Regulatory Supervision in Microfinance: Friend or Foe?

Calma Arcala used a small loan to start a mushroom growing business and today employs 5 people. Philippines 2007. By Opportunity International - AusAID.

Calma Arcala used a small loan to start a mushroom growing business and today employs 5 people in the Philippines. By Opportunity International – AusAID.

Over the past decade, researchers have sought to understand the effects of regulatory supervision on the behavior and efficiency of microfinance institutions (MFIs). The conclusions from these studies sparked numerous debates on the future of the industry. On one hand, the increased supervision of MFIs tend to cut costs and increase efficiency. But the long-term effects may cause a dramatic shift of MFIs concerning the direction of profit, potentially leaving impoverished clients in the dust.

A study by Garmaise and Natividad1 found that evaluations – specifically credit evaluations –dramatically cut financing costs. The evaluations do not significantly increase the amount of loans that MFIs receive from outside creditors, per say, but there is a positive correlation between evaluation and amount of deposits. A 2009 study2 found that banks that increasingly relied on deposits, rather than subsidies, fared better over time and were able to reduce costs.

However, the increase in regulation and deposits has led to speculation of significant shifts in MFI operations. Some have noted that MFIs under regulation progressively take on characteristics similar to small banks3. The concern from this effect then becomes that MFIs would focus primarily on profit and cease offering financial loans to costly or risky clients.

A study by researchers at the World Bank and NYU4 supports this theory of exclusionary lending. Using a dataset on 245 leading institutions, the study shows that profit-oriented microfinance institutions respond to supervision by maintaining profit rates but curtailing outreach efforts to more small-scale customers and women. Conversely, MFIs that were subjected to supervision but relied heavily on donations, rather than deposits, maintained their outreach to smaller and more impoverished clients.

Garmaise and Natividad contend that there is no evidence to support banks decreasing loan size or demographic outreach. However, they do not differentiate between supervised banks that rely on deposits and those that rely on donations.

So is regulation in microfinance a friend or foe? The answer may not be economic or political, but philosophical. Subjecting MFIs to more regulation does seem to help the institution itself, creating cost-efficiency and increasing deposits. Increasing evaluations, however, could transform MFIs into more profit-oriented institutions, thereby threatening to undermine the core values of microfinance lending.

Further research taking into account the size, location and financing of MFIs could offer more insight into policy recommendations.

1 Garmaise and Natividad (2010). Information, the Cost of Credit and Operational Efficiency: An Empirical Study of Microfinance. The Review of Financial Studies, 23(6).

2 Caudill, Gropper and Hartarska, (2009). Which Microfinance Institutions Are Becoming Cost Effective Over Time? Evidence from a Mixture Model. Journal of Money, Credit and Banking, 41(4).

3 Ibid.

4 Cull, Demirguc-kunt and Morduch (2009). Does Regulatory Supervision Curtail Microfinance Profitability and Outreach?. World Development, 39(6).

By Anna Steinbrecher for Microfinance Focus

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