The Ultimate Balancing Act: Investor Confidence and Regulatory Considerations for Microfinance (microREPORT #28)

Publication Date: Jul 2005
Published by: USAID - U.S. Agency for International Development
Document Type: Paper

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How can regulators build investor confidence in microfinance?

This paper explores the legal and regulatory framework for microfinance institution (MFI) investment transactions and its impact on investor confidence in the transition to private capital.

The paper draws upon field visits to Uganda, Peru and the Philippines to address the following questions:

• What regulatory practices promote investor confidence and provide the impetus to increase private investment in microfinance?
• At what point do legal and regulatory obstacles deter commercial investment in microfinance?

The paper finds that:

• Facilitating private sector investment in microfinance is a challenging balancing act for regulators;
• At some point along the “regulatory spectrum”, a balance can be achieved where regulators promote sound practices that also build investor confidence.

The paper describes environments characterized by:

• “Light” regulatory oversight, as those with:
  • Unclear legal status;
  • Low level of monitoring;
  • Secured lending;
  • Lack of protection of minority investor rights.
• “Heavy” regulatory oversight, as those with:
  • Restrictions due to legal status or forms of capital;
  • Limits on loan size or term;
  • Interest rates;
  • Capital and reserve requirements;
  • Cost of regulatory compliance;
  • Restrictions on ownership;
  • Tax burdens.

The paper concludes that:

• Transparent regulation of financial institutions provides security for both institutions and investors;
• Government attitude towards microfinance and investment is very important;
• Clear communication about requirements is helpful for both MFIs and potential investors.