Chapter 7:Rural and Microfinance Instittions:Regulatory and Supervisory Issues orudential tules conductin iness operati g subject to eevisionorbothby a cen tral supervisory authority.Lower-tiers institutions serving the lower end of the market can enable non-bank microlenders to seek greater formalization without actual licensing. As the rural finance and microfinance sector grows,adding a licensing tier that per mits MFls to legally mobilize savings and other commercial sources of funds can encourage capacity building and innovation that are aimed at self-sufficiency and greater outreach. Another approach that has been used is to open a special window for micro-lending as a enables commercial banks,as well as alternative specialized institutions,to cost and regulator structures.Licensing of rural and c anks can also facilitate the emergence However,the prema ew type tion of spec of MEls that tiers with easy entry m tutions,may affect the development of the commercial financial system,and may risk 7 overwhelming inadequate supervisory resources. Thus,the licensing of MFls should be designed to balance promotional and pruden tial obiectives.The main potential threats pertaining to deposit-taking mels are that (a) deposit-taking MFIs could collapse,thus adversely affecting the commercial system,and that (b)prudential regulation of deposit-taking mels could prove to be an administrative burden that distracts supervisors from adequately prorecting the safety and soundness of the main fina ial s .The Consult roup to Assistthe p idelines (Christen, yman, 00) 】view,arguing that leposit taking on a sm scale may essentially go unsupe -especially where the deposits consist of only force I-savings components of the ending product,so that most depositors are net borrowers from the MFI at most times This approach would leave the supervisory apparatus unencumbered from having to deal in-depth with a profusion of tiny MFls. A consensus on the framework for the regulation of rural finance and microfinance institutions has evolved on the basis of country experiences in recent years.This frame work (summarized in table 7.2)identifies differe t cate ories and tiers of institutional cifies the the nee ed for progr ely ronger types of regulation ands supervi sion. The legal and regulatory framework for banking and finance in many countries ma not include lower tiers for rural finance and microfinance banks.Some countries may be in the process of establishing the legal and regulatory framework specifically to create new tiers for rural finance or microfinance banks,which usually have a limited geographical coverage specified by law.Regulation of microfinance activities and institutions may take three main forms:(a)simple registration as a legal entity;(b)non-prudential regula tions that provide standards of business operations and oversight,such as operating and financial r clal reports to be submitted,to protect the interests of clients or members;and Global oce ill tes that the benefits ce may be limited when commercial bankin dards s are applied to MFI Non-ioof inance nance companies and other types of registered institutions providing rura finance and microfinance services are not subject to statutory prudential regulation and 195 195 Chapter 7: Rural and Microfinance Institutions: Regulatory and Supervisory Issues 1 I H G F E D C B A 12 11 10 9 8 7 6 5 4 3 2 periodic reports on operations and financial results, to (c) observing non-prudential rules of conduct in business operations, to (d) securing a proper license and being subject to prudential regulation by a regulatory authority, prudential supervision, or both by a cen￾tral supervisory authority. Lower-tiers institutions serving the lower end of the market can enable non-bank microlenders to seek greater formalization without actual licensing. As the rural finance and microfinance sector grows, adding a licensing tier that per￾mits MFIs to legally mobilize savings and other commercial sources of funds can encourage capacity building and innovation that are aimed at self-sufficiency and greater outreach. Another approach that has been used is to open a special window for micro-lending as a product that enables commercial banks, as well as alternative specialized institutions, to benefit from different cost and regulatory structures. Licensing of rural and community banks can also facilitate the emergence of new types of MFIs that serve specific markets. However, the premature creation of special tiers with easy entry may result in weak insti￾tutions, may affect the development of the commercial financial system, and may risk overwhelming inadequate supervisory resources.4 Thus, the licensing of MFIs should be designed to balance promotional and pruden￾tial objectives. The main potential threats pertaining to deposit-taking MFIs are that (a) deposit-taking MFIs could collapse, thus adversely affecting the commercial system, and that (b) prudential regulation of deposit-taking MFIs could prove to be an administrative burden that distracts supervisors from adequately protecting the safety and soundness of the main financial system. The Consultative Group to Assist the Poorest (CGAP) Microfinance Consensus Guidelines (Christen, Lyman, and Rosenberg 2003) takes a bal￾anced view, arguing that deposit taking on a small scale may essentially go unsuper￾vised—especially where the deposits consist of only forced-savings components of the lending product, so that most depositors are net borrowers from the MFI at most times. This approach would leave the supervisory apparatus unencumbered from having to deal in-depth with a profusion of tiny MFIs. A consensus on the framework for the regulation of rural finance and microfinance institutions has evolved on the basis of country experiences in recent years. This frame￾work (summarized in table 7.2) identifies different categories and tiers of institutional providers of microfinance, and it specifies the thresholds of financial intermediation activities that trigger the need for progressively stronger types of regulation and supervi￾sion. The legal and regulatory framework for banking and finance in many countries may not include lower tiers for rural finance and microfinance banks. Some countries may be in the process of establishing the legal and regulatory framework specifically to create new tiers for rural finance or microfinance banks, which usually have a limited geographical coverage specified by law. Regulation of microfinance activities and institutions may take three main forms: (a) simple registration as a legal entity; (b) non-prudential regula￾tions that provide standards of business operations and oversight, such as operating and financial reports to be submitted, to protect the interests of clients or members; and (c) full prudential supervision. Global experience illustrates that the benefits from regulating microfinance may be limited when commercial banking standards are applied to MFIs without adequate consideration of microfinance methodologies. Non-bank finance companies and other types of registered institutions providing rural finance and microfinance services are not subject to statutory prudential regulation and