The Business Correspondent (BC) Model in Indian Micro-Finance: Serious Regulatory Issues for Attention of The RBI and Lessons For Policy Makers Globally…

Ramesh S Arunachalam

Rural Finance Practitioner

Under the proposed BC model, a regulated entity (Bank) is to use a third party (either an affiliated entity within a corporate group or an entity that is external to the corporate group) to perform activities on a continuing basis that would normally be undertaken by the regulated entity, now or in the future – in other words, it would outsource activities to various kinds of business correspondents (other than NBFCs).

Thus, in the BC model, in effect, there is a transfer of an activity (or a part of that activity) from a regulated entity (Bank) to a third party (BC).

There is no doubt that financial services businesses throughout the world have increasingly used third parties to carry out activities that the businesses themselves would normally have undertaken. While industry research and surveys by regulators/others show financial firms outsourcing significant parts of their regulated and unregulated activities, especially because of cost and other considerations, there is no DOUBT in the fact that these outsourcing arrangements are also becoming increasingly complex and as a result, causing significant problems on the ground. The last few years have demonstrated a range of issues that require attention, when financial service businesses outsource activities…and these are highlighted below:

The most fundamental point is that such outsourcing, as envisaged in the BC model, has the potential to transfer risk, management and compliance to third parties who may not be as well regulated and supervised (as in micro-finance and/or the Corporates in the private sector) - especially in line with the financial functions that they may be performing (which certainly calls for an appropriate kind of regulation/supervision). Several concerns arise in this regard:

1.      In these situations, how can the regulator and/or the regulated financial service businesses (banks in this case) remain confident that they remain in charge of their own business and in control of their business/other risks? A look at the recent micro-finance crisis in India suggests that neither the regulator/supervisor nor DFIs/Banks (like SIDBI especially) were aware of any of the ground level problems/happenings in Andhra Pradesh and their REAL causes.

The presence of unscrupulous agents, rampant multiple lending, serious Corporate Governance violations, ghost clients and several other issues including violation of priority sector norms and the like were neither known/anticipated nor dealt with appropriately/nipped in the bud. This is a serious aspect that needs to be recognized by all stakeholders including The RBI and in turn, it calls for appropriate supervision arrangements with regard to the proposed BC outsourcing activities as well. From my limited understanding, I am not sure that these are in place and hence, my cautionary note with regard to upscaling BC type arrangements, especially using corporates. Also, the complete failure of the self-regulatory mechanism with regard micro-finance, over an almost a 5 year period is another aspect that needs to remembered…

2.      How do the regulated financial service businesses (banks in this case) know they are complying with their extant regulatory responsibilities? How can these regulated financial service businesses demonstrate that they are doing so when regulators ask them? Let us take the micro-finance crisis as an example again. There have been serious violations with regard to KYC and in many cases, the last mile end user clients are just not known. Imagine the consequences of this in line with the anti-money laundering regulations and global FSTF (Financial Services Task Force) recommendations. There have been many cases of lending to non-priority sector clients (including loans to founder directors) and there are no safeguards against these even as on date. Many a time, KYC forms include people who are no longer alive and I have personal documentary evidence of several such cases in AP and other states. Again, I am not sure that DFIs/banks have the capacity and ability to ensure compliance in REAL time and therefore, I would like to stress that arrangements like BCs should be upscaled, if and only if, banks demonstrate the willingness and capacity to have appropriate supervisory mechanisms in line with their regulatory responsibilities. We need institutions like SIDBI and commercial banks to be more accountable and transparent…with regard to the regulatory responsibilities they are discharging…after all, they mainly intermediate public deposits…

3.      Most importantly, how can the regulated financial service businesses assure themselves that their agents (=business correspondents), who are 3^rd parties, are not engaging in practices that could contribute to institutional and other failures including client level abuses? Again, as with the on-going micro-finance crisis, the banks and DFIs like SIDBI cannot do so with a good degree of confidence when the regulator/supervisor asks them. In fact, this turned out to be a killer assumption with regard to micro-finance – banks and DFIs assumed that MFI practices were good on the ground (let us give them the benefit of the doubt) and the regulator/supervisor also did do. The consequences are there for all of you to see and judge…a Macro mess (as Senior Colleague Al Fernandez would call it) with regard to micro-finance and financial inclusion on the ground. Anyone who states otherwise, is simply ignoring real ground level facts and perhaps trying to postpone the inevitable but impending collapse of the rural/alternative finance delivery system in India

Therefore, I would really hope that there is serious introspection into issues such as those given above before upscaling BC type arrangements, especially using Corporates. If the necessary safeguards can be built and implemented on the ground, then, there is perhaps a case for using BCs in India, although I still have very serious reservations with regard to using Corporates as BCs, as mentioned in my post of yesterday… http://microfinance-in-india.blogspot.com/2011/04/permitting-for-profit-companies.html

Last but not the least - when we deal with very vulnerable people, let us be extra careful and try to protect them from excesses and abusive practices that are so widely prevalent in micro-finance as well as the larger financial sector in India. The global financial crisis and the present Indian micro-finance crisis are still very fresh in memory and I am sure that all of you will agree that just as financial inclusion is a fundamental right and a noble cause, protecting clients is equally, if not more, important…

Jai Hind!

Have A Nice Day!