The ability to save

Protecting the small depositor

 

One reason for poor communities the world over responding to the service facility provided by Micro Finance Institutions (MFI) to take in the small amounts of savings the poor generate on a daily or weekly basis is the security offered by the cash being securely looked after at a remote location.

Research has shown that poor savers, especially women, have no ability to secure any spare cash that they may have at any given time, within their household, given the conditions under which they live and the gender exploitation they undergo. So they willingly hand over their cash to a collector, knowing that they can earn some interest and also borrow from the MFI for an income generating activity or in an emergency.

The savings book which the MFI given each depositor records deposits and withdrawals. Commercial banks, finance companies, and finance institutions operating under the cooperative societies laws also have become aware of the huge potential in these ‘bottom of the pyramid’ savers (M.K. Prahalad, of the University of Chicago, wrote a groundbreaking book on the economic power of the poor at the bottom of the economic pyramid, his thesis was that although they would have not large amounts of resources, small amounts they could generate , when totalled over time, would total large investments) and instituted schemes to attract deposits from them.

It is indeed ironic that these institutions, which earlier focused almost totally on the corporate sector, the upper and middle classes, have turned to the poor and the marginalised to attract deposits. A few years ago, such a poor saver would not have been able to get past the armed security guard at the door of the institution, let alone make it all the way to the deposit counter and be treated with respect!

Sri Lanka

As the law stands in Sri Lanka today, in terms of recent legislation governing the financial services sector, only licensed commercial banks, registered finance companies and cooperatives are legally entitled to accept deposits. This has resulted in the large number of MFIs set up under other laws, such as the Voluntary Social Service Organisations, the Societies Ordinance, and the Companies Act, Trusts Ordinance, etc., having to cease accepting deposits.

Due to Sri Lanka currently being classified as a lower middle income country, official and private donor funds which were accessible by these MFI have also dried up, and many of them are facing problems. The reality of being a lower middle income country is questionable, when we have approximately 35% of our total population or 1.5 million families are allegedly getting below the poverty line entitlement of Samurdhi handouts, incurring a bill of Rs. 1.6 billion.

To get around this problem of not being able to accept deposits, some MFIs have taken to the device of getting their members to deposit their savings in an institution which is legally entitled to do so, until the proposed Microfinance Act, which will provide legal cover for their MF operations is enacted.

Money lenders, pawn brokers and cheetu (Rotating Savings and Credit Associations –RoSCAs) have their own legislation under which they operate. Pawn broking is a major activity of formal financial institutions today. It is estimated that 40% of advances from commercial banks for agricultural activity is generated by pawn broking.

Legally there is nothing to prevent an MFI from obtaining a pawn brokers license, provided they qualify according to the eligibility criteria and transacting business with their members. It is reported that the Samurdhi Banku Sangam set up under the Samurdhi Act, continues to take a compulsory savings deduction for the stipend paid to Samurdhi beneficiaries. Whether this is a not a cash deposit, in terms of the Finance Business Act is not clear.

Ponzi schemes

The recognition that the poor have the ability to save and a weak regulatory environment has resulted in many Ponzi schemes being initiated.

Charles Ponzi (1882-1949) was an Italian businessman and confidence trickster in the USA and Canada. He devised a money making scheme, which promised depositors a 50% return on investment within 45 days, i.e. a 100% profit within 100 days.

Ponzi claimed he could do this by buying discounted postal reply coupons in other countries and redeeming them at face value in the United States. In reality Ponzi was paying early investors using funds deposited by subsequent investors! After some time the scheme inevitably went bust. The busted local deposit takers, Sakvithi, Danduwam Mudalali and Dadi Danduwam Mudalali were following in Ponzi’s hallowed footsteps!

The MFIs currently operating in Sri Lanka have placed their hopes in the draft Microfinance Regulatory and Supervision Authority (MR 7 SA) Draft Law which is on the Central Banks (CBSL) website.

Part II Section 10(2) of this draft provides that ‘microfinance business’ is ‘the acceptance of deposits and providing financial accommodation in any form and other financial services mainly to low income persons and micro enterprises’. Analysts have pointed out that this is a very wide definition – further clarification will be required on what a ‘financial transaction’ is, how a ‘low income person’ is defined and what a ‘micro enterprise’ is. How would the draft law deal with other financial transactions such as money lending and cheetus, etc., which have specific legislation governing their operations?

India, on the other hand, in its draft legislation on microfinance, to be taken up in the current Monsoon session of Parliament, the Indian Microfinance Development and Regulation Bill, by Section 42, clearly provides that ‘this act will override other laws’. The bill goes further, ‘by way of explanation,’ to state that ‘microfinance services extended by any MFI registered by the Reserve Bank of India shall not be treated as a money lender for the purpose of any enactment’.

Exploiting capacity

Commercial Banks are also exploiting the capacity of the poor to save to the maximum extent. Events are organised at rural events like rural polas, religious festivals and cultural events like devale peraheras, temple festivals and church feasts, where mobile banking units are deployed to take in savings. Attractive interest rates are being offered.

Hatton National Bank’s pioneering ‘Gemi Diriya’ scheme is another example. The National Savings Bank (NSB) has pioneered using cutting-edge technology to point of sale deposits. The NSB’s field representatives visit rural homes having with them point-of-sale electronic devices connected to the Dialog mobile telephone network and take in deposits from rural households and provide instant electronic confirmation of receipt and deposit in real time, in the presence of the depositor.

The Annual Report states that: ‘The point-of-sale devices have been an immense success, with many branches seeing their monthly transactions grow significantly both in numbers and value.’

Brazil’s boat banks

From Brazil there is news of a very interesting concept of ‘floating banks’. The Amazonia region of Brazil, one of the new emerging BRICS economies (Brazil, Russia, India, China and South Africa) has very poor infrastructure, road access is very poor. To access the communities living on the banks of the Amazon River and tributaries, three Brazilian banks are now competing to offer financial services form boats which ply the upper reaches of the Amazon River system.

These commercial banks have ventured into this once neglected part of the rain forest due a number of factors converging. The first is that they employ low cost appropriate systems, suitable for the modest incomes and small account balances of the inhabitants of the region.

Secondly, availability of new technology, point-of-sale devices connected to internet satellites which permit real time updating of centrally managed accounts, reducing the possibility of fraud and giving the confidence to the depositor that the funds are secure. Thirdly, the positive vibes emerging by extending the financial institutions services to this remote and under banked region of the country, the feel good factor generated among the banks other stakeholders.

One of Brazil’s top private banks, Banco Bradasco, initiated the boat bank concept in 2009. It opened a branch of the bank on a commercial vessel operating on the Amazon River, which carried passengers and goods along a 1,600 kilometre route between Manaus, the capital of the state and the city of Tabatinga, which lies on Brazil’s western border with Colombia and Peru. No roads connect this part of Brazil; the river is the only highway.

The floating branch, in addition to staff, also includes an Automatic Teller Machine and the branch takes cash deposits, makes payments, including disbursement of benefits like pensions, interest payments and annuities and pays out loans.

A Brazilian State-owned bank, Caixa Economico Federal, in 2011, opened a dedicated floating bank staffed by five employees, who carry out the whole gamut of financial services, opening new accounts, accepting deposits, providing withdrawal services, providing home loans, microfinance, credit card facilities and insurance services. Government social welfare disbursements such as pensions, severance payments, unemployment benefits and family welfare allowance services are also provided.

This banking boat, named the ‘Chico Mendez’ after an assassinated leader of a local, forest rubber tappers’ union, covers seven municipalities along the Amazon River, between Manaus and the town of Coari 400 km to the west. This project was a prize from the Inter American Development Bank for the best initiative in providing banking to the unbanked poor and marginalised people.

Another State-owned bank, the Banco do Brazil, Brazil’s largest bank, has installed branches on three boats that ply the Amazon providing health care and social services to isolated communities. The vessels, sponsored by the Governor of the State, reach settlements up river from Manaus as far as 1,136 km into the interior.

To access some inaccessible isolated communities, trips have to be planned for the annual high water periods, when the river in these is navigable by larger vessels. Banco do Brazil also operates branches in the country’s post offices and the floating branches, complement this service, providing opening new accounts, accepting deposits, paying pensions and benefits and offer withdrawals.

Generating funds

Providers of financial services have to generate cash to service their clients. Taking in deposits paying interest on those deposits and lending finds to borrowers at a mark-up on the rate paid for the deposit is the manner in which they generate funds.

Deposit generation is fundamental. The law must provide for a regulated method of doing so. Raising from donors or state grants are not sustainable. Point-of-sale devices combined with communication and internet technology has made it possible for financial service providers to reach out to poor, isolated and marginalised, who in the past could not even dream of participating in the mainstream of the financial service sector.

Whether this is in the isolated Amazon region with a Brazilian river bank or in rural Sri Lanka with the NSB is not the issue. The issue is the enabling environment; the legal regime which creates the operating environment for financial service providers.

Law lacuna

Sri Lanka’s financial services sector is limited by the lacuna in the law and regulatory environment regarding the acceptance of deposits by entities other than licensed banks, registered finance companies and cooperatives.

The 2011 Annual Report of the Central Bank of Sri Lanka, states at page 174, under the caption ‘Microfinance Institutions’: ‘The CBSL was involved in preparing legislation for the regulation of microfinance institutions. There are several categories of microfinance institutions that are registered under various laws, but are not regulated or supervised according to prudential criteria. Hence, to safeguard the interests of depositors and customers and also to strengthen the governance and service delivery of these entities, it was decided to bring under a common regulatory umbrella. Accordingly the proposed law will provide for the establishment of a separate regulatory authority for microfinance institutions.’

It is now some time since the CBSL Report was published and no new legislation to regulate and supervise microfinance institutions has been enacted by Parliament. The draft law, as on the CBSL website, has many limitations. Some of these have been described earlier. But some law is better than no law. The ideal would be if a consultation process takes place with microfinance practitioners and the draft law improved by an interactive process.

The issue of the Samurdhi Banku Sangam, which does not seem to currently come under any sort of prudential regulation, may also be dealt with. It is reported that the name is going to be changed to Divi Naguma Banku Sangam by legislation soon. If new legislation is being contemplated, it may be an opportunity to sort out the regulatory conundrum too.

The financial services sector is a very volatile environment. The successors of Charles Ponzi are very innovative. We have seen in the recent past how they have crept through any legal lacuna available, playing out millions of depositors.

Advances in communication and information technology, such as point-of-sale devices connected to the internet through a mobile telephone network, not only help legitimate financial service providers but also fraudsters, as the Madoff Ponzi scheme, exposed in New York, shows. The legal regime has to be foolproof. The State and the financial regulator cannot shirk this responsibility.

(The writer is a lawyer, who has over 30 years experience as a CEO in both government and private sectors. He retired from the office of Secretary, Ministry of Finance and currently is the Managing Director of the Sri Lanka Business Development Centre.)