Ramesh S Arunachalam
Rural Finance Practitioner
Any solution to the present problems in micro-finance would require attention to the following short and long term aspects and the regulators/RBI would do well to ensure that this happens:
Short Term Measures
- Identify Shared Clients and JLGs with Multiple Loans: Quick and fair identification of all clients with several loans and high levels of indebtedness and their associated JLGs/SHGs across all districts in AP and other states as well etc. Disbursement of further loans to such clients must be stopped immediately and other appropriate interventions provided
- Engage with Stakeholders to Deal with Clients Having Multiple Loans: Objective and candid engagement of various stakeholders including client representatives, MFIs, Govts, Regulators and others concerned so that practical approaches can be derived for dealing with such clients who have multiple loans and high levels of indebtedness. If this is not done, the crisis would erupt again as many low income clients with debts of greater than Rs 100,000 to Rs 150,000 are in no real position to pay back their loans from the own sources of cash/income. So, if at all money was being recovered from such clients, it was because of either ever greening and/or coercive collection. If both are not to happen (and they must SURELY not), then very practical strategies have to be evolved for such clients including possibility of debt swap, moratorium on interest for a specific period of time, rescheduling of loans with a longer repayment period, partial or complete waiver of loans in cases of ultra poor (those with extremely poor livelihoods and high levels of poverty/vulnerability), support for livelihood loans etc. Now, these are not exhaustive suggestions but rather indicative ideas which along with other strategies can be explored and developed
- Ensure Regular Micro-Finance Business for Clients Not Having Multiple Loans: The Regulators/RBI must take the lead and work together with Sa-Dhan and MFIN and ensure that regular micro-finance business takes off in AP and continues in other places – both disbursements and repayment collections – for all clients not coming under category of multiple loan clients given above.
- Create a Uniform Practical Code of Conduct for MFIs: There must a credible assurance from MFIN and Sa-Dhan that, MFIs will ensure that they do not lend (indiscriminately) to those clients who have not been affected by huge levels of indebtedness so far. In this regard, I think the RBI fair practices code could be used as a basis for developing and implementing a code of conduct for micro-finance, obviously incorporating critical points from Sa-Dhan’s and MFIN’s code of conduct. In the code, MFIs must commit that they would actively encourage and support clients with JLG type loans for amounts below Rs 25,000 for 1st time loans and Rs 50,000 for 2nd or 3rd cycle loans (for a variety of purposes). They must also commit that all loan amounts above the Rs 50,000 category would have to be dealt under the individual lending paradigm by the MFIs and such loans would mainly be for productive livelihood purposes.
- Integrate Credit Bureau with CIBIL: The idea of MFIN or any other industry association implementing the credit bureau is fraught with danger as there are huge conflicts of interest. Therefore, it seems most appropriate to integrate the proposed MF client credit bureau with CIBILS operations and the clients with multiple loans (identified above in step # 1) could form the basic platform of this Credit Bureau. Slowly other clients (identified in step 3) could be brought into the credit bureau
Long Term Measures:
1. Create Single Regulatory Regime: The regulators/RBI must bring activities of all institutions and models of micro-finance under a single regulatory regime (otherwise, you could have regulatory arbitrage[i]). To start with, it could be a special cell/unit in The Reserve Bank of India
2. Enable Regulator to Perform Crucial Roles of Legitimizing, Regulating/Supervising and Protecting Micro-Finance: The functions of this single regulatory regime could be as per details below:
A) Legitimizing Micro-Finance: (a) Accreditation and registration of institutions for delivery of basic financial services to low income clients; (b) Granting licenses for deposit taking financial services, when institutions meet the required standards; and (c) Both of the above could be based on rigorous internal as well as external (3rd parties without conflict of interest) assessments of institutions on several aspects
B) Regulating and Supervising Micro-Finance: (a) Appropriate prudential and non-prudential regulation; (b) Supervising both basic and deposit taking institutions for ensuring minimum standards for Governance, MIS, HR and Finance/Accounting systems and internal controls, internal audits and risk management systems, portfolio management systems for all products, and KYC norms and client identification systems etc. Some of these would have to be verified through on-site supervision and special audits and institutions must be given reasonable time to comply. This could include use of third party auditors (without conflict of interest) for portfolio, systems and MIS audits and client audits etc; and (c) Imposition of market discipline and ensuring legal compliances and enforcement of all statutory requirements including prudential and non-prudential norms.
c) Protecting Micro-Finance Consumers and MFIs: (a) Facilitating education/literacy of micro-finance clients in terms of their rights as consumers; (b) Taking action on complaints from clients in terms of violations by service providers through an appropriate mechanism (like appointment of neutral and qualified people as Ombudsman); and (c) Protection of institutions from various State Level Usury interest ordinances, if required and appropriate
3. Place Special Emphasis on MFI Governance: Requiring all MFIs to follow HIGHEST standards of corporate Governance including specific disclosure norms. The following practices should be viewed as critical elements of any such governance ensuring process:
F Establishing strategic objectives and a set of corporate values, in tune with the overall industry objectives that are to be communicated throughout the organisation.
F Setting and enforcing clear lines of responsibility and accountability throughout the organisation.
F Ensuring that board members are qualified for their positions, have a clear understanding of their role in corporate governance and are not subject to undue influence from management or outside concerns. The role and functioning of independent and nominee directors deserves specific emphasis here
F Ensuring that there is appropriate oversight by senior management, effectively utilising the work conducted by internal and external auditors, in recognition of the important control function they provide.
F Ensuring that compensation approaches are consistent with the institutions ethical values, objectives, strategy and control environment including the nature of the industry
F Conducting corporate governance in a transparent manner. Transparency can reinforce sound corporate governance. Therefore, public disclosure is desirable in the following areas:
o Board structure (size, membership, qualifications and committees);
o Senior management structure (responsibilities, reporting lines, qualifications and experience);
o Basic organisational structure (line of business structure, legal entity structure);
o Information about the incentive structure (remuneration policies, executive compensation, bonuses, stock options) etc;
o Nature and extent of transactions with affiliates and related parties[ii]
4. Ensure Rigorous Implementation of KYC Requirements: KYC Implementation of KYC Norms in a rigorous manner by all concerned institutions. This calls for, among others, the following:
F Customer acceptance, customer identification and record keeping standards should be implemented with consistent policies and procedures throughout the organization.
F Each branch office should maintain and monitor information on its accounts and transactions. This local monitoring should be complemented by a robust process of information sharing between the head office and its branches and regarding accounts and activity that may represent heightened risk. This is critical.
F Internal auditors should verify that appropriate internal controls for KYC are in place and that financial intermediaries are in compliance with supervisory and regulatory guidance. The audit process should include not only a review of policies and procedures but also a review of customer documentation and their records along with sampling of a significant number of random accounts.
F The role of audit is particularly important in the evaluation of adherence to KYC standards on a consolidated basis and supervisors should ensure that appropriate frequency, resources and procedures are established in this regard and that they have full access to any relevant reports and documents prepared through the audit process.
F Some MFIs do have multiple related institutions and many MFIs share clients with each other. Customer due diligence here poses issues that may not be present for single entity. Thus, there should be systems and processes in place to monitor and share information on the identity of customers and account activity of the entire group (with all related institutions) as also other MFIs
The above measures, if implemented speedily, should help in the development of a fair, ethically governed, vibrant and competitive micro-finance industry, which is much needed in India today…
[i] Occurs when MFIs structure or relocating activities/transactions to choose the least burdensome regulator. This is also described as regulator shopping.
[ii] For example, the International Accounting Standards Committee defines related parties as “those able to control or exercise significant influence. Such relationships include: (1) parent-subsidiary relationships; (2) entities under common control; (3) associates; (4) individuals who, through ownership, have significant influence over the enterprise and close members of their families; and (5) key management personnel". The IASC expects that disclosures in this area should include. (a) the nature of relationships where control exists, even if there were no transactions between the related parties; and (b) the nature and amount of transactions with related parties, grouped as appropriate. (IASC International Accounting Standard No. 24, Related Party Disclosures)
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