IDLO MF Working Paper

n. 2, October 2007




MICROFINANCE ACTIVITY IN PHILIPPINES
OPERATIONAL AND REGULARTORY CHALLENGES OF THE MICROFINANCE INDUSTRY IN THE PHILIPPINES


Authors
Deolito C. Valdemar
Legal Manager - CARD MRI Laguna Philippines

Rogelio A. Encinas
Manager, Microfinance Examination Group - Bangko Sentral ng Pilipinas

Atty. Magdalena D. Imperio
Deputy Director, Office of General Counsel& Legal Services - Bangko Sentral ng Pilipinas






http://www.idlo.int


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Deolito C. Valdemar
Rogelio A. Encinas
Magdalena D. Imperio

MICROFINANCE ACTIVITY IN PHILIPPINES
OPERATIONAL AND REGULARTORY CHALLENGES OF THE MICROFINANCE INDUSTRY IN THE PHILIPPINES

IDLO MF Working Paper
n. 2, October 2007

Summary:
1. Environment & industry background
2. Challenges for the Microfinance Industry
3. Policy and regulatory environment
4. The regulatory role of the BSP
Annex 1 - The General Banking Law 2000
Annex 2 - Major Players in the Industry

Abstract:
This paper is the combination of perspectives from professional working in a microfinance industry
(CARD) and the Central Bank of the Philippines. It presents thus a cross expertise on the
microfinance industry in the Philippines, its specificities, its challenges and its regulation.

The regulation of microfinance is not simply designed to control an emerging industry. Filling the
regulatory void for microfinance is also a way to foster its development, improve the quality of
service it offers to micro-entrepreneurs, and in particular diversify the array of those services,
allowing for instance savings or micro insurance.

The government of the Philippines as addressed those needs both through institutional and
regulatory activity. Several institutions have been thus created in order to control the microfinance
industry, both within and outside the central bank. The legislation has been completed by specific
dispositions in the Banking Law of 2000 and all following Central Bank circulars. This paper does
an extensive review of this new regulatory framework, highlighting simultaneously how it
constrains the industry (registration requirements for instance) and how it fosters it.


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1. Environment & industry background


Poverty remains a crucial problem in the Philippines. Data from the National Statistics
Office Family and Income Expenditure Survey of 2000 shows that the poverty incidence
of households with per capita income below the poverty threshold is around 24.7% (or
about 5.2 million families).

Key Statistics on Poverty as of Year 2002
Number of Poor Families 5.8M (Annual Poverty Indicator Survey)
Number of Poor Families 1.4M reached by MFIs (PCFC, 2004)
Estimated Gap 4.4M
Estimated Funding Requirement P110B from 2002 to 2007 (ADB, 2002)

Despite the positive support of Official Development Assistance (ODA) and other foreign
aid extended for microfinance programs in the country, microfinance services are
delivered only to one-third of the total poor households.

Demand, Supply, and the Gap For Microfinance Loans
Demand and Supply Gap of
MICROFINANCE Loans
Rural vs. Urban, 1997 and 2000
Year Demand Supply Supply Gap
2002 62.04 2.66 59.38
2003 69.42 3.35 66.07
2004 77.68 4.18 73.5
2005 87.31 5.38 81.93
2006 98.14 6.69 91.45
2007 110.31 8.25 102.06
(in billion pesos)

$1 = 50.00 pesos

This table highlights the supply gap in the market of microfinance in the Philippines.
Developing the industry and filling this gap is one of the major upcoming challenges of
microfinance industry in the country.

A political dynamic
The government, recognizing the importance of microfinance in poverty reduction and
the need to support capacity building of microfinance institutions (MFIs), ranked
microfinance as its top priority in the Medium-Term Philippine Development Plan


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(MTPDP) 2001-2004. Both donors and aid recipient countries all over the world have
increasingly understood that a sustainable microfinance system is an indispensable tool
for poverty reduction, especially in developing countries like the Philippines.
In addition to the past efforts of the Philippine government for poverty reduction,
President Arroyo announced as part of the ten point agenda outlined during her
inaugural address of 2004 that her major policy thrusts between 2005-2010 include the
provision of financing to 3 million micro-enterprises, which are expected to graduate to
become small enterprises by the year 2010, the final year of her Presidential term. To
achieve this target, MFIs will need substantial financial and technical support. The
Philippine microfinance industry has indeed entered a new phase of further development
where the provision of substantial - and even increased - funding to sustain the
evolution from micro to small businesses becomes critical.
Along those public projects, the Rural Microenterprise Finance Project (RMFP) was
implemented from 1997 until the end of 2002, with a total cost of USD $65 million (of
which the Asian Development Bank (ADB) financed USD $20 million, and International
Fund for Agricultural Development (IFAD) supplied USD$14.7 million. [*ADB issued a
concessional loan with a technical assistant grant component and IFAD issued a loan
with incremental investment credit requirements.]


2. Challenges for the Microfinance Industry


2.1 The issue of credit pollution

One emerging challenge among microfinance providers is the spread of credit pollution.
Because many MFIs simultaneously operate in a single town or municipality,
microfinance operations have begun sharing clients. Interviews of borrowers with loan
collection problems indicate that they have taken loans from one MFI in order to repay
their loan with another. Because of this practice, MFIs encounter loan collection
problems. In the case of CARD for instance, prospective clients are asked if they are
members of another MFI, and their neighbors themselves are being contacted, but no
proper credit investigation is being done.
The National Credit Council and the Central Bank of the Philippines have taken steps to
establish a credit information bureau to service the requirements of MFIs. A bill for the
propose credit bureau is presently under deliberation in the House of Representatives
but it has not yet been passed by the Congress. The resultant Credit Bureau would be a
public/private partnership, owned at 49% by the Central Bank of the Philippines and at
51% by private owners. The MFIs would supply a "Blacklist and White List¨ of


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microfinance clients and would use the bureau in order to perform credit checks. This is
an attempt of the Central Bank of the Philippines to contain - and eventually eradicate -
credit pollution. The credit information bureau would be an important infrastructure to
increase financial transparency and to promote a more efficient microfinance sector.


2.2 Issues of governance

Good governance of financial institutions is another challenge for the microfinance
industry. Board members of family-owned rural banks may be expected to practice good
governance to protect their investments. Still, rural banks also need to include
independent Board members, who can provide expert advice on the banks´ financial
operations (one lacks specific data on the percentage of rural banks that are family-
owned, but according to CGAP, this is often the case).
At the same time, cooperatives and NGOs need to improve the quality of their Boards,
whose members serve on a voluntary basis (perhaps by legislating that board members
must have some banking or formal financial education). In the absence of personal
investments in the MFI, volunteer Boards may not be able to implement the appropriate
management systems required in a MFI.


2.3 Performance standard

The National Credit Council has developed a set of performance standards to be applied
to all types of microfinance institutions in the Philippines. The use of the performance
standard will help them to observe financial discipline and governance and to establish
their credibility in the financial markets. Access to commercial sources of capital will be
facilitated. As shown by experience, some commercial banks are willing to invest if MFIs
can show adherence to certain standards that provide an objective basis for judging their
financial performance. At present, however, the performance standards have not yet
been widely adopted by MFIs. This may be due to the absence of incentives for the
adoption of such standards, or to the issue of the applicability of those standards to all
types of micro finance institutions.


2.4 "Microfinance plus": enlarging the array of financial and non financial
products


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One can think of a large array of products, both financial and non financial that can be
offered to MFIs´ clients:
• Microfinance Loans - Business, Housing, Agriculture, Emergency, Health,
Education
• Microfinance Insurance - Life, Non-life, Health
• Microfinance Savings
• Microfinance Remittances
• Microfinance Payment
• Capacity Building
• Business Development Service
Microfinance has proven itself an effective tool to bring poor people out of poverty.
However, in order to sustain and strengthen these impacts, MFIs must acknowledge that
the poor are a heterogeneous group, who therefore require a variety of services, and
that their needs will continue to evolve over time. Unfortunately, many MFIs continue to
consider their clients as static recipients of credit programs, when in fact client
preferences change over time, and microfinance in isolation cannot bring about
development. MFIs that do not respond to those changes by restructuring their loan
products will surely become obsolete.
A survey carried out by Rebecca Coke on gender and its significance in microfinance
during the first half of 2002 found that resources loaned to clients were indeed used to
generate income for the borrowers, which generally had positive effects on the
beneficiaries. However, it was found out that these income-generating endeavors were
not collectively sustained in the long-term. It did not make "entrepreneurs¨ out of the
borrowers, nor did the microfinance loans fund "growth projects¨.
According to Coke: "Given the socia context in which borrowers make business
decisions, the Philippine microfinance programs are not properly designed to meet the
overarching policy goal of economic growth. The programs are alleviating poverty, but
(are) not encouraging long-term development. This can be primarily attributed to an
over-reliance on credit as the sole method for promoting entrepreneurship. This echoes
the concerns of other industry experts regarding the common practice of simply giving
bigger and bigger loans to "successful,¨ repeat clients. Credit alone cannot jump start
development; it must be combined with larger, holistic initiatives targeting individuals
within communities. "
Moreover, through the initiative of JBIC in 2004, the impact assessment and market
research among clients of selected major players in the Philippine microfinance industry
have brought to the fore the following unmet demands by clients:
• Demand for new financial products and services that included recommendations for
health insurance, a variety of types of training in project and financial


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management, and a more rapid loan-size progression for center members
especially those who have moved up the poverty ladder from being very poor and
moderately poor to non-poor.
• Demand for the development of insurance products.
• For some clients who have shown eagerness and possess the skills and resources
to make the transition to higher-earning micro-enterprises, a separate facility that
would offer a range of services beyond financial, such as business development
service; and a response to their business needs and plans by opening access to
special loans such as livestock, multi-purpose and educational.


2.5 Focus on savings

The case studies commissioned by the World Bank to look at the role of microfinance in
building assets and reducing household vulnerability were fairly conclusive that micro-
finance services can "reduce vulnerability by enabling households to accumulate assets.¨
Key categories of assets defined broadly by the poor households and by the case studies
included financial, physical, human, and social, assets, all considered important in
helping poor households to deal with shocks. This effect is significant for the poor at all
levels - extremely poor, moderate poor and vulnerable non-poor. Because this
diversified asset portfolio is a key for the survival of extremely poor households, it is
crucial that better products are developed to deepen outreach. Savings and insurance
services in particular are primordial, given the importance of reducing vulnerability
through asset accumulation. Therefore, appropriate support for those who have just
crossed over the poverty threshold as a result of microfinance intervention is also
decisive. Moreover, many of those clients are likely to be repeated clients, and therefore
less costly, with better repayment records, etc.
Large MFIs like Center for Agriculture and Rural Development (CARD), Inc. and Negros
Women for Tomorrow Foundation, Inc. (NWTF) already responded to these changes by
forming separate research units with the primary function of studying the changing
preferences of clients. To keep MFIs in-tune with the changing needs of their poor
clients, research and continuous product innovation will continue to play a vital role in
the industry´s continuous effort to uplift the lives of the poor. Meeting client needs will
result in high demand for microfinance services among the poor, and in turn, facilitate a
strong cooperation with clients and faster outreach for the MFIs.





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2.6 Reaching more people

Another challenge raised by Dr. Gilberto Llanto, Vice-President of the Philippine Institute
for Development Studies (PIDS), who currently serves as a Research Fellow with the
Rural Development Research Consortium at the University of California, Berkeley, is the
building of the capacity of MFIs to lend to more clients; by going down market to poorer
clients; going up market to larger micro enterprises; or by including market segments
excluded by micro finance services.
Graduation failure is also a challenge for Micro-finance practitioners. It is the cross-over
to the next growth stage. The responsibility may assumed by the field staff who is not
willing to pass on its valued clients to other staff for the reason that their portfolio,
target and accomplishments would be affected. Another obstacle may be due to the
failure to develop clients´ business to the level sufficient to take out bigger loans. One
should also take in consideration the possible fear for loans of a larger amount.
There is especially a strong need to expand operations in areas with a high magnitude
of poor families and where access to microfinance is limited. Only pockets of poor
communities are reached where there is existing road infrastructure and therefore,
markets. There is a shallow depth of outreach, and a significant challenge to reaching
the destitute. In deepening outreach among the poor, MFIs are faced with additional
costs and risks involved in expanding to hard-to-reach areas. One of the challenges
implied by serving the bottom segment of the poor is the increasing need for capital for
expansion and the need for appropriate infrastructure to support operations in very poor
communities.


2.7 Lowering the costs

Average expense ratio (Phils.) 38.8%, Microfinance Council
Standard Operating Expense Ratio 20% or less, National Credit Council
Operating Expense Ratio 18.2% MicroBanking Bulletin

This table suggests that MFIs in the Philippines have ample room to reduce costs
through greater efficiency in the delivery of its services. Banks have to attain economies
of scale to operate efficiently and be able to pass on to their clients the benefit of a lower
interest rate.
Related to the issue of lowering costs and in line with latest innovations in
communications and technology, the challenge for microfinance practitioners is to use
these innovations for more cost-efficient operations. Although a number of MFIs have


8
begun pilot testing Personal Digital Assistants and mobile commerce in microfinance, real
benefits are yet to be demonstrated.


2.8 Morality

FMIs face several moral issues, such as:
• Over-indebtedness of the poor caused by multiple loans and erroneous
assessments by MFI. The Philippines does have a consumer/debtor protection law
but there is no law that prohibits one from having multiple loans. In the case of
CARD for instance, there is a verbal agreement but, as mentioned before, no
proper credit investigation can be effectuated;
• Over saturation of accessible areas and absence of services in remote areas;
• Unfair competition through negative publicity by rival MFIs;
• Violation of code of ethics through client and staff poaching by competing MFI´s.


2.9 No proper lending technology

Some banks engage in microfinance by replicating other banks´ methodologies without
appropriate training. Generally, these other banks do not have adequate operating
manuals for microfinance.
Banks engaged in microfinance operations should have a loan tracking system that
allows daily monitoring of the status of loan disbursements, collections and arrears, and
any restructuring or refinancing.


2.10 Incentives for the microfinance staff

Since microfinance operations are different in many ways from regular lending,
appropriate staff incentives for account officers and supervisors are a necessary
component of a successful microfinance operation.


2.11 Lack of effective internal control systems

In microfinance operations, most credit decisions are made in a decentralized manner at
the branch level. The absence of adequate internal control systems or the deterioration


9
of internal controls in microfinance operations creates opportunities for fraud on the part
of the account/loan officers.


2.12 Effective budgetary control

Excessive administrative expenses such as salaries may force the banks to increase
interest rates, resulting in a higher cost for borrowers. Additionally, inaccurate pricing of
loans and services may result in losses and inadequate allowance for loan losses.


2.13 Unsustainably rapid growth

Banks should not try to grow too rapidly by imitating the strategies of banks operating in
different environments. Growth of microfinance operations should occur within an
environment with an adequate operating manual, effective internal control mechanisms
and appropriately trained officers and employees.


2.14 Training and experience in the field of microfinance

The business of microfinance is substantially different from commercial lending, since the
two key elements that support a traditional credit decision - repayment capacity
information and tangible collateral - are often lacking. Without properly trained and
experienced personnel, microfinance methodologies may not be implemented properly,
which could result in greater delinquency.
Financial sector authorities should therefore adopt rules and regulations to strengthen
the microfinance operations of financial institutions, and they should devise tools to
effectively monitor and evaluate their performance. Toward this end, regulators should
focus on:
• Promoting best practices in risk management of microfinance loans, since they
generally are not secured and no formal information - such as statements of
assets and liabilities, income and expenses, and income tax returns - is available;
• Ensuring that microfinance institutions adopt policies and procedures on
governance, planning, lending technology, provisioning, internal controls,
information systems, and transparency;


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• Promoting the creation of a credit reference system to prevent "credit pollution.¨
In the absence of a national reference system, practitioners in a certain locality
may create and administer such a system on a regional basis;
• Utilizing effective instruments to evaluate microfinance operations. Regulators
should be equipped with the latest techniques for examining the operations of
microfinance institutions, in order to detect early signs of unsound policies or
deterioration of lending methodologies and practices.


3. Policy and regulatory environment


3.1 General Policy

Microfinance in the Philippines is fundamentally supported by a market-based policy and
regulatory framework, crafted by the government, including the Bangko Sentral Ng
Pilipinas (BSP). In 1997, the government laid out its National Strategy for Microfinance
to develop the microfinance market. The government´s microfinance policy is
encapsulated in a Strategy based on the following principles:
• The government´s role is to provide a policy environment that is conducive to the
increased participation of the private sector in microfinance;
• Private MFIs (defined as credit-granting NGOs, microfinance-oriented banks, and
credit unions) shall have a greater role in the provision of microfinance services;
• Market-oriented financial credit policies, including market-oriented interest rates
on loans and deposits, are necessary to ensure the viability and sustainability of
MFIs and the continuing access of poor people to finance services;
• Non-financial (line) government agencies shall not be allowed to participate in the
implementation of credit and guarantee programs. Rationalization of Direct Credit
Program is supplied by a law signed in August 1999. This provides for the phase
out of all subsidized credit program in the agriculture sector within a four year
period. In addition, Executive Order 138 mandates government non financial
agencies implementing directed -subsidized- credit programs to terminate those
credit programs and transfer all funding to government financial institution. The
latter will lend the funds to private financial institution that, in turn, will lend or
retail to borrowers.
• It is important to have appropriate regulation and supervision of microfinance to
"protect the financial system from unsound practices by deposit-taking
institutions and small clients.¨


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This policy was instrumental in making the government assume a new role in the credit
markets that departs from its perceived identity as a dole-out agency of loans into a
policy-making and regulating agent in microfinance activities in the Philippines. From
being a direct provider of subsidized loans, the government has taken a facilitating and
coordinating role in creating an environment that will support the development of
market-oriented financial programs for the poor, through policies and regulations.
Congress issued innovative provisions on microfinance through the revised General
Banking Law of 2000 (Republic Act 8791). It attempted to establish a balance between
the objectives of tightening prudential regulations and ensuring the flow of financial
services to micro enterprises, small enterprises and poor households. The Act has
provisions specific to microfinance, particularly on issues of collateral-based lending,
unsecured loans, and interest due microfinance borrowers and loan amortizations.
The Central Bank of the Philippines showed its support in the development of
microfinance in the country by developing a framework that encourages microfinance
institutions and their activities. The Monetary Board, the policy-making body, has
partially lifted the general moratorium on the licensing of new thrift and rural banks to
allow and encourage the entry of microfinance-oriented banks on a selective basis. In
addition, microfinance loans extended by rural banks and cooperative rural banks were
made eligible for rediscounting with the BSP, encouraging them to increase microfinance
activities by providing them additional liquidity to fund their lending operations.
To execute these provisions, the Bangko Sentral ng Pilipinas (BSP) issued several
circulars and guidelines in support of microfinance development such as:
• The issuance of clear guidelines on the treatment of microfinance-oriented banks;
• The provision of a rediscounting facility for banks engaged in microfinance; and
• The formulation of a supervision format that is appropriate for microfinance
operations of these banks.
Meanwhile, the People´s Credit and Finance Corporation (PCFC) became the
government´s lead institution in mobilizing financial resources for microfinance services.
With funding sourced through loans from the ADB-IFAD, the World Bank with the Land
Bank of the Philippines, the PCFC was able to provide wholesale loans to accredited
microfinance institutions which in turn retailed these to microfinance clients. The PCFC is
a government owned and controlled corporation (under the Rural Micro enterprise
Finance Project, it should be privatized before the project completion), which has a total
partner of 48 microfinance institutions, consisting of rural banks, cooperatives and other
non-government organizations. As of June 30, 2004, PCFC receivables from partners
have amounted to P700 million (US$12.5 million) while the total loans granted by micro-
finance institutions to their clients totaled P1.05 billion. Total disbursements of PCFC to
microfinance institutions since 1997 have reached P8 billion. The repayment rate from


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end-clients to partners is at 98.4 per cent while from partners to PCFC is almost 100 per
cent.
Republic Act (RA) No. 6977 (approved January 24, 1991) requires all public and private
lending institutions, as defined under Central Bank rules, to set aside a portion of their
total loan portfolio for small enterprise credit. Microfinance loans form part of the bank´s
compliance requirements through a mandatory credit allocation prescribed by law.
1
The
7 year period for mandatory allocation was subsequently extended to 10 years by the
law amending RA No. 6977, RA No. 8289 (which was approved on May 6, 1997). RA No.
8289 requires all lending institutions to set aside at least 6% of their total loan portfolio
for lending to small enterprises and 2% for lending to medium enterprises.
As the directed lending program prescribed under RA No. 6977 (as amended) was about
to expire, the following laws were subsequently enacted to continue support of the
national strategy to strengthen microfinance initiatives in the Philippines:
• Social Reform and Poverty Alleviation Act (RA No. 8425 of 1997) - calls for the
rationalization of directed credit programs, emphasizes savings mobilization,
focuses government funds on capacity building, and creates the National Anti-
Poverty Commission;
• Agriculture and Fisheries Modernization Act (RA No. 8435 of 1999) - directs
government financial institutions to act as wholesalers of funds for private
microfinance institutions;
• General Banking Act (RA No. 8791 of 2000) - recognizes the unique
characteristics of microfinance and mandates the Central Bank of the Philippines
Monetary Board to establish rules and regulations for its practice within the
banking sector; and
• Barangay Micro Business Enterprises (BMBEs) Act (RA No. 9178 of 2002) -
requires government financial institutions to set up a special wholesale window
for accredited microfinance institutions. Under this Act, loans granted to BMBEs
are credited as an alternative means of complying with the Agri-Agra Law
(Presidential Decree 717) and RA 6977.
In 1999, Executive Order (EO) 138 was issued, directing: (i) the transfer of directed
credit programs from government line agencies to government financial institutions; (ii)
discontinuance of interest-rate subsidies; and (iii) the use of private microfinance
institutions (MFIs) as vehicles for delivery of retail financial services. This measure and
the laws enacted in support of the National Strategy for Microfinance allowed the
government - and specifically its non-financial agencies - to focus on their respective
areas of competence and comparative advantage in promoting microfinance, such as

1
(See Sec. X342.3 of the Manual of Regulations for Banks).


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through capacity building and social preparation. EO 138 was, however, repealed by EO
558 issued on August 8, 2006, which revived state-administered loan subsidy programs
in the Philippines. Government line agencies may now directly undertake subsidized
credit programs, giving rise to concerns that under EO 558, private-sector credit delivery
to the microfinance sector might dwindle, thus limiting the sector´s growth potential. The
government sought to allay such fears by stating that EO 588 only targets unserved
needy clients identified by the government.


3.2 Entry requirements

• Ownership limitations. The Philippines has limitations on foreign ownership of
MFI´s Per the Omnibus Investments Code of 1987 foreign equity ownership is
limited to 40%, but is allowed at 100% in a "pioneer" priority industry identified
in the annual Investment Priorities Plan (IPP). The Foreign Investment Act of
1991 (FIA) further liberalized the investment climate of the Philippines. In May
2000, the General Banking Law (GBL), in addition to strengthening the
supervisory role of the Bangko Sentral ng Philippines (BSP), allowed 100%
ownership of distressed banks for foreigners.
• Minimum capital requirements
• Capital adequacy requirements
• Restrictions on operations (e.g. Branching limitations)
• Reporting requirements
• Rediscounting requirements
• Slow response of government curtailing growth of microfinance
The government, donors and micro-finance council may develop a systematic and
sustained program of providing technical assistance to the MFIs in various areas such as
strategic planning, financial management, audit and control system, basic banking skills,
simple accounting and financial analysis and MIS, loan delinquency management, asset
and liability management, product development and packaging, risk management,
appropriate pricing of financial products, information tools and appraisal systems,
internal control, human resource development, client and product development and
entry assistance.
All NGOs, including those engaged in microfinance, are required to register with the
Securities and Exchange Commission (SEC) as non-stock, non-profit organizations.
Although microfinance NGOs are required to file annual, audited financial statements and
general information sheets to the SEC, they are not subject to prudential regulation and
supervision by any government regulatory authority.


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This shows a nominal registration, rather than a regulatory system, and there is a need
for real regulation, thus some supervision for the effective operation of credit
cooperatives and MFIs.


3.3 Rationalizing the role of government agencies in microfinance

In 2002, the National Anti-Poverty Commission (NAPC) convened with other government
agencies involved in microfinance capacity building and credit delivery. As a result, each
agency´s specific role in ensuring the success of microfinance was identified, as well as
the relationship between public and private institutions as follows:
• The PCFC shall be loans up to $500.00 per a wholesaler of end-client. Its focus
shall be on poor households as specified by the NEDA poverty threshold indicator.
• The Development Bank of the Philippines shall offer rediscounting of microfinance
loans and shall be a primary wholesaler of small and medium enterprise loans
above $3,000.00 per client.
• The Land Bank of the Philippines shall be a wholesaler of loans for farmers and
fisher folk. It will supervise the PCFC and the NLSF funds. It recently approved a
microfinance-lending program.
• The National Livelihood Support Fund shall provide loans to agrarian reform
beneficiaries through accredited conduits. It is supervised by the Land Bank of
the Philippines.
• The Small Business Guarantee and Finance Corporation (SBGFC) provides
wholesale loans to MFIs.


4. The regulatory role of the BSP


4.1 Policy

In 2000, the Bangko Sentral ng Pilipinas (BSP) declared that microfinance would be its
flagship program for poverty alleviation. The initiatives and programs of the Central
Bank of the Philippines have been in the areas of:
• Policy and Regulatory Environment. Enabling policy and regulatory environment is
integral in the creation of sustainable microfinance institutions. Towards this end,
the BSP has issued a number of circulars that pertain to definition of microfinance
loan, licensing of microfinance-oriented banks, guidelines governing the BSP


15
rediscounting facility, rules and regulations for the establishment of branches
and/or Loan Collection and Disbursement Points (LCDPs) of microfinance-oriented
banks and microfinance-oriented branches of regular banks, and formal minimum
credit risk management guideline including the measurement of Portfolio-At-Risk
(PAR) and appropriate provisioning standards for microfinance loan portfolios,
among others.
• Training and Capacity Building within BSP and the banking sector. A core group of
20 microfinance examiners has been formed to handle the supervision of all
banks with significant microfinance activity, which is about 195 banks in total
including four thrift banks, but excluding cooperatives and NGO´s. The BSP is
committed to increase the capacity and skills of these specialist BSP examiners by
providing then with a comprehensive and focused training program. In the same
way, the BSP offers exposure seminars to provide better appreciation of
microfinance within BSP in general. In addition, the Basic Rural and Thrift
Banking Courses for banks´ representatives now include a session on microfinance
prudential operations. The BSP requires that MFI´s participate in a Basic Rural
Banking course.
• Hiring an experienced microfinance practitioner to serve as a consultant further
strengthens BSP´s capacity. Moreover, a Microfinance Committee and a
Microfinance Unit have been created within the BSP to ensure continuity and
coherence of its programs and projects. The Microfinance Committee provides
overall direction of BSP´s microfinance initiatives. On the other hand, the
Microfinance Unit coordinates and monitors the implementation of its various
activities including advocacy.
• Promotion and Advocacy. In 2003, BSP launched a microfinance regional
advocacy program, in order to reach eight regions by year-end. Microfinance
seminars are held in strategic regions of the country to encourage potential
practitioners of sustainable microfinance to reach more clients. The program also
aims to build collaborative efforts with large corporations and private foundations
for a broader, more accessible microfinance network.
• Moreover, the BSP, in partnership with the National Credit Council (NCC), has
commissioned a study on the formation of a central credit information bureau to
replace the existing system of fragmented credit bureaus. This project will be
particularly beneficial to microfinance operations by reducing the risk of credit
pollution, promoting greater borrower discipline, and lowering credit risk
especially on unsecured lending.




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4.2 BSP's regulation

The BSP - as mandated by the following provisions of the GBL - issued the regulatory
framework for the establishment, operation, and supervision of the microfinance
activities of lending institutions:
Section 40: "In formulating rules and regulations [on credit], the Monetary Board shall
recognize the peculiar characteristics of micro financing, such as cash flow-based lending
to the basic sectors that are not covered by traditional collateral.¨
Section 43: "The Monetary Board shall regulate the interest imposed on micro finance
borrowers by lending investors and similar lenders, such as, but not limited to, the
unconscionable rates of interest collected on salary loans and similar credit
accommodations.¨
Section 44: "In case of loans and other credit accommodations to micro finance sectors,
the schedule of loan amortization shall take into consideration the projected cash flow of
the borrower and adopt this into the terms and conditions formulated by banks.¨
Pursuant to the foregoing mandate, the BSP has issued at least 13 circulars, a circular
letter, and a memorandum that recognizes microfinance as a legitimate banking activity
and establish the guidelines for its operation within the banking sector. These circulars
respond not only to the provisions of RA No. 8791 (the General Banking Law), but also
help to implement the pertinent provisions of RA Nos. 6977, 8425, 8435, and 9178:
Circular No. 272: (dated January 30, 2001) defines microfinance loans as "small loans
granted to the basic sectors . . . and other loans granted to the poor and low-income
households for their microenterprises and small businesses so as to enable them to raise
their income levels and improve their living standards.¨ Microfinance loans have the
following characteristics:
• Maximum principal amount does not exceed P150,000 (approx. USD 3,000),
which is equivalent to the maximum capitalization of a microenterprise under the
Social Reform and Poverty Alleviation Act of 1997;
• Microfinance loans may be amortized on a daily, weekly, bi-monthly, or monthly
basis, depending upon the projected cash flow of the borrowers;
• Interest rates shall not be lower than the prevailing market rates in order to
enable the lending institution to recover its financial and operational costs;
• Microfinance loans are counted towards compliance with the required mandatory
credits to small and medium enterprises.
Banks are required to have adequate loan tracking systems that allow both for daily
monitoring of the status of loan disbursements, collection and arrears, and any
restructuring or refinancing; and for regular monitoring of past due loans and portfolio at


17
risk. However, there is no requirement for a statement of assets and liabilities, income
and expenditures, or an income tax return.
Circular 273: (dated February 27, 2001) partially lifts the general moratorium on
licensing new thrift and rural banks, in order to allow for the entry of new microfinance-
oriented thrift and rural banks. At least 20% of the paid-in capital of the new bank must
be owned by persons or entities with microfinance experience. In addition, the majority
of the members of the board of directors must have microfinance experience, with at
least one member having actual banking experience. At all times, at least 50% of the
bank´s gross loan portfolio must consist of microfinance loans. Finally, the bank must
also have an adequate loan tracking system.
Circulars 282 and 324: provide liquidity assistance to thrift and rural banks to support
and promote their microfinance programs. Eligibility requirements for availing of the
rediscounting facility include, among other things:
• Minimum of one year track record in microfinance with at least 500 active
borrowers;
• Past due microfinance loans may not exceed 5% of loan portfolio, and collection
ratio must equal or exceed 95% of portfolio;
• Existence of Board-approved policies and procedures on microfinance; and
• Key officers and staff must be trained and experienced in microfinance
operations.
Circulars 340, 365, 369, and 505: provide the rules and regulations for the
establishment of microfinance-oriented branches. Branches of microfinance-oriented
banks, microfinance-oriented branches of regular banks, and branches that will cater
primarily to the credit needs of Barangay Micro Business Enterprises may be established
anywhere in the country, subject to compliance with minimum capital requirements.
Additional requirements for the establishment of branches of microfinance-oriented
banks and/or microfinance-oriented branches of regular banks include:
• A manual of operations on microfinance duly approved by the board of directors;
• An adequate loan tracking system;
• The branch must be managed by a person with adequate experience or training in
microfinance activities; and
• At least 70% of the deposits generated by the branch must be lent out to
qualified microfinance borrowers, and the microfinance portfolio of the branch
must at all times be at least 50% of its gross loan portfolio.
Circular 364: (dated January 9, 2003) reduced from 100% to 75% the risk weight
applicable to SME and microfinance loan portfolios that meet certain prudential
standards. The circular in effect relaxes the capital adequacy requirement for institutions
providing microfinance loans and loans to small and medium enterprises.


18
Circular 374: (dated March 31, 2003) provides the implementing guidelines for the
Barangay Micro Business Enterprises (BMBEs) Act of 2002. Government Financial
Institutions (GFIs) are encouraged to lend wholesale funds to accredited financial
institutions - including community-based organizations such as cooperatives, NGOs, and
people´s organizations engaged in granting credit - for on lending to BMBEs.
Circular 409: (dated October 14, 2003) prescribes certain rules, regulations and
standards that govern the microfinance operations of banks. Portfolio-at-Risk (PAR) is
defined as "the outstanding principal amount of all loans that have at least one
installment past due for one or more days. The amount includes the unpaid principal
balance but excludes accrued interest.¨ Banks are required to set up specific allowances
for probable losses on microfinance loans immediately, in accordance with the number of
days of missed payment. Microfinance loans that have been past due for 91 days or
more and are fully provisioned may be written off.
Circular Letter dated October 2, 2002: revised certain reports submitted to the BSP to
include/disclose data pertaining to microfinance loans.
Memorandum to All Commercial and Thrift Banks dated December 30, 2003: requires
the addition of general ledger accounts in the Manual of Accounts for commercial and
thrift banks for purposes of reporting the banks´ transactions pertaining to microfinance.
On January 19, 2006, the Monetary Board allowed rural banks to classify their Micro-Agri
Loan product as a microfinance loan product. Participant banks are required to meet the
following conditions:
• The loan product is included in the bank´s microfinance manual as one of the
types of services or products offered to clients;
• The product must exhibit the criteria/characteristics of a microfinance loan; and
• The micro-agri client must have another source of income sufficient for the
periodic payment of the loan
2
while the loan project is not yet generating income.
As regulator and supervisor of the banking system, the BSP is continuously reviewing
and amending its policies and regulations to ensure that they are receptive to the
growing needs of the microfinance sector.


4.3 Specific regulatory requirements and supervisory practices

The National Credit Council (NCC) approved a Regulatory Framework for Microfinance in
2002 which is available at tp://www.microfinancecouncil.org/resources.htm. The
framework covers only institutions taking deposits from the general public and/or from
its members, specifically banks and cooperatives, and is subject to prudential regulation

2
This is evaluated through a household cash flow analysis.


19
and supervision. Since microfinance NGOs are not allowed to take deposits from the
public, they are generally not covered by prudential regulations.
Banks: are under the regulatory authority of the BSP, including those engaged in
microfinance. The BSP issues the necessary rules and regulations for the safe and
prudent operations of banks. It regularly conducts examination of banks to check for
compliance with banking laws, rules and regulations, as well as soundness of risk
management systems.
To accommodate microfinance activities, the BSP did not create any new special bank
category. Instead, it simply recognizes microfinance-oriented banks that are licensed as
normal thrift or rural banks plus additional requirements in keeping with their
microfinance focus. As a consequence, these entities need to meet higher entry
standards in return for exemption from the general moratorium on the establishment of
new banks except in "unbanked¨ areas. As full-fledged banks, they are also expected to
meet the standard annual supervision fee assessment, which is a function of the net
asset base. The rural banking system, and to some extent, the thrift banking system, a
network consisting of almost 3,200 banking offices all over the country and with a capital
base of almost $1.1 billion, are proving to be ideal delivery vehicles for microfinance,
considering their community-based roots.
Microfinance portfolios of banks are also subject to portfolios-at-risk measurement and
tougher provisioning standards that lead to full provisioning after 90 days of being past
due or upon twice restructuring. This aggressive provisioning requirement is necessary
in view of the unsecured nature of microfinance lending and minimal documentation
requirements.
The BSP also recognizes the special requirements of microfinance operations for the
conduct of bank supervision. This challenge is being met by setting a core of especially
trained examiners.
Cooperatives: are under the oversight functions of the Cooperative Development
Authority (CDA). The approach to prudential regulation and supervision is essentially
the same as for banks since these are considered deposit-taking entities, although it is
limited to their membership. However, CDA´s focus on development activities, which is
also mandated by their charter, has distracted it from more effectively implementing its
regulatory and supervisory mandate. In 1998, the NCC, in coordination with the CDA
and the cooperatives sector developed a Standard Chart of Accounts (SCA) as well as a
set of financial performance standards. Both are being used as a management and
regulatory tools. Work is also in progress to strengthen the CDA´s regulatory and
supervisory capacity, with assistance from BSP.
Non-Government Organizations (NGOs): At present, microfinance NGOs as non-deposit
taking entities, are not regulated but are required to register with the Securities and


20
Exchange Commission (SEC) as a non-stock, non-profit organization. Almost all
microfinance NGOs, though, collect compulsory savings (usually referred to as capital
build-up) from their clients. In view thereof, the BSP has taken a tolerant stance of the
practice provided that forced savings do not exceed the amount of loans per client. The
Microfinance Council of the Philippines (MCP), an association of microfinance
practitioners, has established a set of financial standards which are collected periodically
to ensure that microfinance NGOs are operating in accordance with sound practices. The
performance indicators, which could be the basis for evaluation by donor agencies and
other interested parties, are focused on portfolio quality, efficiency, sustainability,
outreach and savings generation. They likewise need to allow independent external
audit.


4.3 Training and Capacity Building

A high-level Microfinance Committee has been created within the BSP. The committee,
headed by the Deputy Governor of the Supervision and Examination Sector with two
members of the Monetary Board acting as advisers, provides the overall direction for
BSP microfinance initiatives. The BSP has a Microfinance Unit, the Office of the
Consultant for Microfinance, which serves as the implementing and coordinating body for
microfinance activities in the Central Bank and the banking sector. A Microfinance Group
of Examiners has also been created to handle supervision and examination of banks
engaged in microfinance operations.
Training and capacity building of BSP officers and staff and the banking sector has been
a top priority for the BSP. The BSP is committed to enhancing the capacity and skills of
the BSP examiners, officers, and employees (and banking sector personnel more
generally). BSP examiners, officers, and employees have been sent to attend training
courses, workshops, and study tours (both locally and abroad) to increase their
knowledge and skills in microfinance.
The BSP has conducted a series of briefings on microfinance for officers and employees
of banks and has included microfinance as a topic in the Basic Rural and Thrift Banking
Courses conducted by the BSP for new officers and employees of thrift and
rural/cooperative banks. Also, the BSP has offered a briefing on enhancement of internal
controls for microfinance and a workshop on the computation of portfolio at risk and loan
loss provisioning for internal auditors, accountants, and compliance officers of rural and
cooperative banks.




21
4.4 Promotion and Advocacy

The BSP has launched a regional advocacy program that conducts basic seminars on
microfinance for prospective microfinance practitioners in strategic regions of the
country. Members of the Microfinance Committee and members of the Monetary Board
of the BSP have participated in the program.
Examination Manual for Microfinance Operations and Revision of CAMELS: In order to
properly supervise the growing number of banks engaged in microfinance operations,
the BSP developed and adopted appropriate examination policies and procedures to
enhance its capacity to measure institutional risks and the performance of microfinance
operations of banks. The policies and procedures suggested in the examination manual
place particular emphasis on the evaluation of the risk management structure of the
institution, its information systems, and its internal controls.
The examination of microfinance portfolios involves the following five activities:
• Review of microfinance lending policies and procedures;
• Extraction and processing of microfinance loan data for credit and operational risk
evaluation and for verification of compliance with regulations;
• Review of internal audit of microfinance operations;
• Review of internal controls through visits to branches and clients; and
• Review of the efficacy, efficiency, and security of the IT resources of the bank
that affect microfinance operations.
With respect to CAMELS, in order to avoid potential bias against microfinance operations
and at the same time to reinforce the importance of proper management of such
operations, amendments to the CAMELS were introduced










22
Annex 1


The General Banking Law 2000 (r.a. 8791)

• Sections 40, 43 and 44
Recognize the peculiar characteristics of microfinance in the requirements, terms and
amortization of loans and other credit accommodations.
• Circular 272 - implementing provisions of the General Banking Law, Sections 40,43
and 44 on microfinance operations (01/30/01)
• Circular 273 - partial lifting of the moratorium on the opening of new thrift and rural
banks and branches and provisions for licensing of microfinance-oriented banks
(02/27/01)
• Circular 282 - guidelines governing the rediscounting facility to refinance the
microfinance loan portfolio of rural & coop banks (04/19/01)
• Circular 324 - Extension of coverage to include Thrift Banks
• Circular 340 - Rules and regulations for the establishment of branches/LCDPs of
microfinance oriented banks and microfinance oriented branches/LCDPs of non
microfinance oriented banks (07/30/02)
• Circular 365 - Liberalizes 1 year profitable operations requirement (01/16/03)
• Circular 369 - Liberalizes capitalization requirements for Thrift Banks (02/17/03)
• Circular 409 - Rules, regulations and standards governing microfinance operations of
banks specifically the measurement of Portfolio at Risk and Loan Loss Provisioning
(10/14/03)
• Circular 505 - Branching policy and guidelines specifically on the
establishment/relocation/voluntary closure/sale of local branches of domestic banks,
including locally incorporated subsidiaries of foreign banks (12/22/05)

Benefits for microfinance:
- microfinance - oriented branches can be established anywhere in the country
- lower minimum capital requirement from P2.5 m to as low as P0.5 m for 4th - 6th
class municipalities
- servicing of deposits outside bank premises
- lower processing fee



23
Annex 2


Major Players in the Industry

1. Thrift and Rural Banking Sector (BSP 2003)
• 670 Rural Banks and 54 Cooperative Rural Banks with 1,809 bank units.
• 121 Rural Banks and Cooperative Rural Banks in microfinance with P3B
Loan Outstanding.

2. Cooperative Sector (CDA,2004)
• 66,000 registered coops, of which only 50% and of these 85% offer
credit/savings.
• 100 Savings/Credit Coops with assets of more than $2 million, of which
50 are involved in microfinance.

3. NGO Sector (MCPI,2004)
• 30,000 NGOs registered with the SEC.
• 600 NGOs are involved in microfinance.
• 6 big NGOs dominate the microfinance sector with more than $30 million
in outstanding loans.



24
Sources


• JBIC Pilot Study on Sustainable Microfinance for Poverty Reduction in the Phils.,
Nov. 2004
• Microfinance Handbook, Bangko Sentral ng Pilipinas, August 2005
• What does the BSP do to promote Microfinance? - A speech by BSP Monetary
Board Member Antonino L. Alindogan
• Performance Standards for all types of Microfinance Institutions in the Philippines,
National Credit Council - Department of Finance
• Delivering to the Poor: A Search for Successful Practices in Philippine
Microfinance¨, UNDP, NAPC, PCFC, AIM entitled, December 2003
• Performance Monitoring Report, MCP, Inc. December 2004
• MCPI Network Capacity Assessment, Final Report, May 2005
• Microfinance in the Philippines: Status, Issues, and Challenges, Policy Notes No.
2004-10, Gilberto M. Llanto, PIDS, November 2004
• Report and Recommendation of the President to the Board of Directors on a
Proposed Loan and Technical Assistance Grant to the Republic of the Philippines
for the Microfinance Development Program, ADB, October 2005
• MicroBanking Bulletin Issue no. 11
• Strategic Management Project - Portfolio , Ms. Dolores M. Torres