European Code of Good Conduct for Microcredit Provision

EN European Code of Good Conduct for Microcredit Provision Version 1.0

Source of photos : istockphoto European Union, 2011 Reproduction is authorised provided the source is acknowledged. ISBN 978-92-79-21023-5 doi:10.2776/41012 European Commission, Directorate-General for Regional Policy Unit B.1 Communication, Information, Relations with Third Countries Raphaël Goulet Avenue de Tervuren 41, 1040 Brussels BELGIUM Fax : +32 22966003 E-mail : regio-info@ec.europa.eu Internet : http://ec.europa.eu/regional_policy/index_en.htm

Foreword The European microfinance market is a young and growing sector which has considerable potential. However, this market is still quite heterogeneous, due to the disparity of the legal and institutional frameworks in the Member States and the diversity of the microcredit providers. In the EU, microloans are provided by financial institutions, such as commercial banks, savings banks, cooperative banks and public banks, as well as by a number of non-bank entities, such as microfinance institutions, foundations, credit unions, charities, NGOs and others. As a result, microcredit lending practice vary considerably depending on the type of institution providing microloans, its legal setup, the environment in which it operates and its own ability to apply sound and efficient management procedures. Under these circumstances, the design of a widely accepted voluntary European Code of Good Conduct for microcredit provision was identified by the Commission as an important part of its initiative 1 to promote best practices in the field of microcredit. By setting out good practice guidelines and identifying expectations and common standards, the Commission is seeking to support the sector in facing the challenges of accessing longterm finance, maintaining and raising the quality of services and moving towards sustainability. The principles regarding governance and management presented in this document are generally not new, but they reflect best practices across the sector. The purpose of this document is to detail a set of approved standards recognised in the European Union as essential in terms of the operation and reporting of microcredit providers. The work to develop this European Code of Good Conduct has been carried out 2 in close consultation with many actors and stakeholders from the microfinance sector, such as funders, investors, customers, owners, regulators and partner organisations. It drew on the expertise and valuable experience gained by many microfinance actors in the EU, in particular the trade associations the European Microfinance Network (EMN), Microfinance Centre (MFC) and Community Development Finance Association (CDFA). It is our hope that the European Code of Good Conduct for Microcredit Provision will contribute to enhancing good practice and further improving governance and sound management in the microfinance sector in the European Union. Dirk Ahner, Director-General Directorate-General for Regional Policy European Commission Heinz Zourek, Director-General Directorate-General Enterprise and Industry European Commission 1 Communication "A European initiative for the development of microcredit in support of growth and employment" (COM(2007) 708 final/2 of 20.12.2007) 2 The European Code of Good Conduct for Microcredit Provision was prepared by Dr Karl Dayson and Pål Vik of Community Finance Solutions, University of Salford (UK) under a contract signed with the European Commission 4

Code of Good Conduct for Microcredit Provision Acknowledgement The organisations listed below in alphabetical order have contributed to the development of the European Code of Good Conduct for Microcredit Provision : Association of Cooperative Savings and Credit Unions Network of European Credit Unions Association pour le Droit à l Initiative Economique, (ADIE) Banca Etica Bundesverband Offentlicher Banken Deutschlands Centre for European Research in Microfinance (CERMi) Community Development Finance Association (CDFA) CoopEst Deutsche Sparkassen- und Giroverband (DSGV) Deutsches Mikrofinanz Institut (DMI) Eurom Consultancy & Studies European Association of Co-operative Banks (EACB) European Association of Public Banks (EAPB) European Banking Federation (EBF) European Investment Fund (EIF) European Microfinance Network (EMN) European Network of Credit Unions European Savings Banks Group (ESBG) Evers & Jung Express Finance IFN SA Fair Finance Fédération Nationale des Caisses d'epargne Finance Policy Department for Business, Innovation and Skills (BIS), SME Finance Team Good.Bee Holding Groupe Banques Populaires Caisses d'epargne (BPCE) Kreditanstalt für Wiederaufbau (KfW) Luxflag MicroBank Microfinance Centre for Central Europe and New Independent States (MFC) MicroFinanza Rating NRW.Bank Planet Rating Qredits The Financial Services Authority (FSA) Wirtschaftskammer Oberösterreich (WKÖ) Many other participants were involved in the process through questionnaires 5

Table of contents About the Code of Good Conduct........................................................... 9 How was the Code developed?..........................................................................10 Why a Code of Good Conduct for microcredit providers in the EU?...........................10 Which institutions are covered by the Code of Good Conduct?................................10 Who are the intended audience of the Code of Good Conduct?...............................10 How should this document be used?..................................................................11 1 Customer and Investor Relations...................................................21 Introduction...................................................................................................22 Customer relations...........................................................................................22 Sufficient information provided to customer..................................................................22 Customer rights.................................................................................................23 Avoiding over-indebtedness of customers....................................................................23 Customer care..................................................................................................24 Ethical staff and institutional behaviour.......................................................................24 Customer data protection......................................................................................25 Investor relations...............................................................................................25 2 Governance........................................................................................27 Introduction...................................................................................................28 Development of a business plan.........................................................................28 Board............................................................................................................29 Independence of board........................................................................................29 Responsibilities of board.......................................................................................30 Influence of board on microcredit provider...................................................................30 Selection and representation of board members.............................................................31 Board practical work organisation.............................................................................31 Management..................................................................................................32 Management expertise and human resource management.................................................32 Operational manuals...........................................................................................32 External audit...................................................................................................33 6

Code of Good Conduct for Microcredit Provision 3 Risk Management.............................................................................35 Introduction...................................................................................................36 Risk management framework............................................................................ 36 Management of credit risk.................................................................................37 Planning of portfolio quality..............................................................................38 Management of fraud and security risk................................................................ 38 Internal audit function......................................................................................40 4 Reporting Standards........................................................................43 Introduction...................................................................................................44 Common financial reporting standards................................................................44 Common social reporting standards....................................................................46 Common disclosure standards...........................................................................47 5 Management Information Systems..............................................49 Introduction...................................................................................................50 Functional completeness and expandability.........................................................50 Security and staff support.................................................................................51 Glossary.......................................................................................................52 7

Code of Good Conduct for Microcredit Provision About the Code of Good Conduct 9

About the Code of Good Conduct The European Code of Good Conduct for Microcredit Provision provides a set of standards in terms of management, governance, risk management, reporting, and consumer and investor relations that are common to the microcredit sector in the European Union. These standards are for the benefit of customers, investors, funders, owners, regulators and partner organisations. How was the Code developed? The Code has been built on recognised best practice in the microfinance sector and developed in close consultation with the microcredit sector in the EU and its stakeholders. The development of the Code of Good Conduct has been guided by the following principles : An emphasis on incorporating specific and measurable content, on the basis of which microcredit provider managers and boards can take action to enhance their organisations. An emphasis on developing a Code that is adjusted to the diversity of microcredit providers in the EU in terms of market conditions, institutional forms and legal frameworks. An emphasis on raising standards by balancing the need for introducing best practice with realistic operational expectations of the providers. Why a Code of Good Conduct for microcredit providers in the EU? The development of the Code was based on the recognition that in light of the disparate regulatory frameworks in which microcredit providers in the EU operate there was a need for a unifying set of expectations and standards that was common to the sector. The goal is to benefit the sector itself as well as its funders, investors, customers, owners, regulators and partner organisations. The Code sets out good practice guidelines that will better enable the sector to face the challenges of accessing long-term finance, maintaining and raising the quality of services, and moving towards sustainability. Which institutions are covered by the Code of Good Conduct? The Code of Good Conduct is primarily designed to cover non-bank microcredit providers which provide loans of up to 25 000 to micro-entrepreneurs. However, the microcredit sector in the EU is diverse in terms of size, institutional set-up and the markets in which they operate. Consequently, not all practices can be considered good practice or even possible for all microcredit providers. In some cases, regulations may already exist which cover certain domains and practices. The Code recognises this and, where applicable, it specifies the type of institutions not covered by the clause in question. Who are the intended audience of the Code of Good Conduct? This Code of Good Conduct is intended for microcredit provider managers, directors, customers, investors, funders, owners, regulators and partner organisations. It is designed to be a tool for microcredit provider board members, stakeholders and managers in improving the operation of the sector. For customers, it is a tool to ensure that they are treated in a fair and ethical way. For investors and funders, it ensures that the sector operates with transparent and pan- EU reporting standards. For regulators, it gives some reassurance that the sector operates according to sound business practices and principles, and that it is well governed. The purpose of the Code is not to introduce or replace existing regulations of microcredit providers. Rather it is intended to detail a set of common standards in terms of the operation and reporting of microcredit providers. 10

Code of Good Conduct for Microcredit Provision How should this document be used? The Code is divided into five sections : Customer and investor relations : This section covers obligations of microcredit providers towards customers and investors, and rights of customers and investors. Governance : This section covers standards for both management and the board of microcredit providers. Risk management : This section details common approaches and procedure for managing risk. Reporting standards : This section details which indicators microcredit providers must collect, report and disclose. Management information systems : This section details common standards for management information systems. Priority clauses Throughout the document, several clauses have been identified as priority clauses. These clauses are seen as particularly important and are presented as illustrated below. Clause 1.2 Microcredit providers will disclose the cost as an Annual Percentage Rate of Charge The Annual Percentage Rate of Charge must be disclosed in a credit agreement and in any advertising. This refers to the annual value of all commitments, drawdowns, repayments and charges, including fees and taxes paid by the customer and known to the creditor. The clauses are presented as illustrated below : Clause 1.1 For loans of duration of 12 months or longer, microcredit providers will provide clear and accurate information to their customers about their loan in an annual statement. The annual statement must include the amount paid (interest and principal), the balance left (interest and principal) and the structure of the remaining payments (timing, amounts, interest and principal). The annual statement may be transmitted electronically, on paper or face-to-face. The clauses themselves are underlined and where there is further guidance this is found below the clause. Level of difficulty / / The level of difficulty in implementing a clause is indicated by (low difficulty), (medium difficulty) and (high difficulty) Large institutions only Where a clause only applies to large institutions, this is indicated by the symbol, displayed after the clause. Large institutions are here defined as providers that have more than 7 000 active borrowers 3 and more than 70 employees. In the further guidance to the clauses, references are also made to small and medium providers. Small providers refer to organisations with fewer than 4 000 customers and 35 employees, while medium providers have 4 000 to 7 000 customers and 35 to 70 employees. All the clauses are summarised in a matrix at the beginning of the document. In the matrix, the priority clauses are in bold red font. A glossary also explains some of the terms used. 3 Active borrowers are individuals who currently have an outstanding loan balance with the microcredit provider or are primarily responsible for repaying any portion of the gross loan portfolio. Borrowers with multiple loans should be counted as a single borrower. 11

About the Code of Good Conduct Overview matrix Clause number Clause Priority Difficulty Large Only Page I. Customer and investor relations Sufficient information to customer Microcredit providers will... 1.1 Disclose costs in advertising 22 1.2 Disclose costs as Annual Percentage Rate 22 1.3 Provide pre-contractual information to customer 22 1.4 Provide clear information in annual loan statement 22 1.5 Take measures to ensure customers understand terms and process 22 Customer rights Customers have the right to... 1.6 Withdraw from credit agreement or repay within 14 days 23 1.7 Enough time to review terms of contract and ask questions 23 1.8 Early repayment 23 1.9 Have credit history reported to national credit bureaux 23 Avoiding over-indebtedness of customers Microcredit providers will... 1.10 Assess repayment capacity and loan affordability 23 1.11 Have credit policies addressing borrower debt thresholds 23 1.12 Inform borrower without delay of non- or under-payment 23 Customer care Microcredit providers will... 1.13 Regularly assess customer satisfaction 24 1.14 Have policy requiring that complaints be investigated 24 12

Code of Good Conduct for Microcredit Provision Clause number Clause Priority Difficulty Large Only Page 1.15 Have mechanism to deal with customer complaints 24 1.16 Ensure customers are informed of right to complain 24 Ethical staff and institutional behaviour Microcredit providers will... 1.17 Not discriminate in selection and treatment of customers 24 1.18 Set out acceptable and unacceptable debt-collection practices 24 1.19 Have explicit policy on acceptable pledges of collateral 24 1.20 Conduct regular staff appraisals 25 Customer data protection Microcredit providers will... 1.21 Have written privacy policy concerning customer data 25 1.22 Have systems to protect customers personal and financial information 1.23 Train staff to protect customers personal and financial information 25 1.24 Inform customers about use of information and rights to withdraw permission 1.25 Require written customer consent to publicly disclose information 25 25 25 Investor relations Microcredit providers will... 1.26 Take responsibility not to mislead investors 25 1.27 Provide relevant information to enable investors to make informed decisions 1.28 Endeavour to target investors equipped to understand risk 25 1.29 Take steps to verify investors identity to prevent money laundering 25 25 II. Governance Business planning Microcredit providers will... 2.1 Produce a business plan that is reviewed regularly 28 2.2 Produce a business plan covering a minimum of 3-5 years 28 13

About the Code of Good Conduct Clause number Clause Priority Difficulty Large Only Page 2.3 Ensure that the business plan covers a minimum number of aspects of business 2.4 Measure, disclose and improve financial and social performance 28 2.5 Use management control and performance tools 29 28 Board 2.6 Microcredit providers will have a board of directors or equivalent 2.7 The board will have an audit or supervisory committee 29 29 The audit or supervisory committee will... 2.8 Be independent of management 29 2.9 Meet with external auditors on annual basis 29 2.10 Have expertise in financial analysis and accounting 29 The board will... 2.11 Have a minimum number of members 29 2.12 Be composed of a majority of independent board members 29 2.13 Be selected by Annual General Meeting or equivalent body 30 2.14 Be reviewed by Annual General Meeting or equivalent body 30 2.15 Supervise the performance of the senior management 30 2.16 Be accountable for compliance with laws and regulations 30 2.17 Review whether provider is carrying out the mission and business plan 2.18 Monitor financial performance on a regular basis 30 2.19 Be represented on interview panel when hiring chief executive 30 2.20 Have the right to veto executive management appointments 30 2.21 Decide level of remuneration for executive management posts 30 2.22 Approve any changes in pricing policies 31 2.23 Be given portfolio quality and financial performance reports 31 2.24 Have members with understanding of banking and finance 31 2.25 Have members that will develop understanding of credit risk 31 30 14

Code of Good Conduct for Microcredit Provision Clause number Clause Priority Difficulty Large Only Page Microcredit providers will... 2.26 Have rules excluding improper persons from becoming board members 2.27 Have rules stipulating term limits and rotation 31 2.28 Require disclosure of conflicts of interest of board members 31 31 2.29 Have board members with qualifications in finance, business, management and law 2.30 Be able to remove board members not attending meetings without valid reason 31 31 The board will... 2.31 Meet at least four times a year 31 Microcredit providers will... 2.32 Have quorum preventing staff or management majority on board 32 2.33 Disclose proportion of related-party lending in annual report 32 Management 2.34 Management will be qualified to undertake key management functions 32 Microcredit providers will... 2.35 Have succession plan for executive management 32 2.36 Have personnel policies set out in personnel manuals 32 2.37 Have a formal training and induction programme 32 2.38 Have operational manuals covering financial operations and management 2.39 Have operational manuals covering treasury 32 32 External audit 2.40 Microcredit providers will have external audit on annual basis 33 2.41 Auditor will be appropriately qualified 33 2.42 External audit will adhere to national or international accounting standards 2.43 External audit will be accompanied by letter from auditor 33 2.44 Microcredit provider will address issues raised by auditor 33 33 15

About the Code of Good Conduct Clause number Clause Priority Difficulty Large Only Page III. Risk management Risk management framework Microcredit providers will... 3.1 Have processes to identify, assess and prioritise risks 36 3.2 Appoint senior manager to be accountable for risk management 3.3 Assign responsibility for implementing risk controls 36 36 3.4 Assign responsibility for monitoring and providing management with relevant data 36 Managing credit risk Microcredit providers will... 3.5 Take into account risk when designing loan products 37 3.6 Limit credit risks by requiring that two people approve all loans 3.7 Review aggregate exposure to concentrations of credit risk 37 3.8 Ensure any staff incentives are not linked only to loan origination 38 3.9 Measure and track loan portfolio performance 38 3.10 Revise loan loss provisioning rates and methodology regularly 38 3.11 Disclose loan loss provisioning methodology to funders and investors 3.12 Have explicit policy on write-offs and apply it consistently 38 37 38 Managing fraud and security risk Microcredit providers will... 3.13 Specify lending limits for various ranks of officers and credit committees 3.14 Have procedures for rescheduling loans 38 3.15 Have policies and procedures on dealing with collateral 39 3.16 Have policies classifying restricted and unrestricted fund account activity 3.17 Limit handling of cash through banks or using electronic transfers 39 3.18 Have the following measures in place when handling cash... 39 3.18.1 Sufficient security measures to protect cash and assets 39 3.18.2 Standardised and consistent procedures for cash transactions 39 38 39 16

Code of Good Conduct for Microcredit Provision Clause number Clause Priority Difficulty Large Only Page 3.18.3 Segregation of duties for handling and recording cash transactions 3.19 Segregate duties for approving and disbursing loans 39 39 Internal audit 3.20 Microcredit providers will have explicit internal audit function adjusted to size of organisation 3.21 Internal auditor will report directly to board 40 3.22 Internal audit will determine : 40 3.22.1 The reliability of existing information 40 3.22.2 The reliability and accuracy of financial and operational information 3.22.3 Violations of internal controls 40 3.22.4 Existence of uncontrolled risks 40 3.23 Internal audit will be conducted regularly 40 40 40 IV. Reporting standards Common financial reporting standards Microcredit providers will... 4.1 Adhere to common way of measuring and reporting : 44 4.1.1 Current loan portfolio 44 4.1.2 Gross loan portfolio 44 4.1.3 Net loan portfolio 44 4.1.4 Active borrowers 44 4.1.5 Financial revenue 44 4.1.6 Operating revenue 44 4.1.7 Personnel expense 45 4.1.8 Administrative expense 45 4.1.9 Financial expense 45 4.1.10 Portfolio at Risk 45 4.1.11 Write-offs 45 4.1.12 Impairment loss allowance and provision expense 45 4.1.13 Assets 45 4.1.14 Liabilities 45 17

About the Code of Good Conduct Clause number Clause Priority Difficulty Large Only Page 4.1.15 Operational sustainability ratio 46 4.1.16 Financial sustainability ratio 46 4.1.17 Adjustments to sustainability ratios taking into account subsidies 46 Common social reporting standards Microcredit providers will... 4.2 Publicly disclose... 4.2.1 Social mission 46 4.2.2 Average disbursed loan size 46 4.2.3 Median loan size as % of gross national income 46 if relevant for target market and mission... 4.2.4 % of female customers 46 4.2.5 % of rural customers 46 4.2.6 % of poor customers 46 4.2.7 % of customers graduating to mainstream finance 46 4.2.8 % of ethnic minority or indigenous customers 46 4.2.9 % of start-up businesses funded 46 4.2.10 % of customers on welfare benefits 46 Common disclosure standards 4.3 Members of public will be able to access information 47 Microcredit providers will... 4.4 Publicly disclose... 4.4.1 Number of active borrowers 47 4.4.2 Number and value of loans issued and outstanding 47 4.4.3 Value of current, gross and net portfolio 47 4.4.4 Portfolio at Risk 47 4.4.5 Total value of assets and liabilities 47 4.4.6 Operational sustainability ratio 47 4.4.7 Financial sustainability ratio 47 4.4.8 % of cost per loan subsidised 47 4.4.9 Number of loan officers and (total) personnel 47 18

Code of Good Conduct for Microcredit Provision Clause number Clause Priority Difficulty Large Only Page 4.5 Record complaints by applicants and past and current customers 47 4.6 Publicly disclose... 47 4.6.1 Number of complaints by applicants and past and current customers 4.6.2 Complaints as % of applicants and past and current customers 47 47 V. Management information systems Functional completeness and expandability Microcredit providers will have an MIS that... 5.1 Produces key operational and financial reports 50 5.1.1 Income statement 50 5.1.2 Balance sheet 50 5.1.3 Daily loan and delinquency report, ratios and trends 50 5.2 Enables provider to perform full range accounting activities 50 5.3 Operates in accordance with recognised accounting standards 50 5.4 Can monitor and manage loan portfolio quality and functions 50 5.5 Can manage and maintain information about clients 50 5.6 Can facilitate prompt access to relevant information for management, staff and board 5.7 Can handle and incorporate new products, multiple offices, services and delivery channels 5.8 Can cope with planned growth 51 50 51 Security & staff support Microcredit providers will... 5.9 Restrict access to data captured by an MIS 51 5.10 Operate with different levels of user access 51 5.11 Have provisions to store and restore information 51 5.12 Have an MIS that can perform regular back-ups 51 5.13 Have safeguards to prevent illicit or accidental alteration of data files 5.14 Have an MIS that can produce audit trail on crucial operations 51 5.15 Provide training and/or manuals to staff 51 51 19

Code of Good Conduct for Microcredit Provision 1 Customer and Investor Relations 21

1 Customer and Investor Relations Introduction Microcredit providers have clear obligations towards customers and investors. The well-being of customers is intimately linked to the mission of microcredit providers to combat poverty and social and financial exclusion, while private and public investors are increasingly important in the funding of the sector. Hence, establishing principles that guide the treatment of customers and principles that ensure transparency and reliability in dealing with investors is of great importance. This section of the Code sets out a series of obligations incumbent upon microcredit providers towards their customers and investors. This includes a fair and transparent lending process, right to redress, avoidance of customer over-indebtedness, protection of customer data and transparency vis-àvis investors. Customer relations Sufficient information provided to customer Clause 1.1 Microcredit providers will disclose lending costs in their advertising. This will include borrowing rates, charges and an illustrative example. Clause 1.2 Microcredit providers will disclose the cost as an Annual Percentage Rate of Charge This clause has been identified as a priority clause because disclosing the cost of borrowing is crucial in enabling the customer to make informed financial decisions. The Annual Percentage Rate of Charge must be disclosed in a credit agreement and in any advertising. This refers to the annual value of all commitments, drawdowns, repayments and charges, including fees and taxes paid by the customer and known to the creditor. Clause 1.3 Microcredit providers will provide the following precontractual information to the customer and set it up in the credit agreement : Clause 1.3.1 : the identity and geographical address of the lender Clause 1.3.2 : the amount Clause 1.3.3 : the duration of the credit agreement Clause 1.3.4 :the borrowing rate Clause 1.3.5 : total amount payable Clause 1.3.6 : charges for late repayments Clause 1.3.7 : right of early withdrawal Clause 1.3.8 : debt-collection practices Clause 1.4 For loans of duration of 12 months or longer, microcredit providers will provide clear and accurate information to their customers about their loan in an annual statement. The annual statement must include the amount paid (interest and principal), the balance left (interest and principal) and the structure of the remaining payments (timing, amounts, interest and principal). The annual statement may be transmitted electronically, on paper or face-to-face. Clause 1.5 Microcredit providers will take adequate measures to ensure that customers fully understand the products, process and terms of the contract. This may, where necessary and appropriate, include training customer-facing staff to communicate effectively with all customers, reading contracts out load for visually impaired or illiterate customers, or providing materials in local languages. 22