The Regulator’s Dilemma: Navigating Competition Policy

The post was originally published as a guest post on the CGAP Microfinance Blog.

There’s a lot of debate about how best to regulate microfinance. Regulators face the tricky job of safeguarding the stability of the financial sector while simultaneously providing flexibility for institutions focused on the unbanked. Global evidence shows that even well-intentioned regulation and supervision can hamper the ability of institutions to reach poorer populations.

We don’t need more “best practices”. We need ways to think about tough and imperfect tradeoffs. At the Financial Access Initiative, we’ve been wrestling with how best to help policymakers navigate these decisions. We turned to regulatory expert David Porteous to lead the effort. In a new series of Policy Framing Notes, he sums up the tradeoffs that policymakers face, outlining the “regulator’s dilemma”.

The first Policy Framing Note in the series looks at the tradeoffs regulators encounter in trying to encourage healthy forms of competition. Porteous’s focus is on “access enhancing” competition—competition that balances the interests of the individuals (microcredit borrowers, in this case), the institutions that serve them, and society as a whole.

Part of the regulator’s dilemma is that encouraging competition can increase the pressure on microfinance institutions (MFIs) to make more and larger loans to keep up with their competitors. The big tension is that MFIs have limited information about their customers, creating the risk of getting borrowers in over their heads. Credit bureaus can be part of the solution, as they can help provide lenders with better information about their customers, but they have been slow to spread. In many Latin American countries, at least, having more developed credit bureaus correlates with greater competition.

There is a bigger issue at stake here that requires that we step back from assumptions that made sense 5 or 10 years ago. Microcredit is evolving dramatically, and Porteous takes on the question of whether it was and/or still is a distinct market. After all, microloans share many product features with consumer credit products like credit cards, such as being unsecured and generally used for short-term credit. In the past we have differentiated the microcredit market based on the profile of borrowers (low-income and self-employed) and the main usage of microcredit (working capital for microenterprises).  But new evidence about microfinance usage show that borrowers are taking loans for everyday expenses such as paying for health care and putting food on the table. Porteous points out that this evidence, coupled with the fact that formal lenders like commercial banks are increasingly willing to make loans to the poor, means there may be little practical difference between microcredit and consumer credit.

So, what to do? Porteous offers specific ideas, including direct competitive lending by public financial institutions and setting up specialized regulators to focus on competition. What works is ultimately an empirical issue, and a few new studies are starting to shed some light.

Other FAI Framing Notes by David Porteous for the Financial Access Initiative will consider policies towards consumer protection, interest rates and prudential regulation. All will be available at www.financialaccess.org.