What Is the Role of Regulation and Supervision in Microfinance?
Banks are prudentially regulated and supervised to protect their depositors and to prevent risks to the financial system. Credit-only MFIs that do not take voluntary savings from the public pose little risk to the financial system, if any, and can generally be handled with less intensive nonprudential regulation. Prudential regulation and supervision are appropriate for most MFIs that do take voluntary deposits—for instance, savings-based financial cooperatives or credit-only MFIs that want to start attracting savings to finance their growth. But what about community based financial intermediaries that are too small or too remote for effective prudential regulation and supervision? An argument can be made that these should be permitted to exist if they disclose clearly that they are not regulated and supervised – especially those in areas where poor customers have few, if any, other financial service options.
In many countries, various stakeholders push for new laws or regulations creating a specialized type of financial license for deposit-taking MFIs. Such laws and regulations need to be approached with care. New licensing windows for MFIs have been most successful in countries where a critical mass of profitable credit-only MFIs existed before the opening of the window. In some countries, providers who are not the type envisioned see an opportunity for regulatory arbitrage in the new window.
Proponents of new legislation or regulation often fail to give enough attention to the practical feasibility and cost of supervising the new institutions created. In Indonesia, Ghana, and the Philippines, for example, floods of small, often remote and hard-to-supervise institutions were licensed immediately following the opening of a new regulatory window, precipitating a supervisory crisis and the failure of large numbers of institutions.
Although MFIs that do not take voluntary deposits do not need prudential regulation and supervision, they are likely to need to meet certain minimum regulatory conditions as lenders, depending on the country. In a significant number of jurisdictions, and particularly in transition countries, legislation is sometimes necessary to clarify the legal authority of NGOs and other non-bank institutions to engage in the business of lending without a banking license.
In all countries, enforcement of unrealistically low interest-rate caps can make sustainable microlending impossible. MFIs need to charge interest rates that are considerably higher than normal bank rates because the administrative costs of making small loans are high in relation to the amount lent. At a minimum, interest caps are likely to dissuade MFIs from serving more difficult markets.
But high rates can also be attributable at least in part to inefficiencies in the microlender’s operations. Policies that promote competition, such as transparent loan cost disclosure coupled with consumer education, permit customers to price shop – helping to weed out inefficient operators and ultimately bringing down the rates offered by the most efficient MFIs.
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