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Monday, March 28, 2011

Introducing a Self-Regulatory System For Micro-Finance in India: SUBSTANTIVE POLICY Issues for Consideration of The RBI and The Malegam Committee

Ramesh S Arunachalam
Rural Finance Practitioner

The Malegam Committee Report (MCR) has proposed a self-regulatory mechanism, through SROs/Industry Associations, as part of its four pillar approach. While the idea is fundamentally a good one, when ever one considers introducing a new self-regulatory system (or for that matter, reforming such an existing system), a number of important issues must be addressed. These are highlighted in the present post and hope the RBI and/or the Malegam committee looks into some of these issues.

Basically, the concerns include both (1) substantive policy issues on the design of the self-regulatory system and (2) process issues that arise in implementing self-regulatory reform. We take up the former in this post and look at the latter (process issues) in a separate post.

And policy makers should consider the following substantive policy issues in addressing whether self-regulation is appropriate for the concerned micro-finance markets and, if it is, how the system should be designed.

National Strategy for Development of Micro-Finance: What is the government’s (and prime regulators) strategy for developing the nation’s micro-finance industry? Any strategy should consider the structure and competitive position of the micro-finance industry, nationally, regionally and internationally. A strategy should encompass the following:

·         How to ensure that the industry best supports economic development?
·         How to enable the industry to foster market development, competition, and innovation to better meet the needs of clients in micro-finance?
·         How to alter/raise/revise standards of regulation and conduct to ensure that clients and other stakeholders (including investors and other participants) are treated fairly?
·         How to improve integrity of the micro-finance market in general?
·         How to achieve an appropriate cost level for regulation of the micro-finance industry?
  • How to ensure that the MFIs, FIs and various stakeholders have the business focus, competitive positioning, systems, and governance standards required to succeed in their missions?

·    Commitment to self-regulation: Do clients, investors, lenders, MFIs and other stakeholders have a sufficient degree of confidence in self-regulation to make the system viable, both today and going forward? Are the members of the SROs/industry associations committed to the concept of self-regulation, and are they prepared to invest the requisite time and resources? Do the regulatory authorities believe that use of self-regulation in the micro-finance industry is indeed appropriate?

·    Size and complexity of micro-finance industry: Does the micro-finance industry need, and can it support, multiple layers of regulation as has been proposed in the Malegam Committee Report?

·    Effective and efficient regulation: What approaches, according to the authorities and industry stakeholders (including clients), are likely to deliver the most efficient and effective regulation of the micro-finance industry? Do the benefits of self-regulation outweigh the potential extra costs and disadvantages? What about the issue of regulatory efficiency and costs - is it likely to be significant? Finally, can the conflicts of interest that arise be managed appropriately?

·    Regulatory priorities and key risks: The authorities, MFIs and other stakeholders should determine and agree on what regulatory issues and risks (the MCR lists several risks and provides some suggestions to tackle them) need to be prioritized. Does the existing system adequately address those issues and manage those risks? If not, how should the system be reformed to respond more effectively to the issues, and what role should SROs/industry associations play? This should particularly look to address in practical and feasible manner, some of the key issues that have caused the present day micro-finance crisis. With all due respect, it is the blog writer’s humble opinion that some of the proposed solutions in the Malegam Committee Report do not meet the criterion of practicality and feasibility.

·    Fairness and consistency: In choosing a particular SRO/industry association structure, the fairness and the consistency of regulation for different segments of the micro-finance (for profit, mutual benefit and not-for-profit) and larger financial services industry need to be maintained. This means that players in different segments of the industry that offer similar services should be treated equally. This is critical and the omission of not-for-profits and other legal forms in the MCR can perhaps be addressed at the SRO/Industry association level, even if the banking regulation act cannot absorb regulating these legal forms. This again requires close analysis and redressal perhaps

·    Funding: Who should pay for the cost of regulation? While industry players may fund government regulators to a significant degree in many countries, can MFIs and other stakeholders do that in the present context? Which groups of MFIs/stakeholders should fund a self-regulatory system, and how should the costs be allocated among groups or members of a group? Those issues are invariably contentious but need to be addressed as well and this is again something that has not been exhaustively dealt with in the MCR

·    Legal framework: Does or will an SRO/industry association have sufficient powers to perform the responsibilities allocated to it? If not, is changing the applicable/related laws possible in practice and feasible from an implementation sense?

First, in many contexts, most SROs/industry associations often have the statutory authority to perform their regulatory responsibilities, but they can also obtain or reinforce jurisdiction by specific contracts with its members. Second, because SROs/industry associations are private bodies, the countries’ civil code legal systems will also need to be examined for any limits that they may place on SRO’s/industry associations rule-making authority or regarding the extent to which the regulator can delegate activities to an SRO/industry association. Both of these need to be looked at by the MCR in the present context and addressed accordingly.

Some obstacles may however be addressed rather easily: (a) by relying on SROs/industry associations mainly to supervise compliance with regulations (this is a critical aspect of regulation versus supervision); (b) by designing effective working agreements; and/or (c) through MOUs to clarify the role and working relationships of SROs/industry associations with the regulator.

·    Supervision of an SRO/Industry Association: Does the regulator have the powers and the capacity to effectively oversee an SRO/industry associations operations? In some cases, a more limited role for self-regulation may be appropriate; for example an SRO/industry association that is mainly made responsible for supervision of compliance with regulations set by the regulator.

These and other issues will have to be looked at by the RBI and the Malegam Committee before finalizing the regulatory and supervisory arrangements for Micro-Finance in India…

PS: The above paper is based on various ideas and resources available and there are far too many resources to mention here but they are all gratefully acknowledged


  1. It would be self defeating to assume that MfIs could run on their own thru self regulation as the objective and strategy of MFIs is to catalyse inclusive growth and that would be possible only by hand holding by the state and or state run financial institutions.

  2. Dear Souren Ji

    Self regulation is part of any regulatory system and cannot be avioded and please look at the MCR carefully and two of their pillars relate closely to self-regulation. Therefore, given that it is an inevitable part of any regulatory framework (please wait for my forthcomming piece where I dwell on this in detail), at least we must build in sufficient safeguards and from that perspective your points are well taken.

    Warm Regards


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