Does Microfinance Regulation Curtail Profitability and Outreach?

Abstract

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.

Keywords: microfinance, regulation, profitability