Assessment of the Regulatory Framework Issues for Rural Finance and Microfinance Institutions

The assessment of the regulatory framework for the rural finance and microfinance sector covers both the institutional aspects and the benchmarks used to evaluate the sector’s per­formance and soundness. The considerations include (a) assessing the need for prudential supervision versus non-prudential regulation and for the technical capacity for supervi-

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sion, as well as the costs of that supervision; (b) determining which agency should carry out the supervision or regulation, and whether delegated or auxiliary supervision may be warranted or justified; and (c) establishing benchmarks and standards for evaluating outreach and for financial performance and soundness. In addition, certain cross-cutting issues—taxes that may obstruct more effective outreach and costs, and credit information­sharing systems that can help MFIs manage loan delinquencies and reduce costs—need to be considered. Also, PSBs and CFIs—though significant components of the rural finance and microfinance sector—are often excluded from the scope of the regulatory framework. However, an analytical evaluation of their outreach, operating performance, and financial soundness—as well as the primary problems they face or may pose to the rest of the sec­tor—may be an important aspect of the assessment of adequacy of access. A discussion of regulatory issues relating to PSBs and CFIs is contained in box 7.3.

Some key questions in assessing the regulatory framework of rural finance and micro­finance institutions include the following:

• Is there a need to regulate (but not prudentially supervise) those other institutions? If so, what is the scope of the regulation? Very often the distinctions between broad regulatory oversight (sometimes called non-prudential regulation) and detailed pru­dential supervision are ignored in a number of countries. Inappropriate regulatory approach has led to the misallocation of scarce supervisory and staff resources in the attempt to impose prudential standards and requirements on rural finance and microfinance institutions that are not engaged in mobilizing and intermediating public deposits, a step that poses a systemic risk. Prudential supervision involves the regulatory authorities’ verifying the compliance of institutions with mandatory

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standards—such as minimum capital levels and adequacy, liquidity management ratios, and asset quality standards—as measures for financial soundness. Prudential supervision of deposit-taking category C institutions (see table 7.2) is aimed at protecting public savings that are being mobilized and lent out or intermediated, which puts public savings at risk of being lost if loans are not repaid. In contrast, for various categories of institutions—institutions in category A2 and similar insti­tutions in category B—may require only non-prudential supervision or regulatory oversight, as outlined in table 7.2.

• Which agency should regulate the institutions? An important issue is the extent to which regulatory authority should be centralized, delegated, or decentralized (see box 7.4 for further discussion). Box 7.5 contains a further discussion of supervision standards, technical capacity and cost considerations that enter into the assess­ments.

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