Impact of Government Regulation on Microfinance

This paper discusses the role of the government in microfinance. It argues that:

• Microfinance has demonstrated success as a poverty reduction strategy. The important players in microfinance are NGOs, the government and other financial institutions;
• It is necessary to make microfinance a sustainable methodology, by increasing its scope, impact and depth;
• Microfinance needs to be commercialized. MFIs need to transform themselves into formal financial institutions, while commercial banks need to start offering microfinance products.

The paper suggests that governments need to encourage the shift towards sustainable, market-based microfinance by:

• Eliminating unfair competition from public institutions: The government should ideally exit the microfinance sector, or it should act to ensure transparency and reinforce market mechanisms;
• Undertaking regulatory reform through:
  • Permitting credit-only non-depository MFIs to lend freely without prudential supervision;
  • Abolishing financially repressive regulations;
  • Adjusting prudential standards to reflect the specialized nature of microfinance;
  • Allowing foreign equity participation in microfinance.
• Improving the business environment for microfinance by:
  • Focusing on macro economic stability;
  • Strengthening the banking system;
  • Developing infrastructure, especially in rural areas.

[Adapted from Author]