The challenge and value of self-regulation in Microfinance
The financial services sector has been identified as the most regulated sector in the world. Governments, in all countries, make regulations to influence the conduct of operators and thereby ensure the safety of the industry. Financial stability is a critical requirement for economic, and by extension, socio-political stability. Quite often, the implementation of the rules, regulations and strategies to effect this stability gets criticised by operators, especially bankers and other stakeholders, as very stifling. However, those who follow developments around the world and, in particular, the crisis that occurred in the United States, triggered by subprime mortgages, would probably be more sympathetic to and less critical of the so-called over-regulation of the financial system.
Between 2007 and 2010, a subprime mortgage crisis of emergency proportions exploded in the United States. The housing boom had just petered out and real estate values came crashing. US housing prices fell by about 30 per cent on the average while the stock market fell by about 50 per cent by early 2009. It took the stock market up to 2013 to return to its pre-crisis level. Meanwhile, a decline in the values of real estate-backed securities had been activated, unleashing a wave of delinquencies and foreclosures.
Two companies in the mortgage business, Fannie Mae and Freddie Mac, had what could pass for government-protected or sponsored monopoly of part of the secondary mortgage market in the US mortgage industry. This privilege, supported by what seemed to be government’s avowal to keep the two companies afloat, contributed to the crisis. It was alleged that these two companies hired lobbyists and made heavy campaign donations to ensure that the safety controls, championed by other operators, were never implemented. Consequently, these other operators, and indeed the whole of Wall Street, joined the band wagon when they could not beat Fannie Mae and Freddie Mac. They too began to create all manner of exotic financial assets out of the mortgages they bought, in which the public then invested. At the end of the day, Fannie Mae and Freddie Mac paid the ultimate price while the tax payers had deep and festering wounds to leak as an unprecedented crisis, since the Great Depression, ensued. More important, the US Congress and even the regulatory authorities were blamed for not doing enough to stop the over-expansion of the two companies, spurred by their purchase of poor quality mortgage assets.
It is therefore little wonder that all over the world, much emphasis is placed on the proper behaviour of economic agents, especially in the financial sector, because of the usually far-reaching consequences, which their wrong actions may have on the entire economy. The US economy had to go into a recession following the subprime mortgage crisis. This is certainly one route every economy must not travel and should do all it can to avoid.
The promotion of monetary stability and a sound financial environment remains one of the most important elements of the Core Mandate of the Central Bank of Nigeria (CBN). This duty is shared, with great enthusiasm, by the Nigeria Deposit Insurance Corporation (NDIC), in whose vision statement this mandate is emphatically encapsulated: “To protect depositors and contribute to the stability of the financial system through effective supervision of insured institutions…”To achieve the purpose of visions like this regulators must not shy away from the difficult cases that may be thrown up in the course of their work and the NDIC has not failed in this regard.
There is however a growing tendency among operators to treat certain regulatory requirements very lightly, especially when these regulations appear minor to them. But even minor requirement should not be underrated. We all know that it is from the small cracks in the wall that the big shifts occur. For instance, how many operators have strategic plan documents approved by their boards? If not; how do they know where they are travelling to? Without a roadmap, the risk of getting lost on journey is amplified. How many consistently carry out monthly credit reviews? How many operators have written Credit Policy with approval limits and review plans? What about Investment Policy; especially as they are bullish on investments? Are there functional board committees or the key man is everything rolled into one? These may look minor but they constitute the foundation for insider dealings – one of our biggest challenges.
I am aware of the pros and cons of the issue of self-regulation but we cannot throw the baby away with the bath water. Issues of lack of enforcement mechanism and group self-interest have been canvassed against self-regulation. However, it is still very useful and given official backing in the microfinance industries of some countries like India. I think we should pass a bit more responsibility to the operators using their umbrella organizations. As a pioneer pension fund manager, I recall the extent we went in PENOP (the operators’ forum) in cooperation with PENCOM (the regulator) to establish Code of Conduct and set behavioural standards that saw the industry grow in integrity and safety. MBAN and other must not underrate the power of group action.
Looking inwards and improving our processes, even when nobody is looking, is invaluable. While regulators must leave nothing to chance or consider an infraction inconsequential, operators must share the responsibility for the survival of their trade. If Fannie Mae and Freddie Mac were to resurrect today I am sure they will act differently and be harsher than the Federal Housing Finance Agency of the United States. To be penny wise and pound foolish is to be foolish indeed.
In summary, market discipline refers to the way in which market participants influence a financial institution’s behaviour through monitoring its risk profile and financial position. Anybody providing funds to a financial institution is an investor, from depositors to professional investors in sophisticated debt instruments. Investors can exercise market discipline through the price they charge financial institutions for supplying funds, or simply by withdrawing their funds.
Emeka Osuji