Some Suggestions on Legal Framework for Creating Microcredit Banks


Bangladesh is the home of the largest microcredit programmes, as well as largest number of microcredit programmes. Over 10 million poor borrowers are reached by microcredit in Bangladesh. An amount of Tk 60 billion (US $ 1.0 billion) is currently disbursed each year. Grameen Bank alone disbursed an amount of Tk 18.5 billion (US $ 319 million) during the last 12 months.

Two major issues are always discussed in connection with the institutionalisation of microcredit in Bangladesh and elsewhere. They are 1) financing of microcredit and 2) legal and regulatory framework for integrating microcredit with the national financial system. Both issues are inextricably connected with each other. If the issue of appropriate legal and regulatory framework for microcredit institutions is resolved, then the funding issue becomes much easier to address. These two issues are becoming more and more pressing in Bangladesh today.

Under the policies adopted in Grameen Bank II, new branches are financed entirely with deposits mobilised within the locality served by the branch. The response is excellent. A new branch can mobilise more deposits than it needs to finance its loan operation, within the first month. The branch becomes profitable within a maximum of six months. Grameen Bank can mobilise deposits because it is a formal bank. NGOs cannot take deposits because NGO law does not support it. Microcredit can be funded locally at the village level, provided legal framework is created to allow microcredit programmes (MCP) to accept public deposits. If this legal framework is created, donor funding can be reserved for only start-ups, shoe-horning NGO-MCPs to graduate into microcredit banks, training, research and development, other technical support. This will give donor money more leverage than it currently gets.

There are many NGO-MCPs with over 100,000 microcredit borrowers. In Bangladesh, several NGOs have more than one million borrowers. It is not easy to run large microcredit programmes when the prime source of money is donor money. The paradox of the situation is that many of these NGOs operate within areas where there is plenty of money all around them. They can easily get to it if only they are allowed. Not only are they not allowed to take public deposits, in many countries they are not even allowed to take savings from their own borrowers. A legal framework to create enabling environment for the NGOs to convert themselves into microcredit banks will change the whole microcredit scenario.

I am strongly advocating that lawmakers pay serious attention to this issue in the context of reaching the Millennium Develop Goal of reducing poverty by half by the year 2015. This is one enabling step the lawmakers must take.

Creating Microcredit Regulatory Commission

By now all policymakers do recognise that microcredit needs different kind of banking format than conventional banking. Creation of separate legal framework, and a separate Microcredit Regulatory Commission will be the result of that recognition. Some countries (for example Pakistan, Philippines, Venezuela, Uganda) have already passed laws to create microcredit banks. But they closely followed the law that already exists for the conventional banks. I argue that we need to have sharper departure from the existing banking laws. I am not aware of any separate regulatory commission for microcredit that has been created by any country. It will be an important initial step towards institutionalisation of microcredit. India has created separate regulatory body for rural finance. I see no reason why a separate regulatory body cannot be created for microcredit which can develop into a dynamic financial sector in any country with appropriate policy support. Central bank of the country can play an important role within the microcredit commission. Selection of the first chairman of the commission will be very critical. He or she must have deep understanding of microcredit, and patience and skill for creating an entirely new financial sector.


Essential Elements in Legal Framework for a Microcredit Bank

The law for creating a microcredit bank should have two things in mind. First, it should allow and encourage NGOs to convert one or more units of their microcredit operations into MCBs to test out the formal financial world. The law and the microcredit commission should make sure that the NGOs like the new experience. If NGOs convert more and more of their units into MCBs, this will be a testimony to the success of the new law.

Second, the law should encourage creation of start-up MCBs, without going through the process of being born as an NGO-MCP as a first step, and then converting it into an MCB as a second step.

There should be a clear definition of an MCB so that the law is not misused. The law should state clearly that an MCB is a bank which primarily serves bottom 50 percent (or bottom 25 per cent, as the case may be), or people earning less than a dollar (or less than two dollars) a day. There should be clear mention that MCBs would give preference to poor women. The law should be flexible enough to allow a part (say, 40 per cent) of the business of MCBs to go outside of strictly microcredit type banking, such as, providing credit for small businesses with or without collateral. The law should allow poor microcredit borrower to grow into borrowing larger loans as her business grows. No microcredit borrower should be forced to leave a MCB because her loan size has grown bigger over time

Types of Microcredit Banks

The law may give options for several levels of operational areas for MCBs. These levels may be defined by geographical areas such as sub-districts, districts, provinces or whatever is appropriate in the context of the country in which it operates.

Defining by geographical areas would not only be convenient administratively, but also more meaningful in terms of making an MCB focus its services to a given area. Local pride may give impetus leading to the success of the MCB. Inter-area competition can also help improvement of efficiency of the MCBs.

Several types of licences can be issued for setting up MCBs : For instance Type A may allow operation only at the village level or lowest level administrative area. Type B would allow operation within a district or county only. Type C would allow operation within a province or state or division, as the case may be for the given country context. Finally, Type D would allow nationwide operation.

The law should encourage creation of single-unit MCBs in rural and urban areas, with the provision that they can gradually add units and expand their operation over time.

Ownership, Paid-up Capital, and Licence Fees

An MCB may be allowed to start with a nominal paid-up capital of, say, US $ 10,000 for a Type A licence. For a Type B licence it can be US $ 50,000, for a Type C US $ 100,000. For a national licence it may be fixed at, say, US $ 1.0 million. The above amounts are for illustrative purposes only and can be set as deemed appropriate in the context of the country.

Licence fees should be made the cheapest and other requirements the easiest for Type A MCBs. That is, the licence fee for them should be just a token amount. Fees should get higher and other requirements tougher as the MCBs go for wider geographical coverage.

There should be different types of ownerships structures. Each ownership structure would affect what licence fee would be charged as well as what taxation policy would apply.

(a) An MCB may be set up as a not-for-profit company which could be owned (i) wholly by a for-profit company
(ii) partially owned by for-profit company and partially by poor borrowers (iii) wholly owned by poor borrowers, (iv) partly or wholly by not-for-profit company.

If more than 50% ownership is with the poor borrowers then the licence fee would be the lowest. A not-for-profit MCB which is owned wholly by a for-profit organization but not by borrowers may have higher licence fee. Not-for-profit MCBs should not be taxed.

(b) An MCB may be set up as a for-profit company. (i) a for-profit MCB may be owned fully by a for-profit company or a social entrepreneur (ii) a for-profit MCB may be owned jointly by a for-profit organization and a non-for-profit organization. These types of MCBs would have higher licence fees than not-for-profit MCBs.

For-profit MCBs should be taxed. Type A MCBs i.e. those operating at lowest administrative level may not be taxed regardless of ownership structure


Licensing Process

(a) Licenes should be provided after a rigorous quality-check of the microfinance operation of an NGO-MCP. An NGO-MCP can apply for an MCB licence for any level of geographical coverage. After preliminary scrutiny of the application an NGO-MCP may qualify to be considered for a licence. After this a consultation and orientation process may begin. If the regulatory commission finds everything satisfactory it may grant a licence after the completion of the waiting period.

(b) MCBs may be allowed to give agricultural loans and SME loans, but the loans to microcredit borrowers must form more than half of the total loan portfolio.

(c) MCBs may be set up as a start-up bank, without any microcredit track record. In such cases, a provisional licence may be issued only for a sub-district level MCB for a year or two. This may be confirmed and upgraded to a higher level licence after reviewing the performance. Direct licence for a higher level MCB may not be issued, for a start-up MCB.


Deposit Mobilization

MCBs should be allowed to take deposits from borrowers as well as from the public. The restriction on the amount that it can mobilize as deposit can be related to the amount of loans outstanding of the MCB. For example, the deposit mobilization may not exceed a maximum of twice the amount of the loans outstanding..


NGO MCPs and Deposit Mobilization

NGO MCPs that are not registered as MCBs should be allowed to mobilize deposits but only from their members and not from the general public. They may be allowed to take borrower deposits until the balance of deposits equals 75 per cent of their outstanding loans.


Deposit Insurance

It is necessary to protect the deposits of the poor against the risk of failure, fraud or mismanagement of MCBs. There should be some arrangement for deposit insurance for deposits mobilized by MCBs to protect the interest of the depositors.


Access to Local and Foreign Grants and Equity

Since the objective of MCBs is poverty reduction, there should be no restriction on MCBs to accept local subsidized or grant funding or foreign grants or equity.


Interest Rate

There should be no restrictive laws limiting the interest rate to be set for MCBs. MCBs may charge interest rate higher than the interest rate charged by commercial banks for their small loans. But there should be full disclosure to the borrowers and to the public, of the interest rates being charged and how it is calculated.


Types of Loans

MCBs may provide income generation loans, housing loans, education loans, leasing loans, insurance and other financial services. They may offer short term, medium term and long terms loans. Loans should not be restricted to income generation loans only.



The Microcredit Commission should not rush to regulate and overregulate MCBs. As MCBs innovate and develop, they require a flexible and enabling regulatory environment. Keeping in mind that these programs are designed to help the poor, governments should not exert too much control which will discourage MCBs from expanding their operation.

Transforming NGO-MCPs into MCBs will be the only way for self-reliance for the MCPs. Creation of MCBs can strengthen the financial system of a country by filling in a vacuum left by the conventional banks, and give a boost to the emergence of a local level grass-root economy.

 Editor : Muhammad
Executive Editor : Khalid Shams 
Editorial Assistance :
Nazneen Sultana
Lamiya Morshed 
Editorial Advisory Board: Argentina : Pablo Broder, Buenos Aires     Australia : Shan Ali, Sydney     Chile : Benardo Javalquinto, Santiago     Colombia : Mauricio Fernandez, Bogota     France : Maria Nowak, Paris     Germany : Nancy Wimmer, Munich     Malaysia : David S. Gibbons, Kuala Lumpur     Philippines : Dr. Cecilia D. Del Castillo, Bacolod City     USA : Alexander Counts, Washington DC
Grameen Communications Official Home Page