So How Exactly Do We Regulate Microfinance?

Jonathan Morduch, a guest blogger for the Microfinance Blog, is sharing his thoughts about regulating microfinance.

That is indeed the question when regulators so often find themselves playing catch up – trying to figure out if and how something that’s already happening should be supervised.

When it comes to prudential regulation – or safeguarding deposits – the stakes are particularly high. In microfinance, most MFIs aren’t big enough to threaten the health of the financial systems they’re part of if they run into trouble. However, if prudential regulation of microfinance is inadequate – or when it fails – poor customers stand to lose their savings entirely. And the stakes really don’t get much higher than that.

As with other forms of regulation, the basic dilemma is that regulators of microfinance want to ensure the health of financial institutions without creating undue burdens on the institutions, or on themselves. Striking the balance is tricky when experience with regulating financial access and evidence to support hypothetical costs and benefits are so thin.

In his third Policy Framing Note for the Financial Access Initiative, David Porteous sheds some light on why these challenges are so, well, challenging, and describes early experiences with prudential regulation of microfinance in India, Nigeria, the Philippines and Nigeria.

According to the paper, there are two basic ways to integrate microfinance into regulatory frameworks. One is to amend existing regulations; the other is to write new laws that open special “windows” for microfinance. The window approach is appealing, since microfinance is a rather unique animal in the world of financial services. But, as CGAP points out in its 2003 “good practice” guidelines, for the sake of consistency and efficiency, financial regulation really works best when it focuses on activities or functions, not on types of institutions.

In the end, there’s no such thing as off-the-rack regulatory policy, and amending existing regulation to incorporate microfinance just isn’t always doable. Some activities, like mobile banking, are so distinct they simply demand their own sets of rules. What’s more, regulation should always be considered on a country-by-country basis. But paying close attention to early experiences with prudential regulation of microfinance will certainly help policymakers start to make smart choices.


06 September 2012 Submitted by Farhat Abbas Shah (not verified)

Its true the new regulatory frame works will put another expectation, while the existing regulations did not make troubles. We see in the perspective of Pakistan, The Managements of MFIs entirely disappointed the stakeholders. They misused funds and deceived the customers as well.The poverty Lords sitting in “Pakistan Poverty alleviation Fund” could not do their jobs smartly. There are a lot of stories of their corruption, are the talk of the town in the country. Most of them are not sincere with the vision and mission of the sector. The problem is not with the system but with the managers. So there is another food for thought for policy makers to make smart choices.

06 September 2012 Submitted by Ver Maclang (not verified)

I agree. Microfinance Institutions, including cooperatives, are not banks. Prudential regulations for banks should not be imposed on microfinance institutions or cooperatives even. Doing so would be a grave misstep.

06 September 2012 Submitted by Dr V.Rengarajan (not verified)

Microfinance emerged exclusively for the noble cause of poverty reduction and improvement in the livelihood of the poor fellow human being. So it is an unique ‘social animal’ in the world of social financial services. Ultimately it should result in poverty reduction. Thia noble goal makes subtle difference from other sources of finance. If MFIs are expected to deliver the desired good, regulations are necessary not only for protecting the savings but also (mainly) for ensuring ultimate goal. Particularly in the context of unbridled competition and unethical profit oriented commercialization in microfinance favoring more supply side (the means),‘exact regulation’ calls for more ethical and moral investing for taking care of demand side realties holistically (end) followed by candid supervision and monitoring.

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