What led to the dynamic growth of the microfinance market in the Philippines? According to Dr. Gilberto Llanto in this Policy Notes, the microfinance market in the country owes its rapid development to a large extent to the emerging policy environment and regulatory framework crafted by the government. Said progress in developing the policy and regulatory architecture for microfinance is discussed in this Notes in greater detail.microfinance, microfinance regulation, microfinance market

Llanto, Gilberto M.

English

Research Papers in Economics

Policy Notes
September 2003 No. 2003-07
PHILIPPINE INSTITUTE
FOR DEVELOPMENT STUDIES
Surian sa mga Pag-aaral
Pangkaunlaran ng Pilipinas
Developing the Policy
and Regulatory Architecture
for Microfinance
in the Philippines
Gilberto M. Llanto*
PIDS Policy Notes are observations/analyses written by PIDS research-
ers on certain policy issues. The treatise is holistic in approach and
aims to provide useful inputs for decisionmaking.
The views expressed are those of the author and do not necessarily
reflect those of PIDS or any of the study's sponsors.
A
“A house built on sand was washed away.
That built on stone, stood its ground.”
few decades ago, the poor and small-scale cli-
ents such as microentrepreneurs were practi-
cally shut out from the formal financial sys-
tem. It is well known that traditional banks do
not cater to the poor for various reasons, e.g., the poor’s
inability to provide collateral, asymmetry of information,
high transaction costs, and a host of other reasons. As
such, the poor did not have access to loans and other
finance services usually provided by the formal banking
system.
The dynamic and growing microfinance market...
To address this deficiency, microfinance institutions
(MFIs), which initially included only the credit-granting
nongovernmental organizations (NGOs) and then later, a
slowly growing number of rural banks, rose to the chal-
lenge. They set up schemes that evolved through the
years and enabled the poor and the disenfranchised sec-
tors to borrow and enjoy various financial services that
would otherwise not be made possible through the banks.
Recent data from the Microfinance Council of the Philip-
pines (MCP), People’s Credit and Finance Corporation (a
government-owned finance company), and the Bangko
Sentral ng Pilipinas (BSP) thus indicate that as of the
first semester of 2003, close to 800,000 poor individu-
als have borrowed from MFIs (NGOs and rural banks).1
On the deposit-taking side, rural banks, especially those
participating in the Microenterprise Access to Banking
Services project of the Rural Bankers’ Association of the
Philippines (RBAP) report substantial increases in their
deposit bases in view of the innovative microfinance tech-
nologies provided by the project. Credit unions under the
Credit Union Empowerment and Strengthening Project in
Mindanao and the NGO members of the MCP also indi-
cate significant increases in their respective savings cam-
paigns.
The microfinance market in the country, however, owes
its rapid development to a great extent to the emerging
_______________
*The author is Vice-President, Philippine Institute for Devel-
opment Studies (PIDS) and Research Fellow, Rural Development
Research Consortium, University of California-Berkeley.
1For details, please see Gilberto M. Llanto. 2003. A microfinance
promise: to give the poor access to finance services. PIDS Policy Notes
No. 2003-06.September 2003 2
Policy Notes
policy environment and regulatory framework crafted by
the government, including the BSP. This Policy Notes2
provides a brief discussion of the progress so far made
in developing the policy and regulatory architecture for
microfinance. It then draws attention to the need for regu-
lators to make efficient responses to innovations in the
microfinance market.
needs a market-based policy and regulatory
framework . . .
What is the government’s overall policy in microfinance?
The government’s market-based microfinance policy is
encapsulated in the National Strategy for Microfinance
which contains the following principles:
X The government’s role is to provide a policy envi-
ronment that is conducive to the increased participation
of the private sector in microfinance;
X Private MFIs (defined as credit-granting NGOs,
microfinance-oriented banks, and credit unions) shall have
a greater role in the provision of microfinance services;
X Market-oriented financial and credit policies, includ-
ing market-oriented interest rates on loans and depos-
its, are necessary to ensure the viability and sustainability
of MFIs and the continuing access of poor people to fi-
nance services;
X Nonfinancial (line) government agencies shall not
be allowed to participate in the implementation of credit
and guarantee programs; and
X It is important to have appropriate regulation and
supervision of microfinance to “protect the financial sys-
tem from unsound practices by deposit-taking institutions
and small clients.”3
Meanwhile, the basis for the emerging regulatory frame-
work for thrift banks and rural banks engaged in
microfinance is Section 40 of the General Banking Act of
2000. This section recognizes the peculiar characteris-
tics of microfinance and directs the Monetary Board of
the BSP to issue appropriate measures for the regula-
tion and supervision of such banks. In response, the BSP
issued the following circulars:
X BSP Circular 272 (January 30, 2001) which recog-
nizes the peculiar characteristics of microfinance and
directs its exemption from rules and regulations issued
by the Monetary Board with regard to unsecured loans;
X BSP Circular 273 (January 30, 2001) which lifts the
moratorium on bank branching for those banks engaged
in microfinance activities; and
X BSP Circular 282 (April 19, 2001) which opens a
rediscounting window for microfinance.
The end goal of microfinance regulation is to ensure that
MFIs maintain sound and prudent practices in their op-
erations that invariably employ innovative and nontradi-
tional lending methodologies. Thus, according to the Na-
tional Credit Council (NCC), “microfinance regulation re-
fers to the issuance of the necessary rules and regula-
tion, including cancellation, suspension, [and] sanctions,
governing the intermediation of microfinancial services.”4
The current regulatory environment has also considered
the diversity of institutions involved in the delivery of
microfinancial services such as thrift banks, rural banks,
credit cooperatives or credit unions and the credit-grant-
ing NGOs. The BSP supervises the thrift banks and rural
banks while the Cooperative Development Authority (CDA)
supervises the credit cooperatives or credit unions. There
is no regulatory body, on the other hand, for credit-grant-
ing NGOs.
Because of the peculiar nature and characteristics of
microfinance, the BSP is likewise currently reviewing its
supervision and examination process for banks involved
in microfinance. More specifically, following international
————————
2This Policy Notes draws from Gilberto M. Llanto. 2003.
Microfinance innovations and the policy and regulatory environ-
ment: the Philippine case. Paper presented at the International Work-
shop: Assessing the Current and Legal and Regulatory Environment
for MFIs in Asia organized by the Food and Agriculture Organiza-
tion (FAO), Asian Pacific Rural and Agricultural Credit Association
(APRACA) and the Land Bank of the Philippines, Manila, July 15-
18.
3National Credit Council. 2003. Establishing an appropriate
regulatory framework for microfinance in the Philippines. Unpub-
lished document.
4National Credit Council. 2003. Ibid., page 3.No. 2003-07 3
Policy Notes
best practice, it has been recommended that a risk-based
supervision format be applied for microfinance.5 This is
a very important point considering that the results of the
study conducted by the Credit Policy Improvement Pro-
gram (CPIP) of the NCC show that “lenders subject to
BSP supervision guidelines and practices are unclear
about the BSP’s view on small, clean and unsecured loans
that are supported by informal financial information.”6
Thus, it is necessary for the BSP to review its rules and
regulations, e.g., branching guidelines, performance in-
dicators, manual of examination, and others, to ensure
that these do not act as barriers for banks to engage in
microfinance.
On the other hand, the CDA has yet to effectively regu-
late credit cooperatives since it is hampered by the con-
flicting mandates of regulation and development provided
for in its charter. For instance, a CPIP study found out
that the CDA has been mostly engaged in the registra-
tion, promotion and development of cooperatives to the
detriment of its regulatory function. In view of the fact
that credit cooperatives have shown great potential in
providing small-scale clients with access to microfinancial
services, it becomes equally important for the CDA to
provide a strong focus on its regulatory function. As noted
in Llanto (2000), credit cooperatives have shown how
effective they are in mobilizing millions of pesos of de-
posits from thousands of members, mostly coming from
the low- and middle-income classes. They have grown to
be even bigger than some rural and thrift banks and have
provided small borrowers with a reliable alternative to
informal moneylenders in various communities. What is
even more important is that they have given thousands
of small savers accessible deposit facilities. In view of
these, therefore, it is critical that said credit coopera-
tives likewise institute prudential norms and oversight
measures to protect their members’ deposits.7
To help establish the needed information infrastructure
for the effective regulation of credit cooperatives or credit
unions, the CPIP thus prepared a standard chart of ac-
counts, an accounting manual and a set of performance
standards for credit cooperatives/unions. Given some
implementing guidelines from the CDA and assistance
from the CPIP on the tools developed, accredited federa-
tions of credit cooperatives may be delegated to conduct
the supervision and examination of credit cooperatives/
unions.
With regard to credit-granting NGOs, meanwhile, they reg-
ister with the Securities and Exchange Commission (SEC)
as nonstock, nonprofit organizations and follow the regu-
lar corporate rules and regulations. They are not, how-
ever, subject to any prudential regulation. Credit-granting
NGOs collect “forced” savings or the so-called “capital
build-up” as compensating balance or proportion of the
loans of their microfinance client.8 The consensus among
these credit-granting NGOs is that they should be allowed
to collect said savings from their clients without being
subject to any prudential regulation provided that these
collected savings do not exceed their total loan portfolio.
Those that collect savings beyond the compensating bal-
ance shall be required to transform themselves into ei-
ther a bank or credit cooperative, both of which are regu-
lated entities.
Current initiatives are fine . . .
It is fortunate that MFIs and the government, including
the regulatory bodies, continue to engage in a fruitful
dialogue to ensure that the former are able to expand
their outreach and develop innovative lending method-
————————
5The idea of risk-based supervision was first brought out in lo-
cal discussions by Fitzgerald, T. and others. 2000. Regulatory barri-
ers to innovative lending practices: traditional approaches to bank
supervision. Credit Policy Improvement Program, National Credit
Council, Department of Finance. See also Gilberto M. Llanto. 2001.
Risk-based supervision of banks involved in microfinance. PIDS Policy
Notes No. 2001-01.
6National Credit Council. 2003. Op. cit., pages 4-5.
7Gilberto M. Llanto. 2000. Protecting deposits in savings and
credit cooperatives. PIDS Policy Notes No. 2000-08.
8National Credit Council. 2003. Op. cit., page 3. The com-
pensating balance refers to the proportion of the total loan of a
microfinance client that is retained with the MFI as “capital build-
up” or savings. This amount serves as a hold-out deposit on the loan
and can be used by the MFI to offset the borrower’s outstanding
loan balance in case of default.September 2003 4
Policy Notes
ologies. The NCC and the recently-established Microfi-
nance Council of the Philippines provide the needed fora
for ventilating and resolving issues that affect microfi-
nance operations. Current initiatives by these two bod-
ies consist of coming up with a repository of information
for credit-granting NGOs in the Microfinance Council of
the Philippines, setting up of a specialized regulatory unit
in the CDA and the formulation of a uniform set of perfor-
mance standards for all types of MFIs based on portfolio
quality, outreach, efficiency and sustainable operations
and transparency.
There seems to be an agreement among major players
in the microfinance industry on the need to establish a
private sector risk-rating agency to provide risk ratings
for MFIs. The regulatory authority, donors and wholesale
financial institutions will use the risk ratings in their evalu-
ation of the performance of the MFIs. A credit bureau for
microfinance, which shall serve as the repository of credit
information on microfinance clients, has also been iden-
tified as a necessary information infrastructure.
But new developments continue to pose
challenges . . .
The local microfinance industry is dynamic and growing.
From a single, and at times, uniform credit product, MFIs
now innovate on new lending methodologies and prod-
ucts to meet the demand of poor clients. Credit, savings
and insurance products are being developed to respond
to investment opportunities. For various types of risks,
health, disability and other microinsurance products are
similarly being developed. These products address both
income- and consumption-smoothing goals of the client
(Box 1).
Regulators and donors, to some degree, have to make
the MFIs conscious of the greater portfolio and liquidity
risks that new and innovative products entail.9 The prin-
cipal challenge to policymakers and regulators lies in deep-
ening and making more efficient the financial markets
through a favorable and stable policy environment (e.g.,
stable currency and price levels), transparent and appro-
priate legal and regulatory framework, and an efficient
information infrastructure.      
————————
9See, for example, Manfred Zeller. 2000. Product innovation
for the poor: the role of microfinance. Policy Brief No. 3. Rural Fi-
nance Policies for Food Security of the Poor. Washington D.C.: In-
ternational Food Policy Research Institute.
For further information, please contact
The Research Information Staff
Philippine Institute for Development Studies
NEDA sa Makati Building, 106 Amorsolo Street
Legaspi Village, 1229 Makati City
Telephone Nos: 892-4059 and 893-5705
Fax Nos: 893-9589 and 816-1091
E-mail: gllanto@pidsnet.pids.gov.ph;
  jliguton@pidsnet.pids.gov.ph
The Policy Notes series is available online at
http://www.pids.gov.ph
Box 1. Credit cards: a new wave
in microfinance?
As the market for credit cards for the well-to-do becomes
increasingly saturated in the Latin American region, finan-
cial service businesses are looking towards lower-income
strata. Market research by Mastercard, Citibank and oth-
ers has identified medium-low and low-income groups with
incomes as low as US$250 per month as part of an emerg-
ing market for credit cards. These clients are attractive
because they tend to maintain a balance on their accounts
and have low delinquency rates. A specialized card for
microenterprises, for example, has been launched in the
Dominican Republic. A microfinance NGO called ADEMI
has teamed up with Banco Popular to offer a Mastercard
to ADEMI’s microenterprise loan clients in good standing.
Cardholders can receive cash balances and make payments
through the 60 ATMs and 45 offices of Banco Popular
throughout the country. The card also offers travel and theft
insurance, bill payment services and consumer credit lines
for up to 12 months.
Source: Microenterprise Development Review, Inter-American
Development Bank, May 1998.

Developing the Policy and Regulatory Architecture for Microfinance in the Philippines

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Developing the Policy and Regulatory Architecture for Microfinance in the Philippines

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