Sa-Dhan Newsletter Volume 3 Issue 2
Microfinance Regulation
It is generally not indicated to protect commercial
S P E C I A L F E AT U R E S OF MICROFINANCE
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lenders to MFIs with regulation, except perhaps for bond
REGULATION
issues, which are not prevalent for microfinance.
One key measure that central banks and bank supervisors
have taken is to modify conventional regulatory requirements
BASIC ELEMENTS OF THE POLICY AND
to fit the needs of microfinance operations--regardless of
REGULATORY FRAMEWORK
whether these operations are conducted by a specialized
Basic elements of the policy and regulatory framework must
microfinance institution or form a small part of the overall
be in place, whether under existing banking law or under
portfolio of a commercial bank. These special features of
new legislation:
microfinance include:
Mutual understanding between MFIs and policy-makers
The limited size of the microfinance market relative to
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the assets of the financial sector, with very small loans
Liberalization of interest rates: The single most effective
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by large numbers of poor people
way for the government to promote financial services
The practice among most successful microfinancing
for the poor is to liberalize interest rates.
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institutions of mitigating credit risk not by requiring
Low minimum capital requirements: high enough to
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conven tional collateral, but rather by making very small,
discourage a plethora of small, weak, undercapitalized
short term loans with gradual increases in loan sizes
institutions, but low enough to encourage solid MFIs
and maturities, using simple processes for evaluating
that wish to mobilize deposits from the public to enter
business and credit risk, and executing strong systems
the regulated financial system
to ensure excellent on-time repayment
Capital adequacy / reserves / liquidity requirements
The high transaction costs of making very small loans,
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measured against microfinance risk: a more conservative
necessitating high interest rates
capital adequacy ratio, 12% or more, may be justified
Different approaches to branching and distribution
as even strongly performing portfolios area fragile in
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systems, use of simple loan documentation systems, and
the case of downturn. Furthermore, conservative capital
recognition that in many settings cash transactions will
adequacy ratios can serve to boost investor confidence
need to take place outside branch premises.
in this relatively young industry, as investors learn how
to evaluate microfinance institutions.
Lack of scale or sophistication to deal with typical
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reporting requirements.
Performance standards rather than traditional collateral
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requirements: regulators now look at the maintenance
WHEN TO REGULATE MICROFINANCE ACTIVITIES
of excellent aggregate portfolio quality, with rigorous
standards on loan loss provisioning and reserves, and
Bank regulation is established to protect savers, investors
at the adequacy of systems to evaluate risk and maintain
and the banking industry. It is now agreed in most quarters
portfolio quality.
that:
Simplified loan documentation and reporting
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MFIs engaged exclusively in microlending--be they
requirements: are rigorous, but simple, to reflect the
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NGOs, trusts, or companies--need not be subject to
relative small size of many MFIs.
banking regulation
Regulations accommodating NGO ownership: Regulations
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Microfinance institutions that mobilize mandatory savings
should be flexible, enabling a balance in stakeholders.
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as a collateral substitute for borrowers and do not
Choosing domestic or foreign partners with knowledge
intermediate this savings, should not be subject to
on and commitment to sustainable finance for the poor
prudential banking regulation.
is key.
Regulation is needed when it is necessary to protect
Flexible branching regulations: permission to have
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member-depositors who are not well positioned to
smaller, simpler outlets, including collection points,
monitor the financial soundness of the institution
temporary outlets in marketplaces, mobile banking or
themselves (e.g. large open-bond cooperatives). Except
the use of village groups as distribution points for
for small cooperative and other community based
disburse ments and collections.
institutions, entities that mobilize more than small
Fair tax treatment: The immediate introduction of high
aggregate amounts of savings from non-borrowers
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tax burdens upon transformation into a regulated
should be subject to regulation, either by the central
institution can make this transition extremely burdensome.
bank or its designated authority.
Temporary tax relief may be justified.
Unregulated MFIs that mobilize savings from borrowers
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Prudential regulation is only as good as the supervision
should deposit this savings in a bank, should not be
behind it. It is important both to the regulated MFIs as well
free to use this savings to finance its lending portfolio,
as to the regulators that reporting requirements be rigorous
and should attempt to ensure that borrowings exceed
but simple. It is also important to anticipate the number
savings at the individual account level as well as in the
of institutions that are likely to be regulated over a period,
aggregate.
and to build this capacity in the supervising entity.
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