Regulation and Supervision of Microfinance Institutions: Stabilizing a New Financial Market

This paper addresses the issue of development of appropriate regulation and supervision regimes for the microfinance institutions (MFIs). The key issues to be considered before setting standards and framing rules for MFIs are:

• Enforcing legal limits on interest rates will make commercially viable microfinance impossible;
• Microfinance will require norms which are stricter in some specific aspects, and more flexible in others;
• Systems to track and respond to delinquency are particularly crucial.

Comparing MFIs with the conventional banking business, the paper recognizes some of the norms that need to be implemented for the microfinance sector:

• An initial capital/asset ratio no lower than about 20% for MFIs;
• Adjustments accounting for the effect of subsidies on historical financial performance;
• Relatively high liquidity standards for MFIs.

For improving the usefulness of oversight, the paper offers some suggestions:

• Contracting out reviews to experts familiar with MFI operations;
• Regulators having the authority and will to protect the system by imposing sanctions on insolvent institutions;
• For prevention of fraud, internal audit being carried out by the MFI itself.

Further, the main themes stressed in the paper are:

• Applying banking rules to MFIs;
• Adopting transparency in financial accounts;
• Developing low cost methods for MFIs like supervision delegation, self regulation mechanism, etc.
• Assigning complete authority to superintendence.

The paper concludes that for expansion and stability of microfinance:

• Wider understanding of microfinance field is important;
• Development of tools to protect depositors requires thoughtful innovation.