The Role of Governments in Microfinance

The paper examines the complex role that governments play in microfinance. It states that until recently, many governments felt that it was their responsibility to provide development finance, including direct lending to the disadvantaged. But experience shows that when governments engage in retail lending to the poor, they almost always do it badly. Although governments are not usually good at lending, they should play an important role to:

• Maintain macroeconomic stability through appropriate monetary and fiscal policies;
• Involve the private sector such that a critical mass of microfinance providers exists in the region;
• Adjust regulatory frameworks to permit all types of financial institutions to offer services to poor people;
• Avoid interest-rate caps that prevent microfinance institutions from covering their costs and operating sustainability;
• Avoid their direct involvement in credit delivery or the management of microfinance initiatives.

Further, donors can also contribute to greater impact and facilitate the emergence of a strong pro-poor financial system by:

• Ensuring appropriate, specialized technical oversight of their projects;
• Identifying and working in their area of comparative advantage;
• Promoting microfinance associations and supporting interest rate liberalization;
• Taking more risks on promising, but not yet proven, institutions and mechanisms.