Instead of theoretical importance, prominent studies across the countries and some individual country cases do not support the role of regulation in terms of higher outreach and operational self-sustainability. When the impact was decomposed into capitalization of MFIs, government intervention and interactive effect even no influence was observed. I wonder how some researchers preaching the positive impact and claim magical solution of poverty by institutionalizing MFIs?
Zahoor, I think regulation is important for a number of reasons. If the MFI is a deposit taking institution, then regulation is going to be important. In most cases just like commercial banks, external regulation is crucial for MFIs otherwise how do you control for systemic risk? Some well advanced MFIs have credit risk oversight committees, some do not. Operational self-sustainability may not be realized by management of some MFIs yet they are supposed to increase the depth and scope of their outreach in the long run. External regulation in principle is a good thing. Remember the twin objectives cannot be realized at the same time. I think the costs of outreach expansion in the Early to Mid Age stages of the MFI cannot allow it to have a high degree of Operational self-sustainability unless these costs are covered by donor funds (concesional loans or grants). Once the MFI has come of age it can now pursue the objective of improved operational self-sustainability without concessional loans or grants. In Sub-Saharan Africa there is widespread collapse of unregulated MFIs. My take is that External regulation helps to keep the financial health of the MFI in check and ensure financial self-sustainability in the long term. Financial institutions must have external regulation, otherwise they are prone to systemic risk in all their departments and this can lead to collapsing. Check when the investment and commercial banks on Wall Street enjoyed some degree of deregulation. What happened?? Bank Contagion Risk was RIFE!!!
I believe regulation is important. For example, Perú is one of the countries with the highest level of microfinance development. It has also the highest environment climate, if you see for instance the studies made by the Economist Intelligence Unit. For instance, Perú has a special branch for microfinance in its central bank.
Regards
Twin objectives you mentioned are higher outreach and operational self-sustainability. Regulation may not influence both objectives positively. Regulation may influence negatively on self sustainability but not the higher outreach. However, evidence for this proposition is lacking in literature.
Regulation is a reactive response to abuse. Regulators intervene in a market because of a real, or perceived, abuse by one party to the detriment of a second, disadvantaged, party. Microfinance is, so far, generally a philanthropic support of clients that are less likely to provide the investor with as high a return on investment as alternative open-market ventures, and so the prospect for predatory behaviour and abuse is far less than in other financial markets. Perhaps this is an oversimplification, but IMHO, under the above assumptions, regulation will not contribute to those involved in either the consumption, or the provision, of micro-finance.
Dear Mark,
I agree with you on reactive response to abuse. Similarly, regulations serve as an institutions to reduce uncertainty and transaction cost. while regulation could reduce uncertainty under question it could increase the transaction cost. Observations, which provide evidence on negative effect of regulation, could be higher be higher transaction cost emanated from those regulations.
Upananda
Dear Mark and Upananda,
regulation in banking has been a lesson learned. It didn't happend until abuse was rampant. But after that adopted in many countries to prevent abuse, not as a reaction to abuse. Self-regulation fails because the shadow-of-the-future can be to large to justify restrained behavior on the banker.
Regulation should be included also in microfinance. It does not necessary increase costs... It may be more expensive in the short run but cut down the long run costs. Can you calculate the costs of relaxed regulations in the US mortgage market leading to the collapse of the economy in 2008? Refulations wel done may provide to the system the sustainability we all look for. Which brings us to the key point, does the country have an institutional environment capable to provide regulations resulting in minimal distortion and curving abuse? If they tilt the field too much in one direction, or if they are not enforceable, or selectively enforced, then regulatuions will not deliver the benefits and carry all the costs.
You find some answers to your question in our recent paper "From NGOs to Banks..." published in World Development available in full text here at RG
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