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Plenary Session: Creating National and Regional Autonomous Microcredit Funds

Workshop Session: Transformation of Microfinance Operations from NGO to a Regulated MFI

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Workshop Session: Transformation of Microfinance Operations From NGO to a Regulated MFI

Victoria White: I thought I would say a few words just about ACCION since ACCION has to date not been very active in the Middle East region. We have, however, been working in Africa for the last five years or so, but our roots come from starting in the early sixties in Latin America. We are a U.S. private nonprofit headquartered in Boston….we provide technical assistance and training to microfinance institutions. We do plan to hopefully expand into the Middle East region, though, in the coming years. We are currently working with twenty-seven different microfinance partners throughout the Americas and Africa….[M]aybe five, ten years ago most of ACCION's partners…were NGOs, but over the last decade or so there's really been a shift to working more with regulated financial institutions. So much so that today a little over eighty percent of the 1.2 or so million clients in the ACCION partnership and also a little over eighty percent of the $700 million portfolio that is represented by those groups of institutions are under regulated financial institutions.

So, that really forms now the bulk of the kinds of institutions that we work with and that's been really due to two reasons. One, obviously, is that a number of our partners from the beginning, now that we have started working with [them] over the last decade, are regulated institutions. We've seen a lot more banks start to target the microenterprise segment as a market niche and work…with that part of the economy. But secondly, as you can see from this chart, we've had six of our partners [go through] and three…currently going through the process of transforming from NGOs into regulated financial institutions. So that we've seen both working with more regulated institutions and also this transition that we're going to be talking about today of NGOs that have transformed into some form of regulated financial institution.

So what is transformation?….I think there's three main elements that are important when thinking about institutional transformation. The first is the shift which occurs from the non-profit to the for profit status. So you're leaving …the world of donor funded equity base and really creating a share company with private investors, and then becoming a for profit entity. The second is the shift from an unregulated to regulated entity and there are a number of implications there that we'll be talking about briefly. So, going from being perhaps under a kind of general framework of adhering to certain requirements as being licensed or being registered as some kind of association or non-profit NGO to actually being regulated and supervised by the Central Bank. Depending on the regulatory framework that is selected, that can have pretty significant implications. And this third point, the transfer of assets, liabilities and human resources. I put together just a little schematic here…to give you a sense of what we're talking about… There are a variety of different models that are used, but this is one just to give you a sense of how most of the institutions that have gone through this process have done it. What happens is that the assets of the NGO are essentially sold to this new entity that will be this regulated microfinance institution and in exchange the NGO becomes a shareholder. In this case I've done a combination of both being a shareholder as well as a lender through some subordinated debt. And the actual distribution will just depend on the ultimate capital structure that is envisioned for that new entity. But again, as Javier was saying, the NGO remains there and we'll talk about implications of what the NGO's role is….So again there's this shift of the assets, of the loan portfolio, the fixed assets,…into this new regulated entity and in addition the staff as well are shifting over to this new entity. And of course, as shown here, we also typically see outside investors coming in…as shareholders. So, you end up with a new shareholder base in that new entity.

I wanted to touch on four key [lessons] that …the ACCION Network has learned over these years….I think starting with just the motivation for transformation. There's certainly a lot of different reasons organizations go through transformation. I think the two main ones…have been this concept of increasing access to a much more diverse source of funds. So, as Javier mentioned, obviously with a shareholder capital base, institutions have been able to leverage their equity in much greater proportions then as an NGO…. In addition, this concept of being able to actually mobilize deposits from the public. Again, it depends on the particular regulatory structure that the institution decides to fit under because not all regulated financial institutions can take deposits. Assuming that that is the category that is selected, that does really open up a whole branch of new funding sources for the organization. And I think closely linked to that is also the additional products that are then open to clients through not only savings but…a variety of other types of products, for example remittances,… that are now legal for the institution to engage in. But I think the key lesson here has been this need to really be clear from the beginning about the motivations for transformation and to insure that the stakeholders at the organization, the board members, the staff, the management, are really all on the same page about why the institution has elected to pursue transformation.

As we'll be talking about, transformation is not cheap. It doesn't happen quickly. It takes a lot of resources, a lot of time…..Secondly, just to touch on regulation issues, obviously once there has been a discussion around transformation the first question is we'll transfer them into what? I think the big issue here is what does your local regulatory environment permit? Is there currently a category that would be appropriate for your institution? Commercial bank licenses will probably open up all sorts of different possibilities in terms of products that can be offered, but will typically have very high minimum capital requirements.

So, there is a process involved of really looking at what are the options there, and if there's not something appropriate, is there a process that's already underway to create some kind of specialized regulatory framework? We've seen this, for example, in Bolivia with the private financial category that a number of institutions now have transformed into, and in Uganda which just finally passed its legislation for a micro-deposit taking institution license. Both of those categories will enable microfinance institutions to mobilize savings from the public, but they will not be able to offer a checking facility, for example. So, there will be some restriction on the kinds of activities they can do, but they also have much lower minimal capital requirements than the commercial bank license. So there are a lot of issues involved in looking at what the regulatory framework in your country would allow. And then certainly a number of implications that come from those different categories. Central bankers tend to be a pretty conservative crowd by nature and when they look at portfolios that have no formal collateral against them, that makes them pretty nervous. And so there's often quite a long educational process that is needed to really bring supervisors and regulators up to speed on what microfinance is really all about, how risk is managed in a microfinance institution, and that is typically a very time consuming process. And I think here the lesson has been that it is important to work very closely with regulators in your country as you go through this process. It can't be something that's done separately from the regulators themselves. They need to be part of that whole process. And we certainly have seen, I think, a success of this in Uganda where, really from the beginning, all of the key stakeholders were really involved in helping to design the legislation and really thinking through how best to go about creating a specific category for microfinance institutions. But it also obviously has big implications for the Central Bank itself. They are already typically pretty stretched just supervising the banks…. To add now [another] category to their very stretched time commitments is something that needs to really be thought through.

I think a third point is issues around institutional structure…I wanted to just focus on two in particular. As mentioned in an institutional transformation the NGO's asset base is essentially sold to this new entity and in exchange they become shareholders in this new institution. And I think that immediately raises that question of what is the role of the NGO in the future? What is the appropriate percentage holding that that NGO should have in that new regulated institution?….I think, certainly from the PRODEM/Bancosol scenario we learned that it can get very complicated if the NGO continues to do financial services. In those early days the initial idea was that PRODEM, the NGO, would continue doing microfinance and would essentially work in the more rural areas and at the time that it became sustainable it would kind of shift or sell its portfolio to Bancosol, the new bank. What ended up happening is they actually got into quite a competitive type of situation and so you had a NGO that was a significant owner of this commercial bank in direct competition with the bank. And I think there's been a number of other cases too that have really highlighted the importance of really separating the kinds of activities the NGO does post transformation. Other examples have been, for example, getting involved in non-financial service provision, training the same type of market segment of Microentrepeneurs, but doing the non-financial side of it. Alternatively, we've seen cases where the NGO just remains as a trust, so it ceases operating activities and just manages its investment in that regulated entity.

I think, likewise there are issues around who should those other investors be that you bring in. And obviously this has a direct correlation with what is the mission and the vision of this new regulated institution going forward. And so, really from the beginning needing to be very clear with any outside investor that you start talking with about what really their vision is for the future. And I think… it helps to have a diverse group of investors, but all sharing a common vision going forward…. With this whole transformation there are huge implications on the day-to-day operations of the institution. Obviously, with falling under the Central Bank structure there's often a need to bring in new staff that have particular qualifications that the Central Bank is looking for. If the institution, for example, starts mobilizing deposits and it hasn't done that before, treasury management skills become very important. So there's often a need to bring in kind of more banker type staff or balance that with additional investments and a lot of training. In addition, management information systems often have to be beefed up quite significantly. Certainly, if you're mobilizing deposits the Central Bank also wants to know daily or perhaps weekly information on those depositions and your liquidity levels which obviously have big implications for your management information system.

So, there are a number of issues there at the operational level which really need to be addressed from day one. I think what we've seen in the past is there's so much attention placed on putting in place the right capital structure, getting the right investors to the table, details around the shareholder's agreement. We've seen so much attention focused on that then it's …secondary that people start to think about oh, what is the impact on my institution at an institutional cultural level. And I think it's there that often we run into the biggest issues. If you don't have your staff bought into this concept you're going to have big problems. Just keep in mind staff really are your number one asset and they really need to be brought along with this process from day one…..

Read remarks by Clare Wavamunno