Improving microfinance regulations in Bosnia & Herzegovina

Dženana Vračo had been loyal client of LIDER since 2008. She started her own business, a small grocery store in their unfinished home in suburbs of Visoko, back in 2000, and at that time that was the only source of income for her and her family of four. Struggling to meet her ends and facing fierce competition from large supermarket chains, in 2008 Dženana decided to take a risk and with help from LIDER she started additional business of roasting, grinding and selling her own brand of Bosnian coffee. Knowing her coffee well,

Dženana’s store quickly became known for a place where you can get the best freshly roasted coffee in Visoko area. Since that success, Dženana continued to partner-up with LIDER and her business quickly grew from supplying about 30 other stores with her brand of coffee in city of Visoko, to about 300 clients located in 16 cities, some of them even larger supermarkets.

Although her business started as a small family-owned (and employed) business, Dženana now employs 3 permanent employees (as well seasonal workers during peaks), while she handles all the sales.

By constantly investing in her  business, she has significantly improved her fixed assets, and by replacing the old mill with a new, and modern one, she has doubled the capacity to grind coffee in the production process. In the future, Dženana plans to replace the coffee roaster with a new one that will double daily production, buy a new packaging machine that will significantly improve productivity, and hire two new workers to help with production and sales.

However, due to the crisis caused by the COVID-19 pandemic, the turnover of Jenna’s business has been significantly reduced and all plans for further business development have been postponed for some better times.

Ignoring for a moment the crisis caused by the pandemic, even though Dženana has been a truly loyal and successful client of MKF LIDER for many years, we are approaching a point where we simply  can’t help her pursue her dream of running a small and successful company. It’s not for lack of trust or qualification—her repayment record is pristine, and her business plan is sound and viable—it is because as a legally-registered Microcredit Foundation, we aren’t allowed to provide it. In accordance with the existing regulatory framework for microcredit foundations, our loan sizes are capped at only 10,000 BAM (5,000 EUR) while each of those machines she needs to take her business at the next level cost well above 10,000 EUR each.

Although under the current regulation,  Microcredit Foundation can establish a Microcredit Company that can issue loans of up to EUR 25,000 (50,000 BAM) with a wider range of loan products, the extremely complex requirements provided by the law prevent MKF LIDER and other Microcredit Foundations from doing so. This is best supported by the fact that so far, no Microcredit Foundation from FBiH has established its own company.

The term “transformation”, in the context of microfinance, implies the transition from a non-profit institution to a for-profit company or a specialized (Microcredit) bank, and is a very complex and controversial topic in any country. The problem of treating “donated capital,” for institutions that have started microcredit with donor funds, raises many questions for regulators on how to ensure proper management of those funds. This is especially true in BiH, where almost all Microfinance Institutions that exist today were established and began operating with donated funds directed to BiH after the end of the conflict in the early 1990s, with the goal of getting the country’s economy back on its feet. With such a large amount of donated capital in the sector, the FBiH regulator is understandably concerned about protecting these funds, to ensure that they are used for their original purpose: improving the lives of BiH citizens.

BiH’s climate is even more complex than the rest of the world due to the fact that the country has two sets of legal regulations for the state-wide Microcredit sector: one for Republika Srpska and one for Federation of BiH. Although the law in the Republika Srpska allows the Microcredit Foundation to be “transformed” by transferring all assets and capital to the Microcredit Company, the legal framework in the Federation of BiH is much more restrictive in this regard. In accordance with the regulations in the FBiH, even if the Foundation obtains permission to establish its own Microcredit Company, the Foundation cannot transfer its own capital and assets to it, so the newly established institution must start from the scratch. This requirement effectively blocks the possibility of transformation in the Federation, and also prevents consolidation in the sector that the regulator (Federal Banking Agency) would like to see.

As a result of this legal inequality, some Microcredit Foundations in Republika Srpska quickly seized the opportunity to transform into Microcredit Companies and started offering larger loans, and a wider range of products and services in both entities in BiH, thus gaining a great competitive advantage over to MFIs from the Federation of BiH.

What the microcredit sector would like to see is for entity legislators to improve the legal framework for MFIs  and harmonize it at the entity levels, and for state legislators to take into account the specifics of the MFI industry when revising the Law on Prevention of Money Laundering and Terrorist Financing, and to finally and seriously commit to the adoption of a quality legal framework for the development of digitalization in BiH.

While it may sound illogical to some that a nonprofit institution wants to transform into a for-profit institution so that it can help more people who need that help, the history and evolution of the financial inclusion industry in the world proves the case: the best organizations in term of corporate governance and long-term financial sustainability, are for-profit Microcredit institutions and specialized microcredit banks.

When we talk about financial inclusion, we refer not only to access to credit services, but to access to all the services that the financial sector can offer. However, the existing legal framework limited the activity of MFIs to providing microloans only, thus preventing MFIs from providing other services needed by clients who cannot obtain those services from other financial institutions. I am primarily thinking of services in the field of foreign exchange, payment transactions, insurance agency, money transfer, etc., which most MFIs could perform without any problems, perhaps even better than some other financial institutions, because they have all the necessary knowledge, resources, capacities and most importantly the market in the form of clients who lack these services for further expansion of their business activities.

Liberalization of the financial market is one of the priorities of the EU, which can be seen through the implementation of the PSD2 directive, which, among other things, opens the door to the provision of payment services to many organizations that do not have much contact with the financial sector. Given that our country emphasizes that want to be part of the EU family sometime in the future, in accordance with that goal, the legal solutions regarding the issue of enabling the expansion of services offered by MFIs should follow the EU principles. However, even if there is a way to open the way for MFIs to expand their services, whether or not to go in that direction will be a big strategic decision for every MFI, given that BiH is still a small country in which the financial sector in terms of the number of banking institutions that already provide all these services is highly developed.

To truly promote inclusion in the financial sector, the Federation of BiH must reform the legal framework for MFIs. To do this effectively, all actors in the sector need to work together – microcredit organizations, regulators, local ministries, and donors, and find a solution that will help improve the sector and institutions that have served economically disadvantaged clients for years. MKF LIDER, and our colleagues from the microcredit sector in BiH gathered in the Association of Microcredit Organizations in BiH (AMFI), have done an incredible job in the last 20 years to build organizations that empower the disadvantaged population and protect their rights as consumers and users of financial services.

Even in these difficult times due to the COVID-19 pandemic, the microcredit organizations that are members of AMFI have done an incredible job in terms of supporting their clients, especially small businesses and farmers who are most affected by this disaster. As of May, microcredit organizations in BiH, AMFI members, approved a total of 25,632 requests for a moratorium, which is 11 percent of the total number of microcredits, and the total amount of loans for which special measures were approved is 125 million KM, which is 17 percent of the total portfolio of all members of the Association.

This crisis caused by the COVID-19 pandemic pointed to the great vulnerability of the BiH economy, which is largely based on small business and agriculture, but this situation also opens the possibility for the governments on all levels to use the huge potential of the microcredit sector in recovery process for these segments. Microcredit organizations in BiH have vast experience in terms of supporting small entrepreneurs and farmers, and that is why they should be one of the strategic partners of the governments in the process of economic recovery of our country. In addition to direct financing of small businesses and farmers, MFIs have extensive experience in providing non-financial services to their clients aimed at further strengthening their entrepreneurial skills, which in addition to placing funds for business recovery will be a very important form of customer support after this crisis which is unprecedented in modern history.

But for microcredit organizations to continue to support their clients in the right way, especially during this period, and to really use their full potential to help our country’s economic recovery, now is really the right time to improve the legal framework in FBiH. Two years ago, the FBiH government adopted the Draft of the new Law on Microcredit Organizations of the Federation of Bosnia and Herzegovina, which has been waiting in line in the entity’s House of Representatives ever since. Although the proposed draft law on these issues and problems that hinder the further development of the sector remained quite vague and whose content did not include some quality proposals and comments from the sector itself and people who have been engaged in this activity for many years, it can be the beginning of open and constructive dialogue in terms of resolving accumulated problems that limit the further development of the microcredit sector in BiH, which would finally unlock the full potential of microcredit organizations in terms of much greater and better support for small businesses and farmers and thus significantly contribute to economic recovery in BiH.

Precisely because of all this, now is really the right time to improve the legal framework for microcredit organizations in FBiH and therefore let us not limit our influence by saying “it is complicated” or postpone this extremely important step further. Let’s work together to find a way to make the financial sector better for everyone, including inspirational clients like Dženana to whom our support has never been more important and needed than it is now.

Dzavid Sejfovic

CEO LIDER MicroCredit Foundation