The Committee requested an opinion on which aspects of micro-credit could be regulated at European level. This briefing paper endeavours to answer to this complex question and is organized as follows. Paragraph 2 provides a brief overview of the development of micro-credit and microfinance within and outside Europe and shows its current and expected impact on the economy. Paragraph 3 describes the Commission’s action plan. Paragraph 4 offers some recommendations on how to possibly fine-tune the proposed EU action plan distinguishing between banks and non-banks MFIs.

a) As regards the banking model of micro-credit (i.e. micro-credit provided for by commercial banks, savings banks, credit cooperatives and micro-finance banks), the focus of community or national legislative initiatives should be, in my view, on the specificities of risk management for micro credit and on the incentives to be given to banks to support financial inclusion and small businesses. I welcome, therefore, the Commission initiative to establish wider provisions on loan guarantees (which should operate, however, according to rules and practices, to be duly supervised, directed at minimizing moral hazard of the borrowers), whereas I am sceptical on securitisation of micro-credit loans portfolios, considered also that micro-loans are often without a formal rating. In addition to that, regulators should endeavour to foster the use of alternative methods and more appropriate credit scoring techniques for assessing the credit risk of micro-credit, recognizing a more favourable treatment under CRD to those micro-credit loans which historical records indicate as less risky (see e.g. loans extended to non profit institutions). In turn, as regards the incentives to be given to existing (small, medium size and big) banks to engage in micro-credit programmes to promote grass-roots entrepreneurship, useful lessons can be drawn from the US 1977 Community Reinvestment Act and its anti-redlining provisions, which proved effective in downscaling the banking activity (both directly and through the Community Development Finance Institutions and Corporations) in the best interest of local communities and of low income borrowers (today 20% of the total loans granted to private clients in the US).

b) As regards non bank providers of micro-credit, the focus should be, in my view, on a (ideally harmonized) regulation of the entities (MFIs). Hard and soft regulation should both be in place and converge and should be directed at instituting appropriate management and internal control systems for MFI, at establishing an adequate public supervision, at fostering networking (also through the establishment of “second level” MFIs federal organizations providing regional and/or national coordination and technical assistance and support to their members) and at developing best practices for lending. There is also a clear need to push MFIs towards optimal scale reorganization, long term self-sustainability and portfolio growth. MFIs should moreover be regularly subject to performance rating. Although MFI do not pose a problem of protection of depositors, a sound regulatory and supervisory framework is nevertheless recommended, in my view, to enhance the protection of the public funds, the protection of borrowers and the trust of donors, banks and other financial institutions on which MFIs rely, at least partially, for their funding and which in turn must rely on the MFIs to overcome informational asymmetries and access segments of clients which, in many circumstances, would not be bankable without the “intermediation” (in terms of credit assessment and mentoring) of the MFIs. Regulation and supervision should obviously be proportionate refraining from imposing unnecessary costs.

The paper concludes considering also a recent Italian experience deserving, in my opinion, the full attention of European regulators.

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1.

The Committee requested an opinion on the following question: “Which aspects of micro-credit could be regulated at European level in order to support growth and employment? What form should a European initiative take? Should existing financial services legislation take micro-credit into account (e.g. the proposed revision of CRD)? If so, what form should it take and if not should an explicit exclusion of micro-credit be stated?”. This briefing paper endeavours to answer to these (complex) questions in the few pages requested and is organized as follows. Paragraph 2 provides a brief overview of the development of micro-credit and microfinance within and outside Europe and shows its current and expected impact on the economy. Paragraph 3 describes the Commission’s action plan. Paragraph 4 attempts at answering to the questions raised, considering also some insights from an innovative approach to micro-credit and social banking recently emerged in the Italian practice deserving, in my opinion, the full attention of European regulators.  

2.

Micro-credit is the extension of very small loans (micro-loans) to entrepreneurs, to social economy enterprises, to employees who wish to become self employed, to people working in the informal economy and to the unemployed and others living in poverty who are not considered bankable according to prevailing commercial banking standards [1]. It has become a popular, albeit controversial [2], method of facilitating development, not only in poor countries but also in the poorer segments of the richest societies, especially to provide financial support to start ups or micro enterprises, to non profit organizations and to “unbanked” people and other disadvantaged persons. Indeed, traditional commercial banks, with few exceptions [3], have failed so far to meet adequately the demand for credit by those who cannot offer physical collateral, but may be nevertheless creditworthy, especially in the light of the entrepreneurial projects they intend to pursue and finance. Responding to such market failure, the last twenty-five years or so have witnessed a rapid expansion, worldwide, in the number and size of micro-finance and micro-credit institutions [4], often encouraged by public support mechanisms (some of which offered also at the European level: see in particular EU PHARE, European Investment Fund and European Bank for Reconstruction and Development programmes). Nature, size, operational features and economic and financial outcomes of these micro-finance and micro-credit institutions vary significantly from country to country and from institution to institution. Nevertheless, it is well recognized that today micro-finance and micro-credit institutions are already numerous in many developing and developed countries, herein included all Member States [5], and in aggregate serve a large number of clients (according to CGAP by 2000 they already served worldwide about 12,5 million individuals) [6]. Certainly, it is not to believe that micro-credit is a new phenomenon in Europe; on the contrary, it has a lengthy and distinguished history embracing the early English lending charities, the Irish Loan funds and, above all, the savings banks and credit cooperatives dating back to the 19th century [7]. Interestingly enough, a look at history reveals, however, that organizations that depended on charitable (external) funding were more fragile and tended to lose their focus more quickly that those that obtained funds from [continua ..]

3.

The Commission, following its Staff Working Document of 2004 on “Microcredit for European small businesses” [10] and the works and recommendations of its Expert Group [11], with its Communication on “A European initiative for the development of micro-credit” acknowledged that “in the Member States and regions of the European Union micro-credit is often used as a means of encouraging the growth of self-employment and the formation and development of micro-enterprises. As such micro-credit can play an important role in the realisation of the Lisbon strategy for growth and jobs and the promotion of social inclusion”. It also recognized that: a) whilst there is an active micro-credit sector in many Member States and a number of actions have been taken, there is clear evidence that much more can be done”; b) “evidence suggests that banks engage in micro-credit activities (directly or more often in partnership with non bank institutions) where they are encouraged to do so by public support mechanisms”; c) there is scope for Community action in the field, first of all, to improve the legal and institutional environment. In this respect the Commission, blaming that “the institutional framework in the Member States appears to be often ill-suited to the development of micro-credit” due to the fact that micro credit is not specifically addressed in the national or Community legislation, proposes: a) to encourage banks to develop micro-credit operations, directly or through non bank MFIs through a wider provision of loan guarantees and, as portfolio develop, by securitisation; b) to help micro-credit to become sustainable by relaxing interest caps for micro-credit operations; c) to allow MFIs access to borrower databases on default and losses related to micro finance (individuals, enterprises and MFIs); d) to reduce operating costs applying favourable tax schemes; e) to confirm existing EU prudential regulation and supervision for institutions engaged in micro-credit when receiving deposits and other repayable funds from the public and to adapt national regulation and supervision to micro-finance institutions not taking customer deposit so as to ensure that it is proportionate to its costs and to the risks MFIs pose, “so that it does not put a brake on the supply of micro-credit and the growth of specialist MFIs”; f) to examine the needs for a European passport for MFIs other [continua ..]

4.

To conclude, I believe that in devising an appropriate regulatory response to micro-credit at the European level, it should be considered, first, that micro-credit and microfinance are certainly essential to economic and social development and must be promoted, therefore, also through appropriate public intervention and tax incentives. Second, that microcredit and microfinance institutions should attain economic sustainability and should not be based solely or principally on grants or on any other form of paternalistic philanthropy. In this respect, history shows that deposit taking, self-help (as it is the case of cooperatives and credit unions) and/or strong local bonding (as it is also the case of investments in micro-credit made by established banks or financial institutions – herein included savings foundations – as a firm and long term commitment to their community) matter to ensure sustainability and success in the long run. Third, that both banks (specialized or not specialized) and non banks should be very active in the field: in many circumstances, to be successful both actors must pool their specific knowledge and act together, networking also with external training structures, like Universities or private and public small business development centers (as it has been rightly said, “micro-enterprise development experiences from around the world provide few examples of good lenders being good trainers and vice versa) [15]. I also believe that banks are called to upgrade the degree of financial inclusion and that it is even in their best economic interest to do so, as many examples of recent years show. This can be done through different business models: from the simple extension of loans to MFIs to the creation by a bank or by a banking group of a business unit or even a specialized bank devoted to micro-credit. A remarkable example of this latter model is represented by a recent innovative Italian bank (called “Prossima s.p.a.”), incorporated in May 2007, which started operation on October 2007. This initiative is noticeable in size and in character. It is noticeable in size, because “Prossima s.p.a.” is a fully owned subsidiary of “Intesa San Paolo”, a major Italian player in the national banking industry. As such, it has been adequately capitalized from its very outset and operates nationally and internationally also through the existing network of “Banca Intesa San [continua ..]

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