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The Rush to Regulate:
Legal Frameworks for Microfinance
by Robert Peck Christen and Richard Rosenberg
Copyright 2000. All Rights Reserved
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Formal credit and savings for the poor are not recent inventions: for decades, some
customers neglected by commercial banks have been served by credit cooperatives and
development finance institutions. These organizations have legal charters that govern
their financial operations and allow them access to savings or other public funding.
But the past two decades have seen the emergence of powerful new methodologies for
delivering microfinance services,1 especially microcredit. Much of this innovation has
been pioneered by non-governmental organizations (NGOs), who typically do not have a
legal charter authorizing them to engage in financial intermediation. Governments,
donors, and practitioners are now talking about new legal structures for microfinance in
dozens of countries. Microfinance regulation and supervision has suddenly become a hot
topic, with conferences, publications, committees, and projects appearing everywhere.
Much of the attention is focused on NGO microfinance.2
Regulation of microfinance is being discussed in one country after another. But the
people doing the discussing are often motivated by differing objectives, which tends to
confuse the dialogue:
• Looking to fund themselves, NGOs with microcredit operations often want to be
licensed (and thus regulated) in order to access deposits from the public, or credit
lines from donors or governments.
• Sometimes microfinance institutions (MFIs), especially NGOs, believe that
regulation will promote their business and improve their operations.
• Some NGOs, governments, and donors want financial licenses to be more widely
(and easily) available in order to expand savings services for the poor.
• Donors and governments may expect that setting up a special regulatory window
for microfinance will speed the emergence of sustainable MFIs.
• Occasionally, where unlicensed MFIs are already taking deposits, the central
bank’s motivation in pushing to license them is to protect depositors.
1 In this paper microfinance means formal banking services for poor people (definitions of “poor” in this
context vary widely). Governments or others regulate financial service providers when they make rules
for them, controlling for instance the safety standards they must meet. Supervision is systematic
oversight of such providers to make sure that they comply with the rules, or close down if they don’t.
In order to limit the cumbersome repetition of “regulation and supervision,” this paper will sometimes
used “regulation” as a shorthand for that phrase.
Unless otherwise indicated, this paper refers only to microfinance in developing countries.
Microfinance in rich countries presents very different issues.
2 It is worth noting that even today, most of the world’s microfinance clients are served by banks, credit
unions, and other licensed institutions.
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• Many MFIs charge surprisingly high interest rates. Government may view these
rates as exploitative and want to protect small borrowers from them.
• Local authorities are sometimes troubled by the weakness of many MFIs, and
unimpressed with the coordination and supervision being exercised by the donors
who fund them. They want someone to step in and clean up a situation that they
think is hurting the development of microfinance in their country.
• Occasionally governments look to regulation as a means of clamping down on
bothersome foreign-funded NGOs or other groups that it would like to control
• In some countries there is simply no legal structure under which a socially
motivated group can lawfully provide loans to poor clients. Unless such a
structure is developed, loans may be legally uncollectable, and microfinance
providers may even be at risk of prosecution.
• Finally, microfinance is getting a high political profile in many countries,
especially since the 1997 Microcredit Summit and its aftermath. Occasionally,
attention to regulation springs from a government’s sense that it has to do
something about microfinance, for reasons that may combine concern for the
poor and the demands of practical politics.
For all these reasons, microfinance today seems to find itself in the midst of a rush to
regulate. There is no shortage of people willing to offer views on when and how to do it.
But all of them, including the authors of this paper, suffer from the same handicap:
experimentation with microfinance supervision is so recent that we can’t rely much on its
historical results to guide us.3 Some important questions can be answered only
tentatively, if at all. And of course individual country situations vary greatly. So readers
looking for a string of confident practical conclusions or one-size-fits-all advice will find
themselves frustrated (though not completely!) by this paper.
Organizing this discussion proved troublesome: the logical relationships among the
topics are annoyingly complex. At the cost of delaying our arrival at the directly practical
questions, we decided to begin with some important background issues:
• The practical problems faced by bank supervisors who are asked to take
responsibility for MFIs.
• The costs of regulating and supervising MFIs, including the danger that
defining a legal framework can have unintended consequences.
Then the paper moves into policy questions, arguing
3The paper has more examples from Latin America than from other regions, in part because the authors
are somewhat more familiar with this region, but mainly because Latin America has more experience
with microfinance regulation than some other regions.
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• That credit-only MFIs should generally not be subject to prudential
regulation and supervision in which the government supervisory agency is
expected to monitor the financial soundness of the licensed institution.
• That small
community-based MFIs should not be prohibited from deposit-
taking just because they are too small or too remote to be regulated effectively.
• That the push to create special regulatory windows for MFIs may make
sense in a few developing countries, but that in most it is probably premature
right now, running too far ahead of the organic development of the local
• That self-regulation by MFI-controlled federations is highly unlikely to be
The authors believe strongly that the future of microfinance lies in a licensed
setting, because it is the only setting that will permit massive, sustainable delivery
of financial services to the poor. Thus, the cautionary overall message of this paper is
not meant to question the importance of microfinance regulation and supervision, which
are essential to any licensed framework. Rather, we are raising questions about timing,
and about certain expectations that may turn out to be inflated. In focusing heavily on
certain problems, we don’t want to imply that they have no solutions—only that they are
problems that need to be dealt with realistically.
A. The supervisor’s challenges
The problems of bank supervisors4 in poor countries may not sound like a “visionary”
place to start our reflections. 5 But unless we give this subject its due, our planning of
frameworks can lead us into an alluring cloud-land of elegant structures that can’t be
implemented. The most carefully conceived regulations will be useless, or worse, if
they can’t be enforced by effective supervision.
For bank supervisors in many developing countries (though certainly not all), the central
fact of life is responsibility for supervising a commercial banking system with severe
structural problems, often including some sizable banks teetering dangerously close to the
edge of safety. The collapse of one—or a half-dozen—of these banks could threaten the
4 We use the term supervisor to refer to the government official responsible for prudential oversight of
financial institutions, whether in a central bank department, the finance ministry, or an independent
5 In this paper we focus on bank supervisors in developing countries. Of course, their colleagues in rich
countries have plenty of problems too—trillions of problems, in cases like the savings and loan debacle in
the United States or the recent East Asian banking crises.
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country’s financial system with implosion. In trying to manage bank risk, the supervisor
may have to work in a political minefield, because the owners of banks are seldom
underrepresented in the political process. The supervisor’s legal authority to enforce
compliance or manage orderly clean-ups is often inadequate. She6 may not have enough
control over the tenure, qualification, and pay of her staff. Monitoring healthy banks is
challenging enough, but the real problems come when it is time to deal with institutions in
trouble. When a sick bank finally crumbles, its president can start sleeping again (though
perhaps in a different country), while the supervisor has to stay awake at night worrying.
The Minister of Finance may be pacing the floor with her, since in many countries a
government-issued financial license carries with it a guarantee, implicit or explicit, that
the government will bail out depositors if a licensed institution collapses.
If a bank supervisor displays resistance to adding MFIs—mostly small, mostly new,
mostly weak on profitability—to her basket of responsibilities, we should recognize that
her reasons may be nobler than narrow-mindedness or lack of concern for the poor.
Box 1—Rural banks in the Philippines: the burden of supervising small intermediaries
In the Philippines, the sm allest licensed interm ediaries are “rural banks.” Despite the nam e,
they are found in both rural and urban settings. Supervised by the central bank, they are
integrated into the paym ents system. Their operations include credit and deposit services for
relatively poor clients. As of Septem ber 1997, 824 rural banks were serving a half a m illion
clients. These banks had only about 2 percent of the banking system ’s assets and deposits, but
they m ade up 83 percent of the institutions the central bank had to supervise. Branches of the 52
com m ercial banks outnum bered offices of the 824 rural banks by m ore than 2 to 1.
Supervising the rural banks has severely stretched the resources of the Philippine central
bank’s supervision departm ent, tying up as m uch as one-half of its total staff and budgetary
resources at tim es. In the early 1990s one in every five rural banks had to be shut down, and
m any others had to be m erged or otherwise restructured.
A 1996 report estim ated that 200 inspectors were assigned to the rural banks. Even this level
of resources was viewed as inadequate. Each field visit consum ed up to three person-weeks or
m ore. At one point the supervisory departm ent found that this burden, com bined with its budget
lim itations, was severely endangering its ability to function.
Minim um capitalization of $100,0007 to $1,000,000 in equity is now required to constitute a
rural bank, depending on the size of the m unicipality where the bank is located. According to the
1996 report, the experience with the Philippine rural banks showed that m inim um capital for such
institutions should be set higher rather than lower, in order to provide m ore stability and to
rationalize the dem ands on the financial authorities.
Deposits in rural banks are protected under the national deposit insurance system. The
Philippine Deposit Insurance Corporation (PDIC) covers up to 100,000 pesos (about $2,500) per
6 We arbitrarily use the feminine pronoun here to celebrate the increased number of female bank
supervisors in recent years.
7 All dollar amounts are U.S. dollars.
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