The micro-credit sector can play a significant role in improving access to finance and encouraging entrepreneurship. A new flexible and voluntary European Code of Good Conduct for micro-credit provision aims to guide both businesses and financial institutions towards a better working relationship.
While the European micro-finance market is a growing and vitally important support sector for SMEs, legal and institutional differences between Member States have resulted in vastly differing lending practices. This has been further compounded at times by the sheer diversity of micro-credit providers, which range from commercial and savings banks to credit unions and charities.
For these reasons, the European Commission has promoted the establishment of a flexible, voluntary European Code of Good Conduct for micro-credit provision. Such a code should not only provide SMEs with safer access to the micro-funding they need, but should also support the micro-funding sector itself in raising service quality and moving towards sustainability.
The European Commission began to develop the Code by first consulting with key players within the micro-finance sector. Stakeholders, such as investors, customers, owners and regulators, were involved in discussions, and the experiences of trade associations such as the European Micro finance Network (EMN), the Micro finance Centre (MFC) and the Community Development Finance Association (CDFA) was also drawn upon. The need to build upon recognised best practice in the micro-finance sector was consistently stressed throughout this consultation process.
The purpose of the Code is quite clear. It is not to introduce or replace existing regulation, but rather to establish a set of common standards in terms of the operation and reporting of micro-credit providers. The Code is primarily designed to cover non-bank micro-credit providers, which provide loans of up to €25 000 to micro entrepreneurs. It also identifies and excludes certain types of institutions which cannot feasibly be covered by the Code, or whose practices cannot be considered to be good practice.
Micro-credit-provider board members and managers can employ the Code as a tool to improve the operation of the sector, and customers can use it to ensure that they are treated in a fair and ethical way. For investors and funders, the Code ensures that the sector operates with transparent and pan-EU reporting standards, while for regulators it provides reassurance that the sector operates according to sound business practices and principles, and that it is well governed.
The Code is divided into five sections, the first of which covers customer and investor relations. It states clearly that micro-credit providers have certain obligations towards customers and investors, and that establishing transparency and reliability in dealing with investors is of great importance.
The obligations of micro-credit providers include a fair and transparent lending process, the right to redress, the avoidance of customer over-indebtedness and the protection of customer data and transparency vis-à-vis investors. Such providers must also disclose lending costs in their advertising, and for loans of 12 months or longer, they must also provide clear and accurate information in an annual statement. Micro-credit providers must also take adequate measures to ensure that customers fully understand the products, process and terms of the contract.
The second section of the Code covers governance. According to the ‘Handbook for the Analysis of the Governance of Micro finance Institutions’, governance “encompasses all the mechanisms by which stakeholders... define and pursue the institution’s mission... and ensure its sustainability by adapting to the environment, preventing and overcoming crises”.
In order to ensure strong and accountable governance structures, the Code stipulates that micro-credit providers must produce a regularly reviewed business plan at least once a year. A business plan can serve as a road map, by guiding an organisation’s policies and strategies.
Micro-credit providers face numerous risks that threaten their financial and institutional viability and long-term development, thus the third section deals with managing risk. The Code states that providers should have robust systems and procedures for identifying, assessing and prioritising risks, along with internal controls for preventing or detecting undesirable outcomes. There should also be an internal audit function for uncovering breaches of internal controls and fraudulent behaviour.
The fourth section of the Code contains a set of common standards for the reporting and disclosure of social and financial performance indicators. The standards are largely based on definitions of the Micro finance Information Exchange (MIX), which are internationally accepted accounting standards.
Finally, the fifth section sets out common standards for management information systems (MIS), which involve the capturing and processing of raw data and its dissemination to users. An effective and appropriate MIS can enable micro-credit providers to serve their customers with greater efficiency and reliability. MIS capable of producing the data necessary for income statements, balance sheets and daily loan and delinquency reports are identified in this section as priorities.
The Code, which was officially launched at the recent Open Days 2011 – European Week of Regions and Cities in October – is intended to be updated every year through stakeholder contributions and shared best practice.
European micro-credit funding is available through the financial instruments of the Competitiveness and Innovation Framework Programme (CIP). Under CIP, €1.1 billion has been allocated to the financial instruments, designed to facilitate access to loans and equity finance for SMEs where market gaps have been identified.
The Guarantee Facility for SMEs, for example, created within the framework of the CIP, is funded by the European Union and is operated by the European Investment Fund (EIF) on behalf of the European Commission. The initiative aims to stimulate micro lending by providing EU guarantees on micro-credit financing to very small enterprises. EU Micro-Credit Guarantees are provided free of charge.
Another micro financing tool is JASMINE, a joint initiative of the European Commission, the European Investment Bank (EIB) and European Investment Fund (EIF). JASMINE aims to enhance the capacity of non-bank micro-credit providers and micro-finance institutions (MFIs) in a number of fields, in order help them become sustainable and viable operators in the micro-credit market. The European Progress Microfinance Facility also aims to increase the availability of micro-credit loans of below €25 000 by issuing guarantees to share in any potential risk of loss. The facility does not therefore directly finance entrepreneurs, but enables selected micro-credit providers in the EU to increase lending.
Micro loans can make the world of difference to a micro business. For example, Belgian entrepreneur Kaen Aerts secured an EU-guaranteed loan of €12 000 to open a chocolate boutique in Antwerp in 2007, and is now looking to diversify. In Germany, Manuela Voigt received a €25 000 loan which enabled her to set up her speech therapy clinic in Thale. Manuela is now able to provide targeted therapy, consulting and post-treatment services.
Financing Innovation and SMEs Unit
Directorate-General for Enterprise and Industry