Where Angels Prey

Where Angels Prey is a novel by Ramesh S Arunachalam. Please refer to www.whereangelsprey.com for more information

Friday, December 31, 2010

Is An Andhra Pradesh Like Micro-Finance Situation Brewing in Tamilnadu As Well?

Ramesh S Arunachalam
Rural Finance Practitioner

I woke up in the morning yesterday to see MFIs back to front page news in my home state of Tamilnadu for some alleged MFI excesses in Vellore district (which, incidentally, abuts the Chitoor district of Andhra Pradesh). When I spoke to a close friend and colleague, he said that the MFIs were already in the news even a couple of weeks ago - in Salem district of Tamilnadu for coercive repayment collection.

The news items (see images[i] at end of this section) about the Vellore district incident pertained to staff of two specific AP headquartered MFIs, who were supposedly beaten up by the public because they used coercive tactics in loan recovery. The Police were also called and the matter is said to be under investigation.

Let me at the outset state that it is not my intention to malign any of the institutions but it looks like that some of our MFIs have not learnt their lessons despite the AP experience. When several men approach a single woman or set of women clients to collect a loan repayment installment, irrespective whether or not coercive tactics are used, the whole process will itself APPEAR coercive. I hope MFI leaders and CEOs understand this sensitive issue and the fact that it has the potential to get blown up – especially, in small shanty towns and rural areas in India. And unlike in Andhra Pradesh, there appears to be no political support (whet-so-ever) to this issue in Tamilnadu as yet and from what I have heard, the reactions of the public were spontaneous. So, the argument of the public or people acting, because of encouragement by the Government or politicians is neither valid nor appropriate, in the case of the Tamilnadu problem…In fact, when I first started posting in the DFN e group in September, the Andhra Problem had not become political and if the MFIs had handled issues appropriately, I am sure that the present day crisis would not exist…

I really hope that the Tamilnadu headquartered MFIs and their associations (please note that the word is plural as we indeed have many of them today) and state chapters act swiftly to ensure that the problem is nipped (right) in the bud…Some generic suggestions in this regard are given hereafter…for what they are worth and what they are not…

Use of Women Staff For Collections: First, I know that it can be very difficult when several men approach a woman client or a set of clients to collect repayment and that is something that MFIs should avoid at all costs. Even if a larger group is to visit the women clients (either singularly or together), please make sure that there at least a couple of women staff. That should cool the tempers if any and also help in redressing the perceptions about coercive recovery tactics used by MFIs

Plan with Delinquent Clients: A second aspect that can be done is for the concerned MFI(s) to sit down with the client and facilitate them to plan on how to manage their (own) delinquency. A lot of explaining (please see this as part of enhancing financial literacy of clients) will have to be done and clients must be made to realize that there cannot be compromises in loan repayment for financial institutions – otherwise, financial institutions will simply die. I have seen older MFIs, especially the women led MFIs of the 1970s/1980s, engage in such delinquency planning with clients – whereby a delinquent client, is helped to look and analyse her/his cash flows and come up with an assessment of when and how she/he will make the payment. The present day MFIs would do well to deal with delinquency in such a manner…

De-Emphasize Growth and Expansion: A third aspect is that MFIs must not lend indiscriminately and make loose statements about their growth and expansion plans. Even recently, an AP headquartered MFI was seen on Television in Tamilnadu stating that they have already disbursed RS Y000 Crores and that would be disbursing RS X000 crores in the future within a specified time period. The same MFI had talked of adding atleast 5 million clients over a year for the next three year (1.5 million clients in all) and had also stated that equity of RS 1500 crores would be required in addition to loan fund of Rs 40,000 crores. In my opinion, this is the most inappropriate time for an MFI to talk (or rather boast) about its past disbursement and expansion achievements and future disbursement and expansion plan – given today’s problems this is tantamount to Hara-kiri. The MFIs must genuinely focus on clients and would be better off in highlighting REAL measures (not just superficial social performance management issues) related to client welfare that they may be implementing, as part of their operations.

Reach Out to Affected Clients: A fourth issue is that MFIs must show real compassion for their clients, who have been affected by over lending (or multiple lending) and try and reach out to them. It would be a great gesture if the MF industry contributes even contributes a fraction of its earnings to creating a debt redemption fund and/or relief package fund – for those families affected by high levels of indebtedness. Something which I have been advocating for a long time and something that has sadly not happened, despite repeated requests to MFIs bosses, post Andhra Pradesh

Be Sensitive to Genuine Client Delinquency: Another related issue is the aspect of being sensitive to genuine situations that may cause client level delinquency. I was having a conversation with an expert, often called the father of Indian micro-finance – a man who has contributed significant time to building up the Indian MF industry. He gave me an excellent example of sensitiveness to client situations and I appreciated what he said and the organization that is supposedly doing this…there are three unique features according to him… a) If a client is genuinely unable to pay a specific week’s installment, when she comes the next week, make her pay only one week’s installment (although two installments would be due) and instead extend the loan term automatically by one week; b) For a week’s extension in loan term, make sure that there is no commensurate penal interest; and c) Ensure that the staff do not have incentives based on disbursement or repayment or any other such aspect and therefore, reduce/eliminate motivation to over sell or over lend

So what practical steps can be taken by MFIs in Other Places to prevent the crisis from spreading?

As a first step, sit down as a group of MFIs and identify POTENTIAL areas where trouble could erupt – a) areas where there are many MFIs operating and multiple lending and indebtedness are high; b) areas where there is significant sharing of JLGs and clients among MFIs; and c) areas where client livelihoods are very weak and vulnerable and MFIs have been making multiple loans to get back past loans.

Engage with clients in these areas on a regular basis and attempt to ease the situation through various means. This could include MFI consortium based collection, use of larger number of women field workers to collect loans, some loan restructuring on a case by case basis and the like. Of course, while this would be short term in orientation, for the medium and long term, the concerned MFIs must address the crucial issue of how they would apportion the shared JLGs and clients – so that multiple lending and indebtedness are minimized in the future. The state chapters of the concerned associations should take the lead in this regard

Second, the MFIs must also start orientation meetings with civil society at the grass-roots in the various field areas…to clear up perceptions…Where necessary, they must own up past mistakes (without being defensive) and provide a credible assurance (backed by action) that the same will not be repeated in the future…the MFIs could also start to win back the community by engaging in (or at least supporting) activities for the welfare of the community (including clients) and general people in these areas.

Third, the MFIs must refrain from making irresponsible and boastful statements to the media and this is a very critical aspect. Much of what they have said has come back to haunt them and I just did an exercise of compiling statements by MFI and MFI association leaders on the Andhra Pradesh crisis (both Krishna and that of 2010) and I was astonished by what I saw…will post on that separately…

Fourth, for MFIs that are found to be using coercive recovery tactics and engaging in other unsound practices that affect the well being of clients, the associations concerned must take up the matter and ascertain the facts immediately. And then, the associations should take swift action against member MFIs who have violated and/or are violating the agreed codes of conduct. Please note that the 2010 Andhra Pradesh micro-finance crisis happened because the associations concerned did not take any action against the errant MFIs (both in Kolar and Post Krishna in Andhra Pradesh), despite knowing that there were some of their members who were not following the agreed codes of conduct. Therefore, acting against the black sheep in their flock is a must for these associations – that will restore some crediability for them and beleaguered Indian micro-finance industry…

Fifth, reacting to the above post, Mr Hugh Allen (taken from his comments) notes, “The prescriptions for resolving this (Tamilnadu) crisis must take into account two fundamental elements: 1. The importance of savings; and 2. Structuring loan products around flexible repayment schedules. Poor people are better served by savings services because they protect and build assets and reduce vulnerability and risk. Offering loan products that are matched to seasonal household cash flows instead of matched to risk policies determined by an MIS would also be helpful. This is because the latter recognises and adapts to irregular household cash flows (instead of simplistic risk assessment determined by a formula)."

While the above points are well taken and agreed, savings is not mentioned explicitly because currently, there is a regulatory barrier to tap savings. Also, much of what I have suggested above are actions that can be immediately taken to prevent the crisis. Savings is a long-term issue and the central bank needs to convinced first and from my own understanding of the Indian context, the internal control and other systems in MFIs need a serious overhaul before they are permitted to access savings. The idea of flexible re-payment is sort of indicated in my post above (when I talk of delinquency planning and sensitivity to client needs) but I agree that cash flow based products and business cycle loan products would be very appropriate…indeed...and I will post on that separately...

Wishing All of You A Wonderful and Happy New Year!

Please See Relevant News Items...

[i] The news came in the Vernacular press and has been reproduced as is…apologies for readers who do not know Tamil but much of the issues stated there have been covered in this post…

Wednesday, December 29, 2010

Should Indian MFIs Have Access to Priority Sector Funds?

Ramesh S Arunachalam
Rural Finance Practitioner

Introduction: Priority sector lending is the public face of the policy support to financing low income people and sometimes, it gets more attention than required, and perhaps for the wrong reasons. My views on priority sector lending are given below…

Policy Context – Directed Credit and Financial Inclusion: However, before looking at the priority sector funds issue, it seems important to look at the overall policy environment in which priority sector financing is a major tool - for enhancing access of low income people to financial services - under the long standing directed credit paradigm, now subsumed by recent financial inclusion paradigm. A critique and analysis of the same is provided below…

In India, typically, financial inclusion (FI) is presently characterized by:

F  Preoccupation With Opening of Savings Accounts: The jist of this approach is that it deals with enabling low-income people to have access to bank accounts and remittance services. Thereafter, it is assumed that, many benefits will automatically follow – often proved to be killer assumption, in development parlance

F  Large Focus on Consumption Credit and Small Production Loans: While institutions (mostly MFIs) have provided low-income people and women with access to financial services, the focus has largely been in terms of delivery of credit. And within credit, the focus, at least over the last few years, has largely tended to be on consumption loans - small production loans do exist but appear rather small in number (pun intended), especially in relation to consumption loans. This constitutes the bulk of what we typically call as priority sector financing with regard to MFIs, often coming under the micro-credit category[i]

F  Low Outreach with Regard to Vulnerable Groups in Agriculture: Further, with the
priority sector financing, there are three other major issues: a) In many states, the Priority Sector Lending norm of 18% advances to Agriculture includes in majority, many of the non-poor (non BPL households); b) the share of agriculture in Priority Sector Lending (PSL) is not met in some states and it has been going down in few other states; and c) the thrust of the financial inclusion drive, while good, must be properly interpreted - not all excluded people are poor and vulnerable and not all included stay that way.

F  Lack of Suitable and Affordable Risk Management Services: In reality, several critical financial needs are yet to be satisfied for low income people.  I would put these under two major categories: a) formal/flexible voluntary savings[ii] (the most basic ‘insurance’ product); and b) health, asset, accident and life insurance tailored to client needs rather than insurer abilities – I will post separately on this. While there have been some attempts to innovate with regard to different types of insurance, there are few issues that deserve mention here: a) these innovative insurance services tend to be closer to the service providers abilities rather than clients’ actual needs; b) they are not affordable in many cases; and c) they often tend to be available to a small sub-section of people.

F  Lack of Appropriate Livelihood Financing: Yet another financial service that has been in short supply is ‘larger production and livelihood credit’, especially with a focus on post harvest/ production financing. While there have been some attempts to innovate with regard to livelihood financing, three aspects deserve mention here: a) where available, these services tend to be standardized services tailored to service providers abilities rather than clients’ actual needs; b) they are not affordable in several cases; and c) at best, they tend to elude a vast large majority of clients[iii].

The above two aspects of Lack of Suitable and Affordable Risk Management Services and Lack of Appropriate and Affordable Livelihood Financing are note worthy aspects because they again show the huge gaps between a great vision and intended strategy (The Recommendation of The Well Intentioned Financial Inclusion Committee) and actual implementation on the ground, which is narrowly focused on consumption and small production credit

Hence, from the above, we can understand that priority sector is (perhaps) used by banks to provide consumption and/or small production credit through MFIs to end users (low income people). And the AP crisis reveals some impact of the misuse of such financing…multiple lending…indebtedness…inability to repay etc…

Hence, from the above, we can understand that priority sector is used primarily[iv]  used by banks to provide consumption and/or small production credit through MFIs to end users (low income people). And the AP crisis reveals some impact of the misuse of such financing…multiple lending…indebtedness…inability to repay etc…

Access to Priority Sector for MFIs: Having set the broad present day context[v], and given today’s micro-finance crisis in India, the larger is question is whether MFIs should be allowed access to priority sector financing?

To clarify the specific provisions under priority sector, I reproduce the relevant sections from the RBI circular[vi] below:

After the Andhra Pradesh crisis, it is very tempting to argue that MFIs should not gain access to priority sector funds. Without question, it is perhaps true that the availability of abundant (and non supervised) priority sector financing helped MFIs to grow in an unhealthy and inorganic manner and there by resulted in higher levels of indebtedness among the target groups.

However, making MFIs ineligible for priority sector financing (even under these circumstances) seems to be an easy way out - one that will incentivise banks and financial institutions to further lend the savings of the poor to the corporates and others. Therefore, I am very clear that priority sector financing for MFIs must stay – in other words, MFIs must continue to have access to priority sector lending (PSL) funds, subject to certain conditions enumerated below. Also, these PSL funds need to be properly monitored and supervised by the regulators and other entities like banks involved. In my opinion, the lack of sufficient supervision and monitoring[vii] is as much a cause for the present micro-finance crisis as other critical factors and I will post separately on issues related to supervision and monitoring of priority sector funds

Therefore, knocking off MFIs from the priority sector list is inappropriate as it will permanently shut the formal financial services door to low income people and in fact, push them further into the hands of the informal financiers (broadly defined)…That said, we also need to ask the question as to why was priority sector lending established in the first place. Quotations from voluminous reports apart, priority sector financing was established to ensure flow of funds from formal institutions (mainly banks) to people and sectors who did not have access to these funds. And priority sector must continue to do that and more…as suggested below

Some Suggested Proposals:  Here are some initial proposals towards that…and much of the detailing would need to be done…


First, under the micro-credit category[viii], priority sector must continue to provide access to basic consumption credit, but subject to a ceiling. The current upper limit of Rs 50,000 per client does not seem appropriate – in the light of the recent experiences, it may be appropriate for RBI to set a limit to consumption credit thorough priority sector and I would be inclined to fix it at Rs 25,000 per client – Rs 15,000 for consumption purposes and Rs 10,000 for emergency purposes.

Second, under the same category, it must continue to provide access to basic (small) production and livelihood credit, subject to the existing limit of Rs 50,000 and this must be verifiable (if required) – both for purpose as well as end user. This limit could be in addition to existing consumption loan limit, but loans must made on a case by case basis, after judging loan absorption capacity of clients. And the sum total of all loans (consumption and livelihood) should not exceed Rs 50,000 at any point in time.

Third, provisions for larger and specialized livelihood credit, perhaps exist under the agriculture finance (direct and indirect) section of the priority sector and this can be continued but again verifiability and other aspects articulated below are critical

Thus, to summarise, priority sector funds could be used to incentivise the micro-finance industry as follows:

Additionally, the above priority sector funds could be accessible to all MFIs (not-for-profit, mutual benefit and for profit), subject to their meeting some (enforceable) minimum standards with regard to certain non-negotiables – governance and related issues, systems (HR, Portfolio Management, MIS, Finance and Accounting, Internal Audits, Internal Controls etc), client protection/literacy and other aspects (as may be required from time to time). Relatively small and nascent MFIs could have voluntary minimum standards to comply with and the real evaluations for gaining access to priority sector funds could be applied to growing and mature institutions, irrespective of legal form.

The RBI and the Malegam committee would need to devise a method for operationalising the above and it could be a third party audit/rating (without any conflict of interest) or other appropriate mechanisms including due diligence by the lenders forum or bankers association. It would have to be a yearly exercise, at the least and should not be cumbersome given that the number of growing and large MFIs are still few in number.

A final aspect where priority sector could be used to incentivise the flow of funds are the underserved areas and backward districts in India. Special recognition of MFIs that operate in such areas could be another instrument in the overall evaluation of MFIs suggested above…

These are just some initial thoughts and I will post again on the aspect of supervision of priority sector funds as well as the evaluation of MFIs suggested above…I really hope that RBI and the Malegam Committee do not take the easy way out and knock off MFIs from the priority sector list. That would be a huge disservice to the poor and low income people of India…

[i] http://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=5818. There could be more sections relevant depending on quantum of loan but these are the broad and most frequently used categories
[ii] By and large, in many cases that I have seen, the no frills accounts remain dormant and are rarely used.
[iii] While innovative MFIs/FFIs have tried to delivered such services to select clients, the larger and wider penetration of these services is still quite minimal.
[iv] I say primarily because there could be other categories used by banks under priority sector
[v] I have refrained from getting to issues related to origin of priority sector – the word first came to be used in the Indian Parliament by Former Prime Minister and Late Shri Morarji Desai in 1967, who was answering a question relating to investment in certain sectors
[vi] http://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=5818. There could be more sections relevant depending on quantum of loan but these are the broad and most frequently used categories
[vii] Again, this is an honest observation and my intention is not to find fault with any one. Rather, I think we must all objectively look at existing weaknesses and strengthen supervision/monitoring of priority sector funds
[viii] Micro Credit: Provision of credit and other financial services and products of very small amounts not exceeding Rs. 50,000 per borrower, either directly or indirectly through a SHG/JLG mechanism or to NBFC/MFI for on-lending up to Rs. 50,000 per borrower, will constitute micro credit.

Monday, December 27, 2010

Client Focussed Micro-Finance: Why Differences Exist Between Intended and Realised Strategies?

Ramesh S Arunachalam
Rural Finance Practitioner

There are many institutions that claim to be client centred and client focused but that is rarely visible on the ground. What I am saying is that there is a huge difference between intended visions (strategy) and realised actions (implementation on the ground). To understand this and various issues related to the present micro-finance crisis, I spoke to some front line and other staff in Indian MFIs and here is what they said (quoted verbatim and after translation in some cases) - I am merely sharing what I learnt to provide a staff perspective on the various happenings. Often times, staff have been blamed a lot for the present crisis but they too have a perspective and their side of their story...Read on...

Staff A – Field Worker in an MFI: The client focused vision is just for speaking at conferences and meetings. What happens on the ground is total different and we, the field workers bear the brunt. We are told to disburse, disburse and disburse so that targets are met, week on week, month on month and quarter on quarter – I have had senior branch and regional managers telling (and yelling at) me (during meetings) - Do whatever you have to but make sure that Y number of clients are enrolled and given loans in this period.

Staff B – Field Worker in an MFI: Who says that incentives systems based on disbursements do not exist. They do in reality, even if not shown on paper and I and several of my fellow colleagues have made a lot of money through disbursement incentives. In fact, there are also repayment incentives and that is why we have to be tough with the clients, under certain circumstances. Sometimes, I feel that we are caught - in between our MFI supervisors/bosses who want us to meet targets and recover at any cost and opportunistic clients who take every loan that comes their way but cannot repay after a certain level. We get shouted at by both groups of people as well...under these circumstances, client driven micro-finance is not possible to implement…

Staff C – Field Coordinator in an MFI: Initially clients used to be reluctant to take additional loans and I have personally coaxed them to do so, citing the benefits of taking an additional loan. I have even bought and given mobile phones to my clients from loan money and given the rest as cash to them...Now, the very same clients tell me that since they did not ask for the extra loan, they cannot pay back all loans together...as it is very difficult...the irony is that they now even ask for additional loan to pay back the earlier loans...the tables are turned now…and we are at their mercy…today

Staff D – Branch Manager of MFI: The pressures on me are so high and it is impossible to move at the very fast pace of growth all the time – I worry what will happen if people do not pay back loans as I know their income stream is weak and unpredictable. I am even more worried because my superiors perhaps understand the real situation and yet want me to disburse– this is a time bomb that is ticking away...

Staff E – Branch Accountant in MFI Branch: Zero PAR is the most important criterion on which our branch is judged and that is why all/most of our branch staff go to the any defaulting/ potential defaulter’s house on the same day and try and get the payment. To us, ZERO PAR is simply about ensuring 100% on-time repayments always and if we cannot get it from clients, we have to make over the delinquent payment from our resources and then recover from clients. Our institution will not accept anything less than 100% on-time repayment and our incentives are tied to not only loan disbursement but also 100% on-time recovery…we cannot afford to be client driven therefore…

Staff F – Former Field Worker in an MFI: It is great to talk about client oriented or client focused micro-finance but how to ensure its implementation on the ground? The performance targets and all other targets are numbers based – faster disbursement, more loan disbursement, 100% on time repayment and such factors. When this is the case, client relationships will naturally suffer and we cannot be doing things in client interest as we are minimising our contact with them to ensure that things get done efficiently and faster and we even did process mapping recently to reduce our lead time for loans. In fact, the past good relationship built with some clients may also be lost as, in the name of efficiency, we are literally running from one place to another disbursing, collecting, disbursing etc

Staff G – Former Regional Manager in an MFI: Post Krishna crisis, the same issues were discussed and many MFIs said that they would focus on the people but see what happened? Code of conduct documents were said to enhance client focus but they hardly got implemented on the ground. In reality, we are doing non-client oriented things that we were always doing - yet we are claiming to be working on client focused micro-finance.

Staff H – Former in House Trainer in an MFI: Self-regulation does not work on the ground…it can work on paper as enforcement is very difficult because of conflict of interest. There is so much of conflict of interest everywhere – for example, I am the CEO of my MFI, I sit on the Board of the MFI association, I am vice president of local chapter, and aspire to be its chairperson, I am on the board of the national banks/international micro-finance bodies and I or my friends are everywhere – So, no one can question me… and when I set this example, enforcing self regulation becomes a very difficult task and that is why the client oriented micro-finance promised in 2006 did not and will not take off…

Staff I – Former Branch Manager in an MFI: It is impossible to have client focused micro-finance without understanding the livelihood situations. And we are not anywhere close to understanding this…without serious livelihood financing…we cannot achieve client focus and be client oriented…so the fundamental micro-finance approach has to change and in favour of livelihood financing…to reduce vulnerability of low income people and enable them to tap economic opportunities in a better manner. Only then can we truly bring in client focused micro-finance…

Therefore, all concerned stakeholders including MFIs must introspect with integrity and try to build a good balance between traditional performance – i.e., so-called efficiency inducing processes, burgeoning growth patterns, enhanced returns and related issues – and client oriented performance measures. However, this cannot simply happen at the superficial level whereby so-called social performance management measures are just included - undoubtedly, the client related issues must AGAIN (they were when micro-finance started out originally) become an integral part of the whole micro-finance delivery process and through that get reflected in performance appraisal, measurement and reward systems in micro-finance (for various stakeholders). When this happens in totality throughout the micro-finance industry, then, we can perhaps see intended strategies being implemented on the ground…and client focused micro-finance really taking shape…

Please look out for the next post -  “Should Indian MFIs Receive Priority Sector Funds: A Critical Analysis” – 30th December 2010

Friday, December 24, 2010

DFIs and Their Role in The Burgeoning Growth of The Indian Micro-Finance Industry: Some Critical Issues for Self-Introspection…

Ramesh S Arunachalam
Rural Finance Practitioner

While we looked the role of equity in detail, here are some statistics that I have put together on DFIs (and banks) who supported this growth during the period 2007 – 2010 in Andhra Pradesh and other states of India. Please see tables below

As you can see the SIDBI, has led the group and has consistently been ranked 1st among all DFIs/bankers in terms of loans disbursed (for last 2 years) and loans outstanding, in the last 3 years. As Mr Srinivasan (2010) argues in the State of The Sector Report[1], “ SIDBI almost doubled its exposure to Rs. 3808 crores during the year. At this level SIDBI had a share of more than 25 per cent of the market. “

This post is devoted to SIDBI and a companion post looks at the role of banks in the burgeoning growth of micro-finance. At the outset, let me clarify that the objective of this analysis is not to malign any stakeholder (s) – as I have repeatedly said, SIDBI and banks, have been very well intentioned in their support to the micro-finance industry and it is very unfortunate their well intentioned supported has been taken for granted by some MFIs. That said, it is however important that we learn crucial lessons from the happenings so that adequate safeguards can be built, going forward…that is the primary motivation in making this post…

While year on year, SIDBI has increased its outstanding portfolio and disbursement, what is interesting to note is that the growth in year 2008-09 has been phenomenal for SIDBI, both in terms of loans disbursed as well as loans outstanding. What makes SIDBI’s loans even more powerful is that it is real long term funding!

While SIDBI, has indeed played a fantastic role in the development of the Indian micro-finance sector – yet, at the same time, it was always a conservative DFI and that is why it is somewhat surprising to see that SIDBI experienced such growth. It would be therefore good for SIDBI management to introspect and understand the motivations for such unbridled growth during the last few years – especially, because of the consequences of huge indebtedness of the further onward lending by MFIs. They would certainly need to look into their processes and methods of sanctioning and disbursement and also their due diligence checks with regard to end use of loans – that SIDBI has not able to spot the on-going (multiple) lending spree in the Indian micro-finance industry and the associated indebtedness is indeed something to introspect about…

Another issue relevant here is that SIDBI is investing as a social equity investor in many MFIs and the impact of SIDBI’s investments is such it gives tremendous legitimacy to the concerned MFI. In other words, apart from the quantum of investments, the real additionality of SIDBI’s equity investments in MFIs lies in it associating its well established and highly regarded BRAND name with the concerned MFIs. Therefore, its nominee directors are under serious obligation to diligently perform their roles - as independent directors - in a professional and objective manner.

That SIDBI’s nominee director remained a mute spectator when the founder promoter MD of a large MFI gave himself a huge loan to buy shares in the same MFI is indeed a cause for some concern. That action is certainly not acceptable in any financial institution and is unquestionably an act of not-so-good governance. That the SIDBI nominee director again remained a mute spectator to the hurriedly convened board meeting of a large MFI - that too on a Sunday - to sack an immensely successful CEO who led the MFI through a spectacular IPO – is something that is again worrisome. Without question, as a social investor, SIDBI is expected to ensure appropriate and good governance of the MFIs and more so, among the ones where it has invested (its funds as well as its BRAND name) and has a nominee director on board. The above happenings clearly call for a serious review of the process by which: a) SIDBI makes equity investments into MFIs; b) it appoints nominee directors to MFIs; and c) it ensures accountability of these directors. This is another issue that requires deep introspection by SIDBI’s management.

Going forward, it would be very important to ensure that SIDBI provides the right kind of leadership for responsible (micro) finance – a recent world bank collaborated project - that SIDBI is currently implementing under its aegis.  The mechanism of the lenders forum envisaged in this project is welcome but it needs to be operationalised carefully, after incorporating lessons from the present AP micro-finance crisis and building necessary safeguards against any real and/or potential conflicts of interests.

Without question, SIDBI is legitimately one of the pioneers of the micro-finance (especially, the MFI model) movement in India and it has produced several wonderful innovations and contributed significantly to the development of the micro-finance industry – its staff have their heart and soul in micro-finance and they are among the most sensitive and experienced with regard to micro-finance and micro-enterprises. It is up to SIDBI and its staff to develop necessary safeguards to ensure that the micro-finance industry that they helped create does not collapse…under the weight of well intentioned and perhaps sometimes, over enthusiastic support for MFIs…This is something that SIDBI definitely owes this great nation…

[1] State of Sector Report is an annual report brought out by Access Development Services (New Delhi) and Published by Sage Publications (India)…

Wednesday, December 22, 2010

The 2010 Andhra Pradesh Micro-Finance Crisis Revisited...For A Factual Account of The Happenings…

Ramesh S Arunachalam
Rural Finance Practitioner

There has been a lot said about the role of the Andhra Government by many experts, especially from the international micro-finance and the larger development field. While their view points are appreciated, I would also like to set the record straight as a neutral observer...as some one who has closely followed the Krishna crisis as well as the present Andhra Pradesh micro-finance crisis…We need to set the record straight because some crucial lessons exist for all stakeholders and they have, thus far, been ignored…
At the outset, let me clarify that I am not in favour of the ordinance and/or bill that were promulgated/passed by the Andhra Pradesh government as I feel that micro-finance is micro-banking and its regulation (framing of rules) and supervision (ensuring adherence to these rules) should come under the purview of the Government of India and especially, The Reserve Bank of India. I have already strongly put forth this view in my previous posts. The fact that the NBFC MFI model is the dominant one in Indian micro-finance as of today, lends considerable credence to the above argument...and I hope that all policy stakeholders recognise the above basic fact.
Let me now state things, as I have seen them unfold over the last few years...backed by relevant data where available…
The Precursor – The NABARD High Level Policy Conference: Much of the problems evident in the 2005/6 Krishna crisis were articulated by Dr Thorat (Then Managing Director, NABARD) and this writer, in a paper, presented at the NABARD High Level Policy Conference in New Delhi in May 2005. A Senior Joint Secretary, Ministry of Finance chaired the panel that discussed the above paper, and the discussions (with people at the plenary) were rather animated, as the paper and its presentation appeared to have ruffled a few feathers. That the paper provoked a lot of people, especially the proponents of the MFI model, was evident from the fact that the presenters for the next session, devoted to products and innovations, focussed almost entirely on issues raised in the above paper – rather than making their own presentations.
Senior MF industry stalwarts said (on record) that MFIs have good systems and governance and are not engaging in any kind of bad practices. I left the conference with an uneasy feeling – that somehow, the issues mentioned in the paper were going to prove critical to the survival of the micro-finance industry and yet, the micro-finance industry was dismissing the issues raised as either mere aberrations – whereas I knew for a fact that the malaise was indeed spreading fast like cancer…
So, when the Krishna crisis suddenly came up, I was not at all surpised…

The Krishna Crisis: The Krishna crisis of 2005/2006 was preceded by large-scale growth (large scale for the context that existed then). The Krishna crisis effectively started in March 2005, when the late Dr Rajasekhar Reddy, then Chief Minister of Andhra Pradesh, visited Guntur/Krishna Districts in the last week of march 2005 (I recall the date as March 29th, 2005) and asked the then collector, Mr Naveen Mittal (IAS) to enquire into the allegations against some MFIs, made by the then sitting MLA Mr Venkat Rao and others. A huge consequence of the Krishna crisis was that the partnership model of ICICI was done away with…and at least 50 branches of some MFIs were closed…to be reopened later…after assurances by the MFIs and key stakeholders…

Much of the why the Krishna crisis happened has been articulated in the earlier companion post…and I will not get into it here…but one point needs emphasis here… The micro-finance industry came together and promised several things to the Andhra Pradesh government…to cool the heat…
Commenting on the causes of the Krishna crisis, Mr Prabhu Ghate, in the State of the Sector Report notes, “One of the longer term causes was clearly the "quest for numbers" relating to outreach and profitability that is the main motivation of many MFIs. While extending the depth and breadth of outreach is clearly central to microfinance's mission of making an impact on poverty through financial inclusion, and while sustainability is essential if MFIs are to attract lenders and investors in order to grow, the crisis serves as a useful reminder that there are other just as important client-centred consumer protection objectives such as transparency in dealings with borrowers and being careful not to saddle them with more debt than they can handle. These are goals that apply equally to minimalist as well as more holistic microfinance. We are all responsible for building up a climate of expectations (including perhaps the preceding chapter!) that celebrates the interrelated achievements of rate of growth of outreach, efficiency, field worker productivity, etc. without always remembering that they can (i) lead to shortcuts in client selection and training, field worker training and sensitisation, and loan size determination, (ii) be used as the only criteria for incentive payments to field workers and (iii) put a degree of pressure on them that leaves no time for issues affecting client satisfaction, other than loan turn-around time, and progression in loan size etc.[i] [ii]

Accordingly, during the Krishna crisis in Andhra Pradesh in 2005/6, the buzz words, post crisis, were ‘code of conduct’, ‘client led micro-finance’ and the like. And many MFIs (backed by the major MFI association) gave assurances (some of them in writing) that would not engage in multiple or over lending, not use coercive recovery methods, not charge usurious interest rates, refrain from breaking up SHGs, reduce consumption lending and the like. They also promised to clean up their governance and various systems/practices - after several systemic issues were highlighted by the Government of Andhra Pradesh then.
Overall, the MFIs said that valuable lessons had been learnt from the Krishna crisis of 2005/6 and they would hereafter practice client led and people oriented micro-finance.
What happened in the ensuing years is now well known and is briefly articulated below:
1.      Code of Conduct: Sa-Dhan framed its code of conduct (see attached news item below) and assured the Andhra Pradesh government that it would ensure strict implementation of its code. The code was said to be pro-client and supposedly contained several features to alleviate client problems apparently caused by MFIs. The code of conduct was discussed at the subsequent Sa-Dhan general body meeting and also approved by its members who promised to adhere to it during their operations. I was witness to this event. The government of Andhra Pradesh was apprised of the above and several guarantees (including written assurances) were given by some of the MFIs, involved in the Krishna crisis. That few of the MFIs even gave letters in writing is a fact often mentioned by Dr C S Reddy, CEO of APMAS

2.      Banks Were Reluctant to Lend to MFIs After Krishna Crisis of 2005/6: Slowly, things started to get better for micro-finance institutions as the AP Government - on the strength of assurances given by the Micro-Finance industry - let go of its iron handed grip on MFIs and let them function again. However, commercial banks were still not forthcoming to lend to MFIs as some of the private sector banks had lost a significant amount of money during the Krishna crisis. Thus, despite some resolution of the Krishna crisis, the MFIs seemed to be stuck in a situation where they had little resources to finance their increasingly ambitious growth plans, which had not been altogether abandoned and/or altered after the Krishna crisis. Again as the Mr Ghate notes, One short-term impact of the crisis was a heightened perception of political risk among banks, who both increased interest rates, and reduced new lending to MFIs in AP, especially SHARE and Spandana, in the first few months of the current year.” [iii]

3.      Equity[iv] Lends A Helping Hand: This is when social equity investors (including some donors) provided the much needed relief to MFIs - by providing the MFIs with financial resources, they helped MFIs overcome the temporary liquidity problem. Aided by such social equity (investment) pioneers including donors, some MFIs re-started to grow and grow fast. They were rewarded almost concurrently as they received significant equity from other so-called social as well as commercial investors during the same period and thereafter. Please see tables 1, 2 and related figures below

4.      Banks Were Back to Financing MFIs: Equity investors had done the trick as post equity investments, the banks started to get back slowly but surely. Thus, progressively MFIs were also able to leverage higher amounts of priority sector bank funds (which in fact almost doubled as compared to each previous year). Led by SIDBI and supported by SBI, HDFC Bank, ICICI Bank, PNB, AXIS Bank and others, DFIs, banks and priority sector loans emerged as one of the biggest funding sources for MFIs. Please do not forget the fact that the biggest additionality of the equity funding was that it helped re-start bank financing to MFIs in a big way, in the aftermath of the Krishna district crisis… Please see tables 3a and 3b and 4a and 4b below

5.      The MFI Growth Story Again: With the above resource support, many of the MFIs (especially the large ones) were back to their older ways and they started to experience burgeoning growth from April 2007 to March 2009 - adding the largest number of active borrowers and disbursing the largest amount of loans in global micro-finance history, within a short time span.  Therefore, in many ways, these two financial years (April 2007 – March 2009) represent a watershed for Indian micro-finance and I believe that the seeds for the present Andhra Pradesh and Indian micro-finance crisis were actually sown then or thereabouts. That this period of phenomenal growth occurred just 1 to 1 1/2 years after the famous KRISHNA Crisis in Andhra Pradesh (2005/6) is indeed interesting and I think the remarks of Mr C S Reddy, CEO, APMAS (quoted from the CGAP Blog) put the various happenings in proper perspective:

“For almost six years, the MFIs have been asked to improve their practices on the ground. However, there is no improvement. After the 2005-06 crisis, the MFIs came up with the voluntary code of conduct. Its implementation is yet to begin. The SHGs and their federations suffered a great deal due to the exponential growth of the MFIs without any regard for the SHGs.

In 2005-06, MFIs made several commitments like reducing the interest rates, not indulging in multiple lending and that the recovery practices would not be coercive. None of those commitments were acted upon. They did not seem to learn any lessons from the previous experiences. MFIs have pushed a lot of credit resulting in many households in a debt trap.

MFIs have to demonstrate that they “walk the talk”. Those that seem to make comments in support of the MFI practices need to understand the practices on the ground. Responsible microfinance does not exist in practice” - Quoted from CGAP Blog, Crisis or Opportunity.

Please see tables and figures below and annexes 1 and 2 for the data regarding this. The data is sourced from http://www.mixmarket.org/

6.      Large % of MFI Assets As Loans Outstanding: These large MFIs and their fast growing newly established professional peers - sensing a great opportunity of attracting more investment and creating wealth alongside the noble cause of enhancing financial access for the world’s poor – started to invest (and deploy) a majority of their new found financial resources as loan assets to micro-finance and other clients. This aspect is reinforced by a recent mix market article which says that in FY 2009, many of these MFIs had deployed almost 90% of their assets as loans to clients – a phenomenally high percentage indeed for any kind of financial institution. As the article notes, “In the aggregate, Indian MFIs have gone from investing roughly 80 percent of their funding into the loan portfolio in 2005 to closer to 90 percent by 2009. This change has also been a driver of growth for the largest Indian MFIs.[v]

7.      Extremely Supportive Policy Environment:  The best part is that all of the above happened in the wake an extremely supportive policy environment, which, among other things, called for turbo charging financial access and inclusion. Two mainstream Government of India committees – one on financial inclusion (chaired by Dr Rangarajan) and the other on financial sector reforms (Dr Raghuram Rajan) – made out very strong cases for turbo charging financial access/inclusion efforts and speeding up financial sector reforms to enable the greater/faster inclusion. Meanwhile, the MFIs, in the wake of the above enabling environment and the unfolding India growth story (India was growing at > 7-9%), were able to grow very rapidly and at a scorching pace – even as micro-finance was slowly but surely getting integrated into the mainstream financial sector in India. The fact of the matter is that the growth was caused primarily by the NBFC MFIs and 13 of the top 14 MFIs, ranked in terms of number of clients added between April 2007 – March 2009 were NBFC MFIs, which are supposedly well regulated and supervised. That the regulators and/or supervisors did not feel alarmed by this stupendous and unnatural growth suggests some kind of regulatory/supervisory failure indeed…

8.      The Kolar Micro-Finance Crisis of 2009: The Kolar crisis then happened in 2009 and the MFIs had to slow down a bit but MFIN was formed and suddenly a new code of conduct was being discussed and the idea of a credit bureau also took shape. The issues of multiple lending, competition, over indebtedness, aggressive growth, coercive collection etc still remained but they were slowly pushed under the carpet. With the Kolar crisis firmly tackled and no serious lessons learnt, the MFIs started to grow again and many of them received significant equity investments and bank priority sector funding, post Kolar.
9.      Run Up to IPO of 2010: All along, through the years, emboldened by their own phenomenal success, some MFIs had started to bring in radical changes in managerial compensation around then - Promoter, CEO and/or senior management compensation at MFIs (including stock options) sky rocketed and micro-finance started to be hailed as the industry of the future (just like IT was about two decades ago). Some of the MFIs, encouraged by some investors (who perhaps wanted a quick exit) and banks who were chasing them as the new messiahs, even readied for an IPO. Meanwhile, some of the MFI promoters/CEOs and senior management cashed-in on their new found wealth rather quietly. 

10.  The 1st Indian Micro-Finance IPO and Post Listing Aspects: Finally, the market leader MFI was able to secure permission for an IPO despite significant controversies on governance, systems and practices and it experienced great success, tapping almost US $ 360 million to become India’s 1st listed MFI. The shares of the market leader listed at a premium (around Rs 950/share) and they also zoomed after listing to reach an all time high of around Rs 1490 per share. The euphoria was short lived as the market leader dismissed its CEO after a spectacularly successful IPO raising serious doubts about governance in micro-finance and the dirty linen started to be washed in public – with the founder promoter, who came back as executive chairman on one side and the CEO on the other. Legal battle lines were also drawn...The markets always react and they did so in this case, and the publicly traded shares of the market leader MFI started their downward spiral...which is continuing even today…for other reasons…

11.  The Suicides in Andhra Pradesh: Meanwhile, around 80 odd client committed suicide and the reasons stated by the government were high levels of indebtedness caused by reckless multiple lending (by MFIs) to shared clients and JLGs, coercive recovery practices, usurious interest and the like – especially, in the wake of increasingly vulnerable livelihood situations caused by various factors including unseasonal rains, NREGA aspects and the like. While is would be unfair and incorrect to link suicides to MFIs loans alone, there is no doubt that MFI practices did indeed contribute significantly to the indebtedness situation on the ground.

12.  Micro-Finance as India’s Sub-Prime: In fact the situation prompted ‘Dr Y V Reddy, the former Reserve Bank of India governor - credited with saving the nation’s financial system from the 2008 meltdown – to label microfinance as India’s subprime[vi].’ “Ultimately, its something like subprime lending,” Mr Reddy told Economic Times[vii] in an interview ahead of his book release. “The same incentives are operating here... it was securitisation and derivatives that operated in the US. Here it is the priority sector lending by banks.”  “Yes, I agree with Mr Reddy when he says a lot of perverse incentives got aligned,” said Vijay Mahajan, chairman of BASIX, a micro lender, and head of Microfinance Institutions Network. “Here perverse incentives got aligned like in the US and in two years the sector went from helping the poor to preying on the poor.[viii]

13.  The Responses by The AP Government: The Andhra Pradesh government, caught in a very difficult situation, claimed to have no choice but to try and reign in the MFIs; It speedily enacted a hastily put together ordinance, which was not necessarily the most well drafted from a legal perspective but one that sufficient to stem the rot. Post ordinance, the repayments came down considerably and MFIs have also claimed that they are facing a resource (liquidity) crunch. The ordinance has subsequently become a bill.

14.  The Malegam Committee Appointed by RBI: Meanwhile the Reserve Bank of India has appointed a Board Sub-Committee in October 2010 to look into the Andhra Pradesh (and Indian) micro-finance crisis while the ministry of finance is said to be readying a special package for MFIs…The Malegam committee is likely to submit its report in Jan 2011 and we all await this historic report…

Before I wind up this rather long but very necessary analysis, I would like to quote the mix market article[ix] which argues that, “three factors appear to have combined to support the growth of Indian microfinance:

·         Rapid increases in equity investment...
·         ...in an environment with easily available commercial financing...
·         ...and increasing investment by MFIs into the loan portfolio

None of these factors are sufficient to explain growth in isolation – many other sectors have rapid growth of equity or commercial financing, but without the level of growth seen in India. A focus solely on equity investment ignores the far-larger pool of funds provided by priority-sector lending or the changes in MFI portfolio management. Together these factors create a ‘perfect storm’ to grow loan portfolios rapidly and are thus under the microscope for the current crisis.”

Thus, while it is now an accepted fact that MFIs grew at a scorching unbelievable pace and perhaps did not engage in RESPONSIBLE Micro-Finance as promised by themselves, without question, we need to understand the happenings better in terms of motivations. In my opinion, the happenings and data indicate four major drivers for this unprecedented growth and they are given below:

  1. MFIs Grew Rapidly Because They Wanted Greater Investment and Better Valuation and Were Keen to Tap Capital Markets And Create Wealth For All Concerned
  2. The Financial Inclusion Drive by Policy, Donors and International Agencies Also Resulted in MFIs Growing At A Scorching Pace
  3. The Commercial Banks Pushed MFIs To Grow At A Burgeoning Rate So That They (The Banks) Could Achieve The Mandatory Priority Sector Lending Targets Which In Turn Was in Some Sense Driven by the Policy Initiatives
  4. Investors Who Paid a Huge Premium Sought Commensurate Returns ASAP And They Caused MFIs to Grow Very Rapidly

While the above are possible explanations, they need to be better explored and this has to be properly researched and understood by The RBI Board Sub-Committee – as only then can proper remedies, to cure the actual causes, be offered. Otherwise, the solutions provided may tackle just the symptom whereas the disease could still be spreading… I sincerely hope that the RBI Board Sub-Committee, looking into the micro-finance, calls for authoritative (emphasized as reliable/valid) data[x] on the above and analyses the same before outlining its prescriptions for regulation of the Indian micro-finance industry…This is a crucial step that will enable the RBI to take greater charge of the ‘orphaned’ Indian micro-finance industry that is desperately and urgently seeking a legitimate regulator…

[i] Footnote in the State of the Sector Report: Ironically, Spandana was widely lauded by the MFI community for being a highly profitable MFI, and for having unusually high efficiency with extremely low operational costs. It was not clear to most observers at the time that these were being minimised at the expense of repercussions on client
satisfaction. On the other hand Spandana's profitability had attracted adverse political attention well
before the crisis, in response to which Spandana had indeed started reducing interest rates.
[ii] Source: Microfinance in India: A State of the Sector Report, 2006 by Prabhu Ghate
[iii] Source: Microfinance in India: A State of the Sector Report, 2006 by Prabhu Ghate
[iv] My usual caveats apply with regard to the data.
[v] http://www.themix.org/publications/microbanking-bulletin/2010/11/how-has-growth-indian-microfinance-been-funded
[vi] http://economictimes.indiatimes.com/news/economy/indicators/Microfinance-in-India-is-like-subprime-lending-Y-V-Reddy/articleshow/6972903.cms
[vii] http://economictimes.indiatimes.com/news/economy/indicators/Microfinance-in-India-is-like-subprime-lending-Y-V-Reddy/articleshow/6972903.cms

[ix] http://www.themix.org/publications/microbanking-bulletin/2010/11/how-has-growth-indian-microfinance-been-funded
[x] While the above are all serious possibilities, the lack of reliable and valid data prevents us from making a conclusive argument. For example, I have been struggling, despite my deep-rooted contacts in the Indian micro-finance industry to get reliable data on how bank lending to the micro-finance industry in India grew in the same period. Likewise, it has also been extremely difficult to get accurate information on the various equity deals that happened in Indian micro-finance during the last few years. I am close to finishing this and will post separately on the same, as and when credible data becomes fully available