Microfinance regulation – The case in Sri Lanka

21 July 2010 at 23:19 5 comments

By Cheney Wells, KF 11

With the recent financial crisis, and questionable practices by America’s biggest banks, the word “regulation” had made frequent appearances in the headlines of newspapers.

As of yet, Sri Lanka’s government has not implemented a means of regulating the microfinance industry here. However, according to Sri Lanka’s Central Bank website: “A law to regulate and supervise Micro-Finance Institutions is […] being formulated. Action is being taken to establish an independent authority for monitoring micro- finance institutions.”

That there is no regulating authority of yet for the microfinance industry has led to strong hesitation on behalf of Sri Lanka’s Central Bank to promote or support any micro-lending activities in the country.

Just as there has been debate over how much the private banks in the United States should be regulated, there are concerns over the effects of an over-regulated microfinance industry here in Sri Lanka. Such concerns include:

–      A minimum capital requirement for MFIs, which could exclude some of the smaller MFIs from operation if unable to meet the minimum

–      An interest rate cap provisioned by the Act, which make operational and financial sustainability for MFIs a difficult task if the cap is set too low

–      The cost of regulation, which would be borne by the MFIs in the form of a license fee. This cost would ultimately affect the borrowers

What effect regulation of the microfinance industry will have remains to be seen, but MFIs would do well to prepare themselves for complying with what is a near certainty in the future of the industry here.

Entry filed under: KF11 (Kiva Fellows 11th Class), Sri Lanka.

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5 Comments

  • […] here are some other tradeoffs concerning the imposition of regulations, briefly sourced from two posts in the Kiva Fellows Blog (click the links for […]

  • 2. Fehmeen | Microfinance Hub  |  26 July 2010 at 09:13

    The other side of the coin is better sustainability of these MFIs (larger capital requirements would insulate MFIs from a possible repayment crisis, as in another South Asian country, i.e. Pakistan) and client protection (interest rate caps, depending on the margin given to MFIs, may actually benefit borrowers and encourage MFIs to streamline their operations). Of course, I may be wrong, depending on the details of these regulations.

    Plus, if I’m correct, the central bank can only regulate microfinance banks, which means non-bank MFIs are free to do as they wish.

    • 3. Cheney Wells  |  5 August 2010 at 23:57

      Fehmeen,

      There is certainly another side of the coin to regulation in many cases. You’re right to point out the importance of protecting against repayment crises, etc. It is not my place to comment on the specific details of the regulations here in Sri Lanka, but I can say that there is certainly concern about the future situation here, involving MFIs.

      Finally, you are correct in your understanding of the reach of central bank regulations. They cannot control the operations of non-bank MFIs.

  • 4. Donald Nordeng  |  22 July 2010 at 00:54

    While I am not familiar of how MFIs operate in Sri Lanka, rather than require minimum capital or interest rate caps, transparency requirements and record keeping as well as using the board of directors of the MFI to have a basic level of external auditing may be a more flexible approach.

    • 5. Cheney Wells  |  6 August 2010 at 00:00

      A wonderful point, Donald. I personally subscribe more to such an approach as you mention. Whether or not that approach will be adopted in Sri Lanka remains to be seen. Thanks for the comment.


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