Table 1. Tiered Structure and Regulatory Triggers, by Type of MFI

|_Type of MFI_|_Activities that trigger_<br>_regulation_|_Forms of external regulation_|_Recommended regulatory_<br>_authority_|
|---|---|---|---|
|Informal savings and credit groups<br>funded by member fees and savings|None|None required|None required|
|Category A: Nongovernmental organiz<br>donor funds|ations (NGOs) funded by|||
|Category A1: Funding only from<br>donor grants|None, if total loans do not<br>exceed donated funds,<br>grants and accumulated<br>surplus|Registration as a nonprofit society,<br>association or trust|A registrar of societies,<br>self-regulatory body if any|
|Category A2: Funding from donor<br>grants and from commercial<br>borrowings or securities issues|Generating liabilities<br>through borrowings to fund<br>microloan portfolio and<br>operations|Registration as a corporate legal<br>entity, authorization by a banking<br>authority or securities commission|A registrar of companies,<br>banking authority,<br>securities agency|
|Category B: Financial cooperatives<br>and credit unions funded by<br>members’ money and savings|Accepting deposits from<br>and making loans to<br>members|Registration as a financial<br>cooperative|A registrar of cooperatives<br>or banking authority|
|Category C: Special-licensed banks<br>and MFIs funded by the public’s<br>money (deposits, investor’s capital,<br>commercial borrowings)|Accepting wholesale and<br>retail public deposits for<br>intermediation into loans<br>and investments|Registration as a corporate legal<br>entity, licensing as a finance<br>company or bank (with full prudential<br>requirements)|A registrar of companies,<br>banking authority|

- _Note:_ This regulatory classification of MFIs was originally proposed by van Greuning, Gallardo, and Randhawa in 1999, and modified by Randhawa in 2003. Except for informal groups, MFIs are classified into four categories based on the structure of their liabilities, i.e. sources of  funding. Cooperatives in category B have a long but inefficient history of regulation. If their deposit-taking is small in scale and limited to their members, they should be given low regulatory priority. Category C should not include MFIs that require mandatory savings to secure loans as long as most customers are net borrowers most of the time. Formal banks with a microfinance department are not included above as they are subject to prudential supervision, even if it is usually not adapted to the specific features of this segment of business.

10. Regulation of microfinance activities and MFIs may take three main forms: (i) simple registration as a legal entity; (ii) non-prudential regulations 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 (iii) full prudential supervision. Prudential supervision involves verification by regulatory authorities of compliance by institutions with mandatory standards such as minimum capital levels and adequacy, liquidity management ratios and asset quality standards, as measures for financial soundness. Prudential supervision of deposit-taking category C institutions is aimed at protecting public savings that are being mobilized and lent out (i.e., intermediated), which puts them at risk of being lost if loans are not repaid.

11. Member-based MFIs in category B differ from local, informal savings and credit groups in that they are registered with a national authority and may be part of a national network. They are often assumed to be self-regulating through their governance structure. However, this assumption may be untenable as institutions become larger. To improve information and governance, non-prudential regulation may be appropriate, e.g., requirements to provide audited financial statements. Small cooperative groups are beyond the reach and necessity of regulation, but a transition to external supervision may be appropriate at some stage of growth for larger SACCOs and credit unions (CUs). Defining this transition threshold in the abstract is difficult, and needs to be related to the size at which a SACCO’s or CU’s assets approximate those of licensed financial intermediaries or pose risks that could destabilize the financial system. Regulation of MFIs in category A2 is triggered by their use of concessionary or commercial loans or the issue of securities, which signals the need to protect investors. Prudential supervision of Category A1 MFIs that lend out of grant or donated funds is not needed to protect depositors or investors.

12. Tiered structures of banks and NBFIs, including MFIs, enhance the operating and market linkages among regulated and unregulated intermediaries in the continuum of microfinance institutions. Different legal structures for microfinance that regulate different tiers include community-based groups, credit-only NGO MFIs, cooperative financial institutions (CFIs), regulated specialized MFIs, NBFIs, and commercial banks with microfinance products. Policies and regulations that recognize the important roles of these different structures can strengthen the process of commercializing and scaling up MFIs that provide low-income 3