Prudential Regulation in Microfinance

This Policy Framing Note explores the dilemma faced by policy makers in safeguarding the health of the financial system, while encouraging access to financial services.

Prudential regulation imposes costs on regulated institutions and their clients. These costs may cause deposit taking entities to hesitate to take on poor customers with small value deposits. The paper states that:

• Policymakers face a dilemma in protecting deposits while also expanding access to deposit-taking services;
• Many developing countries have tried to address this dilemma by amending existing regulations or opening special windows for microfinance;
• Technological developments have enabled new models such as online correspondent networks, pre-paid cards and mobile phone-enabled wallets for expanding access;
• Extending supervisory net without increasing capacity of supervisors raises reputational risks for regulators;
• CGAP principles of prudential supervision state that regulators should, where possible, regulate activities rather than institutions.

Finally, as external investment in microfinance entities continues to grow, supervisors may be able to harness the benefit of the oversight provided by experienced external investors to help them protect microfinance depositors.