Regulation and Capital Requirement for Microfinance in Ghana

Introduction

Microfinance regulation in sub- Saharan Africa gained momentum from 2001 to 2009 with about 31 countries passing new or revising microfinance regulations whiles 24 countries adopted national microfinance strategies. The regulation of the sector in Ghana however became effective in 2011. Regulations potentially open a door to variety of funding opportunities for the MFIs. It serves to protect the users of microfinance institutions and creates confidence for the activities of microfinance companies.

In Ghana the minimum capital requirement for establishing microfinance for tiers 1 to 3 have been reviewed upwards. New rural banks as well as savings and loans companies which falls under tier 1 are now mandated to show evidence of  a minimum amount of GH¢ 300,000.00 and GH¢16 million respectively. Deposits and non deposit taking microfinance institutions would need to have a minimum capital amount of GH¢500,000.00 and GH¢300,000.00 respectively. Already existing microfinance companies as per the directives have up to 2016 to meet the new capital requirement.

The microfinance regulatory regime was officially made effective in July 2011. After a period of almost two years the capital requirement had been increased largely in responds to certain occurrences’ or observations within the microfinance sector. It is important as an industry to know the key things that might have led to the review of the requirement and further understand the possible impact on the activities of the microfinance sector.

Ghana Association of Microfinance Companies (GAMC) which is the Apex bodies indicates that about 30 companies within the first quarter of 2013 have collapsed. The collapse of these companies are outcomes of various process that have not gone well and not necessary a onetime event. This collapses must be investigated to provide clear reasons to help diagnose appropriate solutions to safeguard the entire microfinance sector from systemic risk and any loss of confidence in the sector as a whole.

Increasing size of amount                                  

Classical microfinance defines microloans as a small short-term loan made to impoverished or low income entrepreneurs. The small nature of micro loans over time has  evolved from country to country but it is still define on the principle of “small” .Practical evidence  however suggests that some  microfinance institutions in  Ghana are now disbursing loans above the amount of five thousand Ghana cedis (GHC¢5,000.00) to individuals as microloans.

Prudential credit managements regulate the quantum of loan that a bank can give to one individual customer. This same regulation applies to MFIs and therefore going by this rule MFIs can give loans in amount up 10% or 25% of MFI capital. The percentages are dependent on whether a loan is collateralised or  not respectively. This, therefore, implies that microfinance with average minimum capital amount of GH¢100,000.00 can technically give loans up to an amount of GHC 25,000.00 if that loan is secured and GH¢10,000.00 if unsecured.

Going by the single obligor rule, MFIs can grant such amounts to individual clients however the question is do the MFIs have the logistics and human resource base to make and monitor such loans? Can we classify these loans as micro?

Micro loans business depends on volumes in order to be profitable. In view of the complexity and the difficulty in managing micro loans, MFIs in Ghana in order to generate enough to cover their cost rather opt for large loans sizes which at least guarantee appreciable interest return.

Accompanying the increasing loan sizes is the rise in the  non-performing loans on the books of most MFIs. The truth is that, the more the non-performing loans increase the more the income sources of the MFIs decreases. This is because interest from loans forms about 90% of total income of all MFIs. The more MFIs record losses the weaker the networth of the MFI .A continuous loss position over time can lead to a negative networth eroding all the capital contributions of the shareholders.

 Branching without recourse to capital requirement

During the pre- regulation period most MFIs established branches to improve outreach, customer growth and increase deposit mobilization. Some MFIs even established more than one branch within their first years of operation. The phenomenon of branch establishment has not necessary ceased during the post-regulation era but the rate has reduced. Most of the multiple branched MFIs have their history dating back to the pre-regulation period.

Studying the MFIs, I noticed that some of the owners of the MFIs saw branching as the only way of growing. They thereby focused on extending their operations to other locations without having to inject new capital. In most cases the growth was fueled by clients’ deposits and short term loans either from investors or the banks. The decision to grow long terms goals (branches) with short terms liquidity created liquidity mismatches which have contributed to the collapse of some of the institutions. The inability to adequately manage liquidity (deposits) has contributed to the inability to meet deposit demands which in most cases have compelled owners of such MFIs to go into hiding.     

There are other factors that have negatively affected the operations of MFIs have contributed to the collapse of some of these MFIs. These factors may include weak credit risk management policies, weak internal control procedures, fraud and poor inter branch management policies.

 What informs the setting up of Microfinance Capital Requirement?

 The main objective of financial regulation is to ensure safety and soundness of the financial sector. This therefore informs the reason behind increasing the capital requirement in order to streamline the risk activities of the MFIs. The increase in the capital requirement is expected to cover MFIs that will want to increase outreach by establishing branches since each branch to be established will have to be supported by an additional capital requirement. An increase capital base therefore ensures that depositors’ funds are not entirely to in the branch expansion.

Empirical evidence suggests that the setting up of capital requirement for microfinance activities are considered based on the hard part of regulation which is the safety and soundness as well as the social aspect of microfinance which is associated with poverty reduction. These underlining factors have affected the capital requirement set for all microfinance banks in most economies across Africa.

Microfinance is a special field considering the fact that it aims at providing financial access to the poor and the low income. This is one of the more reasons why their capital requirements are concessionary low. The stakeholders must therefore consider appropriate framework to ensure a right balance between impact and enforcement. The various players in the industry must therefore understand the actual happenings within the microfinance sector to enable Ghana achieve the best results in line with poverty reduction. These are some of the reasons why there have been reviews in almost all the countries reviewed as shown in the table below.

The table below compares the amount needed as capital need for deposit taking MFI across some selected countries. It can be noted that that the stated amounts are relatively within the same region. This is not withstanding the fact that majority of the amounts quoted have be reviewed over in line with the growth of the particular sector. Another key observation noted here is that although the regulatory framework for Ghana was one of the latest in the category; its capital requirement is one of the highest. The reason behind the different amounts can further be studied to give a broader understanding.

Table: Capital requirement for one Unit branch

Country	Number of years of regulations	Requirement for Deposit taking MFI(USD)
Uganda	2003	195,312.50
Kenya	2005	229,885.00
Nigeria	2005 revised in 2011.	124,069.48
Ghana	2011	263,157.00

    Compiled from many source.

Capital requirement and the future of microfinance

The upward review of capital requirement can help in managing risk associated to the increasing trading activities of the MFIs and further help protect the industry as well as the depositors. There are other non-financial activities that are the main treats to the industry which also requires a positive review. For instance capital amounts cannot protect the sector from the incidence of collapse if the key issues which are more intrinsic in the MFIs are not adequately addressed.

Minimum capital is an entry requirement and cannot help in improving operations of the MFIs and safeguard them against liquidity challenges. Key managers of microfinance institutions must build their capacity in  the management of the MFIs  to avoid liquidity mismatch.

Increasing capital requirement cannot necessary reduce the risk appetite of MFIs owners. The challenge with the microfinance sector in Ghana is that majority of them mobilize short (mostly 30 days) and turn these deposits into loans with tenor of 16 weeks or more. There is therefore an issue of mismatch creating the liquidity challenges. There must a national plan whether private or governmental to establish a specialized fund to support the liquidity needs of MFIs who for me are equally contributing to fill an economic need. The microfinance regulation in Nigeria spells out clearly the setting up of a fund to provide funding support to MFIs. 

The absence of a local “in country” on-lending fund is hampering access to loans to help support the operations of these MFIs. Such loans will have special rate and duration to allow the MFIs to work and repay over time compared with the current harsh borrowing requirement majority of them are exposed to. With the establishment of this fund and some managerial capacity most of the collapsed MFIs might not have gone down.

Another creeping challenge with the microfinance sector is that MFIs are experimenting with the granting of large loan sizes. However, these MFIs do not have the structures, logistic and human resource to appraise and manage these large loan sizes. This experiment has resulted in the  difficulty in loan management a situation that has contributed to  increasing delinquency  within the microfinance sector.

In view to help MFIs to desist from experimenting with large loans sizes, there should the need to have a national definition of a “micro loan” within the borders of Ghana. The MFIs must be provided with a benchmark amount beyond which an institution licensed as a microfinance company must not be allowed to. This will ensure that MFIs avoid mission drift and as well manage loans that they are capable of managing. MFIs must match the loans they grant to their logistics and as well as their human resource to enable them to grow healthy loans.

Review of capital requirement are largely done base on the traditional principles of regulation and the social aspect of microfinance. If considerable investment capital is earmarked for the establishment of microfinance as a regulatory requirement, there is the chance that owners of the MFIs will only consider to target clients that can support their activities to meet their investment returns. Impact of the sector will therefore be missed and the role of microfinance may not be fully achieved.  

Conclusion

The Microfinance sector has become a key player within the financial system of Ghana. MFIs have been identified to be instrumental in achieving financial inclusion.  Apart from the core business of providing financial assess MFIs provide a source of employment to a number of people. When a microfinance company collapses, it goes down with people’s investment and renders the poor client poorer. As regulatory takes steps to protect the sector, the MFIs themselves must look within their set up and operate within the prudential requirements. 

 The safety and soundness of the microfinance sector in Ghana can only be achieved when the capacity of the owners and manager of MFIs are improved. Increasing capital requirement will not arrest the issue of entry, mismanagement and collapse of MFIs.