Tough times for non-bank lenders

     Micro-enterprises face a new wave of regulations that could means a rise in credit costs and prices for consumers, argue Perry V. Zizzi and Vlad Peligrad of Salans

     Two years ago Salans blazed a trail by drafting a new law on micro-finance companies, which became effective in July 2005. The law codified certain existing practices among companies that lend up to 25,000 Euro to micro-businesses - a category of businesses with, traditionally, less access to credit than so-called small and medium-sized enterprises (SMEs).
     During consultations with the central bank (BNR), we and other proponents of the law agreed that micro-finance companies should be bound by consumer protection laws, including truth in lending requirements. Yet, all parties concluded that it was equally important to exempt micro-finance companies from regulation by BNR to allow flexibility of operation and keep compliance costs to a minimum. Thus, the law on micro-finance companies contained only minor reporting obligations for statistical purposes.
     The basic principle of non-regulation applies not only to micro-finance companies but equally to mortgage companies, leasing companies and consumer credit companies: BNR should not have the authority to regulate companies that do not take deposits.

A Big Step Backwards

     Ordinance (No 28/2006) became effective on 3 February 2006. This eliminates many benefits the micro-finance companies law introduced and by-laws regulating leasing, mortgage and consumer credit companies. Unable to restrain its inherent urge to regulate the market for finance products, the Government has opted to enlarge the BNR’s regulatory domain to rein in what the Government worries is rampant indebtedness among some segments of the population.
     This Ordinance requires all non-bank financial institutions (IFNs) to send a statement to the BNR with information about their management, shareholding and finances including turnover and the total amount of credits for the last two years. The BNR must maintain two main registries for IFNs: a general registry and a special registry. (BNR even has the power to maintain a third registry – for pawnbrokers). IFNs listed in the special registry will face more thorough regulation and will be closely scrutinised by the BNR.
     All institutions fulfilling the general conditions of this Ordinance will be registered in the general registry by sending the above referenced statement. Further norms should provide clarity on this Ordinance’s numerous provisions, such as the conditions IFNs need to meet to be registered in the special registry. BNR must issue the relevant norms by this month.
     Affected companies must register with the BNR by 6 August 2006. They can engage in lending activities only after receiving confirmation of registration from the BNR. If they miss this deadline, the Ordinance can prohibit new lending and changes to their existing loans.
     While the idea of a registry is not objectionable, IFNs, like banks, now face restrictions on shareholders, directors, officers and use of funds.

Regulation without reason

     What will be the result of this Ordinance? Credit will probably become artificially more expensive and harder to obtain for all consumers and micro-businesses.
     For IFNs, the cost of compliance seems certain to erode profits and make it harder to attract equity investors, who will be forced to accept lower returns. Likewise, IFNs that borrow from abroad to fund their own lending will be squeezed to find cheaper funding sources if their own profits have declined.
     For consumers, some of the higher costs to IFNs might pass on to them in increased fees and interest rates. For financial institutions interested in lending to IFNs, through securitisation of IFNs’ income streams, this Ordinance creates uncertainty and could cause postponement of plans to securitise until the norms are issued and the impact and implementation of the Ordinance becomes clear.
     Why bother to negotiate a credit facility – whether securitised or otherwise – if some months later the IFN borrower finds that its increased costs limit its ability to pay agreed fees and interest or that its customer base has dried up, thereby limiting the extent of its own borrowing? This way the Ordinance undercuts the thrust of recent laws concerning securitisation and mortgage bonds already approved by Parliament. The many foreign lenders interested in securitisations in Romania (we as a firm have been approached by a large number of them) might now pause to see the results of the Ordinance.
     On the bright side, for banks this creates a more level playing field by boosting IFNs’ regulatory compliance costs closer to those incurred by banks.
     If the Government aims to curb excess credits granted to susceptible individuals and companies, then it should have implemented more targeted legislation that would have been directed, not at non-bank lenders, but at specific sub-categories of borrowers most likely to incur debt beyond their means.
     Instead, the Government has weakened pillars of the economy, such as consumer spending and micro-businesses, and gone well beyond what was necessary to fix the problem it sought to address.