Does Regulatory Supervision Curtail Microfinance Profitability and Outreach?

For microfinance institutions, particularly those aiming to take deposits, an advantage of regulation is that it allows semi-formal institutions to evolve more fully into banks. But complying with regulation and supervision can be costly, creating potential trade-offs. World Bank researchers Robert Cull and Asli Demirgüç-Kunt and FAI managing director Jonathan Morduch examined the balance between the benefits and costs of regulatory supervision, with a focus on institutions’ profitability and outreach to small-scale borrowers and women. The authors analyzed data on 245 of the world’s largest microfinance institutions, with newly-constructed data on their prudential supervision. Regression analysis showed that supervision does not have a significant impact on profitability: microfinance institutions subjected to more rigorous and regular super- vision are not less profitable compared to others. However, this type of supervision is associated with larger average loan sizes and less lending to women, suggesting that it does have a significant impact on outreach. 

Does Microfinance Regulation Curtail Profitability and Outreach?

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Regulation allows microfinance institutions to evolve more fully into banks, particularly for institutions aiming to take deposits. But there are potential trade-offs. Complying with regulation and supervision can be costly, and we examine implications for the institutions’ profitability and their outreach to small-scale borrowers and women. The tests draw on a new database that combines high-quality financial data on 245 of the world’s largest microfinance institutions with newly-constructed data on their prudential supervision. OLS regressions show that supervision is negatively associated with profitability. Controlling for the non-random assignment of supervision via treatment effects and instrumental variables regressions, we find that supervision is associated with substantially larger average loan sizes and less lending to women than in OLS regressions, though it is not significantly associated with profitability. The pattern is consistent with the notion that profit-oriented microfinance institutions absorb the cost of supervision by curtailing outreach to market segments that tend to be more costly per dollar lent. 

Microfinance Meets the Market

Microfinance institutions have proved the possibility of providing reliable banking services to poor customers. Their second aim is to do so in a commercially-viable way. We analyze the tensions and opportunities of microfinance as it embraces the market, drawing on a data set that includes 346 of the world’s leading microfinance institutions and covers nearly 18 million active borrowers. The data show remarkable successes in maintaining high rates of loan repayment, but the data also suggest that profit- maximizing investors would have limited interest in most of the institutions that are focusing on the poorest customers and women. Those institutions, as a group, charge their customers the highest fees in the sample but also face particularly high transactions costs, in part due to small transactions sizes. Innovations to overcome well-known problems of asymmetric information in financial markets were a triumph, but further innovation is needed to overcome the challenges of high costs.