Regulation and Supervision of Microfinance Institutions: State of Knowledge

This paper compares the theoretical rationale for regulating financial institutions with current practice in microfinance.

It further states that:

• The most common method so far, offering MFIs the same regulatory framework as for formal banks as the only option has not proved effective;
• Regulation by means of a special law for MFIs is in danger of stifling institutional variety and innovation in microfinance;
• Self-regulation in its pure form, i.e. without direct or indirect statutory influence, suffers from a large enforcement problem;
• A multi-tier system, with each tier controlled by the next higher one, can help cut costs and make use of information advantages;
• MFIs must be regulated, if they start mobilizing deposits from the general public including non-members. Also member-based institutions should be regulated, if they exceed a certain size;
• Small MFIs in the informal sector must not be forced to submit to regulation, even if they mobilize local savings (e.g. RoSCAs, but not NGOs);
• Regulation of credit-only institutions may be desirable to raise standards in the microfinance sector, but there is no imperative for government to take action;
• Task of supervising MFIs can be delegated to an (possibly also private) institution;
• Due to their distinctive institutional features and business characteristics, the prudential ratios of MFIs differ from those of traditional commercial banks;
• Controlling risk management procedure and institutional structures is more important than controlling ratios (risk management instead of ratio management).