Annexes to COM(2012)769 - Application of Directive 2006/48/EC to microcredit - Main contents
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This page contains a limited version of this dossier in the EU Monitor.
| dossier | COM(2012)769 - Application of Directive 2006/48/EC to microcredit. |
|---|---|
| document | COM(2012)769  |
| date | December 18, 2012 |
3.2.3. Most microcredit can be exempted from the large exposure limit designed to limit concentration risk
Given the small size of microcredits, in theory, there is no loan the value of which would exceed 25% of the regulatory own funds of the banking microcredit providers (the concentration risk limit). However, where the microloans are guaranteed by the same counterparty, such as a state government or local authority, the portion of the loans that are guaranteed could be treated as having been incurred to the guarantor rather than to the microborrowers, which may lead to a breach of the 25% limit. However, the exposure to the public guarantor can be exempted from the application of the large exposure limit.
3.2.4. The Directive requirements in terms of risk management help the banking microlenders to mitigate their risks
Directive 2006/48/EC requires that banking microlenders have in place a comprehensive risk management process to identify, evaluate, monitor and control all their risks. Such requirements help the microlenders to strengthen their internal control frameworks and develop effective risk management skills and strategies, which can in turn reinforce their credibility and profitability while improving the financial stability of the microcredit sector. The development of efficient internal control frameworks also enables banking microlenders to be less exposed to credit risks, money laundering and employee fraud.
3.2.5. Directive 2006/48/EC requires banking microcredit providers to comply with prudential rules to mitigate liquidity risk
On the asset side, banking microlenders may lack a cushion of unencumbered, high-quality liquid assets to enable them to face a liquidity stress, given that microcredits are often illiquid and transformed with difficulty into liquid instruments (through covered bonds issuance or securitisation). On the liability side, deposit-taking institutions may face the risk of deposit run off especially where they have no access to stable sources of liquidity from other banking, public or international institutions.
Directive 2006/48/EC requires that banking institutions, including microlenders, have sound liquidity management strategies, policies and processes to identify, measure, monitor and control liquidity risk on a day-to-day basis, and contingency plans for handling liquidity problems.
3.2.6. Directive 2006/48/EC may involve high administrative burdens which may reduce the attractiveness of microcredit as a banking business while strengthening financial investor confidence in microcredit providers
The application of prudential requirements laid down in Directive 2006/48/EC might be disproportionately expensive for both the supervisory authorities and banking microlenders especially if the latter do not pose serious risks to the overall banking and payment system. When measured as a percentage of total assets, the smaller banking microlenders are, the higher the costs resulting from the application of prudential requirements can be. This may lower the profitability of microlending and reduce its attractiveness as a banking business. However, some prudential requirements, especially those related to prudential reporting, the risk assessment process and capital adequacy can be commensurate with the smaller size and complexity of these institutions, which helps to alleviate the administrative burden.
Even though microcredit institutions have no significant systemic impact in terms of financial stability, the failure of any one of them might affect the credibility of the other banking microcredit providers. As such, the reduced likelihood of failure of applicable firms due to the Directive should be welcomed. In addition, the banking prudential requirements can enhance financial investor confidence in microcredit providers as a safe destination for investor funds. Such confidence can help microcredit institutions to attract more long-term funding enabling them to reach a more significant scale and provide their customers with a wider range of services.
4. Conclusions
The European Commission recognises the need to promote the provision of microcredit and the development of microcredit providers. It should be recalled that the European Commission is very active in this area notably with the JEREMIE and JASMINE initiatives and the European Progress Microfinance Facility launched in 2010 to increase the availability of microcredit for alleviating unemployment of young people and helping to set up or develop their business.
In this context, neither the European Commission, nor a number of national public authorities consider that the prudential requirements as laid down in Directive 2006/48/EC impede the development of microcredit activities. As noted earlier in this report, these prudential rules would not seem to be as penalising for microcredit in the EU as might have been expected, precluding the need for tailoring them to the particular features of microcredit activities. Moreover, microcredit brings together a wide range of actors which are not subject to similar laws or rules and is dealt with in a diversity of ways across Member States depending on the policy framework and the legislation in place. Given this heterogeneous situation combined with the lack of a consistent and commonly used definition of microcredit, any action to modify the prudential and regulatory framework would require prior careful consideration to ensure that microcredit activities are effectively promoted.
It might also be argued that no prudential reform needs to be undertaken if the development of microcredit is considered to be driven to a large extent by non-prudential factors. That does not mean that prudential regulation has no impact on the development of such activities, but that prudential factors do not play a critical role in the development of microcredit, making any prudential reforms not necessary. A number of areas outside of the prudential sphere could instead be the focus of reforms. For instance, a way to foster the supply of microcredits may be to create a more favourable general environment for institutions specialised in microcredit by facilitating their access to financial resources. This development might be promoted through a wider provision of loan guarantees, encouraging closer cooperation between banks and non-banks or more financial transparency.
Under this approach, the development of codes of conduct of voluntary application like, for instance, those which have been issued by the microcredit industry itself in recent years, or more recently by the European Commission,[8] can help to provide a higher degree of recognition and credibility to those microcredit providers adhering to them. Review of the consumer protection environment for microcredit, which is outside the remit of Directive 2006/48/EC, and any appropriate improvements, may also have positive effects on microcredit activities.
Finally, greater attention given to the institutional framework for self-employment and microenterprises could also increase their chance of success and make microcredit more profitable. Measures to simplify legal and administrative regimes or to smooth the transition between unemployment or social welfare dependence and self-employment could be fostered as well.
[1] Directive 2009/111/EC of 16 September 2009 amending Directive 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certain own funds items, large exposures, supervisory arrangements and crisis management.
[2] Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions
[3] The European Commission refers to this amount in the EU microcredit programmes.
[4] Actually, all exposures to small and medium enterprises, including microcredits, carry the same risk weight irrespective of the size, nature (credit or liquidity facility, personal loan, etc.) and risk profile of the counterparty.
[5] A microcredit portfolio should have less risk than the weighted average risk of its constituent microcredits if there is a significant number of loans and the credit risk of these loans does not get worse and better simultaneously.
[6] In particular, the introduction of the so-called capital conservation buffer (2.5% of risk-weighted assets in addition to the current 8% requirement) which would be phased in between 2016 and 2019.
[7] The risk weights are left unchanged in the CRD IV/CRR proposal.
[8] In October 2011, the European Commission issued a comprehensive European Code of Good Conduct for Microcredit Provision developed jointly with individual microcredit providers, banks and their respective national and European trade bodies, regulators, academics, and rating agencies.