Indian Microfinance Regulation and Supervision

Regulation refers to the set of government rules (including laws, regulations, and their implementation) that apply to microfinance. It aims at overseeing the financial soundness of licensed intermediaries’ businesses in order to prevent financial system instability and losses to depositors.

Regulation is "prudential" when it is aimed specifically at protecting the financial system as a whole as well as protecting the safety of small deposits in individual institutions. When a deposit-taking institution becomes insolvent, it cannot repay its depositors. If it is a large institution, its failure can undermine confidence enough so that the banking system suffers a run on deposits. Therefore, prudential regulation involves the government in attempting to protect the financial soundness of the regulated institutions.

Prudential regulation is relatively difficult, intrusive, and expensive because it involves understanding and protecting the core health of an institution.

"Non-prudential" rules encompass regulations about the institution’s business operations, and as such do not have the ultimate aim of protecting the entire financial system. These rules tend to be easier to administer because government authorities do not have to take responsibility for the financial soundness of the organization. These issues include, among others, the formation and operation of microlending institutions; consumer protection; fraud and financial crimes prevention; credit information services; interest rate policies; limitations on foreign ownership, management, and sources of capital; tax and accounting issues; and a variety of cross-cutting issues surrounding transformations from one institutional type to another.

Supervision is the process of ensuring compliance with those rules