Ramesh S Arunachalam, Rural Finance Practitioner
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 removal 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. And the industry pioneers have reacted to the events...
Writing about the current crisis, Mr Vijay Mahajan[ii] notes, "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."
Commenting on the post AP ordinance situation, in an interesting paper[iii], Mr Aloysius (Al) Fernandez asks the question as to whether 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 - could be leading to a Macro Mess?
Undoubtedly, the post AP ordinance situation is quiet alarming and according to industry sources, banks have already stopped the disbursal of around `175 crore to `200 crore to around 44 MFIs the earlier week because of the stalled recovery of micro loans from MFI customers in Andhra Pradesh. Further, it has been reported that the despite the Hon Court’s interim relief, MFIs are still finding it very difficult to lend and/or recover their dues – a situation that was anticipated way back in May 2005...even as the suicides continue to mount according to SERP.
How did all of this happen suddenly? Was it that the IPO glare and resultant riches being made by people forced a sudden wake-up call against micro-finance? Or did the storm, that been brewing for some time, suddenly gather the much needed inertia to erupt. The latter seems more like the case...
Irrespective of whatever has been the trigger for the present crisis, the fact of the matter is that in May 2005, Dr Thorat (Former Chairperson, NABARD) and the author, in a paper titled, “Regulation and areas of potential failure in micro-finance”, presented at the NABARD high level policy conference at New Delhi with a Senior Joint Secretary (Ministry of Finance) as the chairman of the session, had indeed suggested that the burgeoning growth of micro-finance could result in a number of not-so-desirable practices being adopted and also predicted the eventual fallout for MFIs.
Five years hence, there appear to be many such questionable practices in the Indian micro-finance sector. In fact, in response to above concerns expressed in the media about high interest rates, coercive recovery processes and multiple lending practised by some microfinance institutions, the Reserve Bank of India has now set up a Sub-Committee of the Central Board of Directors of the Reserve Bank to study the issues and concerns in this sector, including ways and means of making interest rates charged by them reasonable. The committee is chaired by Shri Y H Malegam, a senior member on the Central Board of Directors of the Reserve Bank of India. Other members of the Sub-Committee include, Smt. Shashi Rajagopalan, Shri U R Rao, Shri Kumar Mangalam Birla and Dr. K C Chakrabarty, Deputy Governor. Shri V K Sharma, Executive Director, Reserve Bank of India is to act as the Member Secretary to the Sub-Committee, which is to submit its report in three months.
The broad terms of reference (ToR) for the Sub-Committee of the Reserve Bank’s Central Board of Directors are now available and among other things, the ToR for the Sub-committee includes: a) review of the definition of ‘microfinance’ and ‘Micro Finance Institutions (MFIs); b) examining prevalent practices of NBFC MFIs in regard to interest rates, lending and recovery practices to identify trends that impinge on borrowers’ interests; c) delineation of the objectives and scope of regulation of NBFCs undertaking microfinance and the regulatory framework needed to achieve those objectives; d) review of money lending legislation of the States and their applicability NBFCs/MFIs; e) examining the role that associations and bodies of MFIs could play in enhancing transparency disclosure and best practices; f) recommending a grievance redressal machinery; and g) examining the conditions under which loans to MFIs can be classified as priority sector lending and making appropriate recommendations in this regard.
While the above ToR suggests the range of issues to be examined by the RBI sub-committee, there are several specific aspects that deserve close attention of this high powered committee and these are highlighted below:
Burgeoning Growth and Standardised Products: First, as Mr Ramakrisha, a rural finance practitioner argues: “In the last few years, 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 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.”[iv]
Prof Sriram[v] concurs, “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.”
And data from the field suggest that the pace of growth in the Indian micro-finance sector, over the last several years, has indeed been burgeoning...
Inappropriate Client Targeting and Multiple Lending: A second issue, according to Mr Ramakrishna, is that “while the size of portfolio has increased manifold, 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 to disburse left, right and centre and many times in competition with several other MFIs in the area. This led to inappropriate targeting and multiple lending. The situation in Coastal Andhra is even 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 between 200,000 to 250,000.”
Thus, multiple lending has become the bane of the micro-finance industry, and it is rampant as MFIs are disbursing the credit, without weighing the livelihood opportunities available to the clients. And as Mr Neelaiah, a senior micro-finance grass-roots practitioner argues, “MFIs need to gauge the client’s absorption capacity and their ability to manage the portfolio.” Without doubt, the ability of poor clients to repay between Rs 3000 – Rs 4500 every week, is rather impossible, without borrowing from other sources (and perhaps at higher rates of interest). At some level, the cycle overturns and causes a crisis as is the case now…”
Prof Rajalaxmi Kamath and Prof Srinivasan[vi] (2009) support the above and conclude that, “The existence of multiple borrowing among the MFI clients implies that repayment, to a greater or lesser extent, is dependent on the borrower’s ability to raise a new loan to repay a prior borrowing. At a macro-level the consequence is that the total outstanding to the financial system is higher than if a single “right-size” loan was provided. This “additional loan” covers two amounts. The first is the enhanced transaction cost the borrower faces, as a consequence of multiple (rather than a single) loan. The second is a potential “delinquent” amount. The portfolio-at-risk is effectively financed by the financial system and is masked. This is like a game of musical chairs, with multiple sources of financing the music stops rarely. When (we are not using the more optimistic ‘if’) the music does stop, the accumulated delinquency will suddenly show up. Again, taking recourse to finance vocabulary, the delinquency has been securitized and funds raised against it.”
As shown in box below, studies by EDA Rural Systems and others also support the above findings and reinforce the fact that multiple borrowings exist in micro-finance. There is an added dimension here – as mentioned by several industry experts and corroborated by a recent study in Andhra Pradesh by APMAS, a majority of the MFIs have effective interest rates in range of 25 - 40%, including charges levied on compulsory insurance etc.
Therefore, given the above issues of rapid growth, inappropriate products and multiple lending, there are several questions that need to be focussed on by the RBI sub-committee:
a) Is it natural and/or healthy for MFIs to grow at the pace that they have grown? How have these MFIs been able to grow so rapidly, especially since 2005? What changes were made to their model which enabled growth at such a scorching pace since 2005? What was the role played by the bankers/lenders/investors in this very rapid growth?
b) What can be said with regard to the capacities and systems of MFIs to manage this growth? What is the state of human resource management systems in MFIs and how much is this to blame for the present day crisis? How can staff working conditions be bettered? How can staff be made more sensitive and accountable to the above concerns and issues?
c) Given that the financial statements of some of the top MFIs themselves admit the presence of frauds including non-existent borrowers, what can be said with regard to overall assets of MFIs (and their actual quality), acquired through such (burgeoning) growth?
d) How widespread is the phenomenon of non-existent clients? How commonplace is multiple lending? What are the implications for priority sector lending?
e) Given that most bank loans to MFIs are public deposits, should the banks have been more careful? What does this whole phenomenon say about the current due diligence process at banks? Are banks cutting corners as far as procedures are concerned? Is there good enough reason to believe that loans were “pushed’’ to MFIs as well as the poor women, resulting in the situation today? What is role and responsibility of Bank and MFI staff/management in this regard?
f) Given that the MF clients have multiple loans and given that the effective interest rates are in the range of 25 – 40%, can these clients afford to pay such interest, especially for multiple loans, especially, in the wake of their livelihood situations?
Corporate Governance in Indian MFIs: A further aspect that requires the close attention of the RBI sub-committee pertains to corporate governance practices in Indian MFIs - which has indeed left a lot to be desired, especially from events in the 2010 in the Indian micro-finance industry, both prior and after the SKS IPO. This fact assumes greater importance given 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 truly independent board nomination sub-committees; (3) Insufficient transparency about ownership/control, related-party transactions and the (group’s) overall financial position; (4) Promoters’ friends/families often leverage themselves highly to acquire stake in order to maintain control over the MFIs; (5) Conflicts of interest at various levels including board and senior management level; and (6) Lack of transparent reporting to the outside world. The RBI sub-committee would do a great service to the micro-finance industry and the NBFC MFIs, if it were to recommend mechanisms to overcome some of the above limitations and set corporate governance standards for NBFC MFIs to follow
To summarise, micro-finance, which started as an informal and local sector, is now in the process of transforming to a full-fledged industry, with significant capital market participation and global integration. Clearly, micro-finance is at crossroads and any attempt to develop it further must also be accompanied by a commensurate effort to establish fair rules of the game (regulation) and enable compliance to these rules (supervision) on the part of various stakeholders. The RBI sub-committee therefore needs to objectively assess this complex situation and evolve pragmatic solutions that would result not only in effective regulation and supervision but also contribute to building a vibrant, healthy and competitive micro-finance sector with sufficient choices for the poor and appropriate safe guards against potential institution failures. And for that, the RBI committee needs to answer specific questions such as those given above, which are in the best interests of depositors and the Indian public …
[i] Andhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Ordinance 2010
[iii] Aloysius P. Fernandez (2010), Is Micro Finance leading to a Macro Mess, The AP Ordinance, Unpublished Paper
[iv] Through an open e mail to the public domain Micro-Finance Practice (MFP) e group at Yahoo Groups
[v] M S Sriram (2010), “The Anxiety of Growth in Microfinance”, Unpublished Paper. Prof Sriram is Adjunct Professor, IIM - A
[vi] Ms Rajalaxmi Kamath and Prof Srinivasan (2009), “Microfinance in India: Small, Ostensibly Rigid and Safe”, IIM B Working Paper
[vii] Srinivasan, N., “State of the Sector Report 2008”, Sage Publications, London, UK, 2009.
[viii] EDA Rural System Private Limited (2010) with MFI client and loan data analysis by Karuna Krishnaswamy and Alejandro Ponce “Competition and the Role of External Agents: The 2009 delinquency crisis in southern Karnataka”
[ix] Kamath, Rajalaxmi, Arnab Mukherji and Smita Ramanathan, “Ramanagaram Financial Diaries: Loan Repayments and Cash Patterns of the Urban Slums”, IIMB Working Paper No. 268.
Please wait for an objective case study on Zaheera Bee, to be put up in the next 2 days. As per available reports, Zaherra Bee committed suicide on 13/09/2010 in Andhra Pradesh because she was hugely indebted and could not make the loan repayments to MFIs/Others.