How to Regulate and Supervise Microfinance: Key Issues in an International Perspective: The Emerging Consensus in the Regulation and Supervision of Microfinance: Synthesis of the Debate

Publication Date: 2000
Published by: GTZ - Deutsche Gesellschaft für Technische Zusammenarbeit GmbH
Document Type: Paper

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What works in regulation and supervision?

This paper synthesises conclusions from the "How to regulate an supervise"and finds that:

• Deposit taking from the public should be regulated and supervisedthere is agreement that capturing deposits is a serious responsibility and requires strong and capable institutions. As long as institutions providing microfinance services fail to demonstrate full financial self-sufficiency, it seems irresponsible to license them to take deposits. The term "deposits" refers to voluntary deposits from the general public, used for financial intermediation. Therefore, compulsory deposits as a substitute for conventional collateral do not need to be regulated;
• Deposit taking requires adequate capital It is the regulator's prior interest that institutions mobilising deposits should back the business with sufficient capital and possible access to additional funds in order to be able to absorb losses without losing poor people's funds;
• Credit-only institutions should in general not be regulated and supervised It is the regulator's role to set reasonable standards of entry and to foster professionalism in this market rather than to stifle the development of microfinance. Given the general constraints of supervisory authorities, an argument can be made to focus on institutions that create systemic risk;
• Microfinance is a line of business Microfinance differs from traditional banking. Any financial institution, however, can hold a microfinance portfolio. There is agreement to view microfinance as an activity rather than as an institutional form. As a consequence, banks and any other financial institutions would fall under the specific microfinance regulations if they engaged in microfinance operations;
• Effective supervision requires sufficient capacity and has to be cost-effective The challenges of regulating and supervising microfinance can only be met if excellent expertise and sufficient resources to complete such tasks are available. To build up this capacity, field exposure, innovative training, adequate organisational structures as well as a sufficient budget are necessary. A reasonable cost-benefit ratio for microfinance supervision based on the size of the markets and costs incurred by building capacity should always be a guiding principle;
• Careful design of a regulatory framework takes time Institution building takes time, which is imperative in microfinance regulation and supervision. The design of a regulatory framework and the development of supervisory instruments and procedures are complex and consist of mutual learning processes and ongoing innovation. A hastily passed, but inadequate regulatory framework is a waste of time and resources which would only delay the creation of suitable conditions for microfinance development;
• Self-supervision so far has not proven to be effective self-supervision is widely thought to be a weak form of supervision since there are few incentives for institutions to impose constraints on themselves. There is a lack of basic preconditions for supervision such as the legal backing to enforce compliance with given standards and the power to close insolvent institutions.