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Microfinance Regulatory Model

Proposed by the Central Bank of Sri Lanka

For 100 Day Programme of the Government

(Details to be discussed if this is acceptable in principle)

1. Main objectives of creating a regulatory framework for the Microfinance Sector

a) To create a formal financial framework exclusively accessible to the low income persons

and families below or around the poverty line to enable them to uplifting their living

standards through formal sector financial services in line with best practices appropriate for

Sri Lanka. Such financial services include;

i. Provide loans to lower income categories of people

ii. Promote savings and create savings culture

iii. Provide other financial services such as pensions, subsidies, remittances and fund

transfer facilities

b) To create and promote a fair financial market for low income public with appropriate

consumer protection and fair market practices along with appropriate prudential standards

for a safe and sound market.

2. Structure of the Microfinance Institutions (MFIs)

MFIs Sector consists of a large number of institutions which can broadly be classified under the following four categories based on size of operations and institutional structure.

a) Community-based institutions/organizations and persons

i. Operate at village level

ii. Some registered under social services law

iii. Some no registration

iv. Accept deposits or contributions from members and lend

b) Non-Governmental Organizations (NGOs)

i. Registered with NGO Secretariat


Cover generally small and large foreign NGOs operating in the world or regions

iii. Lend out of externally mobilized funds

iv. No deposit-taking

c) Commercial ventures/companies incorporated under the Companies Act

i. Operate with profit motive

ii. Lend out of externally mobilized funds

iii. Some accept deposits in innovative methods to mask deposit-taking business

d) State Sponsored Organizations


Divinaguma Community Banks

Accept deposits and compulsory savings from members and lend to them

Operate and supervised by Divinaguma Development Department


Co-operative Banks

Accept deposits from public

Lend to members and invest in bank deposits or Govt. Securities

Registered and supervised by Co-operative Development Department or Provincial Co-operative Development Departments


Agrarian Banks

Accept deposits from members and lend to them

Registered and supervised by Agrarian Department

3. Proposed Four-Layer Regulatory Model to suit 4 MFI categories It is proposed to enact a Microfinance Regulatory Act to cover four regulatory layers with powers for national regulatory policy and guidance by the Monetary Board in order to maintain consistency in line with national objectives. The Monetary Board itself will be a regulator for specialized MF companies and have regulatory powers to issue directions to other three regulators. The Monetary Board alone cannot regulate microfinance sector, given the spread of MFIs country-wide in a large number and monetary and financial policy mandate of the Monetary Board.

a) Divisional Secretaries (DS) to undertake regulation and supervision of community- based small institutions/organizations and persons

i. Setting up MF Regulation Unit at each DS similar to business registration units at DS

ii. Unit to have 2-3 graduates and operate at field level through GNs and the Central Bank to provide basic training.

iii. MFIs to register at DS

iv. Registration is limited to MFIs with a very small asset base capped at a prescribed amount.

v. MFIs to accept deposit and member shares and lend to members, all subject to

max thresholds per member

vi. Such MFIs are not expected to grow beyond the total asset cap

vii. DS to issue few basic prudential and consumer protection rules

viii. The Monetary Board to issue guide lines to DS to implement appropriately

b) NGO Secretariat to NGOs

i. Registration at NGO Secretariat

ii. Only for lending out of external funds

iii. No deposit-taking

iv. Basic consumer protection and governance rules to be issued by the NGO

Secretariat based on guidelines issued by the Monetary Board

c) Monetary Board to license/regulate and supervise specialised commercial ventures/companies (Specialized SMFIs) incorporated under the Companies Act

i. Basic licensing, corporate governance, prudential and consumer protection rules

ii. Sector to have maximum of around 50-75 companies subject to a prescribed maximum threshold of assets to avoid too-big-to-fail and high profile financial institutions

iii. Each company to have a limited branch network of 2-5 in the operating District


iv. Deposit-taking and borrowing for microfinance lending


Central Bank to have a dedicated Microfinance Supervision Department (MSD) to regulate directly FMFIs and indirectly the industry at the national level

d) Dvinaguma, Co-operative and Agrarian Departments to have MF regulation powers in respect of existing MFIs

i. Setting up of Microfinance Regulatory Council/Committee (MRC) at each Department with regulatory powers given under MF Act (Divinaguma Act already contains a similar Management Board, but it lacks regulatory powers and independence) and a MRC Secretariat to implement regulation and supervision

ii. MRC to consist of members (up to 7) representing, the respective Department, Central Bank, Relevant Ministry, Ministry of Finance, Ministry of Economic Affairs and two members from MF professionals for a your year tem

iii. The Monetary Board to issue Directions to MRC in respect of required regulatory measures for implementation

iv. The Monetary Board to arrange examination of MRC by MSD to ensure implementation of regulation and supervision by MRC

4. Microfinance Business Regulation Act

a) Provide for above regulatory model of above four layers

b) Provide for basic rules on prudential (capital, liquidity, loan loss provision, etc.), consumer protection (maximum interest rate or interest margin over deposit rates as appropraite, loan recoveries, etc.) and fair market practices aspects in line with global best practices as applicable to relevant regulatory layers

c) Credit Information Bureau (CRIB) to set up a MFI credit information desk at a minimum service fee.

d) A separate MF deposit insurance scheme to be arranged by the Central Bank as a pay-box funded thorough insurance premium by all-deposit-taking MFIs at a later stage.

e) Provisions in the Act to be more principle-based rather than prescriptive

f) The Monetary Board as the national MF regulatory policy-maker to issue directions and guidelines to respective regulatory layers and examine their performance.

g) Amend or grant exemptions from other relevant Acts appropriately to implement this regulatory model

5. Customer Education and Counseling

a) Lack of awareness of different types of financial products and low level of confidence/trust are barriers to increase access to finance

b) All MFIs will be required to undertake a sustained financial literacy programme for members/borrowers to undertake financial services with them. The Central Bank also can arrange such programmes to assist MFIs through the CBSL Regional Office network.

c) All MFIs should also undertake Credit Counseling and Loan Restructuring as a part of

their business operations

6. Training for the MFI regulators

a) The proposed regulatory mechanism will be effective only if there a mechanisms to provide training to MF regulator staff of Divisional Secretariats and MRCs.

b) The Central Bank can arrange some training modules in this regard at subsidized rates. The Center for Banking Studies and Institute of Bankers of Sri Lanka can be assigned to conduct such training modules

c) Those regulators may need to have some financial provisions for this purpose.