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Transforming Microfinance Institutions
institutions operating in an efficient financial system that serves the significant demand of various unbanked markets. Finally, there is agreement, for the most part, that the need for regulation and supervision arises when microfinance institutions (MFIs) take deposits from the public. Although there is general consensus on the need for a favorable policy environment for microfinance, there is no current consensus on how to create this environment. In particular, there are competing views on whether microfinance should be subjected to specialized legislation and regulations or whether MFIs should be regulated under the existing framework in a country. “Microfinance services can be provided under a wide range of institutional models, which are regulated under laws as different as a banking law, a cooperative law, a specific microfinance law, or any other law defining a lower ‘tier’ of financial institutions” (Staschen 2003, p. 2). The decision about whether to introduce a new law needs to consider the context of each country.2 In Uganda, as in many other countries, the decision was made to develop separate legislation to regulate microfinance—this, however, is only one possible approach. It may be easier, in fact, to adapt existing legislation than to promulgate a new law. Adapting existing legislation could involve amending the law or issuing microfinance specific regulations or both.3 However, both options may suffer from politicalization and consume a fair amount of time, or in some cases, may not be possible. Although this book does not advocate that microfinance be regulated only under a specialized law (rather than the existing framework), it does emphasize the need to understand how microfinance differs from traditional financial services and how effective regulation and supervision should be implemented. The underlying assumption is that institutions conducting “microfinance business,” whether solely or as part of a larger portfolio, may be subject to regulatory provisions that differ from traditional banking regulation. At the very least, the supervisory body needs to understand and
appreciate the different risk profile of microfinance institutions. Thus, this chapter presents an outline to design a regulatory framework that separates microfinance services from the provision of other financial services and as such discusses how to develop or revise separate legislation for microfinance. Even if stakeholders determine that separate legislation is not required, much of this chapter will still be of interest because there is still the need to understand the unique aspects of MFIs if they are to be licensed and supervised under existing legislation or under legislation adapted to microfinance. In part due to political pressure caused by often high but unclear expectations regarding the purpose of microfinance relative to poverty alleviation, governments often make hasty attempts to produce a specialized framework in a short time, or to license MFIs under the existing framework. This can result in microfinance regulation and supervision that is ill-suited both to the developmental stage of the industry as well as to the capacities of the supervisory authorities charged with overseeing microfinance. It is imperative, therefore, that the introduction of microfinance legislation follows a systematic approach. In this chapter, three areas are presented that must be addressed to successfully introduce and implement an adequate regulatory framework for microfinance: policy; legislation, from both strategic and practical viewpoints; and supervision.
Key Policy Issues To begin, a number of key policy issues need to clarified and agreed upon among major stakeholders, including government, investors, the central bank and other supervisory bodies, practitioners, and international donors contributing to the sector. Whether the process of creating a legal framework for microfinance should even be initiated depends on factors including existing government policies,