Microfinanceis, at its heart, an effort to provide financial services to people who are notserved – or are under-served – by the formal banking system. With appropriate,accessible, and fairly priced financial services, people can build theirsavings, cover the costs of unexpected emergencies, and invest in theirfamilies’ health, housing, and education.

The InternationalFinance Corporation estimates that microfinancehas reached some 130 million people worldwide in the last 15 years. Over thisperiod, microfinance has been lauded for its potential to advance financialinclusion and enable people to escape poverty. But it has also faced harshcriticism, with some lenders being accused of profiteering.

Despite theindustry’s widely publicized pitfalls, its potential to improve the lives ofthe poor cannot be ignored. The question now is how to ensure that microfinancebecomes the industry that the world needs. To this end, three important stepsmust be taken.

The first stepis better regulation. Microfinance institutions (MFIs) come in many forms –mainstream banks, specially licensed banks, non-financial companies, financeand leasing companies, non-governmental organizations, cooperatives, and trusts– and follow a variety of business models. All of these intermediaries must berecognized and regulated according to the needs of the economies in which theyoperate.

Inadequateregulation is most damaging to those who need microfinance services the most.Nowhere was this more apparent than in the 2010 microfinance crisis in theIndian state of Andhra Pradesh – a hub of MFI activity – when a decade ofexplosive growth, fueled by aggressive and reckless lending practices, came toa head.

Over-indebtedness,together with coercive recovery practices, led to a series of widely publicizedsuicides, spurring local officials to implement new restrictions on MFIs anddiscourage borrowers from repaying their debts. As repayment rates plummeted,micro-lending ground to a halt.

In order toprevent such outcomes, governments must design regulations that foster asustainable financial-inclusion model, one that enables MFIs to offer long-termsupport to borrowers. At the same time, regulation must deter MFIs frombehaving recklessly with a vulnerable client segment. And regulation should bebased not on past experience, as it is now, but on future possibilities; inother words, the regulatory framework must be flexible enough to accommodatenew innovations.

The secondstep, to be taken by the microfinance industry itself, is to create effectivemechanisms for assessing the industry’s impact. As it stands, some governmentsand academics are uncomfortable with the fact that MFIs, which are supposed tobe providing a public good by advancing financial inclusiveness, are pursuingprofits.

But thefailure of some MFIs to differentiate between profit-seeking and profiteeringdoes not mean that sustainable microfinance should not yield returns abovecosts. The business of providing financial services to the poor requires commitment.Without profits, MFIs are unable to invest in the talent and productdevelopment needed to serve people for the long term.

Manygovernments have now implemented interest-rate ceilings and margin caps tocurtail excessive profits for MFIs, while ignoring the margins of the market’snon-organized alternatives, like pawnbrokers. In order to provide a more balanced perspective onthe microfinance industry compared to other kinds of financial-servicesproviders, MFIs need to do more to measure and explain their social andeconomic value.

The good newsis that industry bodies, investors, and governments have already introducedmetrics for factors ranging from pricing to conduct. While this has resulted ina rather disparate set of indicators, which must be standardized, such effortsare an encouraging sign of the microfinance industry’s commitment to securingits role in the financial-services ecosystem.

The third stepconcerns technology. Mobile connectivity is transforming the global financialsystem by enabling remote, rural populations to access financial services forthe first time. Mobile-payment systems like M-Pesa are changing how peopletransfer, receive, and save money in many developing countries, includingKenya, Pakistan, and the Philippines.

For themicrofinance industry, such systems represent an important opportunity, as theyenable borrowers to apply for, receive, and repay loans on their mobile phones,using a network of local agents to deposit and withdraw cash. But, withoutrobust regulation, MFIs cannot make the most of these developments.

Moreover, themobile-payments revolution has so far been led largely by telecom providers. Ifit is to deliver real benefits to the financially excluded, thefinancial-services industry will need to play a much more active role.

Of course,microfinance alone will not eliminate poverty, or even financial exclusion,regardless of how well it functions. To have a truly transformative impact,MFIs’ operations must be supported by government-led efforts to improve accessto education, training, and employment.

Althoughmicrofinance has already helped countless people worldwide, the WorldBank estimates that some 2.5 billion adults stilllack access to financial services. It is the responsibility of all stakeholders– including governments, regulators, banks, and civil society – to ensure thatmicrofinance continues to be part of the solution.