Basel II and Microfinance: Exercising National Prerogatives

This paper outlines the basic parameters of Basel II and examines its application in emerging markets. The paper argues that:

• The impact of Basel II on microfinance will depend on the degree of implementation in developing countries;
• National authorities must analyze what is needed in a country in relation to the state of development of the banking sector and supervisory capacity;
• Basel II aims to build trust in the financial system through building the effectiveness of supervision and establishing the core infrastructure required for building a sound financial sector;
• For proper implementation, financial institutions need to engage in a dialogue that would make their risk portfolios better understood.

The paper goes on to discuss:

• The background and basic parameters of Basel II;
• Its adoption and application in emerging markets/developing countries;
• Implications for regulated microfinance institutions (MFIs) and microfinance portfolios of other regulated financial institutions;
• Micro loan portfolios of larger banks and non-bank institutions;
• MFIs as borrowers in capital markets.

The paper concludes that the impact of Basel II on MFIs will come primarily from changes in the overall supervision culture, at the systems level and from a possible increase in the cost of borrowing by MFIs in international markets.