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Incentives, Supervision and Regulation of Microfinance Institutions in the developing countries


  • Founanou, Mathurin
  • Ratsimalahelo, Zaka


We analyze the optimal regulation of a MFI that has private information on the intrinsic quality of its loan portfolio (adverse selection) and where the MFI’s choice of effort to improve this quality cannot be observed by the regulator (moral hazard). In designing optimal contracts the regulator faces a tradeoff between inducing proper incentives for efficient MFI and costs of regulation in terms of leaving an informational rent for a high quality MFI. We identify conditions for the optimal incentive contract and show that, not surprisingly, these contracts depend on the accuracy of the supervisor’s signal, the likelihood of facing a high quality MFI, and the cost of supervision. However, since improving the accuracy of supervision is costly, even in the optimal monitoring scheme there generally exists a positive probability of MFI failure. The content of information disclosure is characterized by the optimal monitoring scheme.

Suggested Citation

  • Founanou, Mathurin & Ratsimalahelo, Zaka, 2012. "Incentives, Supervision and Regulation of Microfinance Institutions in the developing countries," MPRA Paper 41428, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:41428

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    References listed on IDEAS

    1. Giammarino, Ronald M & Lewis, Tracy R & Sappington, David E M, 1993. " An Incentive Approach to Banking Regulation," Journal of Finance, American Finance Association, vol. 48(4), pages 1523-1542, September.
    2. Kofman, Fred & Lawarree, Jacques, 1993. "Collusion in Hierarchical Agency," Econometrica, Econometric Society, vol. 61(3), pages 629-656, May.
    3. Laffont, Jean-Jacques & Tirole, Jean, 1986. "Using Cost Observation to Regulate Firms," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 614-641, June.
    4. Valentina Hartarska & Denis Nadolnyak, 2007. "Do regulated microfinance institutions achieve better sustainability and outreach? Cross-country evidence," Applied Economics, Taylor & Francis Journals, vol. 39(10), pages 1207-1222.
    5. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, January.
    6. Mathias Dewatripont & Jean Tirole, 1994. "The prudential regulation of banks," ULB Institutional Repository 2013/9539, ULB -- Universite Libre de Bruxelles.
    7. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, January.
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    More about this item


    Microfinance institution; adverse selection; moral hazard; regulation; supervision; optimal incentive contracts;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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