Resetting microfinance: Why the imminent microfinance sector reforms is long overdue

For several years, the private sector has had cause to complain incessantly about sky-high lending rates in the banking sector, blaming the latter for the perennially low investment in non-current assets which is critical for developing market competitiveness.

In the microfinance sector, lending rates are even worse, so much so it pales in comparison to the oppressive usury witnessed during medieval Europe, for which reason Pope Clement V had to issue a ban in AD 1311.

In today’s microfinance environment, it won’t be far-fetched to find a provider charging between 10-12% interest rate on loans per month.

Heck, you might even find 15% per month. If this does not tickle your moral sensibilities then perhaps a concrete example might jolt your conscience.

Let’s say Aunty YaaYaa who sells tomatoes at Agbogbloshie, borrows GH¢4000 for 3 months at an interest rate of 12%, and recycles the borrowing four times within the year, she effectively pays GH¢5,760 in interest expense, alone, an amount that is 44% greater than the loan principal.

Those that defend the status quo resort to oft cited refrain such as high borrowing cost, high operating cost, etc, etc, as though discretionary choices regarding business model design, is a given.

Some critics have argued, albeit facetiously, that modern microfinance as currently practiced in Ghana is nothing but economic and organized crime masquerading as financial inclusion.

They quip, jokingly, that 'if this is what is called financial inclusion, then may we all be excluded.' Without doubt, policy makers have on their hands a classic case of market failure. The charge that microfinance as currently practiced, constitutes ‘mission-drift’ is a fair accusation – guilty as charged, collectively. Several questions then arise:

1. What kind of a microfinance ecosystem do we want as a country? what policy outcomes should any sector reforms accomplish? In summary, what should change like look?

2. What possible risks could derail such a reform program, from a design or implementation standpoint?

3. What specific initiatives, if any, could mitigate the risks to program implementation?

This article seeks to share some perspectives question 2.

According to the Bank, the Microfinance reform, which is expected to be rolled out soon, will be guided by four strategic themes:

 Pillar 1: Design a system architectural framework that balances market-based approaches with social orientation to serve different categories of consumers.

 Pillar 2: Drive consolidation and modernization of existing institutions to achieve efficiency.

 Pillar 3: Promote population penetration and drive local participation and ownership.

 Pillar 4: Build industry-level support system to enhance operational support, supervisory effectiveness and policy flow.

When all is said and done, the reform should demonstrate tangible social and economic benefits for consumers of financial services. That means (a) a systematic dismantling of usury, (b) improvement in service quality, and (c) product optionality.

What are the risks in terms of program design and implementation?

Using the strategic themes of the reform as a frame of reference, I see two set of risks.

First, I foresee a ground swell of resistance against the idea of mergers and acquisition that may be nudged by the regulator. If the reformers decide to set a new minimum paid-up capital of say GH¢40 million for Microfinance Banks, and GH¢30 million for Community Banks, it would make strategic sense for providers to consider Mergers and Acquisitions as a viable pathway to compliance.

Unfortunately, I don’t see a lot of M&A happening. There is a reason for my cynicism. I do recall, that prior to 2017, following the increment of Bank’s minimum paid-up capital to GH¢400 million, the regulator used moral suasion to encourage and cajole banks that couldn’t meet the mark, to join forces.

The response? Quiet protests and secret petitions. The rest is history. Less than a decade after, we are back to the same junction. So no, I don’t see any vibrant market-led M&A activity that will help drive sector consolidation, as the regulator expects. Instead, I see two things happening.

First, amongst MFIs with net-own funds below GH¢15 million, there will be an institutional exodus; a mass self-relegation to the category of regulated microfinance institutions called, Last Mile Providers.

Secondly, MFIs that have net-own funds north of GH¢15 million, and/or have deep access to the capital market, whether through private placements or public offering, may ride out any grace period that will be offered by the regulator, in an attempt to raise the required capital.

Eventually, water will flow to where water can settle. The risk I see however, which is related to the phenomenon of self-relegation, is the problem of regulatory arbitrage.

Let me explain: All Specialised Deposit-taking Institutions (Tier 1, Tier 2 or even Tier 3) have regulatory compliance obligations that are materially distinct from what, say a Tier 4 operator is obliged to comply with.

Case in point: the Corporate Governance Directive, 2018 enjoins Tier 1-3 license holders to conduct Board self-evaluation annually.

Question: Can a Tier 2 Microfinance company who self-relegates to Last-Mile Provider category, elect to re-register the entity as a sole proprietor to avoid undue regulatory pressure? Not only is the question legitimate, but in the absence of clear and unambiguous directives, this exact dynamic could materialize.

Here are my final thoughts:

1. Lending rates in the MFI sector is usurious. Albeit direct price controls is an ill-advised policy tool in a market-based economy, the regulator must employ other market-based approaches to disincentivize usury. Unfortunately, the practice of issuing Pre-agreement disclosure statements as mandated by Section 57 of the Borrowers and lenders Act, 2020 (Act 1052) has not had the intended positive effect on loan pricing. Something more pragmatic should be considered.

2. BoG must collaborate with SEC and the Ghana Stock exchange to create a fast-track public listing roadmap for MFIs that show interest in raising new capital through an IPO.

3. The grace period to comply with revised capital rules should be granted under strict conditions:

i. Institutions must submit feasible capital plans that demonstrate compliance within a stipulated period.

ii. Institutions with gaps in their corporate governance architecture must submit business plans showing a roadmap to reach 3-lines-of-defence maturity within a stipulated period.

4. Bank of Ghana’s must take pains to avoid the regulatory missteps witnessed during the of 2017 financial sector clean-up. Part of the stakeholder consultations that will accompany this reform should focus on reassuring the market that the current insolvency resolution framework has been strengthened based on lessons learnt from past mistakes.

The author is a Senior Fellow at Yieldera Policy Institute, a think tank focused on the financial sector.