Ramesh S Arunachalam
Rural Finance Practitioner
It has been commonly argued that MFIs have a very useful role to play in micro-pensions. However, there are inherent differences between the traditional Micro-finance and The New Micro-Pensions and this has implications for the use of MFIs in distributing Micro-Pensions. I try and look at some of these issues in a series of posts, starting with this post:
Nature of Product: First, micro-finance (read as small loans) consists mostly of short-term products (1 year normally). Some times, as in the case of larger livelihood loans (through producer organizations like SIFFS), they could have terms of two or three years. The traditional MF loan is an asset for the institution and a liability for the individual client and the MFI has to weigh the pros and cons of making the loan to the clients. Implied in this is the fact that the MFI has to trust the borrower to make the loan repayments and this also involves the MFI having some understanding of the low-income borrower’s (rather volatile) cash flow situation. That said, it can be argued that while estimating this cash flow (over a single year) is itself difficult, it can however be done with some allowances, that MFIs can usually live with.
On the other hand, Micro-Pension is typically a long-term product. There are two issues here: a) The requirement of the MFI to be able to be reasonably sure of (each) clients’ future cash flows and their ability to consistently make several future payments towards the product; and b) The aspect of the client having faith and trust in the MFI (and the fund manger where different), over a very long period of time – especially with regard to the fact that will (indeed) get back their money after this long period of time. So, from both the perspective of the institution (MFI) and the clients, micro-pension is a far more complex product than micro-finance. Therefore, the MFI management and systems including processes and procedures (apart from governance) must be such that they provide a very high degree of comfort (in terms of safety) and transparency to clients. This apart, the MFI must have the ability and local networks that enable them to have in-depth knowledge of their clients and their situations in the first place. This is also very critical.
Nature of Clients: Second, micro-finance primarily uses groups (often JLGs and other times, SGs/SHGs/NLGs[ii]) whereas Micro-Pensions will have to be individual oriented. And often times, when the JLG concept is used, at a center meeting, if one or two members do not repay the loan installment, the common practice is to get other members to pay – for and on behalf of that defaulting member (usually called peer pressure). This could turn out counter productive if the other members have all chosen to pay for a pension product and they do not have any surplus funds with them. In such a situation, they may have to forego making the pension payment (which is in their interest) and repay the loan installment of their peer, who has defaulted. This surely creates a goal incongruence between the MFI and its clients. The same situation also applies to MFIs that use a Zero PAR Policy (http://microfinance-in-india.blogspot.com/2010/11/zero-par-policy-in-some1-indian-mfis.html) as their staff will not come back without collecting defaulting payments. This again creates a conflict between the MFI policy and the clients interest.
Given the above, as a starting point, micro-pensions can perhaps be distributed by MFIs that have robust systems including an efficient and integrated MIS, good internal controls and appropriate internal audits. That said, those MFIs that have a good background in delivering voluntary savings services to low income clients are perhaps more suited for distributing micro-pensions as voluntary savings are individual centric. Further, it seems reasonable to argue that MFIs that have (and/or are moving towards) individual lending may have (such) systems more suited to micro-pensions.
Two other critical aspects deserve special mention here. One, MFIs that are in the early stage of their development life cycle are likely to have nascent/weak internal control (related) systems and hence, they should not attempt to even distribute micro-pensions. Two, MFIs that are very fast growing - tend to be susceptible to frauds as per historical data which has shown increasing frauds in such MFIs - should not be allowed to engage in micro-pensions. If you look at some of these specific cases (http://microfinance-in-india.blogspot.com/2010/11/has-burgeoning-growth-caused-increasing.html), the frauds seem to have occurred (primarily) due to the following factors:
· Lack of adequate management oversight and accountability, and failure to develop a strong control culture within the institution. Without exception, cases of loss reflect management inattention to, and laxity in, the control culture of the MFI, insufficient guidance and oversight by boards of directors and senior management, and a lack of clear management accountability through the assignment of roles and responsibilities. These cases also reflect a lack of appropriate incentives for management to carry out strong line supervision and maintain a high level of control consciousness across the entire MFI. This issue becomes more severe for larger and fast growing MFIs
· Inadequate recognition and assessment of the risk of certain activities, whether on- or off-balance sheet. Many MFIs that have suffered losses neglected to recognise and assess the risks of new products and activities, or update their risk assessments when significant changes occurred in the environment or business conditions including growth. Many recent cases highlight the fact that control systems that function well for traditional or simple products are unable to handle more sophisticated or complex products, especially in burgeoning growth. The period of April 2007 – March 2009 in Andhra Pradesh serves as a testimony to this, especially with regard to rapid growth as well as use of agents (http://microfinance-in-india.blogspot.com/search/label/Micro-Finance%20Agents)
· The absence or failure of key control structures and activities, such as segregation of duties, approvals, verifications, reconciliations, and reviews of operating performance. Lack of segregation of duties in particular has played a major role in the losses and frauds that have occurred. Again, this issue becomes more severe for larger and fast growing MFIs
· Inadequate communication of information between levels of management within the institution, especially in the upward communication of problems. To be effective, policies and procedures need to be effectively communicated to all personnel involved in an activity. Some losses occurred because relevant personnel were not aware of or did not understand the policies. In several instances, information about inappropriate activities that should have been reported upward through organizational levels was not communicated to the board of directors or senior management until the problems became severe. In other instances, information in management reports was not complete or accurate, creating a falsely favourable impression of a business (MFI portfolio) situation, and
· Inadequate or ineffective audit programs and monitoring activities. In many cases, internal audits were not sufficiently rigorous to identify and report the control weaknesses. In other cases, even though auditors reported problems, no mechanism (including action taken reports) was in place to ensure that management corrected the deficiencies. Finally and most importantly, the head of internal audits invariably reported to the CEO or COO at the MFI, who had little or no incentive to bring to the attention of the Board, lapses related to their own activities
Hence, while the case for using micro finance institutions in delivery of micro-pension services is strong because of their (significant) presence in the last mile with regard to low income clients, MFIs must however have very good robust systems as well as experienced personnel, who can, with some basic training, market and administer micro-pensions safely and efficiently. But, even then, it is highly preferable that MFIs play a distribution/intermediary role and leave the management of contributions to a professional fund manager, who can invest and manage the funds prudently in line with the extant regulations…
[i] Based on views of experts, discussion with MF industry observers and past papers like Asher et al 2007. I must specially state that Prof Asher and his wonderful papers have deeply influenced me with regard to Micro-Pensions and a lot of my ideas draw upon and/or elaborate on ideas from his different papers.
[ii] JLG = Joint Liability Group; SG = Solidarity Group; SHG = Self Help Group; and NLG = Neighbourhood Loan Group