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An Index of Regulatory Practices for Financial Inclusion in Latin America: Enablers, Promoters and Preventers

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An Index of Regulatory Practices for Financial Inclusion in Latin America: Enablers, Promoters and Preventers CDEP‐CGEG WORKING PAPER SERIES CDEP‐CGEG WP No. 52 An Index of Regulatory Practices for Financial Inclusion in Latin America: Enablers, Promoters and Preventers Liliana Rojas‐Suarez and Lucia Pacheco March 2018 An Index of Regulatory Practices for Financial Inclusion in Latin America: Enablers, Promoters and Preventers (*) Liliana Rojas-Suarez Lucía Pacheco Canter for Global Development BBVA Research Abstract This paper constructs and index of regulatory quality for improving financial inclusion for the purpose of assessing and comparing the quality of rules and regulations in a sample of eight Latin American countries. The index comprises 11 regulatory practices classified into three categories: those that determine the overall quality of the financial environment where providers of financial services that meet the needs of the poor operate (the enablers); those that deal with specific types of market frictions and regulate the provision of specific financial products and services (the promoters) to large segments of the population; and those that, albeit unintentionally, create distortions and barriers that adversely affect financial inclusion (the preventers). An important novelty of the index is that the assessment of individual regulatory practices not only takes into account accepted standards, but also recognizes that there are important interactions between regulations for financial inclusion as well as between these regulations and other type of government interventions. Among the countries in the sample, by mid-2017, Peru ranked first in this index, followed closely by Mexico. Chile, Colombia, Paraguay and Uruguay obtained lukewarm results, although there were wide differences among these countries’ individual results. Argentina and Brazil were the two countries with the lowest overall scores. An additional contribution of the paper is that, throughout the analysis, countries’ specific areas of strengths and weakness in financial regulatory practices for improving financial inclusion are identified. Key words: financial inclusion, financial regulation, Latin America JEL classification: G21, G22, G23, I25, K21, N26, O10. Executive Summary * This paper was previously published by BBVA Research as Working Paper No. 17/15 and as CGD Working Paper No.468.We are very grateful to Santiago Fernández de Lis and David Tuesta for their suggestions, comments, and invaluable insights. This paper has also benefited from the feedback and input of many BBVA research economists as well as from local experts from the Argentinian, Chilean, Colombia, Mexican, Paraguayan, Peruvian and Uruguayan BBVA teams. We also want to thank Enestor do Santos for his insightful comments on the Brazilian framework, Carlos López Moctezuma for useful comments on this draft and Giovanni di Placido, from Fundación BBVA MicroFinanzas, for his extremely valuable feedback on the microcredit section. The authors are also grateful to an anonymous referee and to participants in a World Bank workshop for their comments. Finally, we would also wish to thank Rosa María Oliveros for her valuable research assistance. Any remaining errors are, of course, the sole responsibility of the authors. This paper assesses and compares the quality of rules and regulations impinging on financial inclusion in a sample of eight Latin American countries: Argentina, Brazil, Chile, Colombia, Mexico, Paraguay, Peru and Uruguay. By identifying weaknesses and strengths of specific regulatory practices in individual countries, the paper aims to support the efforts of policymakers in the region mandated with the task of improving financial inclusion. The paper distinguishes itself from other empirical assessments of this kind in two important and complementary ways.1 First, by concentrating only in Latin America, the analysis focuses on issues and variables that are particularly relevant to the region. Second, the paper recognises that the effectiveness of a number of regulations for financial inclusion is influenced by the quality of other regulatory practices and by certain government interventions. That is, there is an interaction between regulations that affect their overall quality. In addition, relative to other work done in this area, this paper conducts a more specific and detailed assessment of the regulatory practices considered. The 11 regulatory practices discussed in this paper are classified into three categories: those that determine the overall quality of the financial environment where providers of financial services operate (the enablers); those that deal with specific types of market frictions and describe the rules of the game for the provision of specific financial products and services (the promoters); and those that, albeit unintentionally, create distortions and barriers that adversely affect financial inclusion (the preventers). We construct an index for each of these three categories and sub-indices for the 11 regulatory practices/policies that form the indices (Table 1). Table 1: Indices of Regulatory Quality and their components Enablers Promoters Preventers o Simplified Accounts o Electronic Money o Correspondents o Transaction Taxes o Competition Policies o Microcredit o Interest Rate Ceilings o Supervisory Quality o Credit Reporting Systems o Directed Lending o Simplified Know-Your- Customer (KYC) requirements In addition, we also constructed a sub-index for assessing government efforts in promoting Financial Literacy. This sub-index is used as an adjustment factor in calculating the score of the Promoters index. The assessment of individual regulatory practices is based on the construction of sub-indices, whose components include accepted standards as well as relevant interactions with other regulations and government interventions. Sub-indices receive scores in the 0-2 range and are then aggregated by categories to create the enablers, promoters, and preventers indices. A final, overall 1 In particular, The Economist Intelligence Unit report: Global Microscope 2 index incorporating all three categories is also constructed. The paper details the methodology utilized for the construction of the indices. How Enabling are the Regulatory Frameworks in Latin America? A central feature of an enabling regulatory framework for financial inclusion is that it facilitates the adoption and adaptation of innovations that safely allow for an increased usage of financial services by large segments of the population, especially the poor. Thus, such enabling regulatory framework for financial inclusion needs to rest on two pillars. The first is the application of adequate competition policies that encourage a variety of providers to expand the range of customers receiving financial services. The second pillar is a complementary and robust supervisory regime to ensure progress in financial inclusion in a sustainable manner, and this regime requires supervisors to have adequate tools and sufficient autonomy to take action in the event that problems emerge in financial institutions. Thus, the Enablers index is composed of the Competition Policies sub-index and the Supervisory Quality sub-index. The Competition Policies sub-index is made up of four indicators that define rules on (a) market entry, (b) market exit, (c) abuses of market power and (d) the contestability of inputs and interoperability. Results show that regulatory strengths and weaknesses vary significantly across countries. A common characteristic among the highest performers (Argentina, Chile, Colombia, Mexico and Paraguay with a score of either 1.8 or 1.7) is that all countries received the maximum score in the indicator abuses of market power. Beyond that, the regulatory differences are large. On the opposite side, Brazil receives the lowest overall score (1.3) among countries in the sample, closely followed by Uruguay (1.4). The Supervisory Quality sub-index is formed by two indicators: the supervisory powers indicator and the independence of supervisors’ indicator. On an overall basis, Peru and Paraguay stand out as the strongest countries in terms of the quality of the supervisory regime. By contrast, Argentina gets a very low overall score (0.7) and the last position in the sample. One important reason for this low score is that current legislation does not ensure the independence of the supervisor from political influence. In the rest of the countries, the scores also signal evidence of insufficient independence of the supervisor, albeit to a lesser extent than in Argentina. Regarding supervisory powers, Chile, Uruguay, Brazil and Mexico obtain relatively high scores. Table 2 presents the Enablers index and its components. The value of the overall index is the simple average of the scores obtained for the two sub-indices. 3 Table 2: The Enablers Index in Selected Latin American Countries. The Scores Criteria / Country Argentina Brazil Chile Colombia Mexico Paraguay Peru Uruguay Competition policies 1.7 1.3 1.8 1.7 1.8 1.7 1.6 1.4 Supervisory quality 0.7 1.5 1.5 1.2 1.4 2 2 1.5 Enablers Score 1.2 1.4 1.7 1.5 1.6 1.9 1.8 1.5 Paraguay achieves the highest score in the Enablers index, while Chile, Peru and Mexico are not far behind. While the soundness of Competition Policies is the main source of strength in Chile and Mexico, a perfect score in Supervisory Quality supports the overall results in Peru. Brazil, Colombia and Uruguay achieve lukewarm results, while Argentina (with a score of only 1.2) occupies the last position among the countries in the sample. In this country, significant efforts are
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