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 1st 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
[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.
[vi] Dr M S Sriram (2010), “The Anxiety of Growth in Microfinance”, Unpublished Paper. Prof Sriram is Adjunct Professor, IIM - A
[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