MICROFINANCE PAPER WRAP UP: Microfinance Consensus Guidelines: Guiding Principles on Regulation and Supervision of Microfinance, written by Robert Peck Christen, Timothy R. Lyman, Richard Rosenburg

In surveying the landscape of microfinance regulation, the authors make a threshold distinction between prudential and non-prudential regulations. Prudential regulations have dual objectives, the soundness of the financial sector as a whole and the protection of individual deposits. They are typically complex, burdensome to meet and require the oversight of a central financial authority. The current discussion surrounding microfinance regulation has emphasized prudential regulations. The authors believe that in certain circumstances, however, “the most pressing issues are non-prudential – how to enable MFIs to lend legally.” (pg. 4.). Non-prudential regulations are concerned with “conduct of business” and can often be regulated by existing authorities within their respective spheres of influence. In other words, non-prudential regulations may prove adequate to the task where prudential concerns are not at issue. A non-exhaustive list of issues that can be addressed with non-prudential regulations include: permission to lend; fraud and financial crime prevention; interest rate limits; limitations on ownership, management, and capital structure; tax and accounting treatment of micofinance; and feasible mechanisms of legal transformation. This distinction is more than academic because regulations require the dedication of supervisory resources which are themselves scarce. By carefully calibrating prudential versus non-prudential matters, a government may effectively mobilize scarce resources and promote microfinance development.

Consumer protection issues are non-prudential because the underlying concerns are to protect borrowers from abusive lending and collection practices and to provide borrowers with “truth in lending” – or “accurate, comparable and transparent” information about the costs of different microproducts. (pg. 7). These consumer protection practices already exist in some form in many countries, however, existing authorities need to be trained on the unique issues that arise when regulating consumer protection within microfinance. There has been some resistance by MFIs to comport with the disclosure rule that already applies to traditional lenders. Tradtional lenders are required to disclose effective interest rates to loan applicants using a “uniform formula mandated by the government.” (pg.8). The disclosure of the effective interest rate helps borrowers to evaluate the loan’s costs as well as encourages price competition. However, in the case of microfinance, the effective interest rates are higher due to the cost inefficiencies of administering and issuing a large number of small loans. These higher interest rates have caused public and political backlash within some countries notwithstanding borrowers’ demand for microloans despite the higher interest rates. Thus, in addition to applying the disclosure rule to MFIs, consumers and politicians will need to be educated on these cost inefficiencies. In the future, this transparency may create an environment that encourages innovation and creation of cost efficiencies within MFIs.

With respect to prudential regulations, the current discussion has centered on the need to create a “special [regulatory] window” to allow NGO MFIs to take deposits. However, there are threshold considerations one should consider first, such as whether a critical mass of existing MFIs demonstrate financial profitability. (pg. 14). The authors’ believe that in some countries, creating a “special window” may be premature since there are few viable existing MFIs in the first place resulting in wasted resources. Assuming this critical mass exists, the source of funding for a microfinance activity is a further consideration that determines whether a microfinance activity triggers the necessity for prudential regulation. Retail deposits of the general public trigger prudential regulation. However, donor grants, borrowing from non-commercial sources (donors/sponsors), commercial borrowing, and securitized products do not trigger prudential regulation because these sources do not meet the objectives of prudential regulation and/or are presumably regulated by other authorities. A grey area concerns members’ savings from financial cooperatives because in principle these funds are similar to deposits of the “general public,” however, these have often been treated as unregulated sources. Beyond these threshold concerns, there are existing regulatory measures in traditional banking that have applicability when adapted to microfinance, for example: minimum capital; capital adequacy; unsecured lending limits and loan loss provisions; loan documentation; restrictions on co-signers as borrowers, physical security and branching requirements; frequency and content of reporting; reserves against deposits; and ownership suitability and diversification requirements. In conclusion, the authors form a picture of the subtle and changing regulatory landscape of microfinance. The next installment of this subject, due by year-end, will include a discussion on cellphone banking and other forms of branchless banking and expand upon the discussion of consumer protection.

Make your comment at:

http://microfinanceassociation.ning.com/forum/topics/law-and-regulation-in

By Hio Kyeng Lee, Research Associate.

Bibliography:

“Microfinance Consensus Guidelines: Guiding Principles on Regulation and Supervision of Microfinance,” written by Robert Peck Christen, Timothy R. Lyman, Richard Rosenburg published June 2003 by CGAP, available at http://www.cgap.org/gm/document-1.9.2787/Guideline_RegSup.pdf

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