Definitions

"Micro-lending" is a range of social policy initiatives in which public or non-profit agencies use credit as a tool to further objectives such as social welfare, employment, urban development, financial education, and not least to develop the self-esteem of people excluded from ordinary economic activity. It is used to advance business initiatives by private individuals seeking to earn their living through independent work. The primary purpose of micro-lending is therefore not banking. It does, however, incorporate core banking functions, such as lending, deposit-taking or guarantee business.

• "Micro-loans" are small loans used for business purposes by private individuals who seek to earn their living through independent work.

• "Micro-lenders" may be banks or any other institution able to fulfil micro-lending objectives. Typically, micro-lenders acquire legal personality as a charity, a co-operative, a union, an association or an administrative or semi-administrative public body.

• Micro-lending involves banking techniques such as extension of interest-bearing loans and guarantees. It may involve savings schemes ("savings into loans"), capital participation or refinancing through credit within the banking system. Micro-lending may be used in forms other than loans, such as factoring, leasing or seed capital.

The word "micro-lending" embraces two different phenomena and in both of them, lack of access to financial services impedes the economic development of certain groups and areas:

• Where banking remains under-developed as in "third world" countries or rural areas ("unbanked"), micro-lending sows the seeds of a future banking structure through non-banks which will increase in size and become banks in due course. ("pre-bank micro-lending")

• In developed banking systems micro-lending by non-banks addresses those who are excluded from banking ("unbankable") because they are not considered sufficiently profitable as bank customers ("social micro-lending").

While pre-bank micro-lending offers capital and banking services at first hand, social micro-lending targets the long-term unemployed specifically, in order to help them gain skills and eventually to become bankable.

For pre-bank micro-lending through co-operatives, self-help associations, savings groups etc. in areas where banking has yet to be developed, the EU should consider more general exemptions to the banking directives to favour small organisations in their development into ordinary banking. The focus of the present study is on social micro-lending.

"Social micro-lending" has:

• a financial aspect, in which banking services on a small scale are extended to people of moderate means and little or no financial security, in order to recover the costs of lending as well as of refinancing the amount loaned.
• a labour market aspect, where creating self-employment through credit provision aims to reduce unemployment and poverty
• a community development aspect, where channelling capital into under-served and deprived communities or countries boosts the local economy.
• a social welfare aspect, where subsidies, normally granted by the welfare state in developed countries, or through development agencies in the third world, are replaced at least in part by recoverable credit, or made redundant through the creation of own income. As a result, the cost is reduced to donors, the funds are used more productively and the positive effects are more sustainable.

Bank regulation has been tightened up against a background of major international bank crisis, caused by inadequate own capital funds, unsafe credit provision, speculation and general criminal behaviour. It results are seen in limited access to banking, the imposition of supervision and information provision obligations, adherence to collective security systems, requirement of own or at least safe capital to underpin each credit commitment, transparency of risks in the bank balance sheet and, most importantly, a minimum size for banks, as well as skilled bankers. All of these requirements make micro-lending at reasonable cost impossible for banks. This is true not only for specialised micro-lenders who want to obtain a bank licence, but also for banks which are already licensed and who want to start a micro-lending programme.

Findings

While EU-law only forbids deposit-taking simultaneously with lending and taking guarantees at the same time as participations while remaining unregulated, the Member States have in the main employed stricter approaches to lending while developing a system of regulatory exemptions which facilitate micro-lending.

Three approaches may be distinguished for regulation of social micro-lending:

• The market approach: the United Kingdom has left the financial sector, including its social aspects, to the market. Banking in general has had little involvement in social affairs. Consequently non-banks have been given considerable scope to act as social lenders but have received little state support. Within this context, lending is permitted. This approach represents the minimum approach to bank supervision of micro-lending which is also inherent in EU bank supervision legislation. This legal framework is also shared by Ireland and Belgium.

• The welfare state approach: Some countries such as Germany and the Netherlands retain significant public involvement in banking and there is substantial state involvement in social lending. They employ guarantee schemes, tax subsidies as well as state administrative resources and state-owned banks to promote social objectives within the financial sector. This approach only permits very minor private lending and all other lending activities are reserved to financial institutions and banks.

• The social lending approach: France and, in some respects, Italy have an explicit approach to social lending. Social lending is supported officially and linked to non-profit, employment programmes and social welfare activities. While France addresses social lending directly, Italy and, in some respects Ireland and Belgium as well, favour certain types of lender which are presumed to engage in social lending.

In addition to these three approaches to social micro-lending, almost all states retain traditional, small banking institutions and also grant exemptions from bank supervision in respect of such small amounts as are too small even for micro-lenders. In addition Italy has a vast body of social and non-profit co-operatives engaged in lending and mutual guarantees. Ireland and the UK have exempted credit unions, the Netherlands and Germany use their system of community owned banks, while France supports direct involvement of official institutions in the economic development of regions and grants direct exemptions for social micro-lending.

France has a unique approach in granting exemptions to micro-lending from banking law on its own merits. This approach seems to suffice to prevent exemptions for small lenders under banking law from being abused by predatory lenders.

Propositions

1. General

   Social micro-lending in industrialised areas with a highly developed banking system is not in fact banking but a social policy initiative which uses credit for specific purposes. It should not be covered by banking legislation if it is restricted to credit and credit-related financial activities which do not necessitate bank supervision.

   National approaches to facilitating micro-lending through non-banks in the main follow the approach of granting exemptions from bank law to certain institutions. This report instead recommends that the only requirement be that micro-lenders should have the status of having a legal personality, rather than being treated as individuals. It strongly recommends that micro-lending be assessed without regard to specialist legal structures for micro-lending institutions such as associations or co-operatives and that any institution able and willing to meet the criteria of micro-lending should be permitted to engage in it.

   In the place of bank supervisory law, social micro-lending should be subject to adequate protective private law such as the Consumer Credit Directive and usury legislation.

   The EU should amend the banking directives to clarify the wording relating to their application to non-banks. Further, the main effort to promote micro-lending in the EU must lie with the Member States. In furtherance of that activity and to harmonise and co-ordinate it, the EU should pass a recommendation the contents of which are below.

2. EU-Bank Law and Social Micro-lending

3. 1. Considerations

      Given

      1. that the European Union has, in different programmes, expressed its commitment to furthering employment and especially to combating long term unemployment,
      2. that additional employment in the future will primarily stem from the creation and development of small and medium size enterprises and that the EU has dedicated several programmes to help such business creation
      3. that the barriers to the creation of micro-enterprises in particular stem from lack of skills and education on the part of those who could seek employment through self-employment, from a lack of own capital and the need at least for access to all forms of credit and
      4. that banks, due to their increasing size, international competition and standardisation, are reluctant to take on the task of education and start-up help in conjunction with their traditional role as credit provider, that in some countries even retail banking has contracted to the detriment of economically weak individuals and areas,
      5. that small business creation requires tailor-made financial services and personal advice where the interest earned is very low in relation to the integrated additional help and monitoring needed to make these investments sustainable. The banks therefore have difficulty offering such services, especially if the price of lending is either capped by law or by market image and if additional social and educational skills in particular have to be acquired to meet the specific needs of this clientele,
      6. that instead of the increase needed in sophisticated, locally available credit, banks have reduced their presence and the personal services to such clients,
      7. that the experience of micro-lenders in third world countries as well as in certain industrialised countries has shown that new approaches to lending are possible which significantly lower the cost of credit provision by integrating it into social work and educational programmes and by using soft approaches to credit scoring, securities and guarantees as well as to repayment methods and
      8. that such approaches have created significant incentives for people to create micro-enterprises and jobs, helping to reduce the burdens of unemployment and welfare benefit payments, they have created a nucleus for a newly emerging local economy in run-down areas, and they have created financial literacy among groups which otherwise would gradually be excluded from financial services in general,
      9. that without exemption from bank supervision, such micro-lending schemes have been offered through non-banks within existing banking legislation, but banking legislation in most countries still assumes that the extension of money loans, irrespective of their amount, purpose, and relation to other activities should be seen as a banking activity or at least as a near-banking activity and regulated as such. Non-banks are thus regulated in accordance with prudential banking considerations and are thereby significantly impeded in fulfilling their specific objective and indeed even banks are hindered from creating specialist micro-lending units,
      10. that on the other hand there is good reason not to create loop-holes in banking legislation which is designed to further the stability of the unified European money system, to prevent the development of predatory lending through unskilled, immoral and unscrupulous lenders which exploit the difficult situation of those seeking self-employment and the creation of micro-enterprises,
      11. that provision of money loans is a highly developed and sophisticated professional task, including instruments of risk assessment, guarantees and monitoring and that there should not be incentives or even the possibility to create a shadow market for the poor alone, where banking for the poor turns into poor banking. There should therefore also be a guarantee that banks remain accessible and involved in the development of their prospective clients and areas,
      12. that micro-lending in areas not yet banked (pre-bank micro-lending) may be different from micro-lending in areas where the number of unbankable people is rising (social micro-lending), and that pre-bank micro-lending in developing countries and even areas within the European Union certainly requires more opportunities for small loans while social micro-lending merely needs legal acceptance and public support as a means to bridge the gap between the developed banking system and those who are otherwise excluded,
      13. that credit as well as deposit-taking has never been seen in general as a bank activity in so far as all forms of indirect credit such as instalment purchases, leasing and factoring have been seen as ancillary to the main purpose of bank business. The credit function has therefore not been covered by banking legislation but instead by special credit legislation such as the Consumer Credit Directive. The same also applies to such deposit-taking as does not amount to savings but investments or associated activities for other businesses (especially pre-payments) and
      14. that in social micro-lending credit and savings can be seen as activities ancillary to financial education and business start-up assistance, as well as to local development

      the council gives the following recommendations to the Member States.

   2. Recommendation

      1. The Member States should incorporate EU-banking legislation into their national legal orders in such a way that social micro-lending through non-banks is permissible by law and the additional costs in terms of risks, education, urban development and advice are subsidised so that a reasonable return on the loans can be realised.
      2. Social Micro-lending
         • is a scheme of instalment credit for up to Euros 10.000 with fixed interest rates and fixed repayments, granted to individuals with little or no available security or adequate credit history and therefore insufficient access to bank business loans. Guarantees from the client, a group of clients ("peer group") or from third persons may be required in order to create joint responsibilities and networks. Pre-payments for a prospective loan ("savings into loan" schemes) may also be required in order to accustom clients to credit payments. Loans may also be increased step by step ("stepped loans").
         • Its purpose is the education of potential borrowers in financial issues ("financial literacy") and the creation of self-employment and micro-enterprises. ("self-help"). It combats unemployment and develops the local economy in urban areas threatened by economic decline. ("community development")
         • It includes extensive coaching, monitoring and direct help in order finally to (re-)integrate the target group into the general mechanisms of the market economy. Access to banking and autonomous economic behaviour are the primary goals.
         • Social micro-lending is a non-profit activity ancillary to non-banking activities. It differs from bank business lending in so far as expectations in terms of repayment are based mainly on assistance given through the lender for income generation through credit provision.
      3. EU Directives on banks and near banks do not require bank supervision of micro-lending as such, nor do they require supervision of guarantees given by borrowers or third persons to make micro-lending safe. Member States should harmonise their legislation with the effect that micro-lending provided by any legal entity meeting its criteria should not be subject to banking law in general. As micro-lending is an ancillary activity to non-financial social policy measures, it should be treated just as other non-bank credit which is connected to the selling of non-financial goods and services. (i.e. leasing, factoring).
      4. On the other hand Member States should apply the standards of the Consumer Credit Directive to micro-lending and take preventive measures against usury and predatory lending in order to guarantee minimum quality standards in respect of the loans, as well as transparent information and comprehensible terms and conditions. As far as their lending activities are concerned, micro-lenders should have at least the same supervision as credit brokers in each Member State.
      5. Payment-into-loan schemes in which savings are not higher than the instalment of the prospective loan should be regarded as part of the credit and exempted from the prohibition against taking public funds, provided they are secured either through bank or public authority guarantees, through special insurance or through being deposited in a safe bank account in the name of the client. Such view conforms with a comprehensible application of the banking directives.
      6. Micro-lenders should be given easy access to refinancing. For this purpose they should be permitted to take out bank loans and use own capital in whatever form of investment they receive from the public. Investments outside banking supervision should be carefully defined by the law, the application of which should be enforced. For such investments, investors carry the risks of credit failure and shares should only be withdrawn after an initial period of no less than 2 years on condition that the own capital of the micro-lending institution is not reduced.
      7. Member States should facilitate group guarantee schemes, which extend guarantees either to borrowers to obtain access to the general financial services market or to guarantee micro-lenders' refinancing activities. Subsidies to micro-lending organisations should be directed to the coaching, monitoring and educational functions of the main activity and not to the lending itself.
      8. Member States should further legislate to create public awareness on access to financial services for business start-ups. There should be incentives for banks to advance micro-lending schemes through co-operation, refinancing and technical assistance, by offering minimum bank accounts and other financial services in support of business start-ups. These incentives may consist in a legal obligation to disclose the impact of bank lending upon the community ("social auditing"), through a legal obligation imposed on the public banks to fulfil compensatory tasks or through direct state involvement in micro-lending.
      9. Member States should report to the Commission on the circumstances of those elements of their respective populations which are in need of access to financial services for employment purposes on a tri-annual basis.