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<img class="alignright wp-image-24986" style="border: 0 solid #000000" src="https://centerforfinancialinclusionblog.files.wordpress.com/2018/01/thumb_08961175df7c4694bc95b207ebf9a116.jpg" alt="" width="330" height="220" />

The following post was <a href="https://www.cgdev.org/blog/assessing-quality-regulations-improving-financial-inclusion-eight-latin-american-countries">originally published</a> on the Center for Global Development's blog and has been republished with permission.

The most recent <a href="http://www.worldbank.org/en/programs/globalfindex">World Bank</a> data on financial inclusion shows that by 2014, only 54 percent of the adult population in Latin America had an account at a financial institution. This compares to an average of 62 percent of adults worldwide and 70.5 percent for those countries with a similar level of income per capita (the region’s peers). In developed economies, 94 percent of adults have an account at a financial institution.

Many factors could be cited for the low ratios of financial inclusion in Latin America, but in a recent <a href="https://www.bbvaresearch.com/wp-content/uploads/2017/09/Regulatory-Practices-for-Financial-Inclusion-in-Latin-America-vf_mod.pdf">paper</a> published at BBVA Research, that also came as a CGD <a href="https://www.cgdev.org/sites/default/files/index-regulatory-practices-financial-inclusion-latin-america_0.pdf">working paper</a>, we focus on the potential role of financial regulation. We assessed and compared the quality of the policies and regulations that impinge on financial inclusion in eight Latin American countries (Argentina, Brazil, Chile, Colombia, Mexico, Paraguay, Peru, and Uruguay). Peru and Mexico came out on top, with what appear to be the best regulatory frameworks for promoting financial inclusion. But even in these top performers, there is room for improvement.


<h3>Identifying regulatory influences on financial inclusion</h3>
In our recent study, we identified three dimensions of regulatory practices and policies that can influence financial inclusion:
<ol>
 	<li>Enablers: regulatory practices that determine the overall quality of the financial environment where providers of financial services operate</li>
 	<li>Promoters: regulations that deal with specific types of market frictions and describe the rules of the game for the provision of specific financial products and services for low-income populations</li>
 	<li>Preventers: regulations that, often unintentionally, create obstacles for expanding the supply and demand for financial products and services</li>
</ol>
In total, we identified 11 regulatory practices across these three dimensions. The assessment of these policies relies on the construction of three indices of regulatory quality (one for each dimension), and 11 sub-indices (for the 11 regulatory practices that form these dimensions). Additionally, we constructed a non-regulatory sub-index for assessing governments’ efforts to promote financial literacy.

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To form each of the sub-indices, we assessed a number of variables selected on the basis of internationally accepted standards and a vast review of the existing literature. For each variable, we assigned scores in a range from 0 to 2 (where 2 represents the highest level of quality for the variable). For obvious reasons, it is not possible to go into the specifics of each variable and each sub-index here (the detailed explanation can be found in the <a href="https://www.bbvaresearch.com/en/publicaciones/an-index-of-regulatory-practices-for-financial-inclusion-in-latin-america/">study</a>). However, there are two novelties about the construction of the sub-indices that are worth highlighting.

First, in constructing the sub-indices, we recognize that there may be interactions between variables that affect their whole impact on inclusion. Let’s take, for example, the sub-indices of simplified accounts or electronic money. Should regulatory constraints on fees and commissions charged by financial institutions to their customers for owing or using these products be assessed as detrimental or favorable for financial inclusion? The answer, as reflected in our index, is “it depends.” Setting no restrictions on fees and commissions to open and manage simplified or e-money accounts is desirable if the quality of competition policies for the financial sector is satisfactory. In other words, the recommendation to let financial institutions determine fees freely depends on the ability to prevent the emergence of monopoly powers through robust competition policies. In terms of our index, this means that to assess the quality of some Promoter components (simplified accounts and electronic money) we need to recognize their interaction with an Enabler component (competition policies).

A second interesting feature is that the index incorporates an interaction between some of the regulatory practices and other forms of government intervention that can increase the potential of those regulations. Continuing with the example of simplified accounts and electronic money, in the study we considered that the regulation governing the provision of these products is of a better quality if the government promotes their usage by individuals and small companies through additional efforts (such as depositing government transfers to low-income populations in these accounts) than if it stays aside. Finally, the amplifying effect of policies to enhance financial literacy on regulatory practices classified as Promoters is another example of the interactions between regulations and governmental interventions.
<h3>Which countries have the best regulatory frameworks for financial inclusion in Latin America?</h3>
The map below summarizes the results of our index of regulatory practices for financial inclusion in eight Latin American countries. The numbers represent the values of the overall index and of each of the three sub-indices (each ranging from 0 to 2, as mentioned above).

[caption id="attachment_24978" align="aligncenter" width="615"]<a href="https://centerforfinancialinclusionblog.files.wordpress.com/2018/01/rojas-suarez-pacheco-regulatory-figure1.png"><img class="wp-image-24978" src="https://centerforfinancialinclusionblog.files.wordpress.com/2018/01/rojas-suarez-pacheco-regulatory-figure1.png" alt="" width="615" /></a> (click to enlarge)[/caption]

As shown, all the countries have strengths and weaknesses in their regulatory frameworks. Peru appears to have the best regulatory framework, followed closely by Mexico. Obviously, some areas of Peruvian regulation could be enhanced, but in broad terms, the regulatory framework is robust and conducive to financial inclusion. Mexico, on the other hand, has more room to improve the quality of its regulatory framework, especially the regulations classified as Promoters. Still, the country might soon solve some of the deficiencies we identified in our study (for instance, the absence of a dedicated regulatory framework for electronic money). In fact, Mexico’s Congress is currently discussing a draft law that seeks to leverage the possibilities of financial technology (or fintech) to advance financial inclusion.

At the opposite end of the spectrum, Argentina and Brazil have the lowest scores. Both present very low scores along the Preventers dimension as there are various elements in their regulatory framework (from financial transaction taxes to directed lending by the state) that might run counter to financial inclusion objectives. Thus, in these countries major changes to the regulatory framework are needed to achieve sustainable progress in financial inclusion.

The rest of the countries obtain modest results that also tend to be explained by very low scores in the Preventers index but more solid results in the Enablers and Promoters indices. The case of Colombia stands out in this last group: although the country is strong in the Promoters index, the existence of a financial transaction tax, the imposition of ceilings on interest rates, and directed lending practices generate multiple distortions and explain why Colombia’s overall score lags behind Peru and Mexico.
<h3>Does regulatory quality alone explain the financial inclusion gap?</h3>
The answer to this question is “no.” As discussed in the CGD report <a href="https://www.cgdev.org/sites/default/files/CGD-financial-regulation-task-force-report-2016.pdf">Financial Regulations for Improving Financial Inclusion</a>, regulation is important for two main reasons: first, because the right regulatory framework is key to enable the private sector to adopt innovations in digital finance and encourage their use by low-income populations, and second, because policies to increase financial inclusion must be compatible with the traditional objectives of financial regulators. Thus, they should not undermine the stability and integrity of the financial system, while ensuring effective consumer protection.

It should not be a surprise, though, that regulation is not the only factor that determines a country’s success in advancing inclusion. Many other factors matter, including socioeconomic constraints, the macroeconomic environment, institutional quality, and specific characteristics of the financial system. In other words, having an enabling regulatory framework is a necessary but not sufficient condition for sustainable progress in financial inclusion. This is the conclusion of an econometric study in <a href="http://idbdocs.iadb.org/wsdocs/getdocument.aspx?docnum=40368033">Rojas-Suarez (2016)</a> that shows that in Latin America, institutional factors matter most in explaining the financial inclusion gap.

That said, an appropriate regulatory framework is essential for financial inclusion. Thus, by signaling areas of strength and weakness in the regulatory practices of individual countries, the <a href="https://www.bbvaresearch.com/en/publicaciones/an-index-of-regulatory-practices-for-financial-inclusion-in-latin-america/">index of regulatory practices for financial inclusion</a> is meant to support the efforts of policymakers in the region with a mandate to improve financial inclusion. Therefore, beyond the specific country scores, what is truly useful from this index is the opportunity it provides in motivating discussion among market participants, policymakers, and interested researchers, as it already has at the <a href="http://www.lacea.org/portal/index.php?option=com_content&amp;view=featured&amp;Itemid=101">Latin American and Caribbean Economic Association</a> meeting in Buenos Aires last November. Hopefully, these types of conversations will serve to guide regulatory reforms.

Liliana Rojas-Suarez is a senior fellow at the Center for Global Development.

Lucía Pacheco is an economist at BBVA Research.

Image credit: Accion

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Assessing the Quality of Regulations for Improving Financial Inclusion in Eight Latin American Countries

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&gt; Posted by Verónica Trujillo Tejada, Consultant, MIF/ Inter-American Development Bank

Building up a regulatory framework for the development of a microfinance market is a complex task. It requires taking into account a broad variety of topics as well as country specific needs and features. There are some internationally-applicable recommendations for the design of microfinance regulatory frameworks (<a href="http://www.cgap.org/publications/guide-regulation-and-supervision-microfinance">CGAP 2012</a>, <a href="http://publications.iadb.org/bitstream/handle/11319/4898/Gu%C3%ADa%20de%20Principios%20para%20una%20Efectiva%20Regulaci%C3%B3n%20y%20Supervisi%C3%B3n%20de%20las%20Operaciones%20de%20Microfinanzas.pdf?sequence=1">ASBA 2010</a>, and <a href="http://www.bis.org/publ/bcbs175.pdf">Basel 2010</a>) but little is known about how different countries have implemented their guidelines or what the effects are of these rules in each market.

In the recently released paper “<a href="http://www.degruyter.com/view/j/bejeap.2014.14.issue-4/bejeap-2013-0145/bejeap-2013-0145.xml">Microfinance Regulation and Market Development in Latin America</a>,” published by the B.E. Journal of Economic Analysis &amp; Policy, we analyze the relationship between microfinance regulatory frameworks in 17 Latin American countries and the corresponding markets’ levels of development.

One way to characterize microfinance regulations is as either general or specific rules. The general rules are devoted to regulating typical financial system issues, while the specific rules target microfinance products or institutions. Two other regulation classifications are protection rules and promotion rules. Protection rules have the goal of preserving financial system stability or protecting the financial consumer, and promotion rules aim to favor the development of microfinance services or institutions by softening the restrictiveness of the overall regulatory framework.

We find a wide variety of regulatory designs in the Latin American region. Countries such as Chile and Uruguay, for example, stand out for their lack of microfinance specific rules; though their employment of general and protection rules give their regulatory frameworks a base upon which they could build microfinance specific regulation. Other countries such as Honduras, Brazil, and Argentina have included specific or promotion rules in their regulatory frameworks, however either their level of implementation of general and protection rules is below the average of the countries examined in the report, or their frameworks have addressed microcredit but not through the specific criteria the report analyzes.

The analysis between microfinance regulatory frameworks and the level of development of the corresponding markets - which incorporated the size of the microcredit portfolio, number of clients, operative and financial efficiency of institutions, among other variables - enabled us to draw the following conclusions:
<ol>
	<li>All four types of regulation rules – general, specific, protection, and promotion – are significantly and positively correlated with bigger microfinance markets.</li>
	<li>Rules specific for microfinance are related to better MFI financial and operational performance, and better market data.</li>
	<li>Both general and protection rules are significantly and positively correlated with better developed microfinance markets - specifically in terms of profitability, operational efficiency, and portfolio quality.</li>
	<li>The implementation of both specific and promotion rules shows a positive and significant correlation with bigger informal, rural, and microenterprises sectors.</li>
</ol>
So, which would be the elements to consider when designing regulatory frameworks to contribute to the development of a microfinance market?

Of course there is no one formula to apply across countries, as markets and contexts differ. And more analysis (as well as more industry data) is required. However the report indicates that analyzing whether a financial system’s regulation includes ample general and protection rules is crucial for the better development of the microfinance market, preserving stability and the well-being of its clients. Introducing specific rules on microfinance services and institutions, considering the particular features of microfinance activities, could very well support institutional solvency and the employment of adequate risk management procedures. And promotion rules should be considered as a mechanism to favor market development. Regulators must be open to evaluating new actors, technologies, and methodologies for the provision of microfinance services, considering the possibility of granting them individualized treatment - in some cases lowering the usual standards for a short period of time.

To learn more about the analysis and to access the full report, <a href="http://www.degruyter.com/view/j/bejeap.ahead-of-print/bejeap-2013-0145/bejeap-2013-0145.xml?format=INT">click here</a>.

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