> Posted by Verónica Trujillo Tejada, Consultant, MIF/ Inter-American Development Bank
Building up a regulatory framework for the development of a microfinance market is a complex task. It requires taking into account a broad variety of topics as well as country specific needs and features. There are some internationally-applicable recommendations for the design of microfinance regulatory frameworks (CGAP 2012, ASBA 2010, and Basel 2010) but little is known about how different countries have implemented their guidelines or what the effects are of these rules in each market.
In the recently released paper “Microfinance Regulation and Market Development in Latin America,” published by the B.E. Journal of Economic Analysis & Policy, we analyze the relationship between microfinance regulatory frameworks in 17 Latin American countries and the corresponding markets’ levels of development.
One way to characterize microfinance regulations is as either general or specific rules. The general rules are devoted to regulating typical financial system issues, while the specific rules target microfinance products or institutions. Two other regulation classifications are protection rules and promotion rules. Protection rules have the goal of preserving financial system stability or protecting the financial consumer, and promotion rules aim to favor the development of microfinance services or institutions by softening the restrictiveness of the overall regulatory framework.
We find a wide variety of regulatory designs in the Latin American region. Countries such as Chile and Uruguay, for example, stand out for their lack of microfinance specific rules; though their employment of general and protection rules give their regulatory frameworks a base upon which they could build microfinance specific regulation. Other countries such as Honduras, Brazil, and Argentina have included specific or promotion rules in their regulatory frameworks, however either their level of implementation of general and protection rules is below the average of the countries examined in the report, or their frameworks have addressed microcredit but not through the specific criteria the report analyzes.
The analysis between microfinance regulatory frameworks and the level of development of the corresponding markets – which incorporated the size of the microcredit portfolio, number of clients, operative and financial efficiency of institutions, among other variables – enabled us to draw the following conclusions:
- All four types of regulation rules – general, specific, protection, and promotion – are significantly and positively correlated with bigger microfinance markets.
- Rules specific for microfinance are related to better MFI financial and operational performance, and better market data.
- Both general and protection rules are significantly and positively correlated with better developed microfinance markets – specifically in terms of profitability, operational efficiency, and portfolio quality.
- The implementation of both specific and promotion rules shows a positive and significant correlation with bigger informal, rural, and microenterprises sectors.
So, which would be the elements to consider when designing regulatory frameworks to contribute to the development of a microfinance market?
Of course there is no one formula to apply across countries, as markets and contexts differ. And more analysis (as well as more industry data) is required. However the report indicates that analyzing whether a financial system’s regulation includes ample general and protection rules is crucial for the better development of the microfinance market, preserving stability and the well-being of its clients. Introducing specific rules on microfinance services and institutions, considering the particular features of microfinance activities, could very well support institutional solvency and the employment of adequate risk management procedures. And promotion rules should be considered as a mechanism to favor market development. Regulators must be open to evaluating new actors, technologies, and methodologies for the provision of microfinance services, considering the possibility of granting them individualized treatment – in some cases lowering the usual standards for a short period of time.
To learn more about the analysis and to access the full report, click here.
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