Microfinance Regulation and Supervision: Overview of International Experience and Best Practice-Suggestions for India

The microfinance sector in India consists of approximately 800 Microfinance Organizations (MFOs) of different nature and size but there is a lack of comprehensive information. The regulation of financial entities has a triple motive which is to ensure efficient functioning of markets, to protect financial stability of the financial system and last but not the least to protect customers or clients. The generally agreed objectives of prudential regulation include Protection of depositors who are not well positioned to monitor the institution's financial soundness themselves. Prudential supervision is expensive. Furthermore, supervisory authorities have limited resources. Unsupervised deposit-taking institutions are risky. Once the limits are exceeded, the institution must comply with prudential regulation and be supervised. Around the world, microfinance is on the agenda of policy makers, regulators and supervisors. Over 50 countries have implemented or are considering specific arrangements for regulation and supervision of microfinance, either as a separate new law or as amendments to the existing legal and regulatory framework. In summary, most countries base their microfinance regulation on the CAMEL approach.

The microfinance Bill in India proposes RBI as the regulator and supervisor of the microfinance sector. The proposed Bill is a second-best compromise and it legitimises and legalises the existing practices of thrift. Regulation of microfinance in India should be based on the existing patterns of regulation of banking entities but with appropriate adjustments based on the risk perception of the regulated entity. The cost of supervising a large number of small financial institutions can be considerable. Cost efficiency is of paramount importance on both sides, i.e., the supervisor as well as the supervised MFO.

The current focus of microfinance is also the excluded sections from mainstream financial services. This would mean that the literacy levels of microfinance consumers are generally very low and therefore the topic of financial literacy and financial capabilities of the clients has an added significance. Financial literacy is therefore an integral component of client protection. GIZ through its initiatives supports client protection by building knowledge databases of client advisors in safeguarding the the rights of clients and redressing and filing of complaints.