European banking law evolution and the future of microfinance and socially responsible operators

The recent developments in European financial regulation might represent either an opportunity or an obstacle for microfinance institutions (MFIs), ie providers of small loans with frequent instalments and no collateral to financially excluded clients, accompanied by coaching services (but often offering also other financial services). In my book, ‘Microfinance and financial inclusion. The challenge of regulating alternative forms of finance’ (Routledge, 2017), I examine microfinance from a regulatory and comparative law perspective, focusing on the peculiar features of microfinance which might raise concerns or compatibility issues with current legal requirements for banks or lending and payment services providers. Attention is also given to other phenomena often associated with microfinance (such as crowdfunding and FinTech, use of big data in credit scoring, Islamic banking, corporate governance in double-bottom line entities, securitizations).

On the one hand, as a consequence of the shadow banking fear, the post-crisis regulatory wave has been characterised by stricter regulation and extension of the regulatory scope to previously-unregulated entities, which are potentially capable of suffocating alternative financial services providers such as MFIs. On the other hand, EU institutions have appeared interested in furthering financial inclusion by also supporting alternative providers, with the objective of promoting competition and reducing banking monopoly, eg in the fields, among others, of basic payment accounts, PSD 2, crowdfunding and FinTech.

The evaluation of the opportunities and risks for MFIs and other alternative socially responsible providers as well as proposals for ad hoc regimes depends on the type of services and products offered. 

In case of non-deposit taking MFIs primarily offering lending services, the EU does not prescribe the bank form and leaves the decision whether to regulate such activity to the Member States. In fact, absent harmonization in the lending segment (except for mortgage credit and, partially, consumer credit), Member States have adopted very different approaches in regulating the lending market. For instance, UK lending companies are not bound by prudential requirements, except for residential mortgage lenders, and are also otherwise lightly regulated. Similarly, in some countries, lending is permitted by lightly regulated entities (Belgium, Romania, Bulgaria), sometimes even by not-for-profit entities (Poland, the Netherlands, Hungary, UK, Bulgaria, France and, since the 2010 reform, implemented through secondary regulation only in 2014, Italy). Instead, in Germany, Spain, Portugal and Serbia, the banking monopoly has traditionally covered also credit provision. Even after the entry into force of CRR, which requires Member States to identify as credit institutions only entities offering both deposits and loans, such countries remain free to extend bank-like rules to non-banks. Furthermore, more restrictive regimes for non-bank financial institutions (NBFIs) have been introduced in some countries in the wake of the financial crisis, again reflecting the post-crisis fear of the ‘shadow banking’ sector (eg in Italy, with the legislative decree No. 141 of 2010, implementing a bank-like regime for NBFIs but also introducing a special and simplified regime for MFIs). 

The analysis of the functions, activities and contracts of MFIs, also when compared to the shadow banking entities, suggests that these providers might deserve simplified regulation, especially from the prudential point of view, so long as they have a social orientation and only engage in basic activities (see the 2007 Communication by the Commission, A European initiative for the development of micro-credit in support of growth and employment). However, favourable national regimes might be sanctioned under EU State aid law and might conflict with certain EU Directives (eg AML/CT, payment institution, consumer credit). Therefore, an EU harmonization in the field might be able to promote financial and social inclusion, competition and EU freedoms, overcoming obstacles both in EU law and in national laws. 

When MFIs are interested in offering also deposit services, they need to apply for a bank license as required by EU law. After the crisis, though, banking law has become stricter and gives little consideration to proportionality issues despite some limited attempts by the EBA and the Commission in the opposite direction, thereby de facto limiting the development of small banks with a social goal. In the book, I discuss the rationales for simplifications (as regards eg minimum capital, treatment of microloans and alternative collateral under the Basel standard method and SREP, CET1 instruments, governance, liquidity, and reporting requirements) for small and socially responsible banks and possible solutions under current EU law. 

However, arguments are also presented in favour of rules adaptations in a stricter direction (in consideration of specific risks, for instance due to the need for faster loan-loss provisioning) and for improving social performance and social impact measurements, harmonization of criteria and procedures to disclose and monitor such aspects, as well as governance measures, conduct rules and contract clauses reflecting socially responsible objectives and behaviour. 

I believe that such discussion is of interest also for academics and practitioners who are not specifically familiar or interested in microfinance, in consideration of current and widespread debates about the difference between entity-based and activity-based regulation, the need for a functional approach to regulation in the financial field, how to balance financial inclusion, innovation, competition, consumer protection and stability, the optimal regulation of alternative and new financial providers such as FinTech compared to incumbents (subject to stricter regulation after the financial crisis), and how to adjust EU banking/financial law to socially responsible finance, Islamic banking and small banks’ operations. 

Eugenia Macchiavello is Lecturer in Banking Law, University of Genoa and Senior Research Fellow, Genoa Centre for Law and Finance.