Microfinance 101 Regulation and Supervision: What Works

This paper explores the challenges of microfinance regulation. It advocates regulation by risk, and reviews the positive role that rating agencies have played in facilitating transparency and risk assessment for investors and regulators.

Challenges in regulating microfinance include lack of legal status and secured transactions, loan limits, tax burdens, capital and reserve requirements, protection of minority interests, costs of compliance and restrictions on ownership. The paper states that:

• Prudential and non-prudential regulatory policies regulate the overall risk posed by the institution or activity;
• Emergence of mainstream and specialty microfinance rating agencies are the most important recent developments in the industry;
• Pairing independent rating agency review with non-prudential licensing, transparency and governance requirements may be more fruitful than intrusive prudential regulations.

The paper recommends that regulators adopt dynamic guidelines that contain sunset provisions and evolve with emerging economies and financial sectors. Finally, it highlights the regulatory environment for microfinance in Peru, where regulators have effectively controlled risk while promoting investment in microfinance.