What Is the Role of Regulation and Supervision in Microfinance?

Banks are regulated to protect their depositors and to prevent risks to the financial system. Credit-only MFIs do not take deposits from the public and are too small to pose much risk for the financial system. Regulation by the financial authorities is needed for MFIs that do take deposits—for instance, savings-based financial cooperatives or credit-based MFIs that want to start taking deposits to finance their growth.

In many countries, various factions are pushing for new laws to create a special, new type of financial license that is tailor-made for deposit-taking MFIs.  Such laws 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.

Drafters of new legislation typically fail to give enough attention to the practical feasibility of supervising compliance with the new regulations. In Indonesia, Ghana, and the Philippines, for example, dozens of new institutions took advantage of a newly created licensing window, but supervision proved grossly inadequate and a high proportion of them failed.

MFIs that do not take deposits do not need intensive regulation and supervision, but they do need a certain minimum regulatory structure in order to operate. In the transition economies of former socialist countries, legislation is sometimes necessary to clarify the right of NGOs and other non-bank institutions to engage in the business of lending.

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.

Recommended Reading

Robert Peck Christen, Timothy Lyman, and Richard Rosenberg, Microfinance Consensus Guidelines:  Policy Guidance on Regulation and Supervision for Microfinance (Washington, D.C.: CGAP, August 2003).

Robert Christen Peck and Richard Rosenberg, CGAP Occasional Paper No. 4: The Rush to Regulate: Legal Frameworks for Microfinance (Washington, D.C.: CGAP, April 2000).