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Rural and Micro Finance Regulation in Ghana: Implications for Development and Performance of the Industry Africa Region Working Paper Series No. 49 June 2003 Abstract L egislation and regulations governing rural and micro finance institutions (RMFIs) in Ghana have evolved with the market, both opening up possibilities for new types of institutions and tightening up to restrain excessive entry and weak performance in the face of inadequate supervision capacity. The result – though not entirely by conscious design – is several tiers of different types of RMFIs with a strong savings orientation and a much greater role of licensed institutions relative to NGOs than is found in many countries. Small unit Rural and Community Banks (RCBs) are accommodated in the Banking Act; savings and loan companies in the Non-Bank Financial Institutions (NBFIs) Law; and credit unions under a new law being prepared to recognize their dual nature as cooperatives and financial institutions. The informal sector is dominated by a variety of savings-based methodologies, both individual and group. Supervision of a large number of RMFIs is costly relative to their potential impact on the financial system (about 7% of assets), and the Bank of Ghana has adopted a number of strategies to cope with its limited supervision capacity: raising reserve requirement for RCBs to as high as 62%; drastically raising the minimum capital requirement for NBFIs; and permitting self-regulation of credit unions by their apex body. It is currently establishing an Apex Bank to serve the RCBs, link them more effectively to the commercial banking system, and take the lead in building their capacity and, eventually, in undertaking front-line supervision. Although the US$2 million minimum capital requirement makes the S&Ls less accessible for NGO transformation, it has led to introduction of foreign capital. While the RCBs have had limited outreach, some have effectively partnered with NGOs to introduce microfinance methodologies such as village banking, and they are now being strengthened as the backbone for expansion of rural financial services. Linkages also occur between informal savings-based “susu” institutions and both RCBs and S&Ls. The Bank of Ghana has taken a relatively laissez-faire position vis-à-vis the informal sector. Liberalization of financial policies in the late 1980s has enabled RMFIs to develop with relatively little interference, and without a clearly articulated national strategy. Nevertheless, continued high inflation and interest rates (particularly on Treasury Bills) has limited the incentive for commercial financial institutions to reach out to smaller, poorer clients (though enabling weak RCBs to improve their capital adequacy with highly restricted lending). Furthermore, directed, subsidized loans under current government poverty programs threaten to undermine loan performance and weaken the long-run potential for developing sound, self-sustaining RMFIs on a significant scale. While Ghana’s approach has yielded a wide range of RMFIs and products with the potential for substantial outreach to the poor and sustainability based on savings mobilization, it has also permitted easy entry of institutions with weak management and internal controls. Ghana’s experience demonstrates the difficulty of striking the right balance between encouraging entry and innovation on the one hand and establishing adequate supervision capacity on the other. In several segments – RCBs, credit unions, S&Ls – Ghana has gone through a cycle of easy entry, weak performance, tightening up regulations, and some restructuring (through closing insolvent units, takeovers, or infusion of new investment). The Bank of Ghana has exercised considerable regulatory forbearance in allowing weak units time to comply with stricter regulations (or, in the case of the credit unions, to establish a self-regulating system while awaiting passage of a new law). On the whole, this approach appears to have succeeded in giving Ghana a very diverse, reasonably robust system of RMFIs, with relatively little cost in terms of outright failed institutions (and lost deposits) and moderate drain on supervisory resources. Nevertheless, the system has failed to achieve impressive outreach, especially to the rural poor, and remains burdened by a number of weak units that the regulatory authorities are not well equipped to turn around. Authors’Affiliation and Sponsorship William F. Steel Senior Adviser, Private Sector Unit, Africa Region, World Bank Email: wsteel@worldbank.org David O. Andah Managing Consultant, Consultant Management Enterprise (Ghana) Email: cmeltd@ghana.com The Africa Region Working Paper Series expedites dissemination of applied research and policy studies with potential for improving economic performance and social conditions in Sub-Saharan Africa. The Series publishes papers at preliminary stages to stimulate timely discussion within the Region and among client countries, donors, and the policy research community. The editorial board for the Series consists of representatives from professional families appointed by the Region’s Sector Directors. For additional information, please contact Paula White, managing editor of the series, (81131), Email: pwhite2@worldbank.org or visit the Web site: http://www.worldbank.org/afr/wps/index.htm . The findings, interpretations, and conclusions expressed in this paper are entirely those of the author(s), they do not necess arily represent the views of the World Bank Group, its Executive Directors, or the countries they represent and should not be attributed to them. Rural and Micro Finance Regulation in Ghana: Implications for Development and Performance of the Industry By William F. Steel & David O. Andah June 2003 Foreword his country study is one of three being published as part of research on the implications of legal and regulatory structures for the development of microfinance institutions in African countries. This research is a collaborative effort between the World Bank’s Financial Sector Operations and Policy Department and the Financial and Private Sector Units of the Africa Region, with funding from the Financial Sector Board and Africa Regional Programs. The published country studies on Benin, Ghana, and Tanzania, together with work on Ethiopia, South Africa, Uganda, and Zambia in Africa, as well as experiences drawn from other regions, will form the basis for a comparative review in tended to provide practical lessons and guidance to policymakers and donor agencies on how the structure of legal and regulatory systems may affect (and in turn be influenced by) the evolution of microfinance institutions in different country contexts. T Increasing the access of the poor to sustainable financial services is an important part of the World Bank Africa Region’s strategy for supporting the Millenium Development Goals for poverty reduction. Convenient and affordable instruments for savings, credit, insurance, and payment transfers are essential both to cope with the economic fluctuations and risks that make the poor especially vulnerable and to take advantage of opportunities to acquire productive assets and skills that can generate increased income. Microfinance is the application of innovative methodologies that make such financial services available to relatively poor households and microenterprises in small transactions suited to their conditions. Innovative microfinance institutions have had substantial success in making financial services accessible to the poor in many parts of the world, and microfinance is increasingly provided through licensed, commercial financial institutions capable of mobilizing the funds necessary to significantly increase the scale of outreach. The microfinance sector has evolved and developed according to different patterns and growth paths in various countries and regions. The literature on microfinance identifies the legal and regulatory framework as one factor that influences the emergence of different kinds of institutional providers of microfinance and, especially, their development into selfsustaining, commercial microfinance institutions capable of reaching growing numbers of poor clients, especially in rural areas. These country studies provide an assessment of how the legal and regulatory framework influences the microfinance sector and the benefits and risks of different approaches, providing important lessons for other countries that may be going through a similar process of establishing or modifying the legal and regulatory framework for microfinance. Gerard Byam Sector Manager Financial Sector, Africa Region ii The authors are grateful for comments on earlier drafts from Peer Reviewers Joselito Gallardo and Rich Rosenberg, as well as from Kwaku Addeah, Stefan Staschen, Andreas Thiele, Antony Thompson, and workshop participants. The authors also appreciate information and inputs provided by Ken Appenteng Mensah, Ed mund Armah, Eyob Tesfaye, Amha Wolday, the Association of Rural Banks, Bank of Ghana, Ghana Co-operative Credit Union Association, and the Ghana Microfinance Institutions Network. iii Abbreviations and Acronyms ADB AfDB ARB ARBAB BOG CAMEL CBO CUA CUs DANIDA DFID Agricultural Development Bank African Development Bank Association of Rural Banks ARB Apex Bank Bank of Ghana Capital adequacy, Assets quality, Management, Earnings and Liquidity Community-based organization Ghana Co-operative Credit Unions Association Credit Unions Danish International Development Agency Department for International Development (UK) ENOWID FFH GHAMFIN GCSCA GTZ IDA IFAD MFIs MOF MSEs NBFIs NBSSI NGOs NRCD Enhancing Opportunities for Women in Development Freedom From Hunger Ghana Microfinance Institutions Network Ghana Co-operative Susu Collectors Association German Agency for Technical Cooperation International Development Association International Fund for Agricultural Development microfinance institutions Ministry of Finance micro and small enterprises non-bank financial institutions National Board for Small-Scale Industries non-governmental organizations National Revolutionary Council Decree PNDCL RBs RCBs RFSP RMF RMFI S&L SAT SMEs T-bills UK UNDP USAID WWBG Provisional National Defense Council Law Rural Banks Rural and Community Banks Rural Financial Services Project (AfDB, GTZ, IFAD, World Bank) rural micro finance rural and micro finance institutions Savings and Loans Company Sinapi Aba Trust Small and Medium-scale Enterprises Treasury Bills United Kingdom United Nations Development Program United States Agency for International Development Women’s World Banking Ghana iv Table of Contents Foreword ......................................................................................................................................... ii Abbreviations and Acronyms ..........................................................................................................iv I. Background ............................................................................................................................. 1 A. Introduction....................................................................................................................... 1 B. Macroeconomic and Policy Context ................................................................................. 2 II. Structure and Performance of Rural and Micro Finance Industry.......................................... 3 A. Agricultural Development Bank ....................................................................................... 5 B. Rural and Community Banks ............................................................................................ 5 C. Non-Bank Financial Institutions ....................................................................................... 9 D. Credit Unions .................................................................................................................. 11 E. Non-Governmental and Community- Based Organizations ............................................. 13 F. Donor Programs ............................................................................................................... 15 G. Informal Finance ............................................................................................................. 15 H. Government Credit Programs ......................................................................................... 18 III. Licensing and Regulatory Framework for Rural and Micro Finance ................................. 19 A. Structure and Origins of the Licensing Framework ........................................................ 19 B. Evolution of Regulatory Norms ...................................................................................... 20 C. Supervision and Monitoring Mechanisms....................................................................... 26 D. Performance of the Supervision System ......................................................................... 29 IV. Business and Contract Enforcement Environment .............................................................. 31 A. Registration of RMFIs .................................................................................................... 31 B. Regulation of Small Business Activity ........................................................................... 31 C. Financial Contracts.......................................................................................................... 32 V. Assessment of Impact of Regulation on the Evolution of Microfinance ............................. 33 A. Advantages and Drawbacks of Ghana’s Approach......................................................... 34 B. Conclusions ..................................................................................................................... 38 C. Recommendations for Ghana .......................................................................................... 38 Annex 1: Microfinance Legislation in Uganda and Ethiopia ....................................................... 40 Annex 2: Evolution of Legal Framework for RMFIs ................................................................... 43 Annex 3: Summary of Laws and Regulations for RMFIs and Businesses ................................... 46 Schedule 1. Legal and Regulatory Requirements for Different Types of MFIs - Ghana................. 46 Schedule 2. Classification of Regulations According to Objective – Ghana ................................ 47 Schedule 3. Legal Systems and Judicial Processes .................................................................... 47 Annex 4: Reports to Be Submitted by S&Ls, RCBs, and Banks.................................................. 48 References ..................................................................................................................................... 49 BOXES Box 1: Performance Monitoring Data and GHAMFIN .................................................................. 5 Box 2: Types of Group and Individual Savings and Credit Programs ........................................... 8 Box 3: Inventory Credit Scheme ................................................................................................... 14 Box 4: Types of Susu (Savings Collection) in Ghana ................................................................... 16 TABLES Table 2.1: Classification of Rural Banks ........................................................................................ 6 Table 2.2: Average Size of Ghana’s Rural Banks and Credit Unions Relative to African MFIs... 7 Table 2.3: Growth of Licensed NBFIs by Type since Passage of Law in 1993 ............................. 9 Table 2.4: Growth in Credit Unions and Membership, 1968-2001 .............................................. 12 Table 2.5: Performance of Sinapi Aba Trust ................................................................................ 13 Table 3.1: Evolution of Minimum Capital Requirements, in Cedis and US$ .............................. 21 Table 3.2: New Reserve Requirements for Rural and Community Banks ................................... 23 Table 3.3: S&L Provisioning Rates .............................................................................................. 25 Table 3.4: RCBs’ Provisioning Rates ........................................................................................... 25 Table 3.5: Credit Exposure Limit as Percentage of Net Worth.................................................... 26 Table 3.6: Selected Balance Sheet Items (2001) (¢ million) ...................................................... 29 Table 5.1: Assets of Depository Financial Institutions, 2001 (¢ million)..................................... 36 Review of Rural and Micro Finance Regulation in Ghana: Implications for Development and Performance of the Industry William F. Steel and David O. Andah I. Background A. Introduction The purpose of this paper is to assess how the policy, le gal and regulatory framework has affected – and been influenced by – the development of rural and micro finance institutions 1 (RMFIs) in Ghana, especially in terms of the range of institutions and products available, their financial performance and outreach (particularly to the rural and lower- income population). This review of Ghana’s experience is intended to help guide other countries that are in the process of adopting legislation and regulations for RMFIs. The study also examines how the operation of RMFIs and their clients may be affected by the impact of business and commercial laws and institutions on contract enforcement and the operation of businesses. The potential of microfinance to reach large numbers of the poor is now well understood (Robinson 2001). Diversity of RMFIs and products is facilitated by a flexible regulatory environment in which they can develop innovative methodologies for reaching different market niches not served by commercial banks. Nevertheless, at some point – in the sector’s evolution, in the growth of a successful RMFI, in the willingness of investors to enter these niches – regulations are appropriate both to facilitate commercialization and sustainability of the rural and micro finance (RMF) industry (especially through mobilization of savings from the public) and to ensure the stability of the financial system (as well as to protect deposits). Difficult decisions must be made in each country context as to the timing and complexity of regulations in order to promote orderly development without unduly stifling innovation. This review of Ghana’s experience, together with comparisons to other country case studies, is intended to draw lessons on how the timing and design of regulations has developed and affected the diversity, outreach and sustainability of RMFIs. Ghana is particularly interesting because it has evolved a tiered system of different laws and regulations for different types of institutions, largely in response to local conditions, needs and institutio nal developments. The resulting system resembles the tiered approach 1 “Microfinance” refers to small financial transactions with low-income households and microenterprises (both urban and rural), using non-standard methodologies such as character-based lending, group guarantees, and shortterm repeat loans. “Rural finance” includes other instruments and institutions specifically intended to finance rural activities, both farm and off-farm. The common elements are that the clients being served typically lack the characteristics (e.g., titled property as collateral) required by commercial banks or are located beyond the reach of commercial bank branches and that innovative methods and specialized products or institutions are needed to reach these markets. 1 recommended by the World Bank’s 1999 study of microfinance regulation from the viewpoint of a regulator trying to assess what characteristics (such as size and taking deposits from the public) of RMFIs should “trigger” a regulatory response in the sense that the likely benefits would outweigh the costs of supervising relatively small financial intermediaries (Van Greuning et al. 1999). This approach is being adopted in Uganda, which already has one specialized microfinance institution under the existing non-bank financial institution category and a licensed commercial bank offering mainly rural and micro finance services. Uganda’s new (2002) Micro Deposit-taking Institutions Law provides for central bank licensing of specialized microfinance institutions that wish to mobilize savings and use them for lending, while leaving credit-only NGO MFIs and small member-based organizations to operate outside direct regulation (Annex 1a). This approach stands in contrast to the approaches of countries such as Ethiopia, which allows only one category of licensed RMFI (Annex 1b). 2 While Ghana’s approach has fostered a wide range of RMFIs, formal and informal (rural banks, savings and loan companies, credit unions, non-governmental organizations [NGOs], savings and credit associations of various types, and informal savings collectors and moneylenders), it has not been so successful in terms of achieving strong financial performance, significant scale, and true commercialization of microfinance. Although it is premature to judge what approach is most likely to be successful by these standards, it is an appropriate time to assess the extent to which Ghana’s flexible, evolutionary, tiered approach is leading the development of RMFIs in the right direction. After briefly reviewing Ghana’s macroeconomic and policy context in the remainder of this chapter, Chapter II sets out the structure, products and performance of RMFIs in Ghana, as a context for examining the evolution of the legal, regulatory and supervisory framework for RMFIs in Chapter III. Chapter IV briefly reviews relevant aspect of the business and contract enforcement environment, while Chapter V concludes with an assessment of how the legal and regulatory environment has affected the development of rural and micro finance in Ghana. B. Macroeconomic and Policy Context3 Ghana has a population of about 18 million, which has been growing at about 3% per year. Recent statistics (1999-2000) indicate that 63% of the population live in rural areas and 37% in urban areas. Gross domestic product (GDP) for 2001 at current prices stands at US$5.36 billion, with an annual growth rate of 4.2%; per capita GNP of US$390 remains lower than the average per capita income level of US$520 for Sub-Saharan Africa. Inflation and high interest rates have been a persistent problem; the end-of-period inflation rate rose from 13.8% in 1999 to 40.5% in 2000 before falling to 21.3% in 2001, with 91-day Treasury Bill (T-bill) rates reaching 42% in 2001 before declining to 22% in 2002. Ghana’s financial structure is fairly shallow: the degree of monetization of the economy stands at 20.7%, as measured by the M2/GDP ratio. With international reserves at only 1.5 months of imports as of 2001, Ghana’s economy is markedly vulnerable to external shocks. Ghana has focused on poverty reduction as the core of its development strategy. This approach was galvanized in 1995 with launching of the first version of Ghana – Vision 2020 2 Savings and credit cooperatives are also permitted, but under the Department of Cooperatives rather than the central bank. 3 This section draws extensively from Gallardo (2002), with updating of the figures. 2 initiation of institutional arrangements to promote and analyze poverty reduction. The Government prepared a Development Strategy for Poverty Reduction in 2000 and has since prepared the Ghana Poverty Reduction Strategy 2002-2004: An Agenda for Growth and Prosperity. Poverty in Ghana has decreased from 51% of the population in 1991-92 to about 43% of the population living below the poverty line in 1998, although the average consumption level of the poor in Ghana is about 30% below this level. 4 The reductions in poverty levels have tended to be concentrated in the Accra and the rural forest areas. Poverty remains substantially higher in rural areas (52%) than in urban areas (23%), and more than one- half of the population living in the rural savannah zones continue to be extremely poor. Poverty is highest among the self-employed households cultivating agricultural crops, and has decreased only slightly compared to the self-employed households engaged in export-crop agriculture and the wage employees in the public and private sectors. The overall policy framework for microfinance is informed by the poverty reduction strategy, which seeks to balance growth and macroeconomic stability with human development and empowerment in such a way as to positively reduce the country’s poverty levels in the medium term. The strategy identifies the main sources of poverty, and aims to assess all sectoral strategies and programs in terms of the extent to which they contribute to reducing poverty. The overall strategy emp hasizes the reduction of inflation and the need to sharply reduce the fiscal deficit, as a key step to reduce the extent of the public sector’s crowding out of the private sector in the financial markets, and to help lower interest rates. A microfinance strategy paper was prepared through a consultative process in 2000, but was never taken up by Cabinet before a change of government. The poverty focus has led the new regime to expand directed, subsidized credit programs that are not consistent with best practices in microfinance and tend to undermine development of the industry. II. Structure and Performance of Rural and Micro Finance Industry This chapter analyzes the different types of RMFIs in Ghana and their financial products, from the more formal and licensed to the less formal and unregulated. The financial system in Ghana falls into three main categories: formal, semi- formal, and informal: • 4 Formal financial institutions are those that are incorporated under the Companies Code 1963 (Act 179), which gives them legal identities as limited liability companies, and subsequently licensed by the Bank of Ghana (BOG) under either the Banking Law 1989 (PNDCL 225) or the Financial Institutions (Non-Banking) Law 1993 (PNDCL 328) to provide financial services under Bank of Ghana regulation. Most of the banks target urban middle income and high net worth clients. Rural and Community Banks (RCBs) operate as commercial banks under the Banking Law, except that they cannot undertake foreign exchange operations, their clientele is drawn from their local catchment area, and their minimum capital requirement is significantly lower. Some collaborate with NGOs using microfinance methodologies. Among the nine specified categories of non-bank The upper poverty line in 1998 was set at C900,000, or about US$389 at the time. 3