Where Angels Prey

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Monday, January 24, 2011

The Malegam Committee Report on Micro-Finance: What’s On The Platter?

Ramesh S Arunachalam
Rural Finance Practitioner

The much-awaited Malegam committee report is laudable because it is the 1st committee report of (some) significance to attempt the creation on of a (national) regulatory framework for MF in India. The Malegam committee report must be strongly appreciated because it seeks to legitimize microfinance as an integral part of the Indian financial sector. By recommending creation of a new category - called NBFC MFIs (with associated conditions which are perhaps open for discussion) - the report has clearly positioned and mainstreamed micro-finance within the framework of the larger financial sector in India. This ensures that micro-finance will come under the purview of the RBI and no longer can microfinance be treated as a fringe activity or as an orphaned child in the larger Indian financial sector.

A second aspect that deserves appreciation is the fact that while the report has recommended continuation of priority sector funds for MFIs, it was however made it conditional - especially after recognizing some of the key problems like ghost lending, multiple lending, over lending and attempting to outline some measure to tackle them as well.

A third issue that merits appreciation is the fact that the report has sought to promote greater transparency with regard to interest rates…through various measures.

Fourth, the report has recognized and stressed the importance of off-site and on-site supervision of NBFC MFIs (including systemically important ones) while also alluding to the need for significantly enhancing the supervisory capacity of RBI with regard to micro-finance.

Fifth, the strong emphasis on corporate governance is note worthy and specifically, the committee has suggested that corporate governance rules will have to be specified (encompassing several issues) for NBFC MFIs by the regulator. A very critical aspect indeed…

Sixth, there are several other aspects in the report that require commendation:
·         The intent to ensure that the aggregate amount of loans given for income generation purposes is not less than 75% of the total loans given by the MFIs;
·         The strong desire to deal with multiple lending, over lending and ghost lending through several measures including better loan origination procedures, establishment of a credit bureau etc
·         The emphasis on having strong client projection measures in place including various codes for MFIs
·         The desire to keep NBFC MFIs out of the purview of state level money lending acts

That said, I am therefore a bit perplexed by the strong (initial) criticisms of the Malegam report…While stakeholders appear to have perceived several weaknesses in the report, I try to list some of these below and provide some explanations with regard to these issues, apart from suggesting ways forward. Many of these issues can (easily) be addressed by dialogue and discussion and do not take away the excellent work done by Malegam committee – that is a point that I would like to make clear upfront…Read on…

1.   The first cited issue is that the ‘implementation mechanisms’ proposed with regard to various suggested measures perhaps lack the required depth and detailing - but that is (only) to be expected in any such first cut broad strategy report. I think it would be unfair to criticize the Malegam committee report on the lack of implementation detail - after all, much of this can be detailed out only after the RBI accepts the various recommendations and I am sure that necessary precautions (by the RBI) will be taken with regard to codes of conduct, client protection measures, corporate governance etc

2.   A second aspect is the use of caps for annual family income, restricting it to Rs.50, 000/-. This is admittedly a suggestion that perhaps cannot be implemented on the ground. On the contrary, this condition could in fact serve to encourage local level corruption, as more and more clients and MFIs seek to get <Rs.50,000/- annual income certificates from the local village administrative officers (or equivalents). It would be impossible to enforce this and in the spirit of argument - “Do not regulate something that you cannot supervise” – it may even be better to remove this artificial barrier.

3.   A third issue is the capping of “overall interest” and “margins” as well as loan size and total loan amount outstanding - they are again not feasible to implement on the ground and can be easily overcome as shown by the past experience with SSI loan and other such (lending) limits.

The committee must also recognize that caps on loan sizes and total loan outstanding may be some what restrictive for the clients and perhaps even at variation with current RBI policy. Therefore, this aspect also needs to re-looked and adapted accordingly. Further, the capping of loan amounts and loan outstanding would severely hurt the clients (in the medium and long term) in their efforts to climb out of poverty. Hence, the committee may want to go with the existing RBI ceiling of Rs 50,000 for loan size as well as total loan outstanding and back it up by ensuring that MFIs have good loan origination and appraisal systems (especially, for large non-consumption loans to individuals, which must also be permitted) and appropriate ceilings for consumption loans (as already proposed by the committee)

The capping of interest could severely hurt the prospects of nascent/small MFIs and those operating in difficult terrains. More importantly, the resultant search for greater efficiencies will surely result in more short cuts being taken with regard to client acquisition, client engagement and the like - we all know what problems that (all of) this caused in AP in the recent past. Hence, the committee may consider removal of the capping on overall interest, while continuing to suggest the capping of the margins – but through more appropriate slabs and with greater flexibility to accommodate the diverse nature of Indian micro-finance and MFIs. This would be a pareto optimal solution indeed…

An alternative would be to completely remove these caps and go in for caps on return on equity and/or dividends…as this blog writer had proposed earlierhttp://microfinance-in-india.blogspot.com/2010/11/never-waste-crisis-use-it-to-get-micro.html

4.   Fourth, given the need for pluralism and choice, it would be appropriate if the committee recognizes and provides legitimacy/space for operation of other legal forms of MFIs including non-profits and mutual benefit institutions. Even if the RBI does not regulate/supervise them (and in all fairness, perhaps cannot do so in a legal sense without amendments to its own acts), this legitimacy provision will go a long way in ensuring that: a) banks lend to these institutions (I have already heard that some banks are telling some MFIs that only large NBFC MFIs will be supported hereafter); and b) usury laws are not used against them, in an operational sense, as has happened in Andhra Pradesh

5.   Fifth, even within the category of NBFC MFIs, the Rs 15 crore net worth requirement seems a big ask for the small and nascent MFIs. Therefore, it would be appropriate if the committee reconsiders this aspect so that all existing small and nascent players – both NBFCs and those NGO MFIs ready and desiring to transform - are not unduly inconvenienced. This seems fair from an equity (pun intended) perspective…

6.      Sixth, Sa-dhan has played a very important role in the development of the Indian microfinance industry and the requirement of an association having 33 1/3 % of its members as NBFC MFIs needs to re-looked at from a practical stand point. At any rate, not treating Sa-dhan as an MFI association will again be perceived as patently unfair and hence, this aspect also needs to be reconsidered…and perhaps changed accordingly...

7.      Seventh, it would be important for the committee/RBI to take cognizance of the (widely prevalent) agent model of micro-finance in India and address issues related to the use of agents – much of the multiple, ghost, over lending and recovery practices can be traced to the use of this fast tracked model that puts clients as the very last… Read on… http://microfinance-in-india.blogspot.com/2011/01/broker-agent-in-indian-micro-finance.html   

8.      Eighth, it would also be useful if the committee looks at the aspect of equity investment in MFIs and build necessary safeguards to ensure that what happened in AP does not recur again. Specifically, the aspect of MFIs growing very, very fast (through multiple, ghost and over lending), perhaps, on their volition and at the behest of (private) equity investors so as to provide greater and faster returns for themselves/investors/shareholders and get further investments at a premium and so on… needs to be looked at closely by the committee/RBI and strongly addressed…Other wise, we may have a few Satyam like situations down the road…

9.      Last but not the least, the report pf the committee, while providing a good framework for the future, perhaps does not adequately address the existing crisis situation (in AP and slowly beginning to unfold in Tamil Nadu) and issues around these – there are a large number of clients and JLG who have been shared at the field level, with each MFI reaching out to them, on a specific day of the week. For example, there are sometimes 6 MFIs sharing a JLG and its clients and this has been the REAL secret of the micro-finance growth story so far…Add to this the huge levels of indebtedness on the ground and I am not sure that the report provides any way out for these aspects…I hope that the committee and RBI look into and address these issues as otherwise, there would be no REAL way forward…

Overall, the Malegam Committee has done a highly commendable job with a very complex problem and that needs to fully recognized and well appreciated. It has shown the right strategic intent and direction for establishing a uniform national regulatory framework for micro-finance in India that attempts to put clients first…Ladies and Gentlemen, let us give the committee a Big Warm Hand…rather than JUST nitpicking on specific issues that can (perhaps) be sorted out through discussion and dialogue…Clearly, it is about time that we - stop being Penny Wise and Pound Foolish and - recognize the huge and legitimate platform for action that the Malegam committee has provided all of us…

Have a great day and wonderful start into the week!



  1. Dear Ramesh,
    This is a wonderful blog. Your views are highly balanced and enlightening. Thanks for sharing this.

    Vijay Kulkarni

  2. Excellent blog by Ramesh.The opponents of NBFC MFs are moralists which will not help larger reach out to the needy.Pragmatism is necessary coupled with better regulation to ensure to craete a win win situation .That is what Rameshs analysis shows .
    Thanks Ramesh informative articles

  3. Dear Mr. Ramesh,

    Nice post.

    Once the initial recommendations are refined and suitably accepted, I would additionally add that the Malegam committee should recommend the creation of an ongoing working sub-group or expert group that continues to be engaged with the sector for several years to come and that creates an ongoing implementable roadmap for delivery of other critical services that clients need. These include :
    - Savings ( through Bank correspondent and other means)
    - Pensions
    - Remittances
    - Livelihood development
    - etc.

    Bhalchander Vishwanath

  4. Dear Ramesh

    Thank you for summing up the salient points and your to the point recommendations.
    We have reproduced the same on the India Microfinance website.

  5. Dear Ramesh garu,

    As always I enjoyed reading this thoughtful analysis. Knowing your writing style, I think you have been too kind to the committee, perhaps because it may not sound like a good idea to take on a regulator. No doubt the report brings out some excellent recommendations that would go a long way in strengthening the sector. But I doubt if it has done justice to the industry as a whole.

    I am reproducing a response I wrote to Bonam Srinivas on MFP egroup for the benefit of readers of this blog:

    Viewing from the edge of the cliff where the industry stands today, any amount of life support would look like a great relief and such a the life saver must be commended. But my concern is not about that. Looking from a public policy perspective, Malegam committee's role may not be viewed just in light of current crisis but in strengthening financial inclusion agenda. They are expected to offer policy recommendations on need for RBI's regulation of the industry larger national interest.

    I agree that the committee provides much needed legitimacy to the sector by emphasizing the need for enhanced regulation. But what I fail to understand is how is this going to help in cases like AP. Most MFIs that were reigned in by AP government were NBFCs that were already under direct RBI supervision. This has not offered any sort of immunity to MFIs from state control, then what is it that the committee recommends that changes this? I doubt if this changes just by adding a suffix without suggesting necessary amends in state moneylending laws.

    The recommendations were hailed for heeding to the long standing demand for a separate categorization of NBFC MFIs. If this recognition was to come with tighter regulations - much higher minimum capital requirements, limited choice for borrowers, infringement on the fundamental right of citizens to join any number of groups they wish, price controls and killing competition - I am not sure if there anything to celebrate here.

    It has also been cheered that the committee asked the state governments to stay out of microfinance regulation. I don't understand though what is in the report that would stop state governments from doing what it did in AP again and again. What authority does RBI has in controlling state's populist actions. As far as I know - none. Then what use is the statement made by the committee after all?

    Instead of criticizing further let me offer some suggestions the RBI could consider before releasing the regulatory framework:

    1. Seriously consider the proposal of small finance banks. With the capital requirements proposed in the report it would be more meaningful if MFIs are allowed to offer savings services.
    2. Enable public-private partnerships by linking MFIs with state-run microcredit programs. Similar to SHG-bank linkage program.
    3. Bring all private microfinance players under one ambit, not just NBFCs.
    4. Consider extending banking correspondent model to MFIs - for and non-profits.
    5. Drop everything from the report that could stifle competition, threaten the existence of small MFIs, heighten entry barriers, make it difficult to reach remote and difficult terrains, limit borrower choice, limit lending methodology, discourage innovation and those clauses that are impractical to enforce.
    6. Consider expanding the definition of microfinance to include not just micro credit for all purposes but a full suite of financial services.
    7. Offer special incentives and tax breaks to MFIs seeking to reach underserved areas.
    8. Make it mandatory for MFIs to serve poorest segment of population (minimum portfolio %) with affordable loans and consider setting up cheaper source of funds - similar to priority sector for banking.
    9. Relax FDI and ECB norms for MFIs
    10. Finally, regulate not micro-manage

  6. Dear Sasi Garu

    Many thanks and I have enjoyed your analysis and responses as welll and I did with the one above...

    To clarify, the issue is not one of not wanting to take on the regulator - I have been fairly critical of supervision in Indian MF and also talked of regulatory failure here...I am sure you would recall my posts on that...

    That said, I have pointed out several issues that the committee would need to think about seriously and thanks for your views and let me look at them closely and your points are well taken...and I will incorporate them in a DISPASSIONATE holistic analysis of the report that I am currently working on and one which should be out in a couple of days

    Thanks again for your kind words about the posts I make...Honestly, I am evolving as a writer and I appreciate your feedback - both postive and negative

    Thanks once again

    Look forward to meeting you some day...Read a lot of your work and enjoy it...

    Warm Regards


  7. Ramesh - thanks for another good analysis.

    While each recommendation by itself is well-intentioned, the net effect may be disastrous. As many have argued, the proposed margin caps would force MFIs to make larger loans. On the other hand, the income caps will mean those loans are made to borrowers whose incomes less afford the higher debt. It seems possible within the proposed regulation that a borrower earning Rs. 50,000 per year could be given two Rs. 25,000 loans by two different MFIs working within the guidelines.

    What do you think, did I misread the recommendations?

  8. Sasi
    Thanks for your mail and the suggestions. At the cost of repeating some of the things I have the following to say

    - You may be aware that despite several requests from the sector till the recent past RBI was reluctant to regulate the sector as they felt it would stifle the growth. However, while giving the freedom, RBI put the onus on MFIs and Banks to act more responsibly. Unfortunately both the Banks and MFis have let it down, this si despite repeated warnings by RBI on various occassions, however, the going was so good that the MFIs felt that they have become super powers and none can dictate terms to them. At this juncture, let me say that the problem is always that of a few black sheep (be it be Banks /MFis), but unfortunately the price has to be paid by the sector as a whole.

    - The above lead to a lack of credibility on the MFIs/Banks and even the regulator.

    - Also, if for a moment we take a dispassionate look at the sector (more as a layman with no interests in the sector), and this is the card played by the state Govt (right or wrong... I dont want to get into this as it would open up a number of questions) is the suicides of the customer and the lack of customer protection measures under existing regulation. To have the act repealed the Govt needs a strong comfort from the regulator that the customer protection has been adequately addressed through the proposed changes/ suggested measures, hence perhaps RBI had no other option but to micro manage, knowing fully well that it doesn't have the wherewithal to handle this... But I guess it was left with no other option.

    Unfortunately despite this attempt the State Govt still feels that the RBI report is more to protect MFIs interest than the customers interest, so they want more micro management from RBI than what is proposed in the Malegam committee report... Not sure, how RBI would balance this... Ofcourse, the good thing is Malegam Committee has specifically suggested that RBI should come out with a detailed customer protection guidelines, which perhaps would give the state Govt some comfort to withdraw the monsterous act...

    - On the infringement of the civil rights of the clients, I have the following to submit, the problem of multiple/over financing in the sector has become so omni present in large pockets that it was looking like a bubble set to burst and pull down the sector... Everyone was aware of the problem but seemed helpless, all the attempts by Industry association were invain as none had the time or interest to work for a sustainable solution the debate on this continued endlessly till the Govt came down heavily and forced the MFIs to submit the data... You may be aware that within 2 weeks all the MFIs have submitted the data perhaps this is the only way things would work as we are used to learn the hard way.

  9. Also the regulators focus when introducing guidelines would be more to see on handling exceptions, so how do you ensure that the borrower is not becoming a member in multiple groups and threatening the very basic principle of peer pressure on which the model works....

    I also see no infringement on the civil rights as there is no restriction on the borrowing at the household level, he/she can borrow money from other sources individually, not under the group model....in any case there are several studies which show that the group model/ peer pressure does not work when the loan sizes go up beyond a particular limit could be Rs 15,000/- in some pockets which are remote and Rs 25,000/- in slightly better of pockets which are economically active...

    Given that there is such a hue and cry when the MFIs (by and large) are dealing with only a single product not sure if the regulator can afford to take the risk of opening up the savings to them, although the suggestion is a good one. Also, not sure, how many MFIs are equipped to transform into a Bank given their current systems and HR., in my view not more than 3/4.. Should RBI be looking at a special category of Banks for such limited players that too under the current circumstances..

    While we can separately discuss on the pros and cons of some of the suggestions, I really liked one idea of yours which is the public private partnerships.. on which I have been debating for a long time.... I really think there is a fantastic opportunity which is not getting the required attention..

    (a) MFIs in the name of sustainable business are charging commercial rates from the customers.
    (b) Govt is engrossed in using its own inefficient and ineffective channel filled with corruption to channelise the benefits.

    As it is proven that MFIs, are efficient and effective in reaching out the last mile, it would be interesting if the Govt and the MFis can explore and looking at ways of channelising the benefits available from the Govt. to the ultimate client be it be insurance, subsidised interest, housing, pension, loan schemes etc.

    To conclude, I feel once a special category NBFC MFIs is created and the black sheep is weeded out nothing stops RBI from going ahead with your suggestions below which are all a definite need for the long term sustainability of the sector. But the immediate concern for the regulator is to address the customer protection and other issues raised by the Govt.

    Thanks once again for all your comments

    Best Regds

    Bonam Srinivas