Last month the Deputy Permanent Secretary of the Ministry of Finance, Dorothy Mwanyika, announced that the government will enact a new law governing the microfinance sector. This is welcome news. Despite having 52 banks with over 600 branches, over 5,500 savings and credit cooperative societies and 170 credit-related NGOs, Tanzania still has one of the lowest financial inclusion rates in East Africa.
Recent World Bank statistics show that just 17% of the adult population has access to formal financial services (or 22% if unregulated providers are included), compared to Kenya’s 42% and Rwanda’s 33%. Existing regulation is insufficient to address the complex needs of the sector and does not cover all providers. To address this problem, the Bank of Tanzania (BOT) is looking to reform the legal and regulatory framework governing microfinance activities. This month’s briefing will highlight some of the strengths and weaknesses of this framework and explore ways in which it can be improved.
Brief history of the microfinance sector
In the year 2000, the Tanzanian government adopted the National Microfinance Policy (NMP) as a means to reduce poverty and spur economic growth. The NMP came at a time when the microfinance sector was underperforming due to a disjointed legal and regulatory framework: microfinance institutions (MFIs) were poorly managed and different laws were being applied to different microfinance schemes.
Despite its adoption, and despite the proliferation of MFIs in the country, the NMP has not fully succeeded in revolutionising the microfinance sector as originally envisaged. The Tanzania Association of Microfinance Institutions and the Tanzania Informal Microfinance Association of Practitioners, which represent the formal and informal stakeholders, are pushing for reform in the sector.
Current legal and regulatory framework
MFIs are currently governed by the BOT and the following laws:
|The Bank of Tanzania Act 2006||BOT Act|
|The Banking & Financial Institutions Act 2006||BFI Act|
|The Banking & Financial Institutions (Microfinance companies & Microcredit Activities) Regulations 2005||Microfinance Regulations|
|The Banking & Financial Institutions (Financial Cooperative Societies) Regulations 2005||FCS Regulations|
|The Banking & Financial Institutions (Internal Control & Internal Audit) Regulations 2005||Internal Control Regulations|
|The Banking & Financial Institutions (Licensing) Regulations 2008||Licensing Regulations|
Strengths and weaknesses of the current framework
Weakness – unregulated MFIs
The BOT Act states that the BOT’s principal function is to, among other things, regulate financial institutions. "Financial institutions" is defined under section 3 of the BOT Act as an entity engaged in the business of banking, with "banking" meaning the receiving of funds from the general public through deposits, bonds and other securities. These definitions are very broad and presumably include the majority of MFIs.
However, the Microfinance Regulations only apply to MFIs licensed by the BOT as "microfinance companies". There are, of course, MFIs in Tanzania that come in unincorporated forms, namely cooperative societies. According to the FCS Regulations, a cooperative society becomes subject to supervision applicable to large-scale financial institutions if it possesses deposits in excess of TSH 800 million (USD 440,000). If this amount is reached, a cooperative society will graduate into a "financial cooperative society" as per regulation 9 of the FCS Regulations.
One important observation can be drawn from this: the current legal framework does not clearly identify which MFIs fall within the BOT’s regulatory ambit. On the one hand, the BOT is empowered to regulate and supervise any MFI by virtue of section 4 of BFI Act. Yet, the FCS Regulations make it clear that small-scale MFIs are not subject to the Microfinance Regulations (and thus the BOT’s control) until they reach a certain threshold. Even if these MFIs fall under the "financial institution" heading, regulation 23 of the Licensing Regulations stipulates that an institution licensed by the BOT must be "in the form of a company limited by shares and incorporated under the laws of Tanzania".
You therefore have a situation where a regulator is empowered to regulate the unlicensed, but the unlicensed have been left unregulated.
Weakness – exposed customers
MFIs can reach audiences which have typically been ignored by banks and other traditional lending institutions: the poor, the rural and small-scale enterprises. Nevertheless, the current framework fails to adequately protect the needs of this wider and much more vulnerable audience.
For example, pricing is singled out in the NMP as a matter which should be left to a MFI’s control. After all, it alone "has the full knowledge of its costs, the market it faces, and its own business strategy". This is reflected in the law under section 24 of the BFI Act, which broadly lists the type of activities which financial institutions may engage in. Regulation 26 of the Microfinance Regulations gives the BOT the power to prevent MFIs from abusive lending practices. However, this power is exercised only upon monitoring the collection practices of the MFI itself. Outside of this, the regulation does not allow unsatisfied customers to issue complaints to the BOT in the event that they are subjected to abusive and exploitative practices.
Strength – prudential regulation
MFIs that are regulated by the BOT are subject to prudential regulation; a type of regulation which ensures that certain professional standards are met and kept. Regulation 9 of the Internal Control Regulations obligates MFIs to implement "an effective system of internal controls that is consistent with the nature, complexity, and risk inherent in their on and off-balance sheet activities". The purpose of this system is to, among other things, mitigate risks.
The Internal Control Regulations go on to describe the sorts of controls which should be used in such systems, notably "top level reviews; appropriate activity control for different departments or divisions; physical controls; checking for compliance with exposure limits and follow-up on non-compliance".
Strength – innovative regulator
The BOT has extensive powers under the BOT Act and BFI Act, which means it is in a prime position to innovate the microfinance sector. Fortunately, the BOT is using its powers to do just that.
In November 2014, the BOT established the Small Entrepreneurs Loan Facility (SELF), to give out loans to MFIs which are serving undercapitalised entrepreneurs. To qualify for a loan, a MFI must meet the following criteria:
- Be a legal entity
- Be operating or willing to operate in a project area chosen by the BOT
- Have a board of directors
- Have staff qualified in microfinance delivery services
- Have been in business for at least 1 year
- Have a business plan which covers a period of 3 years
- Have evidence that there are additional sources of funds to sustain the project after SELF pulls out
Microfinance Act – a game changer?
One of the reasons why Kenya and Rwanda have such high financial inclusion rates is due to the presence of clearly defined microfinance laws. Tanzania should be able to catch-up in light of the upcoming Microfinance Act (the Act).
The Act presents the perfect opportunity for the BOT to put the NMP back on track. The Act could, for instance, provide for a variety of legal structures (e.g. company limited by guarantee, cooperative societies) and accommodate the variety of services provided by MFIs (e.g. securing loans with non-traditional securities). Furthermore, the Act could establish a separate microfinance regulator to reduce the burden on the BOT’s already overloaded supervisory resources. In fact, the Deputy Permanent Secretary has suggested that an independent microfinance coordination unit will be established within the Ministry of Finance to deal with all MFIs which are not managed by the BOT.
In addition, it is hoped that the Act will address some of the practicalities which burden the operations of MFIs, such as difficulties in enforcing defaulted loans, and stringent know your customer requirements which are hard to operate with small clients in rural areas.
The BOT currently estimates that the first draft of the Act will be available around June 2015. We will provide a further update once the draft becomes publicly available.