Korea

Caribbean Europe Latin America

PARTIAL TAX Tax is paid at a reduced rate on net income of Z$15,000 and above Tax is paid at the reduced rate of 12% on net income. Local tax, property taxis also paid

Philippines

Business transactions with non-members are taxed. CU only taxed in full when the per capita share of capital reaches P15,000. Property tax and withholding tax on investments also paid.

Trinidad & Tobago Great Britain

VAT, sales tax on some goods and services paid

Guatemala

Uruguay

Tax is paid on net income earned from non-member activiti Property tax, VAT also paid Income tax is paid on interest earned from investments. 10% on income earned from serving non-members. Tax is paid at a reduced rate

3. Countries with systems that tax CUs’ net income are listed below, with specific tax details. REGION

Africa

COUNTRY Kenya

TAX ASSESSMENT Tax is paid on net income

Rwanda

Tax is paid on net income

South Africa

Tax is paid at the rate of 30% on net income

Uganda

Tax is paid at the rate of 30% on net income

Indonesia

Asia

Caribbean

OTHER TAXES PAID Withholding tax on investments

Property tax

Nepal

Tax is paid at the rate of 15% on net income

Sri Lanka

Tax is paid at the rate of 20% on net income

Uzbekistan

Tax is paid on net income

Vietnam

Tax is paid on net income

Bermuda

Security tax of 7.5%, VAT at 10% and Business Turnover Tax of 1%

Subject to all taxes, including payroll tax, a hospital levy and tariffs on import goods.

Suriname

Tax is paid on net income

Bulgaria

Tax is paid on net income

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REGION

COUNTRY

TAX ASSESSMENT

Chech Republic

Act No.513/1991 of November 5, 1991 prescribes how taxes are paid Tax is paid at the rate of 25% on net income

Latvia

Europe

Lithuania Macedonia Northern Ireland

Tax is paid at the rate of 8 % on net income Tax is paid at the rate of 15 Sales tax % on net income Tax is paid at the rate of 20% Yes on net income

Russia

Tax is paid at the rate of 24% Property tax on net income

Bolivia

Tax is paid at the rate of 25% of net income

Brazil Latin America

OTHER TAXES PAID

Local and federal taxes

Ecuador

Tax is paid at the rate of 25% 1% tax on credit operations, of net income 2%on profits and property tax

Honduras

Tax is paid on net income

Mexico

VAT

Nicaragua

Tax is paid on net income

North America

Canada – CUCC

South Pacific

Australia

Tax is paid at a rate between Sales tax. Capital tax is paid to the 18-28 % on net income federal government, but CUs are exempt from provincial capital taxes. Tax is paid on net income

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APPENDIX VI Country Applications of Profit Tax On Non-Profit Making Non-Bank Finance Institutions EUROPE & ASIA Bosnia Herzegovina, Exempt Armenia, Exempt Bulgaria, Exempt Azerbaijan, Taxed Romania, Exempt Bangladesh, Taxed Russia, Taxed Pakistan, Exempt Georgia, Taxed Indonesia, Exempt AFRICA Algeria, Exempt Vietnam, Exempt Egypt, Taxed Ghana, Taxed Malawi, Exempt Morocco, Taxed Nigeria, Exempt South Africa, Exempt Tunisia, Exempt Uganda, Exempt Zambia, 3 percent

Source: The Microfinance Gateway/Non-profit NBFIs

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