exactly.....i also have done my dissertation on "efficiency and financial sustainability of micro finance institution  in sri lanka". so i feel i can add some credit ur statement.....muhammad yunus is the pioneer of micro finance.he was started to strengthen the poor people life through giving financial assistance or aid.but in 20th century most of the micro finance institution show the transormation....they try to earn profit as much as possible....but they don't care about poor people needs.

As evidence of MFIs social mission  drift to commercialization, the average loan size normally increase.

If you keep the profit motive out, you also keep the available funding out.  Funds become available because they get a reasonable return on investment.  The alternative is to have a no-profit motive, but then the only funding available will be donor funding.

Yes, in principle. We have ample evidences of market failure to accommodate socially and economically deprived people. Despite the call fro inclusive capitalism and social enterprising free market economy cannot stay put, generously to address the glaring issues, disguised exclusion. regulatory framework is expected to ensure certain compliance and governance. How ever, the nature and configuration of the regulatory regime matters a lot.

The transformation into a for-profit MFI does not in itself create lower access for low-income families. The MFI may target this "market segment" as before. The crucial thing is that the MFI maintains its non-profit status. If it changes both from, say an NGO, and into a bank, and at the same from non-profit to for-profit MFI, the average loan, hence outreach may suffer. But caveats exist. If being a bank attracts wealthier customers, the bank may be in a position to cross-subsidise to the benefit of poorer customers. Thus, we should look at the whole loan portfolio distribution, not only its average.

Average loan size is troublesome. NGO-MFIs are capital constrained and often need to ration loan sizes. When transforming the MFI get access to several more capital sources which can be used to increase loan sizes to EXISTING customer. Moreover, transformed and regulated MFIs need to become more transparent in their pricing. This combined with access to more funding which allows economies of Scale and at the same time economies of scope (combined services of savings and loans) help transformed MFIs to reduce their interest rate. In a paper I'm working  on with Marek Hudon and Bert D'Espallier we find that transformed MFIs reduce their interest rate with around 1/3, thus the opposite of mission drift. Hope to submit the paper to a good journal before Christmas.

For more information see:

Hartarska, V., Shen, X. & Mersland, R., (2013),“Scale Economies and Input Price Elasticities in Microfinance Institutions.” Journal of Banking and Finance. Vol. 37(1), pp. 118-131.)

Delgado, M.S., Hartarska, V., Parmeter, C. & Mersland, R., (forthcoming), "Should all microfinance institutions mobilize microsavings? Evidence from economics of scope" Empirical Economics.

yes, because a regulated entity can collect deposits.

Evolutionary trends and competitive pressures change the very nature of the intermediaries: on the one side the most brilliant informal ones often try to scale up positions, getting sounder and bigger and progressively migrating towards formality and full recognition from supervising authorities, whereas on the other side many smallest players (if not most of them) find it difficult to survive in the long run and their mortality rate is unsurprisingly high.

A comprehensive picture of the industry has to consider not only its competitors, but also its clients and products. The clients looking for financial products in a poor and backward country are rather undifferentiated, but as soon as development starts, diversities come out like mushrooms and sophistication requires new products and services, tailor made for different segments of clientele. 

see R.Moro Visconti, Poverty traps and Microfinance, IBIDEM, Stuttgart, 2011, p. 396

It depends on how effectively regulatory mechanism function in India. Certainly there is a scope to increase financial inclusion through micro financial institutions. Government needs to encourage reach of micro financial institutions to led in backward rural districts and to the most vulnerable sections of the society, possibly through incentives like reimbursement of part of the high transaction costs, which will be incurred if they really go and serve these vulnerable sections of the society    

Tricky question!:

A lot depends on the country in which the transformation happens, subjects as regulatory framework, institutional infrastructure and other particularities of the financial system will play a major role in the outcome of the transformation 

The answer I found more appropiate is "yes in theory, not so in practice". Theoretically, as more funding becomes available, the old NGO becoming a bank can have less expensive credits. In practice it is also true that the clients of a NGO may feel that a bank won´t give them the money because they are not creditworthy. That reason I believe is one of the causes of mission drift. Banks are richer institutions, it doesn´t matter they origin, they generally look for richer clients.

Anyway, what I think the question is very very important for the microfinance industry.

Regards

Gustavo Concari

This will depend a lot on the type of regulation and whether combined with other initiatives. All else equal, it is rare that a regulation will expand access in the long-term. It can in the short run, but usually that will deter interest in the area of activity.

For example, you could make a rule that says "you must lend to this group because they can't get loans to start business and so they stay poor", but then formal institutions could require a large opening deposit and charge monthly fees without a large balance, potentially having the effect of limiting both access to basic banking services and finance at the same time.

I think a regulation which made it easier for a poor person to open a bank account (such as ensuring that all children have a birth certificate) would do more to increase their access to finance than a regulation that they must have access to loans.

The only way that I can see how a regulation would help attract capital to micro-finance would be rules that would limit risks, but that is not feasible or perhaps even desirable to enforce everywhere.

Within the formal financial sector additional regulation increases compliance costs.  As costs go up prices (interest rate or reducing the component of high risk lending) need to adjust in order to maintain a level of financial performance that allows for sustainable on-going activity.

To manage costs the level of service reduces or technology replaces some staff processes.  A common example is using credit scoring to screen initial loan applications.  These set the hurdle high enough to weed out most likely failures but in doing so screen out potential borrowers who would have succeeded.  An error type 1decrease in favour of an error type 2 increase.

Reducing costs also contributes to the mission drift noted by Gustavo as it is cheaper to monitor loans to urban poor than to widely dispersed rural very poor.

Bureaucracy tends to increase and unfortunately in low income countries the level of political interference and corruption also increases with increasing bureaucracy.

When comparing the time taken to process loans, collateral required, discrimination etc. between loans in the informal sector and those in the formal sector the price of collective risk pooling through regulation is not shown in the interest rates.  Informal money lenders are experts at risk assessment and the more likely successful way forward in LICs is a slow integration of the informal finance sector and not by regulation.

Stuart, what would you think of introduction a regulation which was a reduced regulation which in some way facilitated the entry of informal lenders into formal status? As a means of negotiation, some sort of support services could be offered, or even access to public funds if they had demonstrated reliability, for example. In seeking to develop financial markets, it seems sensible to coopt those who already have most knowledge of finance to implement, but at the same time real efforts would certainly be needed to address situations where these people used the influence on credit allocations in unsavoury manners.

yes it need to be regulated in order for the operators to aviod un wanted risk

Integration of the informal into the formal sector is, in my view, a sound policy to pursue if approached sensibly.  Nathan, we have one PhD scholar working on this.  We would certainly favour collaboration with like minded scholars.

The informal sector can benefit from an ability to accept deposits if it accepts central bank oversight.  It may also benefit from access to technology which allows it to provide better record keeping.  The transition is to bring the informal into the formal sector so to expand the services to clients and to have some central oversight of them. This assist the providers to expand in the remote and more distant from "regular formal sector" institutions areas and industries.

A gentle regulatory framework recognising this is the first steps on a pathway is needed.  It has to be win-win otherwise the informal will stay out and the formal control of money supply, credit markets and financial incentivising of target industries will not be achieved.  Neither subsidies or penalties will achieve a sustainable outcome but an encouraging regulatory change can.

i suppose major issue of Microfinance providers is "interest rates" though they have resolved the issue of collateral but due to increased operational cost or loan processing and monitoring cost  per loan is higher than commercial banks and MFIs. in countries where your aim is to target the  ultra poor then you would need Microfinance institutions (not for profit) working side by side with microfinance banks. 

Indeed, regulatory framework and adequate supervisory mechanism are needed to strengthening microfinance institutions. However, transformation of microfinance institutions into regulated financial institutions itself should be attached with affirmative action programs by the whole stakeholders to bring financial inclusion attained with enhancement financial access for the poor. In this sense, it is time to provide a comprehensive financial education, encourage community development  and empowerment, and government public policy alignment for the poor.

Check our our new paper "From NGOs to Banks....." recently Publishing in World Development. You find it here at RG. It provides some insigths to your question

Transformation of Microfinance institutions into regulated financial institutions will drastically reduce or remove the primary objectives of they existence, which is to provide resources and access to capital, such as credit, or loans to the financially undeserved or low income class.

The concept of providing bigger loans and thus leaving aside small credits and small customers, is very important in Microfinance and is called "mission drift", quite easy to understand. Many authors have studied the subject and it is a very interesting topic.

Sometimes Microfinance Institutions are obliged to do so because in order to fulfill and pay the regulations the central banks have, they must find new and better ways of funding themselves, something they do looking for better of clients. As someone has already said, that poses an important question on the institution.

In accordance with Mr. Concari answer, I add that formal institutions funded by governements have also political control incentives tied to credit allowance.

transformation in this paper is defined as an establishment of a regulated. financial institution (RFI) by a non-government organization (NGO) or a. group of NGOs by transferring its loan portfolio completely or partially to the. RFI. Among the varying factors that motivated the microfinance NGOs to