Outsourcing and The Use of Agents in Indian Micro-Finance and Regulatory Implications

Ramesh S Arunachalam

Rural Finance Practitioner

Outsourcing is defined as a regulated (or semi-regulated) entity’s (in this case MFI’s) use of a third party (either an affiliated entity within the same group of institutions or an entity that is external to the group) to perform activities on a continuing basis that would normally be undertaken by the regulated entity (MFI), now or in the future.

Outsourcing can be the initial transfer of an activity (or a part of that activity) from a regulated entity (like MFI) to a third party (center leader or group leader acting as an agent) or the further transfer of an activity (or a part thereof) from one third-party service provider (center leader or group leader) to another (local leader), sometimes referred to as “subcontracting.” In some jurisdictions, the initial outsourcing is also referred to as subcontracting. There are several issues here and these are highlighted below:

1.   MFIs can use third parties to carry out activities that they themselves would normally have undertaken. I have seen some MFIs outsourcing significant parts of their regulated and unregulated activities and these outsourcing arrangements are also becoming increasingly complex.

2.   Outsourcing has the potential to transfer risk, management and compliance to third parties (group or center leaders) who may not be regulated (like the MFIs). An example is the preparation of KYC documentation by the agent (s).

3.   In these situations, how can the MFI remain confident that they remain in charge of their own business and in control of their business risks? How do they know they are complying with their regulatory responsibilities? How can they demonstrate that they are doing so when regulators ask them? Most importantly, how can they assure themselves that their agents (group or center leaders) and/or other 3^rd parties (local leaders) are not engaging in practices - that could contribute to failure of their delivery model and cause a lot of problems for them (the MFIs) on the ground - as has happened in Andhra Pradesh now? I strongly believe that this is one of the major causes for the current problems in Andhra Pradesh

For the record, I must state that, while some MFIs continue to deny the existence of agents (also called as broker agents), I have personally seen enthusiastic center leaders and/or group leaders (and ex-field workers) being treated/used as local agents. Again, let us get this clear. Agents, are per se not bad but they need to be used under a proper framework and with appropriate training and systems. In fact, the late Shri Sitaram Rao (a close dear friend and very knowledgeable colleague) and I, have discussed several times (in late 2006/2007) that, in a few years time, micro-finance in India could indeed have the equivalent of direct sales agents (DSAs), provided they are well trained and used appropriately.

However, that has not happened and agents are not under a framework currently and thus, they could pose a serious threat to the whole business of micro-finance - as has happened in Andhra Pradesh now – through their indiscriminate lending to shared clients/JLGs, use of coercive recovery practices, disbursements of benami and non-existent loans, charging higher than stipulated interest rates and the like.

Therefore, I think the time has now come for us to take a call on this phenomenon and either regularize it and bring agents under a proper (regulatory) framework or ban the use of agents and ensure that MFI staff themselves cater directly to the clients…Here are some of my suggestions in this regard for The RBI Board Sub-Committee…not necessarily in any order of importance…

Some Suggestions for Consideration[i][1]

I.          MFIs Must Develop and Implement A Policy For Using Agents: MFIs seeking to outsource activities in micro-finance should have in place a comprehensive policy to guide the assessment of whether and how those micro-finance activities can be appropriately outsourced. The policy must mirror policy/standards set by the RBI in this regard

II.         MFIs Must Establish A Comprehensive Outsourcing Risk Management Program: MFIs should establish a comprehensive risk management program to address the outsourced micro-finance activities and the relationship with the service provider (agent who could be group/center leaders/others). Otherwise, crisis like the present one will surely occur and therefore, it is in the interest of the MFIs do so.

III.        MFIs Must Periodically Assess the Impact of Their Outsourcing on Customers: MFIs should ensure that outsourcing arrangements neither diminish their ability to fulfill their obligations to customers[ii] and regulators, nor impede effective supervision by regulators. They should therefore commission an external appraisal of the same and also publish these annually.

IV.       MFIs Must be Careful In Selecting Agents: MFIs should have the appropriate due diligence in selecting third party service providers (Centre/Group leaders) – and that is not happening due to the burgeoning growth being pursued most MFIs. There should be minimum criteria for appointing an agent and the associations like MFIN, Sa-Dhan and/or INAFI could even have an agent certification course. When bad elements become agents under a loose coordinating framework, then the situation becomes a recipe for disaster as is currently the case in Andhra Pradesh today. In my opinion, the village level bodies such as those under Indira Kranti Pratham (IKP) or village level SHG federations are perhaps the most suited to becoming agents of MFIs and this needs to be explored seriously. In fact, this will make it a win-win relationship for all concerned.

V.        MFIs Must Have Written Contracts to Manage Agent Relationship: Outsourcing relationships should be governed by standard appropriately written contracts that clearly describe all material aspects of the outsourcing arrangement, including the rights, responsibilities and expectations of all parties including the MFI and agents, especially from a customer protection stand point. That is a very critical issue.

VI.       MFIs Must Have Alternative Contingency Plans, In Case of Political Risk: MFIs and their service providers (agents) should establish and maintain contingency plans, including a plan for sudden events and problems that may occur including political risk. There is no better example than the present Andhra Crisis

VII.      Confidentiality Aspects: MFIs should take appropriate steps to require that service providers protect confidential information of both the MFIs and their clients from intentional or inadvertent disclosure to unauthorized persons. This again has been a source of problems in Andhra Pradesh

VIII.      Regulatory Issues: Regulators should take into account outsourcing activities as an integral part of their ongoing assessment of MFIs. Regulators should also assure themselves by appropriate means that any outsourcing arrangements do not hamper the ability of the regulated entities (MFIs) to meet their regulatory requirements. Regulators should be aware of the potential risks posed where the outsourced activities of many MFIs are concentrated with a limited number of service providers (agents) as in micro-finance – the same person (center leader) acting as an agent for different MFIs and the multiple of sharing of JLGs and clients. This is again an aspect that has been witnessed in Andhra Pradesh

Therefore, it would be very useful if the RBI sub-committee looks at this phenomenon of outsourcing (MFIs using center/group leaders and others as agents), assesses the extent to which it is prevalent on the ground, ascertains the impact of (current) MFI outsourcing arrangements especially on customer protection aspects and comes up with a concrete proposal for formalizing the use of agents in micro-finance. Without question, either the agents must be formalized under a proper framework or they must be eliminated. Allowing agents to operate under an adhoc unclear (regulatory) framework (or even no framework at all) is surely a recipe for disaster as evident from the current Andhra Pradesh situation… This is one of the immediate issues in customer protection (in micro-finance) that the RBI Sub-Committee must address…as part of its mandate…

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[i]Source: Extracted and adapted from Thorat and Arunachalam (2005), “Market failures in Micro-finance”, Paper presented at the NABARD High Level Policy Conference at New Delhi.Not all MFIs have agents but there are some who do have and use them.

[ii] For example, KYC norms and documentation, done by agents tend to have problems and this is something that needs to be ascertained