This is part one of a two-part series on the recent knowledge exchange visit by representatives from the People’s Bank of China and the Legislative Office under the State Council of China to Peru and the United States in order to gain a better appreciation of the regulation and supervision of non-bank non-deposit taking financial institutions.

Peruvian Microfinance Industry

The Peruvian microfinance industry has developed quickly in recent years. In Peru, small business and micro loans are well defined. Small enterprise loans are defined as loans between 20,000-300,000 Nuevo Sol (US $7,100-107,000) and micro loans are defined as loans with amounts below 20,000 Nuevo Sol (US $7,100). The overall outstanding micro-loan portfolio in Peru exceeds US$ 11 billion.

Fifty-five out of the 63 supervised financial institutions in Peru provide microfinance, including 38 institutions, which specialize in providing microfinance (one bank, five finance companies, 13 municipal savings and loans institutions, nine rural savings and loans institutions as well as 10 EDPYMEs – specialized licensed micro and small enterprise institutions).

Those specialized institutions can be classified into six categories: (1) municipal savings and loans institutions; (2) rural savings and loans institutions; (3) EDPYMEs which do not take deposits; (4) pawn lending; (5) finance companies that initially started as evolving EDPYMEs but are now allowed to take deposits; and (6) one specialized microfinance bank which originally started out as a non-governmental organization (NGO) and later transformed into a bank – MIBANCO.

All six kinds of specialized institutions are subject to the supervision and regulation of the Superintendencia de Banca, Seguros y AFP (SBS). It was noteworthy that in Peru non-bank non-deposit taking EDPYMEs are also subject to very similar supervision and regulatory provisions as deposit taking institutions which allows them to more quickly convert into deposit-taking financial institutions at a later stage in time.

Peru’s microfinance has expanded rapidly and already covers all provinces and cities. The industry has witnessed a very rapid expansion in credit availability both in terms of loan volume and numbers of clients. Due to increased competition and transparent interest rate policies and improved regulatory and supervisory standards, Peru has witnessed a decline in the effective loan interest rates and high loan portfolio quality along with a vibrant but stable inclusive financial system. The well supervised and privately funded microfinance sector has resulted in a substantial expansion in both available credit and savings services across the countryside and improved financial inclusion.

Regulation and Supervision of Microfinance Institutions

Peru has established a very sound regulatory mechanism with prudential regulation of the microfinance industry while also effectively balancing consumer protection and financial transaction transparency.

SBS Peru sees three main objectives in its role of regulating the microfinance sector:

• Maintaining financial stability, especially given the size of the sector and the number of clients that are served;
• Consumer protection; and
• Ensuring the high efficiency of microfinance industry and supporting the transition of non-deposit taking institutions to transform into deposit taking players able to offer a broader range of financially inclusive services.

SBS Peru focuses on four main regulatory/supervisory approaches:

• Focus on the various types of products and services offered by institutions which allows them to look at risks;
• Prudential regulation focused on market access, capital adequacy ratio, internal-external audit, loan loss provisioning and risk controls;
• Strengthening the protection of sustainable development of microfinance institutions; and
• Protecting the rights and interests of microfinance consumers as well as improving market transparency.

What was particularly important in the case of Peru as well as other countries that regulate and supervise microfinance institutions was the aspect of loan classification, provisioning, and write-off regulations.  Stricter provisioning and write-off guidelines help to address and manage one of the primary risk aspects of financial institutions that offer unsecured microfinance credit – the quality of the loan portfolio.  The SBS regulations require more aggressive provisioning and write-off policies for microfinance loans compared to regular loans and this helps to mitigate and better manage this particular risk factor.

Interest Rates

SBS Peru does not set interest rate ceilings and is a big proponent of supporting a competitive market place focused on full disclosure and transparency of rates, fees and charges. While all financial institutions are free to set their own interest rates and fees, SBS Peru does require that all fees must fit within certain categories and any new proposed fee categories must be submitted in advance by the bank to SBS for review.. Even though there are no interest rate ceilings, based on full transparency and a competitive market, effective interest rates have declined in Peru. All financial players are required to follow a standard effective interest rate calculation tool, which is provided by SBS Peru. Financial institutions are also required to maintain a website listing their effective interest rates which include all fees and service charges. SBS Peru helps to discipline the market by publishing all interest rates on loans and savings instruments in the country on their consumer protection webpage.

Funding of Microfinance Players

After the global financial crisis, Peruvian MFIs guided under the direction of SBS Peru focused more on local private sources of funding. Prior to the global financial crisis, more than 50 percent of the funding for the microfinance sector came from external funding, but today the vast majority of funding comes from deposits (accounting for about 74.5 percent of the total funding sources), loans provided by banks as well as the local capital market place. While EDPYMEs cannot raise deposits, they can borrow up to 10 times their paid-in capital. On average the industry has a healthy 16 percent capital adequacy ratio, which is well beyond the regulatory standard and ensures the strong but safe growth of the industry.

Consumer Protection

The regulatory framework on financial consumer protection in Peru is quite extensive and is comprised of laws issued by the Parliament and rules issued by SBS Peru, including the Consumer Protection Code (Law N° 29571), Complementary Law to the Consumer Protection Law in Financial Services Issues (Law N° 28587), Regulation for Information Transparency and Contracting with Users in the Financial System (SBS Peru Resolution N° 8181-2012), SBS Peru Circular Letter about User Services (G-146-2009), Categories and Names for Charges (SBS  Peru Circular Letter B-2213-2013), Methodology to Calculate the Minimum Payment in Credit Card Lines (SBS Peru Circular Letter B-2206-2012) and Credit and Debit Card Regulation (SBS Peru Resolution N° 6523-2013).

There are three main objectives to financial consumer protection policies in Peru:

• Promote responsible financial decisions by consumers;
• Reduce the information gap between financial institutions and customers; and
• Enhance the quantity and quality of information and financial disclosure.

The two main approaches for consumer protection focus on consumer rights and regulatory requirements for financial institutions. Consumers are to be provided with full disclosure of all charges and fees and there are to be no hidden charges. In terms of the requirements for financial institutions, there are strict requirements for categories and names for all fees charged that the institutions must abide with and all contract clauses, which must be reviewed by SBS Peru in advance. All financial institutions, including all non-bank non-deposit taking EDPYMEs must have a consumer protection officer who is in charge of ensuring compliance with SBS Peru standards and provides regular reports on the status of all consumer complaints.

SBS Peru goes the extra mile in ensuring full and open disclosure for all borrowers by:

• Reviewing and proving all standard loan contracts and clauses;
• Requiring a summary sheet for loan products and an informative note for all deposit products that must be annexed to all the financial produce agreements;
• Loans must include the complete interest rates, fees and charges and the annual effective cost rate or annual effective yield rate (when applicable) and these summary sheets must be signed by all customers and filed by the financial institutions; and
• Ensuring that financial institutions provide customers with a summary table of payments. This was added after it was noted that many clients did not read their contracts, to ensure that all fees, charges and interest rates are clear to the consumer.

SBS Peru also follows very strict anti-abusive contract regulations and policies that allow consumers to go to the authorities to nullify any contract provisions that are found in violation of these regulations. In addition, the regulator in Peru pays close attention to over-indebtedness of debtors and requires financial institutions to ensure that loan analysis includes:

• The overall indebtedness of the loan applicant;
• The extent to which the loan can be repaid and the establishment of a precautionary mechanism;
• The ratio of total credit to the total asset value; and
• Managing the risk of potential over-indebtedness.

If SBS Peru finds institutions violating these principles, they can be punished for practicing predatory lending habits.

SBS Peru has developed very detailed procedures for redress and complaint management. All financial institutions are required to submit indicators, reports and statistics to the bank, including the number of complaints handled, the type of operation product or service, the purpose, whether the complaints were resolved in favor of the customers or not, and the average time taken to resolve complaints. SBS Peru regularly publishes comparative information on complaint statistics submitted by all supervised entities, which provides an incentive for financial institutions to better police themselves and for the public to access as a sort of informal better business bureau. While SBS Peru does not handle the disputes between consumers and financial institutions directly, they can impose penalties on those financial institutions, which violate the consumer protection regulations. Additionally, financial consumers can resort to a third-party arbitration or the court to resolve any outstanding consumer protection complaint against a financial institution.

Credit Information Sharing

A sound credit reporting system has been established in Peru to strengthen the supervision and practices of financial institutions as well as protect consumers. At present there are four credit registry bureaus – three private bureaus and one public bureau under SBS Peru. The credit registry bureau under SBS Peru has been connected with Peru’s national ID register and the tax administration system to ensure the accuracy of general information for both individuals and institutions. What was interesting to hear about is SBS Peru generated a series of client numbers for all customers prior to the establishment of the national ID register. This numbering system is still used today to facilitate foreign workers who do not have national IDs and are not in the register.

The public credit information bureau sources data from all financial institutions including microfinance institutions. This credit information is also used by SBS Peru to monitor the overall financial system as well as used by the financial sector to improve lending practices. Because the credit reporting is a requirement for all regulated financial institutions, these players are allowed to access the credit bureau for free. The credit bureau has kept track of the positive and negative debt position of all formal borrowers since 1995.

The system continues to play an important role in ensuring that the sector is monitored and provides an early warning indicator to control the potential of over indebtedness in market and ensures overall financial stability. On the client side, there are also a series of personal data protection rules that govern credit reference sharing information that is quite extensive.

CONCLUSIONS

There were several important lessons learned in Peru that were particularly useful for the Chinese delegation.

Regulation and Supervision

It was clear from the visit that a well-developed regulatory and supervisory system forms an important foundation for the financial sector and, in the particular case of Peru, ensuring the safe expansion of both non-deposit taking as well as deposit-taking microfinance players that provide services to a sizeable percentage of the population. Unified principles and clear criteria also help to avoid regulatory arbitrage practices by financial players and provide basic protection for consumers as well as investors. This also includes the important aspect of stricter loan loss provisioning and write-off policies for unsecured microfinance loans.

Private Sector Funding

Liberalized funding, primarily from banks and the capital markets, allow institutions to grow and expand outreach.

Liberalized Interest Rate & Fee Structure

Market competition and full disclosure transparency can be a much more effective way to support a reduction in effective interest rates than interest rate caps. Based on Peru’s experience, loan interest rate caps often only result in a reduction in access to financial services. Clear disclosure of all fees and charges, use of annual effective interest rates, and improved consumer protection rights help to expand credit services while at the same time stabilizing effective interest rates in the market.

The Role of Consumer Protection

Proper financial consumer protection policies and practices can help to improve discipline in the market, provide full information disclosure, and prevent over-indebtedness. Information disclosure can also help improve financial literacy with consumers being provided with more adequate knowledge and information about financial products and services.

In order to protect borrowers and prevent over-indebtedness, financial institutions can be monitored to ensure that borrowers are protected from most forms of predatory lending practices. Peru’s strict requirement that ensures financial institutions focus on the applicants’ ability to repay helps to reduce over-indebtedness in the market.

The Role of Credit Information Sharing

Accurate positive and negative credit histories in the financial system can help reduce the cost of loans, strengthen market monitoring and analysis, and maintain the stability of the financial sector.

Note: Next week, we will provide part two of this series with observations on the knowledge exchange visit the Chinese delegation experienced in the United States.