Sunday, October 31, 2010

MFIs have access to collateral free, soft interest loans that comes with almost no conditionalities — on an unlimited scale today. The money mela of MFIs in the rural areas looks more than a trifle scary.

P. Devarajan

SHOULD micro finance institutions (MFIs) be policed? Some would wait while others want regulation today. A recent paper (May 2005) by Mr Y.S.P. Thorat (Managing Director, Nabard) and Mr Ramesh S. Arunachalam, styled "Regulation and areas of potential failure in micro-finance" has argued for a single regulatory authority for all models and forms of micro-finance.

"It will also help overcome the problem of using alternative legal forms to overcome micro-finance regulations," they write. The authors prefer a special cell or unit in the RBI which "could then be moved to a separate regulatory authority, if required."

And they cite three factors (to back themselves) which are: a) significant proportion of loan funds to the sector are coming from commercial banks - in ways, these are indeed public deposits being on-lent and the sector virtually has unlimited access to `condition less' collateral free loans at `soft' interest rates; b) the sector has grown considerably and should continue to grow even more and perhaps at a more scorching pace. The volume of money invested in the sector and institutions (individuals) is therefore by no means small by any standards; and c) there are some striking similarities to the NBFC failure scenario of 1990s and the early warning signals available point to several potential areas where market failure could indeed occur."

Their study has found quite a few infirmities in the MFI sector: several entities under a promoter group offering funds; possibility of opaque transactions between group entities not ruled out; no single serious regulator — multiple regulators with different levels of supervision and no serious co-ordination among regulators and supervisors; ghost clients are possible along with ghost branches and ghost fieldworkers; same clients are shown as borrowers for loans from multiple lenders; financial intermediaries in micro-finance tend to have weak governance, management information systems and controls and perhaps, very weak risk management functions; by and large collateral free, soft interest, condition less (no personal guarantee) loans — virtually on an unlimited scale today. The money mela of MFIs in the rural areas looks more than a trifle scary.

With the MFIs driven by profits (is that a sin?), suppliers of finance to the sector have grown in terms of funds and stakeholders (Nabard, SIDBI, private and public sector banks, private investors, semi-wholesalers and many others).

Most of them seem to be chasing an available pool of 20-30 larger and medium MFIs and for the authors, "there is a serious risk of rapid and burgeoning growth fuelled by the supply (wholesaler) side and not backed by appropriate growth in MFI systems and administrative capacity to manage that growth - this could result in portfolio quality problems. With growth, the systems are being severely tested and may have to be re-designed. Also, while general design of systems tend to be good on paper, implementation in terms of consistency needs to be enhanced.

In many ways, systems and procedures are non-negotiables and minimum requirements for MIS, internal control, internal audit, human resources and other systems need to be prescribed, adhered to and also verified through loan portfolio and system audits by third party auditors."

Firing away, the authors are for inscribing KYC (Know Your Customer) norms on a rising client base and use of agents to expand outreach.

But has the MFI sector to be hurried into a corral? The fetching faith of the authors in the efficacy of regulators is understandable though hard to share when a large swathe of rural and urban poor exist outside the financial system.

Importantly, the MFI sector works on three key models - the Nabard-Self Help Group- Bank Linkage scheme; the institutional MFI model supported by SIDBI, ICICI, banks and others; the partnership securitisation model of ICICI and other banks. These models work "through a complex array of institutional forms - including not-for-profit entities, mutual benefit organisations and for-profit institutions - that perform social and financial intermediation in different degrees. There is lack of clarity with regard to legal aspects in the Indian environment both with regard to appropriate form and associated legal compliances," explains the study.

All these players regularly come under the scanner of the RBI and should by now be aware of the financial and legal trapdoors; perhaps, the risks are no different from that inherent in corporate loans. Would it not be better if RBI and Nabard discreetly nudge the big players to be circumspect for the sake of sustaining the MFI movement, instead of collaring the poor who will be hurt the most? Why should the organised banking industry blindly cater to just about 20 or 30 MFIs and not spread the risks and aid the MFI movement across the country? Tough and intrusive laws have not averted financial scams, at least not in India.

Where are the Rogue MFIs? Where are the Fly by Night Operators?

Ramesh S Arunachalam

It has become very commonplace to argue that ‘Rogue MFIs’ or ‘Fly by Night Operators’ are the ones who are responsible for the present Andhra Crisis. This statement is certainly worthy of serious investigation and the RBI and other regulators must attempt to get to the root of this statement. Further, all the industry associations must transparently share all information on their members so that any black sheep (hiding within) are immediately identified and dealt with. It is also imperative that the names of the so called Rogue MFIs are publicised through various forums so that donors, investors and lenders boycott them in totality.

But there is one problem however – where do we begin to search for these so called ‘Rogue MFIs’? I guess the logical point would be to start with the people who made the statements in the first place. The onus is now on them to help identify the ‘Rogues’ or ‘Fly by Night Operators’ from among and/or outside their saintly flock.

Indian Micro-Finance in 2010: The Imperative Need for Appropriate Regulation

Ramesh S Arunachalam

2010 has been a very interesting year for micro-finance where it has consistently made front page news in the media. Starting off with India’s largest MFI, SKS Microfinance Limited, filing its draft red herring prospectus (DRHP) in the first quarter, the year promised much for micro-finance. And indeed we have not been let down – from the filing of the DRPH through the controversial SKS IPO and the sudden and unceremonious sacking of the SKS CEO (Mr Suresh Gurumani) after a spectacularly successful IPO to the devastating suicides in Andhra, the promulgation of the AP Ordinance[i](and the subsequent court drama) and the appointment of an RBI Board sub-committee for micro-finance, a lot of water has indeed flown under the micro-finance bridge. In fact, these happenings in micro-finance prompted a close friend to say that the events of 2010 in Indian micro-finance could provide a great story line for a micro-finance movie.

That said, post AP ordinance, I read an interesting paper[ii] by Mr Aloysius (Al) Fernandez, one of the pioneers of Indian micro-finance. Al talks candidly about the present situation in Indian micro-finance and asks the question as to whether Micro Finance could be leading to a Macro Mess?. He basically refers to “micro finance driven by pressures resulting from venture capitalists and other private investors which is characterized by quick growth, high profits, high cost (interest and remunerations especially for senior staff), IPOs and quick exits.”

Undoubtedly, the post AP ordinance situation is quiet alarming and as The Deccan Chronicle[iii] notes, “In another blow to the micro finance industry, banks have halted disbursements of sanctioned and approved loans to companies operating in the sector. The development was confirmed to this publication by industry sources who refused to be identified given the sensitive nature of the development. Earlier, these firms had been barred by the Andhra Pradesh government from collecting their dues till they were properly registered as mandated by a new ordinance....According to industry sources, banks have already stopped the disbursal of around `175 crore to `200 crore to around 44 MFIs this week because of the stalled recovery of micro loans from MFI customers in Andhra Pradesh. The state government’s recent ordinance has banned micro finance companies from lending or recovering their dues until they are registered with District Rural Development Authority.”

But while the post ordinance situation is indeed a matter of grave concern to the micro-finance movement and actually threatens its very existence, it was not totally unexpected. In fact, in 2005, Dr Thorat (Former Chairperson, NABARD) and the author, in a paper[iv] presented at the NABARD high level policy conference at New Delhi, had suggested that the burgeoning growth of micro-finance could result in a number of not-so-desirable practices being adopted. Commenting[v] on the above paper, Mr Devarajan of The Hindu Business Line (Saturday, Oct 1^st 2010) then argued that, “MFIs have access to collateral free, soft interest loans that comes with almost no conditionality’s — on an unlimited scale today. The money mela of MFIs in the rural areas looks more than a trifle scary."

Five years hence, there appear to be many questionable practices in the Indian micro-finance sector and some of these are evident from the quotes below:

In a succinct mail to The Micro-Finance Practice (MFP) e group at Yahoo Groups, Mr Ramakrisha has summed up the situation as follows: “First, the growth of the MF industry has been phenomenal in terms of number of MFIs, borrowers, size of the portfolio. At the same time, there has not been much innovation in terms of loan products to meet the diverse needs of the clients. Rigid loan products with weekly payments are not suitable to 80% of the rural borrowers except for traders, petty businesses and dairy. And, when they are unable to cope up with the pressure of weekly repayments to the multiple MFIs, crisis like this blows up.

Second, the size of portfolio has increased manifold, but the methodology for targeting the right clients to meet appropriate credit needs has not evolved over a period of time proportionate to the size of portfolio. Hence, field staff are forced disburse left, right and centre and many times in competition with other multiple MFIs in the area. This led to inappropriate targeting and multiple lending. The situation in Coastal Andhra is worse. According to the regional coordinators of some MFIs, some of the households are managing 8-10 different loans including bank linkage and size of the loan is in between 200,000 to 250,000. Thus, multiple lending is becoming bane of the micro-finance movement, and it is rampant as MFIs are disbursing the credit, without weighing the opportunities available to the clients that too beyond the capacity. MFIs need to gauge the client’s absorption capacity and their ability to manage the portfolio.

Third, a majority of the MFIs have effective interest rates in range of 32-40%, including charges levied on compulsory insurance etc and one is not sure whether the borrowers can afford this interest, especially for multiple loans”.

Commenting on the burgeoning growth in Indian micro-finance, Adjunct Professor at IIM (A), Dr M S Sriram[vi] argues, “This anxiety for growth is partly dictated by the fact that the investors in the market based models are impatient and look for returns. The more the investors put pressure on returns, the more the pressure is on fast growth and this in turn makes the organisations cut corners to achieve growth. The growth story of microfinance thus is giving enough cause for anxiety. In the process they are creating an unnecessary storm in the lives of the poor by offering them something that is difficult for them to digest in such a quick time. This in the short run will harm the interests of inclusion. …The response of the state has not been in the desirable direction. Instead of harping on caps on interest rates and threatening to remove microfinance out of the priority sector list, it is necessary for the State/RBI to look at specific instances and pull the delinquent organisations up. Nothing prevents the RBI from causing an audit of the end-use of the loans of MFIs, looking at their governance more carefully and advising the institutional representatives on the boards of these MFIs to exercise independence.”

Talking about the current crisis, Mr Vijay Mahajan[vii], Chairman MFIn and BASIX, adds, "More disturbing are the recent reports alleging that some poor women have committed suicide due to the burden of over-indebtedness caused by MFIs. If even one of these cases is true, it is a matter of shame for all of us in the sector. Though we should not give up on the principle of sustainability and thus cost-covering interest rates, the greed and ambition of promoters/CEOs should not be allowed to convert a boon into a bane for the poor. This brings to mind a Kabir's couplet: "A poor man's sigh of grief is enough to burn even gold." Let us put our house in order before it is too late." Mr Vijay Mahajan[viii]further notes, “it is time that the sector gets a regulator which will go beyond prudential regulations and cover all aspects such as prevention of over-lending, excessive profit and coercive recoveries and also grievance redressal of clients.”

Arguing about Corporate Governance in the current Indian MF context, an observer[ix] says that, “India’s MF landscape is largely dominated by promoter-owned/controlled MFIs that have distinct characteristics: (1) Inadequate checks and balance over executive decision making and behaviour; (2) Lack of transparent reporting to the outside world; (3) Lack of truly independent board nomination sub-committees; (4) Insufficient transparency about ownership/control, related-party transactions and the (group’s) overall financial position; (5) Promoters’ friends/families often leverage themselves highly to acquire stake in order to maintain control over the MFIs; and (6) Conflicts of interest at various levels including board and senior management level”.

And Ms Shashi Rajagopalan, Independent Practitioner and Director, RBI, while commenting on the current crisis, agrees that, “Notwithstanding the sleight of hand by which large numbers of women are shown to be shareholders through MBTs, many NBFC MFIs are closely held companies, and, in my view, statistics quoted by such closely held companies are hard to ascertain. It appears to be in everyone's interest to pretend that these companies are indeed growing at the rates claimed and that their default rates are indeed the rates claimed. Anyone buying into these figures, has either never given and collected credit, or, is either incredibly naive, or has a stake in pretending that this is indeed a wonderful gift to the low income group.”

Noted Economic Times Journalist M Rajsekhar[x]^, agrees and further adds that, “Even the regulators have their concerns. For instance, RBI deputy governor Ms Usha Thorat flagged possible risks like conflicts of interest, co-mingling of MFI and bank funds, misrepresentation and other agency-related risks recently in her talk at a seminar co-hosted by the US Federal Reserve, IMF and the World Bank in early June. …Today, some of India’s leading MFIs face charges of both corporate mis-governance and lending irregularities — like coercive repayment techniques and harsh repayment schedules that result in women taking fresh loans to settle existing debt. Any regulatory framework chosen must check corporate mis-governance and ensure microfinance doesn’t degenerate into predatory lending.”

Thus, without question, Micro-finance in India is at cross roads and the path it traverses has significant implications for millions of the poorest people in India, who are still out of the ambit of having access to meaningful and affordable financial services. Therefore it becomes imperative to take a close look at the present legal framework for micro-finance, analyse its strengths and weakness (in the light of what has happened in 2010 and before) and most importantly, suggest changes to present legal framework so as to make it effective, both from the perspective of reaching out to large numbers of people as also preventing institutional/other failures during the delivery of a wide range of financial services for low income people. Specifically, this calls for a fresh perspective on regulation and supervision of Micro-finance in India including eclectic and practical answers to the following questions:

· Is further regulation necessary? If yes, what kind of institutions should be regulated?

· What aspects (prudential, non-prudential etc) should be focussed on in the framework?Should the framework have any non-negotiables in terms of specific things to be done by the regulated bodies

· What kind of supervisory mechanisms (On-site, off site, third party etc) are envisaged?

· What capacities would be required to effectively implement such a regulatory framework?

· What checks and balances would be required for the proposed framework to be effectively implemented on the ground?

· Who should be the regulatory body be and why? RBI? NABARD? SIDBI? Others?

And last but not the least, there is also an urgent need to focus on Corporate Governance practices of MFIs, which has left a lot to be desired, especially from the 2010 Indian experience. As Dr N R Narayana Murthy has said, ‘Corporate governance, is about maximizing shareholder value legally, ethically and on a sustainable basis, while ensuring fairness to every stakeholder - the company’s customers, employees, investors, vendor-partners, the government of the land and the community.’ The micro-finance industry needs find ways by which MFIs can be persuaded to practice this in full earnest.

[i] Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Ordinance 2010

[ii] Aloysius P. Fernandez (2010), Is Micro Finance leading to a Macro Mess, The AP Ordinance, Unpublished Paper

[iii] http://www.deccanchronicle.com/node/190441

[iv] Thorat Y S P and Ramesh S Arunachalam (2005), “Regulation and areas of potential failure in micro-finance”, Paper presented at the NABARD High Level Policy Conference, New Delhi.

[v] http://www.thehindubusinessline.com/2005/10/01/stories/2005100102220600.htm

[vi] Dr M S Sriram (2010), “The Anxiety of Growth in Microfinance”, Unpublished Paper. Prof Sriram is Adjunct Professor, IIM - A

[vii]http://www.editorialjunction.com/opinions/vijay-mahajan-micro-loans-macro-returns/

[viii] http://www.financialexpress.com/news/MFI-body-seeks-regulator-to-check-indiscipline-in-sector/700225/

[ix] Cited from CGAP blog, www,cgap.org and quote is from a post by Ramesh S Arunachalam

[x] Rajselhar, M , The Economic Times, 27 June 2010

Microfinance crisis - Failure to learn?

By Ramakrishna

Source: MicrofinancePractice@yahoogroups.com

Reproduced as it is from Public Domain

To: MicrofinancePractice@yahoogroups.com

From: rkrishnay@yahoo.com

Subject: [MFP] Microfinance crisis - Failure to learn?

Dear All,

The discussions have been happening around crisis management rather than discussing about the core issues honestly. We all know the core issues but the entire MF industry shied away to discuss these issues during the normal times and State Government became possessive about its initiative of SHG movement without proactively engage MFIs and banking industry in formulating the strategies for financial inclusion. Is Micro Finance Industry learning from the past? I am not very sure

as the present crisis is not the beginning and end of it.

Still the second crisis (first crisis is limited to Guntur district and involved one MFI) in micro finance industry emanated from Krishna district and spread across coastal districts like wildfire during 2006-07 and finally led into hacking one of the MFI staff into death not faded away from our minds. Reasons for that crisis also same – multiple loans from different MFIs to single households, inappropriate targeting, unhealthy competition among MFIs which led to street fights in the field, no transparency in transactions particularly interest rates etc. Still scenario is same and MFIs must honestly introspect and act upon the following issued which otherwise might led different crisis;

1. MF Industry growth is phenomenal in terms of number of MFIs, borrowers, size of the portfolio. At the same time, not much innovation in terms of loan products to meet the diverse needs of the clients. Rigid loan products with weekly payments are not suitable to 80% of the rural borrowers except for traders, petty businesses and dairy. Few of the clients from top bottom only could reap the benefits by following the loan for savings approach. Remaining borrowers predominantly engaged in agri and allied activities, finally ended up in availing multiple loans from wherever they can. Finally when they are unable to cope up with the pressure of weekly repayments to the multiple MFIs, crisis like this blow up. MFIs by and large except few like BASIX not innovated customized loan products.

2. As mentioned earlier, size of portfolio increased manifold, but methodology for targeting the right clients to meet appropriate credit needs not evolved over a period of time proportionate to the size of portfolio. Hence, field staff are forced disburse left, right and centre and many times in competition with other multiple MFIs in the area. This led to inappropriate targeting and multiple lending. Situation in Coastal Andhra is worse. According to the regional coordinators of some MFIs, some of the households are managing 8-10 different loans including bank linkage and size of the loan is in between 200,000 to 250,000.

3. Now majority of the MFIs effective interest rates are in between 32-40% including charges levied on compulsory insurance etc. All the MFIs need to introspect about the borrower’s ability to generate 30-40% returns on investment from their livelihood activity. MFIs disbursing the credit without weighing the opportunities available to the clients that too beyond the capacity. MFIs need to gauge the clients absorption capacity and their ability to manage the portfolio. According to Sa-dhan, 28% of the total MF portfolio in the country concentrated in AP.

4. Biggest MFIs who accounts for major share in the portfolio and number of borrowers are busy in growing rapidly leaving the responsibility of engaging in public policy (except Basix and few others from CBMFIs) and communications to consulting/resource organizations and few individuals. Thats why still MF industry is unknown territory to press, politicians, public representatives and civil servants alike. No steps were taken up even on small scale to engage in action research/piloting/collaborations between largest Self Help Group based programs of Government and MFIs from either side.

At the same time, Government is equally responsible for the current situation by not formalizing the regulatory framework for the MF industry and by overestimating the SHG movement to cater the credit needs of the poor. Equal amount of problems are plaguing the SHG-bank linkage programs (no protection for member savings, hence members are cleverly adjusting their savings towards loan repayments while books of accounts showing huge savings accumulation, corruption, high opportunity costs interms of time to avail bank linkage, rigid repayment terms and conditions (EMIs) to easily operate etc).

Present crisis will revolve in the coming days with court interventions due to the flaws in the hurriedly drafted ordinance. But, unless the core issues discussed and solutions found, micro finance bubble can easily burst as it is the only industry build on to service millions of people scattered across the country and it is very difficult to manage the repayment culture which dependent on the values and power relations of both lender and borrower. I dont think MF industry never ever gain power over its clients.

Thank you for your patience and warm regards,

Rama Krishna.

Where Angels Prey

Sunday, October 31, 2010

Saturday, October 30, 2010

Financial Express Bureaus, October 30, 2010

Financial Express Bureaus, October 30, 2010

Friday, October 29, 2010

Reuters, October 29, 2010

Link: http://www.financialexpress.com/news/New-rules-could-erode-MFIs-profits/704053/

Kingshuk Nag, October 29, 2010

D Rajasekhar, October 29, 2010

Thursday, October 28, 2010

Express India October 28, 2010

Link: http://www.expressindia.com/latest-news/Microfinance-institutions-set-for-pain/703777/

Wednesday, October 27, 2010

Tuesday, October 26, 2010

Monday, October 25, 2010

Kartikdesai, October 25, 2010Link: http://www.indianexpress.com/news/perhaps-some-regulation/702004/4

Kartikdesai, October 25, 2010

Link: http://www.indianexpress.com/news/perhaps-some-regulation/702004/4

Sunday, October 24, 2010

Saturday, October 23, 2010

Kartikdesai, October 25, 2010
Link: http://www.indianexpress.com/news/perhaps-some-regulation/702004/4