Bank superintendents implement prudential regulation that simultaneously seeks protection of the stability and solvency of financial intermediaries and several dimensions of financial deepening. If they use only one instrument, a given level of safety is achieved at the expense of some intermediation. The question addressed by this dissertation are the excessive losses of intermediation efficiency from a single, uniform (pooling) regulation, which treated loan portfolios built with a traditional banking technology or with a microfinance technology as if they carried the same risk profile. Given significant differences between the two lending technologies, in their ability to match their clienteles and to recognize different risks, a differentiated (separating) set of prudential norms would contribute more to the dual goals of stability as well as financial deepening and breadth of outreach. This task is specially challenging in developing countries exposed to frequent systemic shocks.
The dissertation develops a simple theoretical framework to guide regulators about the welfare shortcomings of pooling regulation, compared to separating regulation. If the risk profiles of the portfolios are different, different prudential norms should be applied. The problem for the regulator, however, is incomplete information about these risk profiles and the high costs of overcoming the information imperfections about their characteristics. Given high operational costs, the regulator must determine if the efficiency losses from not differentiating justify the development of a separating regulation.
To illustrate the issues, the dissertation discusses in detail the experience of Bolivia with the emergence of a competitive and successful regulated and non-regulated set of microfinance institutions. Relying heavily on innovation, these institutions have achieved exceptional financial performance (growth, profitability, and low default indicators), even during adverse systemic shocks, in contrast to banks. The regulators are puzzled by this heterogeneous performance and the dissertation offers a framework to guide their efforts. The actual experience of Bolivia indicates that the differences are important enough for the authorities to seriously address the operational costs of a separating framework. It further suggests dimensions of different risk profiles that should be taken into account by the authorities, in order to accomplish the double goal of efficiency and stability.