## _wp04174

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### Key findings on saving mobilization by MFIs
- MFIs have been successful in mobilizing deposits while the outreach of the banking sector remains limited in the surveyed countries (Benin, Guinea, Tanzania, and Ghana).
- Rapid increases in MFIs’ membership and loan activities in Benin and Guinea were supported by continued increases in deposits (1997–2003).
- Deposit collection has played a central role in the development of the microfinance sector because poor households value access, security, liquidity, and returns for savings (Hirschland, 2003).
- MFIs have overcome three main barriers to bank deposit use (World Bank, 1997): (i) high opening and minimum account balances, (ii) high travel time and transport costs to branches, and (iii) lack of familiarity with bank branch operations and procedures.

### Country summaries and key statistics
- Benin
  - 35 bank branches nationwide for a total population of 7 million.
  - Formal saving and loan cooperatives (SLCs) are the only MFIs that collect savings and, thanks to their extensive domestic branch network, have mobilized significant savings.
  - Deposits at the SLCs reached the equivalent of 10 percent of non-central government commercial bank deposits at end-2003.
- Guinea
  - Banking reach constrained by limited number of deposit money banks; credit concentrated on the largest domestic companies.
  - MFIs began filling the gap; deposits increased substantially between 1997 and 2003 but remained a small proportion of commercial bank deposits (1.5 percent).
- Ghana
  - Microfinance sector has a strong savings orientation and a greater role of licensed institutions relative to NGOs.
  - Rural and Community Banks (RCBs): 115 institutions operating at end–2001; total number of recorded depositors in all RCBs is 1.2 million with about 150,000 borrowers.
  - Savings and Loans companies (S&Ls): eight S&Ls had over 160,000 depositors and 10,000 borrowers by 2002.
  - In 2002, private deposits with MFIs amounted to about 6 percent of commercial bank deposits.
- Tanzania
  - Only about six percent of the population has a bank account (4 percent in rural areas).
  - MFIs have about 2 million deposit accounts (6 percent of population).
  - MFIs hold about 60 percent and 11 percent of total commercial bank deposits and credits, respectively (2002).
  - Primary microfinance sources: about 650 savings and credit cooperatives (SACCOs) with a total of 130,000 members (0.4 percent of the population), and NGOs relying on foreign donor assistance.
  - Three commercial (deposit-money) banks active in microfinance: National Microfinance Bank (NMB), Cooperative and Rural Development Bank (CRDB) Ltd, and Akiba Commercial Bank (ACB).
  - Tanzania Postal Bank (TPB) used its country-wide post-office network to promote and mobilize savings, provide transfer and remittance services, and a loan guarantee service to small borrowers.

### The community-based approach and benefits
- MFIs operating outside the formal banking sector relied on local communities to support development, often forming cooperatives to mobilize savings and funds.
- Cooperative banking and savings and loan associations exemplify the community-based approach:
  - In Benin, SLCs dominate the MFI network.
  - In Ghana, RCBs (unit banks owned by community members via share purchases) account for the largest share of microfinance services; S&Ls are the second largest.
  - Modern cooperative societies have started expanding services to non-members to overcome resource constraints.
- Benefits
  - Client level: group savings schemes allow joint mobilization of savings and use of joint savings as security for loans, enabling larger collateral aggregation.
  - Institutional level: group/community-based collection creates economies of scale, enabling institutions to operate on a full-intermediation basis rather than specializing only in savings or lending.
  - Macroeconomic level: deposit-collecting MFIs can increase domestic financial savings mobilization by tapping resources of the poor who are otherwise isolated from the formal financial system.
  - Social empowerment: MFIs serving groups and communities can empower underprivileged constituencies to contribute more effectively to economic development and poverty reduction; MFIs commonly focus on women but also serve other social groups.

### Varieties of savings-credit schemes observed
- Village Banking (adaptation of Grameen Bank, introduced to Africa by K-REP): members mobilize share capital and savings (sometimes matched by donors); loans made to groups of ten, benefiting half at a time; the second half accessed after repayment by the first.
- Group savings with credit scheme: group members pool savings jointly to qualify for loans; group savings may serve as collateral.
- Group and individual savings with credit scheme: both group and individual accounts coexist; group savings provide additional security for individual loans; loan repayments are individual but handled through group accounts.
- Individual savings with group lending: group handles collection of individual savings, receives loan for distribution, and bears group responsibility for recovery.
- Individual approach for both savings and credit: used when individuals have credible credit histories or the group approach is inappropriate.

### Formalizing informal intermediation and MFI linkages
- Licensed MFIs have replicated and formalized informal savings-collection methods to mobilize savings from lower-income households.
- Interactions between licensed MFIs and informal players:
  - Replication of informal savings mobilization methods (e.g., susu collector function expanded via “Mobile Banking” services in Ghana).
  - Integration of informal institutions into licensed MFIs’ operations (e.g., informal savings collectors placing deposits with larger MFIs; licensed MFIs working with Susu clubs in Ghana).
- Complementarities with banks
  - MFIs build on informal mechanisms to create channels for capital infusions from formal banks, donors, and governments.
  - Banks and MFIs service substantially different client bases; MFIs benefit as bank clients through deposit management, liquidity management services, and credit facilities.
  - Branch network sharing and cooperative arrangements can extend outreach and achieve economies of scale.
- Risks and limitations
  - Banks cautious in extending credit lines to MFIs due to spillover risk if MFIs fail.
  - Expansion of credit to new borrowers may increase default risk, loan administration and monitoring costs, and potential contamination of borrower pools.

### The Ghana Susu system: types, functions, and MFI leveraging
- Susu collectors
  - Collect daily voluntarily saved amounts from clients and return them at the end of the month minus one day’s amount as commission.
  - Expanded by licensed MFIs with “Mobile Banking” services acting as collectors to mobilize savings and offer additional services such as promised loans and life insurance benefits.
- Susu associations
  - Rotating (ROSCAs): collect savings and allocate them to each member in turn.
  - Accumulating: allow regular contributions to be accumulated for lump sum costs.
- Susu clubs
  - Combine ROSCA and accumulating features; members commit to save over 50- to 100-week cycles and pay commissions and fees when advanced the targeted amount early.
- Susu companies
  - Registered (late 1980s); collect savings and provide loans after a minimum saving period.
- How MFIs leverage susu mechanisms
  - Susu club operators become clients of licensed financial institutions, placing mobilized savings in safe instruments and accessing lending facilities to offer more advances to their own clients.
  - Licensed MFIs capitalize on informal agents’ intimate knowledge of clients; pilot programs provide funds to susu collectors who then on-lend to their own clients.
- Outreach impacts
  - Interactions have resulted in greater effectiveness in reaching lower-income brackets and women.
  - In Ghana, lower-income brackets and women account for between 65 to 80 percent of the clients of those susu schemes.

### Risks, mitigation, and financial sustainability of group lending
- Identified risks
  - Under group lending, individual members bear higher risk compared with limited liability schemes.
  - Contagion effect: default by one borrower affects the credit rating of the group and can cause group default.
  - Coordination failure: individual borrowers may default expecting others to default.
  - Group lending schemes may be overly conservative, selecting only the safest projects.
- Mitigation mechanisms
  - Sequential lending reduces contagion and coordination failure risks.
  - Self-selection leads to formation of groups of relatively safe borrowers.
- Determinants of improved MFI financial performance
  - Autonomy over management decisions.
  - Ability to set lending and deposit rates to maintain a spread consistent with profitability.
  - Vigilance in avoiding/reducing nonperforming loans.
  - Focus on addressing capacity and skills constraints.
- Country evidence
  - Benin: financial rehabilitation programs of 1989-93 and launched in 1999; many SLCs expanded deposits and loan portfolios, recovered nonperforming loans, and achieved break-even or positive net profits in current operations.
  - Ghana: RMF sector performance improved due to (i) a more commercial approach, (ii) restructuring through re-capitalization and capacity-building, and (iii) strengthened regulation; at S&Ls and credit unions, weak performance improved through greater commercial focus and better management and reporting. From 1996 to 2001, the proportion of “unsatisfactory” credit unions declined from 70 percent to 60 percent and that of those in the worst categories from 42 percent to 15 percent.
  - Guinea: four existing MFIs reported strengthened performance over 1997–2003 by lowering the share of non-performing loans (NPLs), raising lending rates, and maintaining a wider interest rate spread than in the banking sector; the share of NPLs in the four MFIs was considerably lower than that of the commercial banks.

### Restructuring experiences and regulatory evolution (Box 4)
- Case study highlights
  - Benin: largest MFI’s loan portfolio deteriorated significantly in 1998; comprehensive rehabilitation (reducing NPLs, blocking new credit extension, improving internal controls, restructuring network) programmed to continue until 2004; total deposits and credit expanded rapidly and positive net profits were recorded in 2002; microfinance law enacted end-1997 with application decrees and central bank instructions in 1998.
  - Ghana: World Bank-assisted recapitalization and capacity building of rural credit banks in the early 1990s; number of RCBs classified as satisfactory rose from 23 out of 123 in 1992 to 61 out of 128 in 1996.
  - Guinea: donor operational and financial audits after largest MFI failure identified severe liquidity problems; liquidation decision followed and central bank issued instructions to strengthen regulation; microfinance law being prepared.
  - Tanzania: restructured and recapitalized banks involved in microfinance required to comply with licensing and regulatory requirements before restarting; largest microfinance-oriented commercial bank emerged from restructuring and is being prepared for privatization; CRDB restructured and recapitalized before lending to downstream cooperatives.
- Regulatory design principles
  - Frameworks for licensing, regulating and prudential supervision need to be well adapted and flexible to reflect specific characteristics and stage of evolution of the microfinance sector.
  - Peculiarities of the microfinance sector necessitate either a dedicated law for the sector, or adequate treatment under other legislation.
  - Priority given to greater supervisory attention to larger institutions and/or more risk-prone MFIs.
  - Regulation should provide clear guidelines for semi-formalizing and fully formalizing institutions (examples: Benin, Tanzania).
- Minimum regulatory requirements and supervision practices
  - Core requirements: licensing, information transmission requirements, prudential norms.
  - Licensing approach: gradual — newer and smaller institutions encouraged to apply for licensing with fewer regulatory requirements; larger institutions regulated and supervised more closely.
  - Supervision practices: Benin — several on-site inspections during the year; Guinea — off-site and on-site audits but capacity constraints; Ghana — reliance on strict regulatory requirements due to high supervision costs.
  - Suggested prudential rules for larger institutions: capital requirements, risk concentration limits, liquidity limits, well-defined provisioning requirements.
- Prudential items and country application (check marks preserved as in source)
  - Minimum capital — Benin √; Ghana 1/ √; Guinea √; Tanzania 2/ (√)
  - Reserve requirement — Benin √; Ghana (blank); Guinea (blank); Tanzania √
  - Capital Adequacy ratio — Benin √; Ghana √; Guinea (blank); Tanzania √
  - Limit on total risks — Benin √; Ghana (blank); Guinea (blank); Tanzania (blank)
  - Limit on loans to a single borrower — Benin √; Ghana √; Guinea √; Tanzania √
  - Limit on insider loans — Benin √; Ghana (blank); Guinea (blank); Tanzania (blank)
  - Limit on total large loans — Benin (blank); Ghana √; Guinea (blank); Tanzania (blank)
  - Limit on liquidity ratios — Benin √; Ghana √; Guinea √; Tanzania √
  - Limit on coverage of non-short term liabilities by non-short term assets — Benin √; Ghana (blank); Guinea (blank); Tanzania (blank)
  - Ceiling on non-secured loans — Benin (blank); Ghana (blank); Guinea (blank); Tanzania √
  - Ceiling on fixed assets — Benin (blank); Ghana (blank); Guinea (blank); Tanzania √
  - Ceiling non-microfinance activity — Benin (blank); Ghana (blank); Guinea (blank); Tanzania √
  - Provisioning requirements — Benin √; Ghana √; Guinea √; Tanzania √
  - Footnotes:
    - 1/ In Ghana, these prudential rules apply to microfinance institutions subject to commercial banking laws.
    - 2/ In Tanzania, the prudential rules apply to commercial and microfinance banks (including unit rural banks) registered under the commercial banking law. Saving and credit unions are effectively not regulated or supervised.
- Accompanying measures
  - Institutional capacity building: bookkeeping and reporting standards, strengthening internal controls and credit decision mechanisms, improving technology and human resources.
  - Supervision capacity: address competence and effectiveness of supervising staff.
  - Borrower information infrastructure: development of borrower database infrastructure, improved data compilation, establishment of credit bureaus.
  - Judicial and enforcement environment: enforcement of microfinance regulations and general business-related laws crucial for sector development.
  - Role of donors: coordinated government and donor effort helpful particularly for capacity-building and supporting infrastructure.

### Conclusions — policy implications and constraints
- Demand and institutional form
  - Poor populations, particularly rural, value both deposit and credit facilities; growth of cooperative banking and combined savings and credit institutions reflects demand for both.
- Formal–informal linkages
  - Strong linkages exist; formal institutions have drawn on informal savings mobilization methods and in some cases become bankers to informal institutions.
- Operational characteristics
  - Group-based savings-cum-credit institutions rely on peer pressure and joint liability rather than collateral; MFIs often rely on short maturities, high-frequency payments, and sometimes compulsory security deposits.
- Financial sustainability
  - MFIs that mobilize deposits and extend credit tend to fare better financially than those specializing exclusively in either activity or dependent exclusively on donor/government funds.
  - Performance depends critically on management autonomy (deposit and lending rate setting), vigilance to avoid nonperforming loans, and building institutional capacity.
- Linkages with banks
  - Growing MFIs–bank linkages are mutually beneficial: MFIs obtain deposit facilities, liquidity management and emergency lines; banks expand client base and networks. Linkages facilitate small entrepreneurs’ graduation from microcredit to conventional bank loans.
- Role of donors and NGOs
  - Donors/NGOs support dissemination of best practices, capacity building, and borrower entrepreneurship; donor dependence can weaken financial discipline and constrain sustainability if not balanced with domestic saving mobilization.
- Main constraints to regulatory and supervisory framework development:
  - Lack of bookkeeping and reporting standards, internal controls, and credit decision mechanisms at MFI level.
  - Shortage of skilled and trained staff in supervisory institutions.
  - Weak borrower information/database on credit histories and repayment records.

*Source: Extracted from IMF Working Paper content unit _wp04174.*

### Box 1.  Saving Mobilization by Microfinance Institutions in Selected Countries ....................5

### Box 1.  Saving Mobilization by Microfinance Institutions in Selected Countries

### Key findings from selected countries
- MFIs have been successful in mobilizing deposits while the outreach of the banking sector remains limited in the surveyed countries (Benin, Guinea, Tanzania, and Ghana).
- Rapid increases in MFIs’ membership and loan activities in Benin and Guinea were supported by continued increases in deposits (1997–2003).
- Deposit collection has played a central role in the development of the microfinance sector because poor households value access, security, liquidity, and returns for savings (Hirschland, 2003).
- MFIs have overcome three main barriers to bank deposit use (World Bank, 1997): (i) high opening and minimum account balances, (ii) high travel time and transport costs to branches, and (iii) lack of familiarity with bank branch operations and procedures.

### Country summaries and key statistics
- Benin
  - Very limited banking outreach: 35 bank branches nationwide for a total population of 7 million.
  - Formal saving and loan cooperatives (SLCs) are the only MFIs that collect savings and, thanks to their extensive domestic branch network, have mobilized significant savings.
  - Deposits at the SLCs reached the equivalent of 10 percent of non-central government commercial bank deposits at end-2003.

- Guinea
  - Banking reach constrained by limited number of deposit money banks; credit concentrated on the largest domestic companies.
  - MFIs began filling the gap; deposits increased substantially between 1997 and 2003 but remained a small proportion of commercial bank deposits (1.5 percent).

- Ghana
  - Microfinance sector has a strong savings orientation and a greater role of licensed institutions relative to NGOs.
  - Rural and Community Banks (RCBs): 115 institutions operating at end–2001; total number of recorded depositors in all RCBs is 1.2 million with about 150,000 borrowers.
  - Savings and Loans companies (S&Ls): eight S&Ls had over 160,000 depositors and 10,000 borrowers by 2002.
  - In 2002, private deposits with MFIs amounted to about 6 percent of commercial bank deposits.

- Tanzania
  - Banking system penetration very limited: only about six percent of the population has a bank account (4 percent in rural areas).
  - MFIs have about 2 million deposit accounts (6 percent of population).
  - MFIs hold about 60 percent and 11 percent of total commercial bank deposits and credits, respectively (2002).
  - Primary microfinance sources: about 650 savings and credit cooperatives (SACCOs) with a total of 130,000 members (0.4 percent of the population), and NGOs relying on foreign donor assistance.
  - Three commercial (deposit-money) banks active in microfinance: National Microfinance Bank (NMB), Cooperative and Rural Development Bank (CRDB) Ltd, and Akiba Commercial Bank (ACB).
  - Tanzania Postal Bank (TPB) used its country-wide post-office network to promote and mobilize savings, provide transfer and remittance services, and a loan guarantee service to small borrowers.

### The community-based approach in MFI development
- MFIs operating outside the formal banking sector relied on local communities to support development, often forming cooperatives to mobilize savings and funds.
- Traditional community-based cooperative groups (local clubs, village associations) played a central role in savings mobilization and microfinance expansion.
- Cooperative banking and savings and loan associations exemplify the community-based approach:
  - In Benin, SLCs dominate the MFI network.
  - In Ghana, RCBs (unit banks owned by community members via share purchases) account for the largest share of microfinance services; S&Ls are the second largest.
  - Modern cooperative societies have started expanding services to non-members to overcome resource constraints.

- Benefits of group-based approaches:
  - Client level: group savings schemes allow joint mobilization of savings and use of joint savings as security for loans, enabling larger collateral aggregation.
  - Institutional level: group/community-based collection creates economies of scale, enabling institutions to operate on a full-intermediation basis rather than specializing only in savings or lending.
  - Macroeconomic level: deposit-collecting MFIs can increase domestic financial savings mobilization by tapping resources of the poor who are otherwise isolated from the formal financial system.
  - Social empowerment: MFIs serving groups and communities can empower underprivileged constituencies to contribute more effectively to economic development and poverty reduction; MFIs commonly focus on women but also serve other social groups.

### Varieties of savings-credit schemes observed (examples from Ghana and Tanzania)
- Village Banking (adaptation of Grameen Bank, introduced to Africa by K-REP): members mobilize share capital and savings (sometimes matched by donors); loans made to groups of ten, benefiting half at a time; the second half accessed after repayment by the first.
- Group savings with credit scheme: group members pool savings jointly to qualify for loans; group savings may serve as collateral.
- Group and individual savings with credit scheme: both group and individual accounts coexist; group savings provide additional security for individual loans; loan repayments are individual but handled through group accounts.
- Individual savings with group lending: group handles collection of individual savings, receives loan for distribution, and bears group responsibility for recovery.
- Individual approach for both savings and credit: used when individuals have credible credit histories or the group approach is inappropriate.

### Formalizing informal methods of intermediation
- Licensed MFIs have replicated and formalized informal savings-collection methods to mobilize savings from lower-income households.
- Two key interactions between licensed MFIs and informal players:
  - Replication of informal savings mobilization methods (e.g., susu collector function expanded via “Mobile Banking” services in Ghana).
  - Integration of informal institutions into licensed MFIs’ operations (e.g., informal savings collectors placing deposits with larger MFIs; licensed MFIs working with Susu clubs in Ghana).

### Looking for financial sustainability
- Formalization of informal techniques and group-based instruments used to promote financial sustainability by addressing:
  - Asymmetry of information,
  - Lack of collateral,
  - Difficult enforcement of legal rights.
- Linking savings and credit programs helps overcome asymmetry of information and lack of collateral by using group responsibility and peer pressure as substitutes for collateral, reducing transaction costs and improving repayment rates.
- Example: Ghana RCBs shifted from standard commercial individual loans with high non-performing loans to short-term loans (4-6 months), weekly repayments, and a compulsory up-front savings of 20 percent as security.
- Group lending with joint liability encourages self-selection of good credit risks and lowers group risk because default risk is shared.
- A number of limits/risks may exist in group lending schemes with joint liabilities, where the behavior of one individual may affect the repayment of the group as a whole.

_Italic: Source: Box 1. Saving Mobilization by Microfinance Institutions in Selected Countries, extracted from the provided IMF content unit._

### Box 2. Building on Informal Sector Savings and Credit Mechanisms: The Example of the

### _wp04174 - Box 2. Building on Informal Sector Savings and Credit Mechanisms: The Example of the Ghana Susu System

### Types and functions of susu institutions
- Susu collectors
  - Collect daily voluntarily saved amounts from clients and return them at the end of the month minus one day’s amount as commission.
  - Expanded by licensed MFIs with “Mobile Banking” services acting as collectors to mobilize savings and offer additional services such as promised loans (proposed for example by Nsoetreman Rural Bank and First Allied S&L) and life insurance benefits (introduced briefly by the State Insurance Corporation in the 1980s).
- Susu associations
  - Rotating (ROSCAs): collect savings and allocate them to each member in turn.
  - Accumulating: allow regular contributions to be accumulated to cover lump sum costs for special future events (e.g., funerals).
- Susu clubs
  - Combine ROSCA and accumulating features, operated by a single agent.
  - Members commit to save a pre-defined amount over the medium-term (50- to 100-week cycles) and pay commissions on each payment and fees when advanced the targeted amount before the end of the cycle.
- Susu companies
  - More recent (late 1980s) and registered.
  - In addition to savings collected using traditional susu collectors, they provide loans after a minimum saving period.

### How MFIs leverage susu mechanisms
- MFIs use susu associations, clubs, and companies to expand services:
  - Susu club operators become clients of licensed financial institutions, placing mobilized savings in safe instruments and accessing lending facilities to offer more advances to their own clients.
  - Licensed MFIs capitalize on informal agents’ intimate knowledge of clients; pilot programs supported by RCBs and S&Ls provide funds to susu collectors who then on-lend to their own clients.
- Outreach impacts
  - Interactions have resulted in greater effectiveness in reaching lower-income brackets and women.
  - In Ghana, the two groups (lower-income brackets and women) account for between 65 to 80 percent of the clients of those susu schemes.

### Risks and mitigation in group lending schemes
- Identified risks:
  - Under group lending, individual members bear higher risk compared with limited liability schemes; group lending is preferred only if gains from lower overall risk outweigh the default risk transferred to nonborrowers.
  - Contagion effect: a default by one borrower affects the credit rating of the group and can cause group default.
  - Coordination failure: individual borrowers may default expecting others to default, potentially prompting group default even when all members are solvent.
- Mitigating mechanisms:
  - Sequential lending (loans provided sequentially to different sub-groups) reduces contagion and coordination failure risks.
  - Self-selection leads to formation of groups of relatively safe borrowers, limiting transfer of risk from the group to individual borrowers.
- Concern:
  - Group lending schemes may be overly conservative in risk-taking, selecting only the safest projects.

### Evidence on MFI financial performance and sustainability
- General determinants of improved financial performance:
  - Autonomy over management decisions.
  - Ability to set lending and deposit rates to maintain a spread consistent with profitability.
  - Vigilance in avoiding/reducing nonperforming loans.
  - Focus on addressing capacity and skills constraints.
- Country examples:
  - Benin
    - Following financial rehabilitation programs of 1989-93 and that launched in 1999, many SLCs were able to substantially expand deposits and loan portfolios, recover nonperforming loans, and achieve break-even or positive net profits in current operations.
  - Ghana
    - Rural microfinance (RMF) sector performance improved in recent years due to (i) a more commercial approach, (ii) restructuring through re-capitalization and capacity-building, and (iii) strengthened regulation reducing the proportion of distressed RCBs.
    - At S&Ls and credit unions: weak financial performance due to welfare focus and low interest rate policies improved through greater commercial focus and better management and financial reporting.
    - From 1996 to 2001, the proportion of “unsatisfactory” credit unions declined from 70 percent to 60 percent and that of those in the worst categories from 42 percent to 15 percent.
  - Guinea
    - The four existing MFIs reported strengthened financial performance over the period 1997–2003 by lowering the share of non-performing loans (NPLs) in total credit, raising lending rates, and maintaining a wider interest rate spread than in the banking sector.
    - The share of NPLs in the four MFIs was considerably lower than that of the commercial banks.

### Links between MFIs and banks: complementarities and risks
- Complementarities
  - MFIs build on informal mechanisms (susus and tontines) to create channels for capital infusions from formal banks, donors, and governments.
  - Banks and MFIs service substantially different client bases: banks focus on the formal private sector and government; MFIs service poor and rural households and informal small entrepreneurs.
  - MFIs benefit as bank clients: commercial banks manage MFIs’ deposit accounts, provide liquidity management services (e.g., emergency credit lines), and sometimes extend credit facilities that allow MFIs to expand services.
  - Branch network sharing and cooperative arrangements (examples: Guinea, Tanzania) can extend outreach and achieve economies of scale.
  - Banks can use MFI networks to expand credit to rural clients; MFIs can link micro-enterprises to corporate supply chains (example: NMB of Tanzania).
- Risks and limitations
  - Banks have been cautious in extending credit lines to MFIs due to spillover risk if MFIs fail.
  - Expansion of credit to new borrowers may increase default risk, loan administration and monitoring costs, potential strategic collusion among informal lenders, and contamination of borrower pools—so borrowing costs may not fall initially.
  - Nonetheless, credit from formal MFIs is generally much less costly than from informal money lenders.

### Roles of donors and NGOs in microfinance
- Channels of support
  - Domestic NGOs or donor-managed microfinance projects.
  - Microfinance institutions functioning like leasing companies that receive wholesale external resources and lend to clients—mainly credit-only schemes often using group solidarity lending.
- Country illustrations (credit-only NGO/donor-supported institutions)
  - Guinea: PRIDE/Finance and 3AE operate wholly donor-financed micro-lending entities in urban areas; PRIDE/Formation provides independent training.
  - Benin: Nine associations involved in microfinance; PADME and PAPME are significant; these associations do not collect deposits and rely on domestic banks or external donors; converted into private voluntary associations in 1997; funded by donor institutions including the World Bank under a private sector development project (1999) providing credits to on-lend and grants for technical assistance.
  - Ghana: NGOs focus on poverty with deep penetration to poor clients; total outreach limited to about 60,000 clients; NGOs are not licensed to take deposits and rely on donor funds; they introduced international methodologies such as group solidarity.
- Advantages and criticisms
  - Advantages: NGOs/donors disseminate best practices, provide capacity building, training, and entrepreneurial skills development; efficient in regions where licensed MFIs are scarce.
  - Criticisms: NGO support may weaken financial discipline in MFIs; dependence on donor money rather than deposit mobilization can constrain growth and sustainability; donor-directed lending may crowd out commercially viable projects and misdirect lending; NGOs’ broader activity portfolio limits outreach in microfinance.
  - Policy implication: Donor support should balance lending resources with encouragement of domestic saving mobilization and capacity building to promote full intermediation and sustainability.

### Government role and regulatory evolution
- Historical reliance on state-owned banks to extend rural credit and microfinance led to large losses requiring restructuring, recapitalization, privatization, or liquidation.
- Lessons learned:
  - Shift toward financially viable approaches to microfinance and development of regulatory and supervision frameworks adapted to support sustainable microfinance.
  - Regulatory evolution often followed a cycle of easy entry, weak performance, and tightening regulation plus restructuring.
  - Failures of major institutions precipitated major restructurings enabled by simultaneous strengthening of regulatory environment and supervisory capacity to avoid moral hazard problems.

*Source: Box 2, _wp04174 - Building on Informal Sector Savings and Credit Mechanisms: The Example of the Ghana Susu System*

### Box 4. Restarting on a Sound Base: Restructuring and Addressing Regulatory Failures

### Box 4. Restarting on a Sound Base: Restructuring and Addressing Regulatory Failures

### Restructuring experiences and lessons (case studies)
- Benin
  - Largest microfinance institution’s loan portfolio deteriorated significantly in 1998.
  - Institution stopped new credit extension and engaged in comprehensive rehabilitation with donor technical assistance.
  - Program aimed at: (i) reducing nonperforming loans; (ii) temporary blocking of new credit extension; (iii) improvement of internal control and procedures; and (iv) restructuring the network through changing the status of some of the SLCs and putting some under tutelage.
  - Rehabilitation programmed to continue until 2004.
  - Outcomes reported: total deposits and credit expanded rapidly; progress in recovering nonperforming loans; positive net profits were recorded in 2002.
  - Legal/supervisory context: microfinance law enacted at the end of 1997; application decrees and central bank instructions setting prudential rules and reporting requirements in 1998; authorities concentrated on strengthening supervision capacity with donor assistance.
- Ghana
  - World Bank assisted recapitalization and capacity building of rural credit banks at the outset of 1990s.
  - Coupled with strengthened supervision and stricter reserve requirements by the central bank, positive results followed.
  - Financial health indicators: number of rural credit banks classified as having satisfactory financial situation increased from 23 out of 123 in 1992 to 61 out of 128 in 1996.
- Guinea
  - Donors involved in operational and financial audit of the largest microfinance institution after its failure.
  - Audit identified severe liquidity problems and losses due to bad portfolio quality, mismanagement and capacity problems, and weaknesses in regulatory and supervisory environment.
  - After liquidation decision, the central bank issued instructions to strengthen the regulatory environment and a microfinance law is currently being prepared.
- Tanzania
  - Restructured and recapitalized banks involved in microfinance were required to comply with licensing and regulatory requirements before restarting operations.
  - Largest microfinance-oriented commercial bank emerged from restructuring and recapitalization of the state-owned bank; it is being prepared for privatization.
  - Privately-owned bank CRDB was restructured and recapitalized before entering the microfinance sector and lending to downstream cooperatives for on-lending.

### Objectives and coverage of the regulatory framework
- Rationale
  - Create a healthy environment for microfinance activities while not stifling growth by imposing undue requirements.
- Design principles
  - Frameworks for licensing, regulating and prudential supervision need to be well adapted and flexible to reflect specific characteristics and stage of evolution of the microfinance sector.
  - Peculiarities of the microfinance sector necessitate either a dedicated law for the sector, or adequate treatment under other legislation.
- Country approaches (as discussed)
  - Benin: dedicated microfinance law.
  - Guinea: microfinance law currently being finalized.
  - Ghana and Tanzania: regulation under commercial banking laws, and separate laws for cooperatives and non-bank financial institutions.
- Adaptive regulation by institution type
  - Benin: microfinance law regulates deposit-collecting institutions; credit-only institutions regulated mostly through individually signed framework agreements with the Ministry of Finance.
  - Guinea: prudential regulations vary with institution type — three categories: MFIs that collect deposits and lend only to members; those that collect deposits and lend to non-members; and those that undertake mainly donor financed lending operations.
  - Ghana and Tanzania: three-tiered systems — most formal institutions regulated as banks, semi-formal as nonbank financial institutions, informal remain unregulated.
- Prioritization principle
  - Greater supervisory attention to larger institutions and/or more risk-prone MFIs given high unit cost of supervision and limited supervisory resources.
- Life-cycle and tiered formalization
  - Regulation should provide clear guidelines for semi-formalizing and fully formalizing institutions (examples: Benin, Tanzania).

### Minimum regulatory requirements and supervision practices
- Core regulatory requirements: licensing, information transmission requirements, prudential norms.
- Licensing approach: gradual — newer and smaller institutions encouraged to apply for licensing with fewer regulatory requirements; larger institutions regulated and supervised more closely and strictly.
- Supervision practices (country illustrations)
  - Benin: several on-site inspections during the year assessing governance, accounting, financial and credit management, compliance with prudential ratios.
  - Guinea: central bank uses off-site and on-site audits but supervision impeded by institutional capacity constraints, especially lack of qualified staff.
  - Ghana: high costs and limited supervision capacity led Bank of Ghana to rely more on strict regulatory requirements than on intensive supervision.
- Suggested minimum prudential rules for larger institutions include:
  - capital requirements (minimum capital limit, minimum retained earnings, or capital adequacy ratios),
  - risk concentration limits (on single borrowers),
  - liquidity limits,
  - well-defined provisioning requirements.

### Accompanying measures (capacity-building and supporting infrastructure)
- Institutional capacity building for MFIs:
  - bookkeeping and reporting standards,
  - strengthening internal controls and credit decision mechanisms,
  - improving technology and human resources.
- Supervision capacity:
  - address competence and effectiveness of supervising staff, and focus given high unit costs of supervision.
- Borrower information infrastructure:
  - development of borrower database infrastructure, improved data compilation, establishment of credit bureaus.
- Judicial and enforcement environment:
  - enforcement of microfinance regulations and general business-related laws crucial for sector development.
- Role of donors:
  - coordinated government and donor effort is helpful particularly for the first two accompanying measures.

### Prudential requirements summary (Box 6)
- Prudential items and country application (check indicated as in source):
  - Minimum capital — Benin √; Ghana 1/ √; Guinea √; Tanzania 2/ (√)
  - Reserve requirement — Benin √; Ghana (blank); Guinea (blank); Tanzania √
  - Capital Adequacy ratio — Benin √; Ghana √; Guinea (blank); Tanzania √
  - Limit on total risks — Benin √; Ghana (blank); Guinea (blank); Tanzania (blank)
  - Limit on loans to a single borrower — Benin √; Ghana √; Guinea √; Tanzania √
  - Limit on insider loans — Benin √; Ghana (blank); Guinea (blank); Tanzania (blank)
  - Limit on total large loans — Benin (blank); Ghana √; Guinea (blank); Tanzania (blank)
  - Limit on liquidity ratios — Benin √; Ghana √; Guinea √; Tanzania √
  - Limit on coverage of non-short term liabilities by non-short term assets — Benin √; Ghana (blank); Guinea (blank); Tanzania (blank)
  - Ceiling on non-secured loans — Benin (blank); Ghana (blank); Guinea (blank); Tanzania √
  - Ceiling on fixed assets — Benin (blank); Ghana (blank); Guinea (blank); Tanzania √
  - Ceiling non-microfinance activity — Benin (blank); Ghana (blank); Guinea (blank); Tanzania √
  - Provisioning requirements — Benin √; Ghana √; Guinea √; Tanzania √
- Footnotes (preserved as in source)
  - 1/ In Ghana, these prudential rules apply to microfinance institutions subject to commercial banking laws.
  - 2/ In Tanzania, the prudential rules apply to commercial and microfinance banks (including unit rural banks) registered under the commercial banking law. Saving and credit unions are effectively not regulated or supervised.

### Conclusions — key findings and policy implications
- Demand and institutional form
  - Poor populations, particularly rural, value both deposit and credit facilities; growth of cooperative banking and combined savings and credit institutions reflects demand for both.
- Formal–informal linkages
  - Strong linkages exist; formal institutions have drawn on informal savings mobilization methods and in some cases become bankers to informal institutions.
- Operational characteristics
  - Group-based savings-cum-credit institutions rely on peer pressure and joint liability rather than collateral.
  - MFIs often rely on short maturities, high-frequency payments, and sometimes compulsory security deposits.
- Financial sustainability
  - MFIs that mobilize deposits and extend credit tend to fare better financially than those specializing exclusively in either activity or dependent exclusively on donor/government funds.
  - Performance depends critically on management autonomy (deposit and lending rate setting), vigilance to avoid nonperforming loans, and building institutional capacity.
- Linkages with banks
  - Growing MFIs–bank linkages are mutually beneficial: MFIs obtain deposit facilities, liquidity management and emergency lines; banks expand client base and networks.
  - Linkages facilitate small entrepreneurs’ graduation from microcredit to conventional bank loans.
- Role of donors and NGOs
  - Donors/NGOs have supported dissemination of best practices, capacity building, and borrower entrepreneurship; NGO direct lending impacts are mixed due to subsidized lending effects.
- Government role and regulatory design
  - Governments play key role in laws, regulations, institutions for licensing, prudential regulation, and supervision.
  - Practices vary widely; requirements for MFIs are generally less demanding than for commercial banks; newer and smaller MFIs face less exacting licensing and supervision.
  - Growing linkages and potential systemic effects imply licensing, regulation, and close prudential supervision of MFIs will become increasingly important.
- Main constraints to regulatory and supervisory framework development:
  - Lack of bookkeeping and reporting standards, internal controls, and credit decision mechanisms at MFI level.
  - Shortage of skilled and trained staff in supervisory institutions.
  - Weak borrower information/database on credit histories and repayment records.

*IMF Working Paper — Box 4. Restarting on a Sound Base: Restructuring and Addressing Regulatory Failures*

### References

### _wp04174 - References

### Microfinance regulation and policy
- CGAP, 2000, “The Rush to Regulate: Legal Frameworks for Microfinance,” CGAP Occasional Papers, No. 4 (Washington: Consultative Group to Assist the Poorest).
- Ouattara, K., 2003, “Microfinance Regulation in Benin: Implications of the PARMEC Law for Development and Performance of the Industry,” Africa Region Working Paper, No. 50 (June) (Washington: World Bank).
- Steel, W. and D. Andah, 2003 (June), “Rural and Microfinance Regulation in Ghana: Implications for Development and Performance of the Industry,” Africa Region Working Paper, No. 49 (Washington: World Bank).

### Microfinance institutions, practice, and outreach
- Bank of Tanzania, 2004, “An Overview of Microfinance Industry in Tanzania,” paper presented to the Joint BoT/NBAA seminar on the role of microfinance in poverty alleviation (unpublished; Dar es Salaam: Bank of Tanzania).
- Bennett, L., 1998, “Combining Social and Financial Intermediation to Reach the Poor: the Necessity and Dangers,” in Strategic Issues in Microfinance, ed. by M. Kimenyi, R. Wieland, and J.D. von Pischke (Ashgate Publishing).
- Blavy, R., 2003, “The Microfinance Sector in Guinea,” in Guinea—Selected Issues and Statistical Appendix 2003 (Washington: International Monetary Fund).
- Chao-Béroff, R., 2003 (July), “Rural Savings Mobilization in West Africa: Guard Against Shocks or Build an Asset Base,” The Microbanking Bulletin, No. 9, pp. 16–18 (Washington: Microfinance Information Exchange).
- Hirschland, M., 2003 (July), “Serving Small Depositors: Overcoming the Obstacles, Recognizing the Tradeoffs,” The Microbanking Bulletin, No. 9, pp. 3–8 (Washington: Microfinance Information Exchange).
- Ledgerwood, J., 1999, Microfinance Handbook: An Institutional and Financial Perspective (Washington: The World Bank).
- Rutherford, S., 1999, “The Poor and Their Money,” Finance and Development Research Program Working Paper, No. 3, Institute for Development Policy and Management, University of Manchester.
- Wright, G., 2000, Microfinance Systems: Designing Quality Financial Services for the Poor (New York: Zed Publishers).

### Theoretical, evaluative, and contextual studies
- De Aghion, A. and J. Morduch, 2003, “Microfinance: Where Do We Stand?” in Financial Development and Economic Growth: Explaining the Links, ed. by C. Goodhart (Basingstoke: Macmillan/Palgrave).
- World Bank, 1997, “Voices of the Poor: Poverty and Social Capital in Tanzania,” Environmentally and Socially Sustainable Development Studies and Monograph Series, No. 20 (Washington: World Bank).

*Source: _wp04174 - References*

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