Lecture 5 Governance, regulation and legal form of microfinance institution

Question 1

Two types of regulation

Answer 1

prudential and nonprudential.

Question 2

Prudential regulation

Answer 2

governing financial soundness of a financial institution (FI).

The purpose of prudential regulation is to determine the health of FIs. * Prudential regulation ensures that FIs are liquid and solvent and doing well with:
* Capital Adequacy, * Asset Quality, * Management, * Earnings, * Liquidity, and * Risk Mitigation.

Prudential regulation is the main preventative measure to guard against failure of FIs

Question 3

Non-Prudential Regulation

Answer 3

The purpose of non-prudential regulation is to improve the quality of the markets in which FIs operate.

• It includes: * Legal and judicial protocols for secured transaction * Contract enforcement and bankruptcy procedures
• Tax and accounting treatment of FIs and products * Authority to grant permission to undertake financial activities
• Establishing and transforming FIs * Credit bureau operating parameters. * The above are sometimes referred to as “soft infrastructure” regulation.
• Promote transparency and accountability (e.g., presentation of effective interest rates and full disclosure of the risks); * Financial crimes prevention (e.g., money laundering and funding of terrorist operations);

Question 4

Four basic alternatives for MFI oversight are available.

Answer 4

• Direct regulation and supervision by a central bank or bank regulatory authority;
• Regulation by a regulatory/supervisory agency other than a central bank/bank regulatory authority (such as a unit in the ministry of finance in charge of NBFIs, or another ministry).
• MFI self-regulation and supervision (for example, a cooperative or credit union association overseeing its member institutions); and
• Essentially unregulated and unsupervised MFIs.

Question 5

Size of firm matters

Answer 5

Client-owned MFIs such as such as credit unions and cooperatives are usually formally restricted to receiving deposits from members only. * However, the larger they become, * The smaller their community interests, and * The more they begin to look like banks.

Often, client-owned MFIs get unfair competitive advantage. * They might grow to become among the largest FIs in a country. * Possibly also become too big to ignore regulatory and supervisory norms.

Question 6

Balance Conflicting Objectives? Risk vs consumer protection

Answer 6

For example, standard prudential norms greatly reduce risk without restricting initiative. * In contrast, over-reactive regulations (no customised loan products, for example) can be counterproductive in two ways: increases risk and stifles innovation.

Question 7

Why Governance Matters for MFIs?

Answer 7

First, tremendous growth leads to a greater number of clients and assets as well as more elaborate structures to manage.

Many NGOs are turning into (shareholder-owned) regulated financial institutions - legal changes.

Third, institutions are evolving, from focussing mostly on a single product (usually credit) to becoming more complete banking institutions to * Provide not only credit, but also savings, money transfers, remittances, payment systems and insurance

Fourth, assets and liabilities management (ALM) principles are now increasingly important - especially if banks are lending deposits

Question 8

Internal and external corporate governance

Answer 8

Internally by the MFI itself (e.g., boards, auditing, CEO characteristics and incentives), or * Externally (e.g., through market competition, public regulation).