Candid Unheard Voice of Indian Microfinance

Lessons from the Indian microfinance crisis, an open letter to Andrew Mitchell

2011-12-16T15:58:00.000+05:30

Ramesh S Arunachalam

Two crucial aspects in microfinance—client origination/targeting and loan appraisal—have been neglected in favour of unprecedented growth (caused by a desire to fully commercialise microfinance and rapidly enhance access/outreach of such services) and this has resulted in the present crisis

An open letter to the right honourable Andrew Mitchell, UK International Development Secretary, on lessons from the Indian microfinance crisis

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Lessons from the Indian microfinance crisis, an open letter to Andrew Mitchell

2011-12-16T15:16:00.000+05:30

December 16, 2011

Ramesh S Arunachalam

Two crucial aspects in microfinance—client origination/targeting and loan appraisal—have been neglected in favour of unprecedented growth (caused by a desire to fully commercialise microfinance and rapidly enhance access/outreach of such services) and this has resulted in the present crisis

An open letter to the right honourable Andrew Mitchell, UK International Development Secretary, on lessons from the Indian microfinance crisis

Respected Sir,

Good afternoon! I am delighted that The UK Department for International Development (DFID) is launching SAMRIDHI (a programme promoting microfinance and impact investment in India) in partnership with SIDBI in your esteemed presence (Sir) at 6pm today, the 16th December (Friday) at the British Council Division, Kasturba Gandhi Marg, New Delhi. Much as I wanted to attend the same, I am unable to do so and hence, this open letter Sir for your kind consideration and necessary action.

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Subjectivity and inconsistencies in microfinance code of conduct assessments

2011-12-15T17:48:00.000+05:30

Ramesh S Arunachalam
While there are many contradictions, inconsistencies and subjective interpretations in the CoC assessments which seem to draw the attention away from the real issues, we hope the sponsors and developers of the SIDBI-World Bank COCA tool recognize the fact that it far from being a reliable and valid psychometric measure of code of conduct assessments

While previous articles looked at the award of free points in the code of conduct assessments (COCA) reports and the peculiar findings arising therein, this article looks at issues of subjectivity and inconsistency in CoC assessments with tangible examples.

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The award of free points in microfinance code of conduct assessments

2011-12-15T15:58:00.000+05:30

Ramesh S Arunachalam

It is meaningless that the COCA tool rewards mere existence of policy and/or management statements of policy implementation when it should be really looking at solid evidence in support of implementation of the voluntary codes of conduct on the ground

An earlier Moneylife article (Have sophisticated thermometers ever reduced the temperature?) raised the issue of how the fastest growing NBFC-MFIs received higher (better) code of conduct assessments (COCA) scores in relation to the lower growth and not-for-profit counterparts. This peculiar finding has necessitated a close analysis of the eight SIDBI-World Bank sponsored code of conduct assessments found in the public domain (http://www.sidbi.com/micro/codeofconduct.html)

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How to ensure success of the Great Indian Microfinance credit bureau?

2011-12-14T17:56:00.000+05:30

Ramesh S Arunachalam

For better credit reporting and the credit bureau to work, ‘the boards of MFIs’ must be able to re-orient their organizational vision to one of responsible finance—this means they will have to move away from their desire for ‘super fast’ unnatural growth to balanced natural growth and normal profits

Okay, the preceding article summarized issues concerning the Microfinance credit bureau in India. If that is the situation, what then can perhaps make credit reporting better and also a credit bureau to really work in terms of checking multiple, over and ghost lending? In my opinion, there are several things that need to happen and I hope that the RBI, IFC, Omidyar and the microfinance industry work together in ensuring that these happen on the ground…

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The Great India Microfinance Credit Bureau: Questions that beg an answer…

2011-12-14T14:11:00.001+05:30

Ramesh S Arunachalam

The establishment and use of a credit bureau in an emerging market like India a very challenging task. If serious efforts are made, it could take several years from initial discussions to regular use of the credit bureau—one that produces reliable and valid credit information reportsin a transparent manner and not just some reports

It indeed very nice to see an increasing emphasis placed by many stakeholders on the use of credit bureaus (and better credit reporting) in microfinance. One such stakeholder is the International Finance Corporation (IFC), “which is holding a ‘South Asia Regional Workshop on Microfinance Credit Reporting’ in New Delhi on 14 December 2011. IFC and co-sponsors Omidyar Network launched phase one of MFI Credit Bureau project in India in June 2009 working closely with MFIN and the existing credit bureaus, as a result of which about 45 MFIs have started reporting to a credit bureau and 55 million client records have beenuploaded as 2011 draws to a close.” (http://www.microfinancefocus.com/ifc-expand-microfinance-credit-bureaus-coverage-india)

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Have sophisticated thermometers ever reduced the temperature?

2011-12-12T18:09:00.000+05:30

Ramesh S Arunachalam

The hype of the moment in microfinance is undoubtedly to subscribe to all kinds of code of conducts, client protection principles, social performance and other self-regulating initiatives. To set the record straight, had all the stakeholders really subscribed to these in the first place, there would have not been such a crisis in Indian microfinance

The ongoing Microfinance India Summit has a special session titled, ‘Client protection and Code of Conduct: From principles to practice and compliance’. The session is to be held on 13 December 2011 (1.30 - 3.00 p.m - Breakout Sessions). As the session introducer notes:

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What is said at conferences is very different from what is implemented in practice

2011-12-12T07:29:00.000+05:30

December 12, 2011 07:13 AM

Ramesh S Arunachalam

It is very easy to talk high flying concepts at conferences and also publicly claim that the same is being applied in practice. In reality, however, much of the intended strategies do not get implemented in microfinance and that is something that conference organizers, industry associations, regulators and stakeholders must take notice

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The Micro-Finance India Summit 2011

2011-12-11T17:39:00.000+05:30

Ramesh S Arunachalam

Social performance is the ‘in’ thing in micro-finance and an entire session is devoted at the Micro-Finance India summit towards the same and a special social performance report is also to be released at the Summit. The Micro-Finance India Summit session is titled, “Beyond the Buzz, Embedding Social Performance within Practice” and the emphasis of the session is described below

Session Outline: Beyond the Buzz, Embedding Social Performance within Practice

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The Microfinance India Summit 2011: Bridging The Hiatus, Building Trust?

2011-12-10T14:22:00.001+05:30

Ramesh S Arunachalam

Tackling informal collateral and collateral substitutes in Indian microfinance

2011-12-09T18:05:00.000+05:30

Ramesh S Arunachalam

Priority sector lending to MFIs—need for adequate supervision

2011-12-08T16:43:00.000+05:30

Ramesh S Arunachalam

The special category of NBFC MFIs: Lessons for the Department of Non-Bank Supervision, RBI

2011-12-03T14:23:00.000+05:30

Ramesh S Arunachalam

Dissecting the mechanics of growth in Indian microfinance

2011-11-28T15:10:00.002+05:30

Ramesh S Arunachalam

Let us stop crying over spilt milk but let us not forget what has happened in the past in the desire to achieve scale speedily. Going forward, it would be prudent for the Department of Non-Banking Supervision, RBI as well as proactive MFI boards (like Sahayata and SKS) and other stakeholders to look at growth trends closely

An earlier article in Moneylife (Lessons from the commercial microfinance model in India,) showed how the burgeoning growth of the commercial non-banking finance company (NBFC) model in Indian microfinance—during the period April 2008 to March 2010—perhaps led to the 2010 Andhra Pradesh microfinance crisis, which was the third in a series of crisis situations (the first being Krishna and second being Kolar) in the last six years.

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Life after Vikram Akula at SKS Microfinance: Some unanswered questions?

2011-11-23T16:18:00.001+05:30

Ramesh S Arunachalam
It seems unlikely that Vikram Akula’s exit will transform SKS Microfinance into a better governed and managed microfinance company. Only time can tell if and whether the exit of Vikram Akula would bring better times to SKS micro-finance, its investors and clients

The board of SKS Microfinance is said to be meeting in Mumbai today and it has been widely speculated that Vikram Akula is all said to resign from SKS Microfinance as its executive chairman. While the reasons for this are not exactly known, it has been suggested that the poor performance of the company during the last quarter has brought increased pressure on Mr Akula to resign.

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Lessons from the commercial micro-finance model in India

2011-11-21T15:30:00.000+05:30

Ramesh S Arunachalam
Fresh perspectives and radical (systemic) changes are required for developing an enabling micro-finance regulatory and supervisory mechanism that can really work on the ground for the benefit of large numbers of low income people

Moneylife reported last week that charges of serious misreporting and mismanagement have again surfaced in the public domain with regard to Indian micro-finance. Specifically, the article reported that Sahayata Microfinance Pvt Ltd, which was the darling of so many investors, lenders and stakeholders had apparently gone astray - with its now suspended CEO and senior management supposedly involved in serious misreporting and mismanagement. (http://www.moneylife.in/article/award-winning-sahayata-microfinance-is-the-latest-to-go-astray/21549.html)

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Award winning Sahayata Microfinance is the latest to go astray

2011-11-18T16:24:00.000+05:30

Ramesh S Arunachalam
Charges of serious misreporting and mismanagement again surfaced in the Indian micro-finance. The question is how could a company like Sahayata Microfinance, which was darling of so many investors, lenders and stakeholders go astray

I came across a very interesting news item in a newspaper today:

“Sahayata Microfinance Pvt Ltd has suspended the brass, including its chief executive, on charges of mismanagement. The Rajasthan-based microfinance company has also stopped fresh lending temporarily, to set its house in order. Following the suspension of management and poor performance, rating agency CARE downgraded its non-convertible debentures of Rs 19.5 crore from CARE BB+ to CARE B-. In September some board members pointed out prima facie evidence of the management’s misrepresentation of company performance. The board has ordered a detailed portfolio audit. The investors have placed an interim -management to control operations, to ensure the business continues uninterrupted. The company will resume loan disbursement from December. The board questioned chief executive, chief financial officer and other senior managers on charges of serious misreporting and mismanagement. ... While chief executive was suspended with immediate effect, the CFO and head of operations were stripped of their duties immediately. They were subsequently suspended.” (Business Standard, November 18, 2011,)

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Who Should Regulate Indian Micro-Finance?

2011-11-17T14:13:00.000+05:30

Ramesh S Arunachalam

Lack of a proper regulatory framework, including lack of proper supervision had played an important role in the disorderly growth of the NBFC MFIs

A recent news item stated that, “In its report ‘Trend and Progress of Banking in India 2010-2011’, The Reserve Bank of India (RBI) states that if State Governments start enacting their own legislations to regulate microfinance institutions (MFIs) including the ones regulated by the Reserve Bank, there will be plurality of regulation leaving scope for regulatory arbitrage. The responsibility for regulating NBFCs has been given to the Reserve Bank, thus, empowering it to regulate the NBFC- MFIs. If other States also come out with legislation similar to the Andhra Pradesh Government, it will raise concerns not only about multiple regulations but also about client protection, as borrowers would then be subject to different regulations. If there are separate regulations governing NBFC-MFIs in individual states, the task of regulation by the Reserve Bank of MFIs operating in more than one State will become even more difficult. This may also impact the business of MFIs, which are operational in more than one State, it says.” (RBI against State Govt regulating microfinance institutions,)

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Complaints of low-income MFI clients must be resolved at the earliest

2011-11-11T17:07:00.000+05:30

Ramesh S Arunachalam

If complaints of low-income MFI clients are resolved at the earliest, it would help avoid another crisis, as was seen in 2010

During the peak of the crisis, I remember Suresh Gurumani, the then CEO of SKS Micro-Finance, responded to my post in the micro-finance practice a Yahoo discussion group by saying that one of the most important tasks that he had accomplished at SKS (when has was there), was the establishment of toll-free number where low-income consumers could file their complaints. While I am not sure how the initiative has worked on the ground, it is imperative to follow-up on the idea for several reasons given below and it would be great if the proposed micro-finance bill explicitly brings in the following aspects—concerning complaints and consumer protection mechanisms—as part of the overall regulatory and operational architecture for micro-finance in India.

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Will the Micro-finance Bill address real ground level problems?

2011-11-08T16:03:00.000+05:30

Ramesh S Arunachalam

Responsible Indian microfinance in India: Still a pipedream year after crisis

2011-11-01T17:03:00.000+05:30

Ramesh S Arunachalam

The self-help group & bank- linkage model has been touted as the panacea for solving the current crisis facing Indian microfinance. But this linkage model faces a number of issues that need urgent attention

The Indian microfinance crisis continues and there seems no sign of real revival on the ground. Of late, we have been hearing that a savings-led model may have prevented the recent (ongoing?) Indian microfinance crisis! I am not sure that a mere savings-led model would have prevented the crisis and here is why.

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MFI savings mobilisation: Should they get an okay for tapping into public deposits and low-income clients?

2011-10-26T09:10:00.000+05:30

Ramesh S Arunachalam

MFIs should not garner deposits from low-income customers. The RBI, which will become the sole Indian microfinance regulator, also feels so—and there are a number of facts that support the apex bank’s view

There is an ongoing debate on whether MFIs (microfinance institutions) in India should be allowed to access savings from low-income people and/or access public deposits. While opinions range from a strong ‘yes’ to an absolute ‘no’, the debate has reached an emotional high with many stakeholders openly arguing for letting MFIs access savings of low-income people. However, a recent article in Mint suggests that (http://www.livemint.com/2011/10/18190834/RBI-against-letting-MFIs-colle.html), the RBI (Reserve Bank of India), which is to become the sole regulator of microfinance in India, has argued against letting MFIs garner savings from low-income people. It was a huge relief to read this, and without any doubt, the RBI is ‘spot on’ when it says that MFIs should not be permitted to access savings of low-income people.

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Has MFIN, one of the self-regulatory bodies in Indian microfinance, been accountable for its actions and statements?

2011-10-24T14:24:00.000+05:30

Ramesh S Arunachalam

Bordercrossing Books: “The Journey of Indian Micro-Finance”

2011-10-23T10:01:00.001+05:30

October 22, 2011 in Andhra Pradesh Microfinance Crisis, Book Review | Tags: andhra pradesh, bordercrossing books, india, microcredit, Microfinance, ramesh s arunachalam |

Book Review by philmader

Ramesh S. Arunachalam, 2011: The Journey of Indian Micro-Finance: Lessons for the Future. Chennai: Aapti Publications.

The microfinance crisis in India which broke out in fall 2010, first imperiling numerous borrowers and then an entire industry, is the most fundamental event in the world of microfinance since the Nobel Peace Prize in 2006. In hindsight, it may even turn out to be the defining moment of microfinance history – never before has the dark side of microfinance, and the vulnerability of the industry, been so brutally exposed to a global audience.

Naturally, these events have attracted a host of opinions and analyses ranging from simply blaming the Andhra government for bringing down a healthy industry, to accusing MFIs of having become worse than loan sharks. And yet, so far, we understand very little of why India’s vast microfinance sector went so far astray. Thankfully, people like Ramesh S. Arunachalam are out to change this.

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Trident Microfin is under a Corporate Debt Restructuring plan: How can Kotak Bank slap a legal notice on the microfinance institution?

2011-10-21T21:12:00.000+05:30

Ramesh S Arunachalam

According to certain media reports, Kotak Bank has slapped a legal notice on Trident Microfin for a dishonoured cheque. But the microfinance institution is under a CDR plan. This is a peculiar case—and there are a number of legal issues and questions surrounding this move

In the last couple of days, we have had news releases that claimed that “Kotak Bank has slapped a legal notice on Trident” (Kotak Mahindra Bank slaps legal notice on Trident, 19 Oct, 2011, PTI ), which is part of a CDR (Corporate Debt Restructuring) plan. And we have had various stakeholders condemning the action already. Moneylife decided to look into the various (legal issues and questions) surrounding this peculiar happening where a company committed to a corporate debt restructuring (CDR) has been apparently sent a legal notice.

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MFIN-NCAER study: Here’s the proof that microfinance agents are thriving in Tamil Nadu

2011-10-19T16:06:00.000+05:30

Ramesh S Arunachalam
The MFIN-sponsored NCAER study has acknowledged the role that microfinance agents are playing in places like Hyderabad and Jaipur. Curiously, Chennai does not find a mention in this study. Here’s some concrete evidence to the contrary

Yesterday (18th October), we had written on how microfinance agents have spread their tentacles far and wide across the country, and how they are breeding resentment against MFIs (See:MFIN-NCAER study unearths agents’ role in microfinance, but does not find these middlemen in Chennai). We had also written on how the MFIN-NCAER study acknowledges the presence of these middlemen, but the report has a number of loose ends.

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MFIN-NACER study unearths agents’ role in microfinance, but does not find these middlemen in Chennai

2011-10-18T16:28:00.000+05:30

Ramesh S Arunachalam

Agents have spread their tentacles far and wide across the country, and they are breeding resentment against MFIs. The MFIN-NACER study acknowledges the presence of these middlemen, but the report has a number of loose ends

As the Ministry of Finance and the RBI (Reserve Bank of India) are trying to solve the Indian microfinance regulatory puzzle, there is further evidence on the use of agents in Indian microfinance. The question to be asked then is whether and how the proposed Microfinance Bill will prevent use of such middlemen in the future.

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The National Rural Livelihood Mission (NRLM) should take charge of dry-land farming now

2011-10-15T15:54:00.000+05:30

Ramesh S Arunachalam

For implementing the inclusive growth agenda, it is crucial to prop up agriculture, the soft underbelly of our economy. Here’s what can be done

Inclusive growth is an area that we have been talking about for a few years now, but integrating agriculture into the Indian economy has been rather difficult for many reasons. Agriculture continues to be the soft underbelly of the Indian economy and unless the millionsⁱ involved in Indian agriculture are enabled to participate meaningfully in the growth process of the country, inclusive growth will remain an elusive dream in India. Let us make no mistake about that!

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The RBI and the Ministry of Finance should view the MFIN-sponsored NCAER study on small borrowings with a great deal of caution

2011-10-13T17:28:00.000+05:30

Ramesh S Arunachalam

Can a study sponsored by MFIN, the association of for-profit NBFC MFIs and conducted by NCAER to enquire into the operation of MFIN’s own member-NBFC MFIs—on aspects such as multiple lending, over-indebtedness and coercive repayment—address various issues in a fair manner?

Yesterday (12th October), Moneylife had written on how the Union Minister for Rural Development, Jairam Ramesh had said that MFIs (microfinance institutions) are not any sort of panacea and how the findings of a NCAER (National Council for Applied Economic Research) study does not provide a robust defense of MFIs (See: Microfinance institutions not the answer for poverty alleviation, says Jairam Ramesh ).

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Microfinance institutions not the answer for poverty alleviation, says Jairam Ramesh

2011-10-12T16:04:00.003+05:30

Ramesh S Arunachalam

Union Minister for Rural Development, Jairam Ramesh, released a joint study by NCAER (National Council for Applied Economic Research) and CMCR (Centre for Macro Consumer Research) on ‘Assessing the Effectiveness of Small Borrowing in India’ at New Delhi on 10th October. According to Mr Ramesh, MFIs (microfinance institutions) “are not answers to poverty alleviation and certainly not the panacea they like to see themselves asⁱ”

While Moneylife will be doing a detailed critique of the NCAER study (sponsored by the Microfinance Institutions Network, MFINⁱⁱ ), its methodology and findings separately, certain aspects of the study, based on material currently available in the public domain, deserve to highlighted:

First, it is very interesting to note that the minister’s interpretation (of the NCAER study findings) runs counter to the views of Dr Rajesh Shukla (Director of NCAER-CMCR), as expressed in two prelaunch articlesⁱⁱⁱ . In these articles, Dr Shukla argues, “An alternative source of finance like microfinance has come as a breakthrough… MFIs attempt to alleviate the deplorable situation of the poor and require freedom to operate”^iv .

On the contrary, after releasing the report, Mr Ramesh said, “the findings of the study did not provide a robust enough defense of MFIs vis-à-vis the self-help groups (SHGs).” The real comparison of MFIs should be with moneylenders (the informal sector) and not SHGs, he noted. He further added, “There was hype governing some of the MFIs. They set out to claim that they are solving India’s poverty problems. If they were modest in their ambitions, the vehemence with which their critics struck back would have been even much lesser… vehemence of backlash was directly proportional to the exaggerated nature of the claims of many of these institutions.” He made this statement at the release function while referring to the recent fracas in the functioning of MFIs in Andhra Pradesh.^v

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A workable microfinance & financial inclusion policy: How can it be formulated?

2011-10-08T18:05:00.000+05:30

Ramesh S Arunachalam

India needs a microfinance policy that is holistic, futuristic and yet practical in terms of satisfying unmet ground-level financial needs of low-income and excluded people. It should be developed through a truly bottom-up and democratic process with widespread stakeholder input and consultations

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Microfinance industry: Where is the self-help group-bank linkage model headed?

2011-10-07T12:39:00.000+05:30

Ramesh S Arunachalam
The SHG-bank linkage model is ideal for providing credit at the grass-roots level for weaker sections of society and for poor women. However, a few issues need to be addressed to make the model more comprehensive

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Indian microfinance crisis: What can international agencies like CGAP learn from it?

2011-10-04T17:10:00.000+05:30

Ramesh S Arunachalam

The Consultative Group to Assist the Poor could not spot the inherent weaknesses in the commercial microfinance model that it was unabashedly promoting. This is a reason for self-introspection by its board, senior management and other stakeholders involved in its governance. CGAP, as an institution, should become more accountable to low-income people, whom it exists to serve in the first place

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Microfinance securitisation: Impact of client-acquisition strategies and other factors

2011-10-03T18:36:00.000+05:30

Ramesh S Arunachalam

MFI corporate governance norms: How can these be put in place?

2011-09-30T17:52:00.001+05:30

Ramesh S Arunachalam

It is great for banks to appoint many nominee-directors to MFI boards, but they must act responsibly on the ground

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Ten practical steps to eliminate multiple, over and ghost lending at MFIs

2011-09-30T17:50:00.000+05:30

Ramesh S Arunachalam

The idea of thinking that a credit bureau alone could eliminate multiple, over and ghost lending and usher in responsible micro-finance lending seems very naïve. In fact, this could result in the credit bureau becoming a red herring rather than an actual solution. And unless the systemic issues are addressed, responsible micro-finance lending will remain a distant dream

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Microfinance industry must speak in a collective voice in PIL before Madras HC

2011-09-28T14:49:00.000+05:30

Ramesh S Arunachalam

MFIs, banks, SIDBI and respective industry associations must be given a fair chance to implead themselves into the Public Interest Litigation filed at the Madurai Bench of the Madras High Court

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Indian microfinance credit bureau: Why is it not fully operational yet?

2011-09-27T18:29:00.000+05:30

Ramesh S Arunachalam
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Seal of excellence and social performance management: Will they work in the agent-led decentralised microfinance model?

2011-09-24T18:09:00.000+05:30

Ramesh S Arunachalam

As concepts, a seal of excellence or social performance management will make good yardsticks to monitor Microfinance Institutions, but there will be practical difficulties in measuring these yardsticks and implementing them

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Proposed Microfinance Bill has to look at the centre leader as a microfinance agent

2011-09-23T17:06:00.000+05:30

Ramesh S Arunachalam

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Should for-profit companies be permitted to act as business correspondents for banks?

2011-09-20T17:51:00.000+05:30

Ramesh S Arunachalam
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The need for due diligence for business correspondents who deliver financial services to low-income people

2011-09-19T16:24:00.000+05:30

Ramesh S Arunachalam
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Redeeming the Indian microfinance industry requires MFIs to put their clients first

2011-09-13T17:14:00.001+05:30

Ramesh S Arunachalam

Low-income people want appropriate products and quality service and MFIs which focus on meeting client needs in an ethical manner will be the most successful in the long-term

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Establishing standards for effective management information systems for MFIs

2011-09-12T16:31:00.000+05:30

Ramesh S Arunachalam

A good MIS is absolutely necessary for MFIs to manage the interface with clients and conduct activities/processes in a manner that is efficient, effective and transparent

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Tackling the burgeoning agrarian crisis in India

2011-09-10T16:49:00.001+05:30

Ramesh S Arunachalam

Farmer suicides are a tragic indication of the seriousness of the widespread indebtedness caused by imperfections in the agricultural sector that must be corrected urgently. Good recommendations and well-meaning schemes are available on paper. But making them work for a large majority of the poor and marginal farmers is critical

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Re-engineering financial inclusion in agriculture is key to promoting inclusive growth

2011-09-08T17:32:00.001+05:30

Ramesh S Arunachalam

Proper financing of agriculture must enable and facilitate a wide range of innovative solutions that will strengthen the primary producer that is critical for fighting poverty in Bharat

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National Rural Livelihood Mission: Understanding the vulnerability of low-income groups

2011-09-06T14:51:00.000+05:30

Ramesh S Arunachalam

Financial inclusion of sugarcane farmers in modern-day India

2011-09-03T18:27:00.000+05:30

Ramesh S Arunachalam

In some ways, financing arrangements today penalise the small producer for mistakes of other parties. There is an urgent need to make financial products for low-income people client-sensitive and responsive

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Microfinance institutions should be permitted to transform into banks as it will help them improve services and reduce costs

2011-08-31T17:54:00.000+05:30

Ramesh S Arunachalam

Before allowing MFIs to become banks, the Reserve Bank of India must ensure that these institutions are equipped with adequate due diligence and sound KYC policies and procedures

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How and why did microfinance agents become a part of the Indian microfinance business?

2011-08-29T16:19:00.000+05:30

Ramesh S Arunachalam

It is important to understand that MFIs co-opted local leaders as agents in their desire to grow rapidly, to cope with the costs of servicing the last mile and maximize profits

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Can the marriage of MFIs with banks be a sustainable option out of the microfinance crisis?

2011-08-25T10:39:00.000+05:30

Ramesh S Arunachalam

There is a feeling among bankers that the acquisition of MFIs could strengthen the functioning of these institutions and enable the much-needed funds infusion. But any such takeover would first require an assessment of the portfolio of these MFIs

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Never waste a crisis: Some suggested incentives for the proposed microfinance bill

2011-08-19T17:56:00.000+05:30

Ramesh S Arunachalam

Linking the implementation of norms and safeguards to availability of priority sector lending can minimise the risk of failure while improving the protection of the interests of clients and investors

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Implementation safeguards against notorious agents are an imperative for the proposed microfinance bill

2011-08-18T17:13:00.000+05:30

Ramesh S Arunachalam

While macroeconomic changes are essential to iron out the chinks inherent in the industry, a close look is needed to look at the ground realities and the current agent-led decentralised microfinance model

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Independent India@65: Inclusive growth for Bharat remains an elusive dream

2011-08-17T17:20:00.000+05:30

Ramesh S Arunachalam

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Who should regulate the microfinance sector?

2011-08-14T15:27:00.000+05:30

Ramesh S Arunachalam

There are far too many serious issues that require attention so that they are not repeated again and the Reserve Bank of India or some central institutions cannot undertake this task as they do not have the resources or the local presence

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A number of short-term issues need to be tackled expeditiously for resolving the Indian microfinance crisis

2011-08-11T13:02:00.002+05:30

Ramesh S Arunachalam

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What went wrong with Indian microfinance?

2011-08-09T18:02:00.000+05:30

Ramesh S Arunachalam

For starters, here are some questions for SIDBI’s board and senior management so that they can initiate the task of learning from their past experience

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SIDBI must rework its microfinance strategy

2011-08-07T13:00:00.000+05:30

Ramesh S Arunachalam

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Crucial to have the right members on the Microfinance Development Council

2011-08-04T15:07:00.000+05:30

Ramesh S Arunachalam

The proposed Council to advise the government on the microfinance business should have proper representation from among all the stakeholders who will be alert to the task, while those who have specific business interests should be avoided

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Four ways to improve the regulation of compensation at MFIs

2011-08-02T18:09:00.002+05:30

Ramesh S Arunachalam

The compensation of senior management must be worked out by an independent remuneration committee constituted of knowledgeable members, and this process must be seen to be transparent and fair

As I wrote in the article on the Moneylife website yesterday, the regulation of compensation at microfinance institutions (MFIs) needs to be improved. In this report, I have outlined four strategies that the stakeholders in the Indian microfinance industry (regulators, bankers, investors, credit raters and others, like the associations of MFIs) should seek to achieve in our own little ways. These are practical things to try and implement on the ground, to ensure that processes in the governance of compensation at MFIs become transparent and are indeed perceived to be fair. (Read, "Regulating the compensation awarded to bosses of MFIs".)

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Governance of compensation awarded to bosses of MFIs

2011-08-01T21:48:00.001+05:30

Ramesh S Arunachalam

The senior management of these institutions that claim to be serving the poor, receive unusually high payments which is not determined through an explicit process

Compensation is indeed a very sensitive and critical aspect of governance in MFIs and it has serious implications for the detailed regulatory guidelines being prepared by the Reserve Bank of India (RBI) and the microfinance bill being drafted by the Union Ministry of Finance (MoF).

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Who is an independent director? Who should be treated as an independent director in NBFC MFIs?

2011-07-29T17:09:00.001+05:30

Ramesh S Arunachalam

MSME and Rural Finance Practitioner

It is critical to define the criteria for independent directors and implement this strictly in the interests of good governance; otherwise we could be in for a ‘blind date’ with yet another crisis

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Governance of MFIs: Time to implement ‘connected lending’ provisions of RBI circular of 2007

2011-07-28T16:40:00.000+05:30

Ramesh S Arunachalam

MSME and Rural Finance Practitioner

Is it appropriate for a company, established to provide access to finance to low-income people, to lend to its promoter and managing director to buy shares in the same company at par value?

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Local level supervision is critical to ensure consumer protection in microfinance

2011-07-26T17:24:00.000+05:30

Ramesh S Arunachalam

MSME and Rural Finance Practitioner

Self-regulation in the microfinance business has not worked for various reasons. Most importantly, it involves the distribution of small sums, almost totally in cash, to people who are vulnerable, and in areas so widely spread out that it is quite impossible to ensure fairness on a day-to-day basis

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Establish standards for MFI independent directors as first step to ensure good corporate governance

2011-07-23T23:25:00.002+05:30

The RBI and the Union Finance Ministry must provide clear guidelines on the appointment, roles, compensation and evaluation of independent directors for microfinance companies, critical for effective and ethical operations

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Increasing frauds, internal lapses at MFIs: Need to strengthen supervisory arrangements to protect the poor

2011-07-22T19:55:00.001+05:30

Ramesh S Arunachalam

A long list of instances of failures of microfinance institutions holds several important lessons for the RBI and the finance ministry on the regulation and supervision of the sector

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Does a five-star board guarantee good corporate governance?

2011-07-20T15:11:00.001+05:30

Ramesh S Arunachalam
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Learning from experience: The key to drafting a good microfinance bill for India

2011-07-16T18:13:00.001+05:30

Ramesh S Arunachalam

There are critical lessons from the crises we have suffered over the past two decades, that the authorities will do well to learn from, as they plan the course ahead for the microfinance sector

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Early Lessons From the Indian Micro-Finance Credit Bureau Initiative: Aspects to Look Into While Finalising the Proposed Micro-Finance Bill

2011-07-13T07:38:00.000+05:30

Ramesh S Arunachalam

Rural Finance Practitioner

It has almost been several months and the credit bureau for micro-finance is nowhere in sight – at least for the outsiders. This depressing (credit bureau) situation can be explained by several challenges that make setting up of a credit bureau, for low income people, especially complex in emerging markets like India. So what then are the challenges? Here are some aspects that I have identified through the credit bureau saga...Read on...

· Lack of strong and committed leadership to ensure that credit bureau is indeed functional within the stipulated timeframe – several deadlines have gone by and we keep hearing threatening statements (I even saw one today that the credit bureau would be operational soon) that credit bureau is ready and will be operational. It has been getting ready from Dec 2009 and objectively analyzing why these deadlines have constantly shifted would surely help us understand the real issues better.

· The credit bureau initiative has no serious regulatory support what-so-ever – I have not seen one statement from the RBI affirming the validity of the on-going credit bureau efforts and wonder what role will the RBI have in ensuring data integrity, especially given the proliferation of agents, multiple loans to shared JLGs and clients and also the lack of a unique ID. The ground situation is so messy that I doubt that any meaningful data will go into the credit bureau and I hope that the RBI looks into the various issues ASAP so that it is not caught on the wrong foot later.

· Absolutely unrealistic targets which means that quick wins and early results are not possible to show. This gets further exacerbated by the micro-finance industry’s underestimation of data quality and information technology issues which are dealt with later. Quick wins provide a great momentum and that has not been possible in the Indian scenario. This is what makes the credit bureau a real Red Herring! From Dec 2009, when MFIN has been formed to date, I have seen a number of public statements on when the credit bureau is likely to be ready and used and I would like some one to get into the reasons for the shifting goal posts. I, for one, feel that this is occurring because of lack of proper data at the grass-roots and also the use of the decentralized agency model at the grass-roots (please see following post: http://microfinance-in-india.blogspot.com/search/label/Micro-Finance%20Agents)

· Lack of reliable ground level data. A number of issues affect data quality in micro-finance and especially in India. There are both structural problems (agency models, shared JLG, shared clients) and bad credit-granting practices (over-lending, multiple lending, successive greening etc). Among the data issues observed are: lack of unique identifiers (people in villages especially can have the same names and initials); lack of location identifiers (e.g., village/street names and building numbering, especially in rural areas are hugely duplicated); unavailability of key credit information (e.g., especially because of the highly prevalent agency model); and poor data quality of available information (e.g., huge errors in data entry, data manipulation, frauds as you have been reading etc).

· A range of information technology issues. Different IT-related constraints prevent the smooth establishment of a credit bureau. Among the IT issues observed are: the very lack of a standardized core MIS system at the MFI level; weak IT infrastructure within MFIs (branches not connected to headquarters, etc.); basic IT commodities not available or not reliable (e.g. unstable power supply; slow or unreliable Internet connections); hardware and software provisioning issues (e.g., limited availability of hardware brands and models to ensure quick and efficient processing of very large volumes of repetitive data that characterize micro-finance); and lack of experienced service providers for infrastructure setup and maintenance.

· Design is often haphazard and not using accepted standardized best-practices. The problem is further compounded because MIS at the MFI level is not upto commonly accepted standards. Please see my post on MIS given earlier: (http://microfinance-in-india.blogspot.com/search/label/MIS)

· The lack of focus on execution to overcome lack of implementation capabilities. I also see no serious effort what-so-ever by the micro-finance industry to overcome the implementation bottlenecks. All I get to hear is, “the job is very difficult as this is a low income financial services industry and therefore what the industry has achieved so far is commendable”. What I find very strange is that the industry is low tech when it suits itself and especially, in terms of basic data and technology but a path breaker and innovator when it comes to the Governance of Compensation (Please see excellent article by John and Rajshekar in the Economic Times, dated Feb 2011).

All of the above issues do indeed make setting up a credit bureau in an emerging market like India an extremely challenging task – if serious efforts are made, it could take 3 or more years from initial discussions to regular use of the credit bureau (that produces reliable and valid credit information reports and not just some reports). So, folks, tune down your expectations…and I hope that the powers that be, who argue that a credit bureau will solve all problems in Indian micro-finance, do look into the above and other issues of practical relevance. I would also like the DFIs and commercial banks to come out and vouch safe the integrity and quality of the data being supplied to the credit bureau by MFIs – in terms of data integrity, internal consistency and physical compatibility with client existence and records and they must make themselves accountable and responsible for the quality and integrity of such data. Unless, all of the above are done, the credit bureau will just remain another idea like the multiple Codes of Conduct, supposedly operational on paper in the Indian micro-finance industry for a long time now!

Cheers

Have a Nice Day!

Client Sensitive Products Rather Than Interest Rate Subsidies or Loan Waivers Can Help Further Cause of Real Financial Inclusion in Agriculture

2011-07-13T06:41:00.002+05:30

Ramesh S Arunachalam

Rural Finance and MSME Practitioner

Even as the search for a micro-finance law to enhance financial inclusion continues, there are very small things, which if done, can stablise the inclusion of large number of low income people (farmers) and prevent them from getting excluded again.

Let me start with an example and I hope that all commercial banks and (any) MFIs involved in this space attempt to redress the same. I also hope that the RBI looks into this issue so that the tripartite contract farming products become more sensitive to the needs of the low income clients and are indeed fair to them

Let us take the case of sugarcane farming (while the problems mentioned here affect all farmers, the effect on marginal/small producers is much higher as they do not have diversified sources of income), which illustrates the need for available livelihood financial products to be made more client sensitive and responsive. Sugarcane financing is typically undertaken through contract farming in India, with tripartite agreements between banks/MFIs, sugar factories and clients.

For arguments sake, let us say that a marginal sugarcane farmer has 1 acre of land and normally, 35000 sugarcane setts (seeds) can be planted in this area. Assuming a germination of 60%, the farmer will have to gap fill the remaining 40% setts again, if he/she is to get a decent yield. Population is the key to getting a good yield but to maintain population, the farmer has to gap fill and often unilaterally bear the cost. And more often than not, for a variety of reasons beyond the farmer’s control, the setts supplied do not germinate fully.

For example, 35000 setts are typically planted in an acre. Each sett has 2 eyes and this makes it 70,000 eyes in 1 acre of land. Each eye grows to become a shoot weighing approximately 1 kilo in 11/12 months, depending on the variety. If 70,000 eyes germinate (100% germination) and each of them reaches 1 kilo in 11/12 months, then the farmer gets a yield of 70 tonnes per acre. If there is 60% germination, then the yield is 42 tonnes per acre (70000 setts x 60% germination x 1 kilo = 42 tonnes) and so on. Therefore maintaining the sugar sett population, at a high and optimal level, is very crucial to getting a good yield.

As part of the arrangement in contract farming, the farmer gap fills the sugar cane setts (in case of poor germination) and he/she bears the cost of poorly germinating seeds, which is typically added to the loan. Thus, the farmer bears the burden despite the fact that poor germination often occurs because of poor setts supplied by the sugar factory {mainly due to supply of more than mature setts or immature setts or setts from a ratoon (2^nd cycle) sugarcane crop and often caused by factors beyond the farmer’s control}.

Please note the fact that the cost of gap filling is always invariably borne by the small producer, even if poor seeds (setts) have been supplied by the sugar factory. The sugar factory is the key player here because it decides which farmer’s crop will go for seed, when it will be cut and supplied and the like. Therefore, under the tripartite arrangements, the onus for quality of setts (seeds) are almost entirely that of the sugar factory.

Likewise, there are many other instances in sugarcane cultivation, where the small producer is hit quite badly and there are several examples of other problems given below:

Supply of poor fertilizer and related inputs by factory,
Delays in supply of fertilizer which means that the farmer may have to apply the same at an inappropriate time,
Cane cutting by factory when the sugarcane is overripe (beyond 12 months),
The cut cane being allowed to lie on the ground and lose moisture and sugar content as a result of which there is considerable weight loss and consequent yield and revenue loss for the small farmer (This is a serious problem for small producers as the contractors arranged by the sugar factory for transporting the cane from the farmer’s field to the sugar factory insist on bribes/bata and “Bakshish” to lift the cane. If producers do not comply, they leave the cut cane to dry in the field and this can seriously reduce the yield and return for the farmers.).

While several other problems can be listed, the larger point is just a simple one – the financial product is simply not sensitive to the needs of the small farmer and it perhaps even penalizes him/her for the ‘wrong doing’ of other parties. Poor seed supplied by the sugar factory could cause lower germination but gap filling cost is always that of the farmer. The machines in the sugar factory could have been stopped (due to failure/fault) and as a result, the cane of the small farmer cannot be unloaded and thus, not weighed at all – there are many cases, where the small farmer has lost almost 50% of weight and resultant revenue because of lorries not being weighed for 3/4 days.

Now, despite all these (human-made) odds, the small farmer/producer has to repay the loan with interest. And if they cannot, they (This is true for all types of small producers including silk weavers in Kanchepuram or Malda/Murshidabad, different kinds of artisans across India, fishers in the south Indian peninsula and several others) become ‘untouchables’ and get excluded from the formal system – often never to get re-included again and left to the mercy of the ‘infamous’ money lenders

And often times, MFIs/Banks use the joint liability group mechanism to ensure that the loan gets paid by guarantors, even if the yield from the sugarcane crop is not sufficient to cover the loan. In some ways, the above financing arrangement is outrageous as it penalizes the small producer for mistakes of other parties in the arrangement which reduce yield and revenue.

The fair thing to do would be ensure sharing of the risk and also such costs among the three parties – producer, sugar factory and financier – this will enable alignment of incentives and ensure that there is congruence in all actions and inputs.

Similar analysis can be provided for other kinds of small producers – the key lesson here is that finance (livelihood or micro-credit), as it currently exists, is not at all fair to the client or producer. Hence, finance must focus on fair and quality servicing and attempt to be sensitive to the client needs and design and deliver products that are fair and useful to them. More of improper finance could only be disastrous and this is one of the main reasons as to why we see a cycle of inclusion and exclusion among low income clients and newer programs being initiated time and again, from days of the erstwhile IRDP.

As a beginning, the RBI must take up the cause of low income sugarcane farmers who perhaps number several million in number in India – a single client sensitive financial product would ensure that a large number of low income people are indeed prevented from getting excluded here. And the same analysis to ensure fairness to clients can be initiated with a variety of crop related financial products for low income people. These rather than any interest rate subsidy or subvention or loan waiver would serve the cause financial inclusion better.

Cheers

Have a Nice Day!

Will The Proposed Micro-Finance Bill Eliminate Ground Level Problems?

2011-07-12T08:43:00.001+05:30

Ramesh S Arunachalam

Rural Finance and MSME Practitioner

For all those who believe that the bill would be better without the intervention of the State government, here are a list of ground level issues from Andhra and other states and I would like practitioners to ask the question as to whether the proposed bill would solve any of these problems and if so, how?

1. Incorrect or misleading information (e.g., of interest rates on loans) provided as part of the sale strategy so as to influence sale positively for the MFI/institution. The MFIs have usually done this by specifying “flat rates” and thereby made clients to feel that the loans come at a low cost. Even when the intended strategy is to talk of reducing balance interest, at point of sale, this is most often mentioned as a flat rate.

2. Other (insurance) charges are usually not mentioned.

3. All terms and conditions not clearly mentioned to the client including loan installment delayed payment penalties etc

4. Use of inappropriate sales techniques (e.g., hard selling through multiple home visitation, promise to ‘green’ (refinance) subsequent loans, door-to-door solicitations, limited-time offers and even intimidation)

5. Request for kickback (bakshish) as a percentage/flat fee made by the field staff/agents/others

6. Fraudulent loan policy with part payment to client and part payment to field staff, as a result of which many problems occur at time of repayment. Please see increasing frauds in MFIs and this year the frauds in SKS have become larger and please see http://microfinance-in-india.blogspot.com/search/label/Microfinance%20Frauds

7. Loan contracts have inappropriate wording regarding client obligations that they (clients) may not understand

8. Written documents do not reflect the terms and conditions agreed before transaction was made

9. Clients not given copies of contracts, policies, records or other documents

10. Forced terms and conditions - e.g., client’s ability to repay or to amortize not considered

11. Contracts do not provide full disclosure of costs and other terms

12. MFI Process is reckless - e.g., without due reference to the borrower’s ability to repay or the clients ability to meet subsequent insurance obligations – resulting in over indebtedness and multiple lending

13. Giving false expectations on interest on loans

14. Products cost higher than disclosed because of hidden charges

15. MFI Products cost higher than disclosed because of difference between intended and realized pricing – stated versus implemented due to several aspects

16. Inaccurate recording of client’s transactions with a view to collect more money from clients – loan repayments with wrong balances in terms of loan outstanding and/or other aspects

17. Illegal and abusive behavior in the conduct of transactions such as harassment to force clients to pay; imposition of unnecessary fees or surcharges & consolidation of debts at a higher rate; provision of loan to pay insurance premiums and the like etc

18. Use of illegal/fraudulent methods of payment and collection – showing full payments as delinquent and pre-payments as regular payments and thereby taking away the clients’ money. Similarly using clients insurance payments towards loan repayments

19. Hard intimidatory actions (Zero PAR to other aspects) against a client who has no legal recourse or defense – in case of their being delinquent

20. Physically abusive behavior in the payment (loan repayment) collection process on a regular basis

21. Collateral like ration card or house patta (title deeds) are physically taken even though the contract specifies non-collateral lending. This is especially true for delinquent clients

22. Sharing of client information with other entities to enable cross selling

Aspects like the above cannot be monitored and set right by the Central Bank, associations, SROs etc. This can be done perhaps by the state and state alone. Make no mistake, if problems such as the above are brushed aside, the AP crisis will reappear again and I will in a series of posts highlight various ground level problems.

Cheers

Have a Nice Day!

Who Should Regulate and Supervise Micro-Finance in India?

2011-07-10T09:19:00.000+05:30

Ramesh S Arunachalam

Rural Finance and MSME Practitioner

Two aspects with regard to regulation and supervision deserve mention here. As noted in chapter 35 of my book, while the increased interest in regulating all of micro-finance is clearly welcome and certainly long overdue an important question here is: which specific institution is best positioned to perform the given responsibility? Should it be the RBI or NABARD or NHB or a new agency or even the industry associations (Sa-Dhan, MFIN or INAFI etc)? There are no easy answers but if the right process is followed, then I am sure we can get not only the framework right but also ensure that most appropriate institution(s) get(s) this complex job. Here are some lessons from past experiences that could assist in helping us make the choice.

A regulatory system is more efficient if the responsibilities are assigned to the institutions/bodies that have the powers, resources, skills, and knowledge to perform their roles most effectively. If one uses this framework of analysis, the assets of a proposed new body (Micro-Finance Development Council, MFDC) as per a special bill to be enacted in Parliament or SRO or similar organization (such as an industry association like Sa-Dhan or MFIN or INAFI) should be compared to the statutory regulators’ assets as they pertain to specific regulatory activities. This is a very critical exercise and must be done objectively and with utmost integrity. A related key question here is whether the proposed new regulatory body or SRO or industry association has, or can obtain, sufficient skills, resources, and capacity to undertake its responsibilities effectively. If sufficient capacity does not exist or cannot be developed, building a regulatory structure that relies on such new bodies, SROs or industry associations will not yield the desired result. It may be safer to go with the major (primary) regulator (s) in that case. That said, other factors should also be considered in choosing the institution to function as the authority and they include the following:

· Legal jurisdictions: Which institution has the legal jurisdiction to make rules and to supervise the micro-finance industry players involved – especially, given their diverse and varied legal forms?

· Power and authority: Which body has the power and authority to investigate, discipline, and impose effective sanctions on the micro-finance industry players involved? For example, most SROs or industry associations may have the power only to collect evidence from and to discipline member firms and their employees.

· Conflicts of interest: Do significant conflicts of interest arise/exist? Conflicts of interest always exist in regulatory systems, but vary depending on the type of regulation and institution involved. There are obvious trade-offs and these need to be evaluated as well

· Existing regulatory mechanism as a platform: Is there an existing regulatory structure that can serve as a foundation for the proposed new micro-finance regulatory system? Has it been effective and can it be used as a platform?

· Industry specific knowledge, skills and experience: Who possesses the knowledge, expertise, and skills required to regulate and supervise micro-finance?

· Industry information and data: Which institution has access to the information and data needed for the task of regulation and supervision? For example, would an SRO/industry association have access to all relevant records and information? Or could an SRO/industry association obtain the necessary access?

· Regulatory tools: Which body has the necessary regulatory tools (including information technology tools) for the complex task of micro-finance regulation/supervision?

· Resources including finance: Last, but not the least, which institution has the funding and resources to do an effective job and deliver in terms of regulating and supervising micro-finance in an enabling manner?

I really hope the various stakeholders approach the issue of finalizing the exclusive micro-finance regulator/supervisor using an objective and professional process, giving due consideration to issues such as those identified above

Micro-Finance Loan Assets and Supervisory Issues: Lessons From the 2010 Indian Micro-Finance Crisis

2011-07-10T09:17:00.000+05:30

Ramesh S Arunachalam

Rural Finance and MSME Practitioner

As noted in Chapter 31 of my recently released book, there are several peculiarities with regard to micro-finance loan assets and using these, I attempt to offer practical (regulatory and) supervisory lessons for governments and central banks, involved in building inclusive financial systems. These have much relevance for supervising financial inclusion and priority sector lending efforts and need to be carefully considered while devising regulation and supervisory arrangements–irrespective of whether MFIs (different legal forms) or business correspondents (various types of legal entities) are involved in the last mile intermediation.

First, micro-finance loan assets tend to be predominantly small in amounts but large in number. Second, while the transactions are also small, they are however numerous (repetitive) and most often, predominantly cash oriented – this makes it difficult to trace the source as well as end use. Third, the geographic diversity is huge and these assets tend to be spread over remote rural areas and/or urban slums that make it rather difficult to physically locate them. Therefore, establishing the identity of the micro-finance borrower and, hence, the loan asset becomes rather difficult. Fourth, while many of the lenders ask for KYC documentation, it must be noted that what is provided is far from accurate. Therefore, it is very easy for an MFI to show the same assets for different lenders and re-deploy the (surplus) funds in other activities like real estate and the like. There is increasing evidence of this happening in India. Much of this was highlighted, as far back as May 2005, in the (now infamous) paper of Thorat and Arunachalam (2005).

Thus, as noted above, these peculiarities can cause serious problems in supervision of micro-finance assets and especially, those who buy these securitized assets must be very careful as there is a good chance that there may be no real persons at all with the associated assets or the assets themselves may have been hypothecated or pledged to other lenders.

That said, what are some of the practical issues with regard to supervision of micro-finance assets, especially those created as part of priority sector lending? I attempt to outline some of the critical issues, which perhaps need to be kept in mind while drafting regulatory and supervisory mechanisms as proposed in the draft bill…Read on…

Supervisory Requirement #1: Ensure exclusivity of micro-finance assets: The only way to safeguard against the above problems is to ensure the exclusivity of micro-finance assets to specific lenders and that is something that only the regulator can mandate via regulation and ensure through supervision. As per this, each MFI will have to exclusively earmark certain number of whole branches/units across its portfolio and geographies to respective lenders. And this should not be done on a geographic basis as then it may be unfair to some lenders – rather allocation of branches should be done in a fair manner using stratified (by quality of branches) random sampling methodology to ensure that all lenders get a somewhat equal share of excellent, good and ordinary branches. This will ensure equitable distribution of portfolio at risk across the lenders.

Supervisory Requirement #2: Mandate a consortium approach for lending to large MFIs: Further, the lenders will also have to take a consortium approach to lending to the MFIs (at least for those MFIs that have portfolios greater than US $ 100 Million or Rs 500 crores). This will prevent MFIs from setting off one lender against another and also ensure that the micro-finance market is less of a borrower-dominated market. If one were to look at the instances in the years 2008 – 2010, there are a number of cases from India where MFIs set off one lender against another and this led to dilution of terms and conditions, including monitoring and supervisory arrangements. In my opinion, a lot of the present problems in India can be attributed to such tactics. Again, “consortium lending” is something that only the regulator can mandate via regulation and ensure through supervision. And make no mistake, no lenders forum (even those established through the ongoing World Bank responsible micro-finance project) can ensure consortium lending because, by their very nature, the lenders are fierce competitors for the available large and medium sized MFIs. Therefore, only a regulatory diktat can ensure this on the ground.

While lenders typically use rating agencies prior to sanctioning a loan, in this case it is the consortium that must choose a credit rating agency, which among other things must be really independent in terms of not having any other relationship to the larger micro-finance industry and the MFI being rated – especially, the rating agency must not have a sister concern that is involved in capacity building and/or be a part of a larger corporate group that has such interests in the micro-finance industry. Also, ratings for the same MFI must be rotated among the mainstream rating agencies so that repeat ratings do not become a wrong incentive (or an incentive for providing a higher rating grade). And raw data collected as part of the ratings must be made available for verification by the supervisors’, their examiners and lenders’ internal auditors, as and when required. This may not even be used but it still has to be provided by the rating agency to the consortium of lenders.

Supervisory Requirement #3: Make high quality randomized loan portfolio audits mandatory on an annual basis: While many of the banks and lenders are going in for loan portfolio audits and the like[i], much of the principles used in all these toolkits will have to be changed significantly, especially, in line with lessons from the present Indian crisis. And mainly, client level sensitivities and the prevalence of decentralized models/agents and their practices will have to be factored in specifically. Further, loan portfolio audits are seldom effective in the absence of a transparent MIS that is integrated across geographies, products and clients groups and that again needs to be ensured on the ground[ii]. Also, loan portfolio audits must be conducted by people who are not only independent evaluators but also seen to be independent in terms of having no other relationship with the concerned MFI (or the larger micro-finance industry), at least over the previous 3 years. And finally, there is a critical need for ensuring statistically valid random sampling of an MFI’s portfolio while conducting such an audit and that again needs to be implemented on the ground. All of this can be ensured only by regulation and it is hoped that the regulators will do that and also ensure implementation through appropriate supervisory arrangements. While credit rating agencies could also conduct the loan portfolio audits, they must adhere to the transparent terms set out above for portfolio audits and also those mentioned for credit rating agencies earlier.

Supervisory Requirement #4: Make it mandatory for MFIs to provide an annual MIS and systems audit report: Another issue that needs to be made mandatory by regulators is the requirement of an annual MIS and other systems audit – to be certified after due examination by regulator/supervisor empanelled professionals. An appropriate process should be followed for such certification to be effective. This must form part of the annual filing of returns along with the aforementioned annual loan portfolio audit certificate.

Supervisory Requirement #5: Have one credit bureau with a unique ID linkage: Lastly, while credit bureaus are very useful, the regulatory/supervisory authority must own the credit bureau. However, the central database should be available for use (on a lease basis) for the different credit bureau service providers. MFIs can link up to different credit bureaus service providers to submit the data but all of this information will have to go into the regulator/supervisor established central database. Likewise, all concerned industry stakeholders should be able to access this data at a cost of course, subject to various terms and conditions. And it would be great if the credit bureau architecture piggyback rides on unique national IDs for each individual, accessing a micro-finance loan. Only then, can the micro-finance assets become really traceable and accounted for in the complete sense and the real impact of financial inclusion and priority sector lending efforts be transparently and objectively supervised and determined.

[i] I myself participated in the development of loan portfolio audit toolkit with MicroSave that is prominently used in India and other countries

[ii] Please see chapter with regard to MIS at MFIs in Part III of my book, The Journey of Indian Micro-Finance

What Kind of Regulation Do We Need For Micro-Finance in India?

2011-07-10T09:14:00.000+05:30

Ramesh S Arunachalam

Rural Finance and MSME Practitioner

One of the key questions that continues to bother a lot of stakeholders in the Indian micro-finance industry is: ‘what kind of regulation and supervision is required for the healthy development of the industry?’ A friend once told me that regulators are just like parents who have teenagers at home. The parents can handle their teenage kids in two basic ways: a) Be proactive, over-prescribe and get involved in every little activity of their children; or b) Lay out the broad desirable outcomes for their children (in terms of their education, relationships etc) and then step aside to let their natural environment take over. They are however always present in the background to act as a check and also, help their children overcome difficulties, as and when they arise.

The above is a useful metaphor for understanding two broad extremes of regulation with regard to micro-finance in India: a) We could have a super micro-finance regulator looking at every transaction of micro-finance market participants including MFIs; or b) We may choose an approach whereby the super- regulator lays out the broad desirable outcomes for their various micro-finance participants and then steps aside to let broader market and environmental forces take over, all the while being present in the background through supervisory staff and special (third party) auditors patrolling the micro-finance market.

Essentially, these two types of regulation may be defined as follows:

1. Completely rule-based regulation: one where the regulator tries to be present in each and every micro-finance transaction that takes place, through a comprehensive, extensive and rather voluminous rulebook, tight supervision/policing and a penalty system using checklist compliance. In effect, under such a regulatory framework, the regulator would have to anticipate every possibility (with regard to the micro-finance transactions), every change and innovation in the micro-finance market, and then writes rules around them. Unquestionably, this is a very tough and arduous task indeed and especially from the perspective of creating a plethora of rules in the first place.

2. Principle-based regulation: Under this type, the regulator would be more focused on the outcome (s) of the regulation. Thus, the regulator will articulate broad principles and allow micro-finance market players to innovate around them, keeping the outcomes (as defined in the principles) ABSOLUTELY and completely sacrosanct. A key point to be noted is that this approach does not totally eliminate the need for rules. There will still be rules to follow in any such micro-finance regulatory system but, most importantly, it will not foster the practice of micro-finance compliance officers using the ‘checklist’ approach to ensure staying within the spirit and letter of the law.

Plain checklist compliance can be counter-productive, as there may be no case of regulatory violation, yet there may be mis-selling and malpractice, as we have seen during the last few years in Indian micro-finance. In such an environment, compliance officers will never work towards a desired outcome of enabling the low-income client/customer to come out of poverty or lead better lives, but rather will primarily try to outwit regulators. And once a regulatory loophole is discovered, it will become a frantic race to the bottom with the rest of the micro-finance industry following the leader in a holistic fashion. This is what happened with regard to KYC norms and priority sector lending guidelines in Indian micro-finance. Therefore, the checklist compliance and penalty system[1], which is a strong part of rule based regulation, can be made more accountable if principles based regulation (with appropriate rules) is used.

There is a third way to look at micro-finance regulation. Here, the market incentive structure is used to take most of the reasons behind misconduct out of the market and then use a principle based approach to target an outcome. The challenge is to find the right balance that allows for market innovation, while taking away the incentive and power that the MFIs have over the low income clients, especially due to a skewed knowledge structure and associated incentives. One of the tools for such regulation is the use of financial incentives in a manner that nudges MFIs and other micro-finance market participants into doing the right things. The use of dividend caps and linking this to gain access to special (priority sector) funds is an example of this.

While I will let you make your own judgment on this, I strongly believe in a principles-based approach with incentives and some rules - even while flagging the issue that to translate principles into rules that work on the ground would indeed be a huge challenge in a micro-finance market as vast and diverse as the Indian one.

[1] I am not arguing against having checklist compliance but rather arguing for doing this with better accountability.

Supervisory Issues From The 2010 Micro-Finance Crisis: Implications For the Draft Micro-Finance Bill 2011

2011-07-10T09:04:00.001+05:30

Ramesh S Arunachalam

Rural Finance and MSME Practitioner

The proposed draft micro-finance bill in India is very welcome and in fact, chapter 35 of my recently released book, The Journey of Indian Micro-Finance, does propose a similar option along with two other alternatives.

That said, while the bill is indeed welcome, in the light of what has happened in Andhra Pradesh (outlined in this blog and also chapters 2 to 17 of the book) and also the general lessons learned from the present micro-finance crisis (chapters 18 to 28 in the book) and regulatory lessons (chapters 29 to 34 in the book), the bill, which does not have the required safeguards, runs the serious risk of implementation failure. Make no mistake about that!

Stepping back from the bill, without question, it is clear that policy (and/or lack of it) has also played an important role in the disorderly growth of MFIs and the challenges arising therein. I shall look at this in detail here and outline the implications for the proposed bill! I would like the concerned stakeholders to take it in the right spirit and again, let me reiterate that the idea is to strengthen the bill rather than undermine it. Thank you Ladies and Gentlemen for a patient reading…

A first crucial aspect is that laws will have to follow policies and the point to note is that we have no serious national micro-finance policy in India, as on date, despite the acknowledged importance of the subject. Therefore, before (and/or at least simultaneously along with) the bill, it seems important to draft a policy in a democratic manner and this policy will have to outline various aspects including the following:

1) What is the proper scope of micro-finance, given the Indian context? What specific problems and issues will it be expected to address?

2) Which institutions (stakeholders) are providing such MF services, through what delivery channels and to whom? What key lessons with regard to these different models are discernible and especially, in the light of the recent micro-finance crisis? The aspect to be noted here is that while past policy pronouncements have been well-intentioned and talked of a range of financial services that the present bill is also talking about, in reality, micro-finance has been somewhat limited to the delivery of large scale consumption credit (and perhaps some small production credit) to low income people. Therefore, the bill cannot assume that a wide range of financial services will indeed be delivered. This difference between intended and realized strategies on the ground, is an aspect that needs to be factored in thoroughly and this leads to the next question.

3) What is expected of micro-finance over the next 3 years? 5 Years? 10 Years?

4) Given the above, what should the scope of regulation/supervision be? Who should be the regulator (s)? Supervisor (s)? and other aspects as required

Thus, the need of the hour is a proper national micro-finance policy that can drive the laws and not vice versa and there should be no compromise on that! In fact, policy sums up aspirations and laws become enabling mechanisms to achieve that. So, it would be great if we make an effort towards that (please also read http://microfinance-in-india.blogspot.com/2011/05/does-india-need-micro-financefinancial.html)

OK, that said, I see three major reasons for (having) a bill of this kind and Chapter 35 of my book delves into this fully and I summarise the key aspects here:

a) To provide legitimacy and a proper regulatory framework to MFIs (Legitimacy For Micro-Finance Institutions and Players) and others involved in delivery of financial services to low income people

b) To ensure that MFIs indeed satisfy the broader objectives for which they have come into being (in the first place) and also that they operate and function in a sound and legal manner, in accordance with norms and standards required of such (pro-poor financial) institutions (Regulation and Supervision of Micro-Finance Institutions and Players), and

c) To protect clients from MFI bad practices as well as institutions that operate legally and correctly from usury laws (Protection of Micro-Finance Clients and Institutions)

The proposed bill, which addresses the aspect of providing legitimacy for MFIs, has indeed made a great beginning. This is something that Dr Thorat and I argued in a paper, way back in May 2005. It also looks at the aspect of protecting institutions from State level usury laws and that is a trifle scary because only those institutions that operate within the ambit of the law must be (so) protected. Institutions that engage in multiple, successive, and/or ghost lending and use coercive recovery practices must surely not be legitimized. Likewise, those institutions that have improper governance (as prof Sriram notes in his EPW, June 12^th 2010 paper) and fraudulent systems again must not be protected. What is worrying here is that, from the face of the bill, the ability to distinguish between not-so-legal and good institutions (MFIs) is not clear, in any significant measure. Further, the aspects of regulation and supervision of MFIs (in terms of the real provisions) are not known. Also, the mechanisms for client protection and redressal are perhaps not adequately addressed. So, in the absence of these, with all due respect, the bill is indeed incomplete and there are serious ramifications indeed as the following example will illustrate.

For example, the bill proposes under section 23 that

These are huge tasks and admittedly, while the bill says that the Reserve Bank can either do it directly and/or delegate these to other institutions, several key questions arise: a) how are these tasks to be structured at the RBI (assuming that they would be done by RBI in the first place)?; b) Does the RBI have sufficient capacity to effectively and efficiently manage the various tasks including supervision?; c) In case the RBI delegates these tasks, what about the alternative institution and its capabilities with regard to these tasks including supervision?; and d) several other aspects

The above questions are very relevant and cannot be ignored. The idea here is not to find fault but rather to highlight serious practical issues that would need to be considered first before the bill is passed. Therefore, I try and look at supervisory issues from the present micro-finance crisis using the example of NBFCs and banks {with regard to their own (NBFC) and priority sector lending (PSL) micro-finance portfolio} and raise the important question of whether or not, the RBI and its concerned departments indeed have the wherewithal to ensure that the implementation of the provisions of the proposed draft micro-finance bill (that has been put up on the Finance Ministry website). Read on…

First, let us get some basic issues right…

The dominant MFI model in India is the commercial model where the MFI is registered as an NBFC with RBI and taps commercial funding (debt and equity) through different means. This model is based on fast track growth and generally carries a standard loan product-delivered to clients through joint liability groups and/or agents-based on weekly repayments and having loan related insurance. The emphasis is on-efficiency, standardized processes, large outreach and enhanced profitability–all elements of hardcore commercialization, strongly supported by agencies such as CGAP.

While there could be some modifications to the above model to suit different contexts; the above description is true, by and large, of most NBFC MFIs. The dominant NBFC MFI model is also based on the notion that, to reach and include vast number of unreached and excluded people (including the poor), MFIs must tap commercial funding in a big way from lenders and investors – Mr Vijay Mahajan’s[i] statement to this effect, when SKS was to tap the capital markets, strongly resounds in memory. To do this successfully, the model also believes that commensurate (market) returns must be provided to the commercial investors. It is important to note that much of the basic tenets of this (commercial) model have evolved from the global development of new wave micro-finance – which was spearheaded by several stakeholders including CGAP, especially since 1997 onwards[ii].

As noted in the earlier posts in this blog and also in the book, the fastest growing MFIs, who have perhaps contributed to the present crisis situation in India, are primarily NBFCs MFIs that come under the purview of the Department of Non-Bank Supervision (DNBS), RBI. These NBFC MFIs themselves grew at a phenomenal rate, adding several million clients and dollars to the gross loan portfolio over the period April, 2008 to March, 2010. Thus, the following basic facts are discernible from the data:

· 13 of the top 14 MFIs (ranked on the basis of active clients and gross loan portfolio added from April 2008 to March 2010) are NBFCs

· 6 of them are Andhra Pradesh headquartered NBFC MFIs and they constitute the largest chunk within this group of 13 NBFC MFIs. 9.76 million clients were added by these 6 Andhra Pradesh headquartered NBFC MFIs from April, 2008 to March, 2010 whereas the 8 other state NBFC MFIs added just 4.52 million clients (this is less than 50% of the outreach of Andhra Pradesh headquartered NBFC MFIs). Likewise, these 6 Andhra Pradesh headquartered NBFC MFIs increased their gross loan portfolio by 2.076 billion US $ during this period whereas the 8 other state NBFC MFIs recorded a growth of just an additional 703 million US $ (which is less than 1/3^rd of the gross loan portfolio of Andhra Pradesh headquartered NBFCs)

· All of the 13 NBFC MFIs (including the 6 Andhra Pradesh headquartered NBFC MFIs) file quarterly papers with the department of non - bank supervision (RBI)

· As the graphs below indicate, there was phenomenal growth in gross loan portfolio (GLP) and active clients for 10 of these top 14 NBFCs during the year April 2008 – March 2010

Please note that the phenomenal growth spurt was led by 5 large Andhra Pradesh headquartered MFIs (SKS, Spandana, Share, Basix and Asmitha), who added 2049 million US $ and 9.59 million clients between Apri,l 2008 and March, 2010 – which is very significant indeed.

This is equivalent to each of these 5 large Andhra Pradesh headquartered NBFC MFIs, adding a gross loan portfolio of Rs 78.55 crores (Rs 1 crore = Rs 10 million and exchange rate assumed is Rs 46 per dollar) per month, month after month, quarter after quarter, year on year for the 24 months in question.

And as noted in box 1 below, please also recall that the department of non-bank supervision is supposed to supervise every NBFC that has a loan portfolio of over 100 crores closely and each of these 5 MFIs were adding almost 78% of that threshold value of (Rs 100 Crores portfolio) every month, quarter on quarter, year on year for the 2 years in question – Apri,l 2008 to March, 2010.

Box 1: Off-Site Monitoring and Surveillance System for Non-Banking Financial Companies

Off-site surveillance of NBFCs involves scrutiny of various statutory returns (quarterly/half yearly/annual), balance sheets, profit and loss account, auditors’ reports, etc. A format for conducting the off-site surveillance of the companies with asset size of Rs.100 crore and above has also been devised.

Source: RBI Website, http://www.rbi.org.in/

In numerical terms, this is equivalent to each of these 5 large Andhra Pradesh headquartered NBFC MFIs adding almost 79916 clients every month, quarter on quarter, year on year for the 2 years in question – April, 2008 to March, 2010. This translates to adding about 2664 (fresh) active clients every day, month after month, quarter on quarter, year on year for the 2 years in question. This is a huge task indeed.

In the past, it has taken many MFIs, several years to reach the figure of 75,000 clients and/or portfolio size of Rs 75 crores which is why the RBI specified that NBFCs with asset size greater than Rs 100 crores are systemically important/significant and need to be closely supervisied.

Clearly, these are trends that should have grabbed the attention of anyone, let alone the regulators/supervisors but, for some reason, they perhaps did not.

Thus, there appear to be several issues and challenges with regard to NBFC supervision and these are highlighted below.

The first issue here is, whether or not this huge and unnatural growth - quarter on quarter during the period April, 2008 – March, 2010 - raised any alarms within the department of non -bank supervision, RBI, especially with regard to the following:

· What is the motivation of these MFIs to grow at this never before seen pace?

· How were they growing[iii] in terms of market development strategies (client acquisition etc)?

· What is their business model and is it in accordance with the RBI NBFC regulations and the RBI code of conduct?

· Where and how were they getting the resources (debt, equity etc) for this burgeoning growth? Where exactly were these resources coming in from (India, Abroad etc)? Please read India Today (June 6^th issue) which states that terrorist, Dawood Ibrahim, is involved in both secondary and primary equity markets, under the guise of foreign institutional investors. Under these circumstances, I am sure, it would be important for the regulator/supervisor to know about the antecedents of the various foreign institutional investors. Again, I am not sure whether the department of non-bank supervision was aware of the burgeoning equity investments (including their antecedents) in Indian micro-finance, especially during the years, 2006 -2010

· What is the current and likely future impact of this burgeoning growth on the low - income clients?

· Are the RBI NBFC and other codes of conduct being followed in letter and spirit? Do the NBFCs have sufficient governance and systems to manage this turbo charged growth and, more importantly, not to violate any of the provisions in the law and the code of conduct?

· Is appropriate and required KYC documentation available?

At this juncture, it seems pertinent to look at what Dr Rangarajan and others have had to say about the business model of the NBFC MFIs and also apply the same to this analysis.

"The business model of microfinance institutions is faulty. They must revisit the model to support the income earning ability of the borrower," Prime Minister's Economic Advisory Council chairman C Rangarajan said at an event organised here by Skoch Consultancy. Rangarajan said multiple lending done by MFIs is inconsistent with the very repayment capacity of borrower. He said MFIs have been indulging in multiple lending and large parts of the loans are given for consumption purposes and this model of business has landed them in trouble. "Income earning capacity must be criteria for granting loans... The provision of credit for consumption must be a small part of the total loan," Rangarajan said“[iv]

Others have tended argue for the same and I reproduce a quote from Dr Al Fernandez’s post on the CGAP blog. As Mr Fernandez argues,

“The State of the Sector report 2010 (N. Srinivasan) indicates that out of 60 MFIs which reported on profitability, six had ROAs over 7%; thirty five had ROAs over 2%. In contrast the public sector banks in 2009 had average ROAs of 0.6% with the best being 1.6%, while the best private bank had ROAs of 2%. The yield on portfolio confirms this picture; in the case of 23 MFIs it was above 30 % (the highest being 41.29%). The report also says that economies of scale have not led to lower interest rates or lower yields. This implies that MFIs maximized their profits and competition did not decrease rates as it was expected to. The largest MFI recorded a 116% jump in net profit at Rupees 81 crores ($18 million) in the second quarter ending September 2010 as against the corresponding period last year. “

The cornerstone of this argument is essentially this:

Many MFIs engaged in multiple lending for consumption purposes often granted loans without assessing the loan absorption capacity of the clients. Implied in this statement is the fact that MFIs have pushed loans indiscriminately to low-income clients for consumption purposes without any sensitivity to their debt servicing ability and tried to grow (very fast) in this manner and make unnatural profits. Again, as with the above, it seems more and more clear that MFIs grew to attract capital at high valuations (see below) and, thereafter, had to justify these high valuations by providing better returns to investors. And investors likewise, as they had paid huge premiums, wanted to recover their investment fast and hence, were perhaps pushing the MFIs to grow faster. Hence, as diagrammed in figure 3 below, there appears to have been a mutually reinforcing cycle of multiple/over/ghost lending, fast growth, high profits, very high share valuation, equity investments, faster growth, greater profits, more returns, turbo charged growth and so on.

Now, the key question here is whether the department of non-bank supervision at RBI spotted any of this?

Second, it is during this period (April, 2008 – March, 2010) that the NBFC MFIs (including the above 13 NBFC MFIs among the top 14 MFIs) received equity worth several million USD and this again should have been disclosed as per the filings with the RBI. The data in table 1 suggest the following two basic facts:

· This group of NBFC MFIs can be categorized into 2 groups, on the basis of the equity investment they received (please see table below). As a group, 5 of the 6 equity leader NBFC MFIs who received a large inflow of equity were among the top 6 Andhra Pradesh Headquartered NBFC MFIs and they were also part of the 13 NBFC MFIs in the top 14 NBFC MFIs.

· In fact, as noted above, these 5 Andhra Pradesh headquartered NBFC MFIs (SKS, Spandana, Share, Basix and Asmitha) grew at a phenomenal rate adding the equivalent of Rs 78.55 crores per month in gross loan portfolio and about 79916 clients per month, making them systemically very important.

Again, given the above, it would be useful to know whether or not, this unprecedented and sudden inflow of equity, into select NBFC MFIs, raised any alarm bells for the concerned department at RBI, especially in terms of the following questions:

· Why has there been a sudden inflow of equity into micro-finance and, that too, at a scale not seen before at all?

· As Ms Naina Lal Kidwai argued at the Sa-Dhan March 2010 National Micro-Finance Conference and similarly, as Mr. N Srinivasan wrote in the State of the Sector Report (2010), we surely need to understand what made micro-finance so attractive to equity investors, especially, during a period of serious global economic crisis?

· What kind of MFIs are receiving this equity inflow; at what valuations and why?

· Who is investing in these MFIs and what are their expectations in terms of returns etc? What returns, if any, did the investors actually get?

· Where is this equity money coming in from, in terms of countries? This is especially critical given the fears about not–so–legal money from (from people like Dawood Ibrahim - Please refer India Today, June 6, 2011) coming into the stock market via foreign institutional investment.

· Is there anything abnormal with the operations of these MFIs in terms of growth or profits or earnings per share or promoter and management compensation etc?

There is some very interesting data - on the last point with regard to these 5 Andhra Pradesh headquartered MFIs - in the recent Intellecap (Inverting the Pyramid[v]) report. As the Intellecap report[vi] notes, “Indian MFIs are receiving the highest valuations in the world. A recent report by the Consultative Group to Assist the Poor (CGAP) and JP Morgan[vii] shows that the median price to book value (P/BV) multiple is 5.9 in India, thrice that of global multiples. Some have been quick to call this “irrational exuberance” on the part of investors.

Analysis shows that while the leading large MFIs have been able to command very high premiums, valuations vary across the sector based on investor type, MFI class and stage of investment. The vast market potential, demonstrated growth of the sector and positive macro-economic outlook contribute to relatively higher valuations in India.

In addition, the number of investors (see below) chasing deals with the few large, high growth MFIs has driven up their valuations considerably. These MFIs are able to command valuations upwards of 10 times their projected profit after tax (PAT). Early stage MFIs are, on the other hand, typically valued lower, at between one and three times the book value[viii]. Across the sector, the drivers of value are primarily growth and returns, both demonstrated and potential. Thus, to put Indian MFI valuations in perspective, it is instructive to compare the return on equity (RoE) and PAT growth of the leading MFIs with other financial service business, banks and NBFCs. As shown in table 2, leading MFIs outperformed Banks and NBFCs on both counts. On average, MFI Roe is 32.1%, a full 12 percentage points higher than that of Banks and NBFCs. MFI profits grew over three times that of the sample banks’, and five times that of the sample NBFCs’ between 2006 and 2009. The closest comparable, in this sample, to MFIs in terms of business model is Mannapuram General Finance[ix], as their clientele is similar to that of MFIs and loan sizes are relatively low (INR 20,000), although their loans are backed with collateral. Despite the company’s RoE and PAT growth being lower than those of MFIs, its P/BV is at 8.4, higher than average for leading MFIs. Thus, given the enormous market potential, the ambition of leading Indian MFIs, and their demonstrated high growth, prudent cost management and thus high returns, the current valuation levels are not surprising.”[x]

The above makes it reasonably clear that one of the major reasons for MFIs to grow, in the manner they did, was to attract capital at higher valuations.

Again, the key question here is whether the department of non-bank supervision at RBI spotted this?

A third issue is also relevant here. The amount of (priority sector) debt leveraged by these 13 NBFC MFIs (in top 14 MFIs) and other NBFC MFIs is obviously huge and that would be clear from the filings made by them to the department of non-bank supervision. This would also be clear from the filings made by banks to the DBOD. In numerical terms, the growth of debt for MFIs from commercial banks and SIDBI is given below and this growth is best described as phenomenal:

As Mr N Srinivasan says in the 2010 State of Sector Report,

“Bank loans to MFIs did not exhibit any overt signs of increased risk perceptions towards the microfinance sector. The total loans extended to MFIs and outstanding at the end of March 2010 is estimated at Rs.15085 crore.[xi] Public sector banks have taken to MFI financing in a big way. Public sector banks (not including SIDBI) had an exposure of Rs. 4737 crore to MFIs in comparison to private sector banks' exposure of Rs. 4133 crore. Foreign banks had outstanding loans of Rs.1994 crore and FWWB had increased its exposure from Rs. 295 crore last year to Rs. 360 crore. 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.”

Again, the key question here is whether or not, the concerned departments (of non bank supervision (DNBS) and DBOD) felt alarmed about this burgeoning growth of priority sector lending (PSL) funds from Banks to NBFCs in terms of the following aspects:

· Is there any cause for alarm given the huge growth of (PSL and other) funds from banks and DFIs to MFIs?

· How and where are the MFIs investing these priority sector loan (PSL) and other funds?

· For what specific loan purposes are these PSL and other funds being used?

· Which banks/institutions are providing these PSL funds to different MFIs? What do the growth trends say?

· Is there any reason to believe that these priority sector loan funds may be used for non-priority sector purposes? If so, what are the reasons and what are the ways of addressing this?

· Have any of the institutions provided loans from their PSL funds to their promoter, senior management and/or board members? If so, for what purposes?

All of the above questions need to be looked into by the RBI because even some interest from the concerned department and/or any of their local offices, in cautioning the MFIs, might have, after all, prevented this crisis and/or mitigated the damage to a large extent measure.

This becomes even more significant when one considers the fact that during the period in question (April, 2008 to March, 2010), the top 6 Andhra Pradesh MFIs grew at a phenomenal rate, were able to receive significant equity infusion and perhaps used this equity to leverage PSL funds in larger measure. And it must also be noted that all of this happened in the backdrop of the Krishna district crisis, which the RBI was able to successfully intervene in and resolve.

Therefore, it is imperative that the RBI looks into all the regulatory and supervisory aspects highlighted above for, as much as the micro-finance industry is a sunrise sector as claimed by several industry experts, it is also a very sensitive area that requires careful handling from a client perspective. And this is especially true given the fact that MFIs are trying to sell what is perhaps the most attractive product on the face of this planet to a very vulnerable set of people. It would also be interesting for the RBI to look at whether the department of non - bank supervision and the RBI department that deals with supervising priority sector lending to banks (the DBOD) were in fact even talking to each other on something unusual happening in the micro-finance industry. These will certainly provide valuable lessons for design of future supervisory arrangements.

In summary, I leave you with these key questions:

1) Did the department of non-bank supervision miss these (significant) trends? If so, why? What lessons can be learnt from this with regard to supervisory arrangements in the future (especially those given in the proposed bill)?

2) If not, having spotted these happenings in the first place, why did it not take necessary corrective action? Again, what lessons can be learnt from this with regard to supervisory arrangements for the future (especially those given in the proposed bill)?

3) If the concerned RBI departments could not monitor 12 to 13 NBFC MFIs that were supposed systemically important, then, how can they be expected to set up supervisory mechanisms for several hundred MFIs as per the proposed Micro-finance bill? Without sufficient supervision, none of this will work on the ground. I believe that the Malegam committee arrangement was very good because it ring fenced the large NBFC MFIs. This bill however clubs all of the MFIs together and this means that some several hundred (or even thousand) organisations (including coops) may have to be regulated/supervised and no single regulator/supervisor may be able to achieve this effectively.

That is certainly some food for thought and let me reiterate that India is a great country for legislation but the implementation record is rather poor in many cases. We certainly require a micro-finance bill to provide legitimacy to the micro-finance sector and that is a noble objective indeed but we cannot and must not stop with that. Rather than being a paper tiger, the bill should have the teeth and mechanisms to ensure orderly growth of the sector and for this, the most critical aspect is to look at the supervisory capacity of the RBI (and/or other organizations) and evaluate it to see what needs to be done to ensure ground level implementation.

I leave you with these questions and thoughts and hope that the concerned people and powers that be, pay attention to these critical issues. I will flag more issues in the coming days and again, the objective here is not to undermine the capacity of concerned people or the good work being planned. The objective, solely, is to assist in enabling the development of better regulatory and supervisory mechanisms that can work on the ground towards the benefit of large numbers of low income people, who continue lack access to quality financial services at the grass-roots.

[i] Mr Vijay Mahajan is Chairman, BASIX, Chairman, MFIN and Chair, Executive Committee, CGAP

[ii] This is a description of the commercial model as I understand it.

[iii] Green field client acquisition vs. other strategies (including sharing of clients, takeover of SHGs/other MFI JLGs etc), market skimming (first time loans to new clients), financial deepening/multiple lending to older clients and several other strategies.

[iv] Source: Quoted from http://economictimes.indiatimes.com/news/news-by-industry/banking/finance/finance/mfis-business-model-faulty-pm-panel/articleshow/7225090.cms

[v] Inverting the Pyramid (Third Edition), Indian Microfinance Coming of Age, Published by Intellecap, (2010)

[vi] Inverting the Pyramid (Third Edition), Indian Microfinance Coming of Age, Published by Intellecap, (2010)

[vii] CGAP, JP Morgan, occasional Paper: Microfinance Global Valuation Survey 2010, March 2010

[viii] Analysis by Intellecap.

[ix] A listed NBFC that provides gold and vehicle loans, amongst other services.

[x] Inverting the Pyramid (Third Edition), Indian Microfinance Coming of Age, Published by Intellecap,(2010)

[xi] Footnote is cited from, State of Sector Report, Micro-finance in India, 2010 by N Srinivasan, Sage Publications. The original footnote states that the statistics are ‘based on provisional data made available by NABARD and further information collected by the author (N Srinivasan) individually from some banks.’

Does India Need a Micro-Finance/Financial Inclusion Policy?

2011-05-07T09:09:00.004+05:30

Ramesh S Arunachalam

Rural Finance Practitioner

There has been a lot of talk about microfinance and financial inclusion in India, especially during the last few years. Especially during the last 6 months, the discussions have centered around having an appropriate regulatory framework for microfinance, scaling up financial inclusion, the need for a sole microfinance regulatory and the like.

As before, every one (and this writer included) have been talking about these aspects, often providing their rather divergent and diverse views. But, it seems to be that, we are again running off, without serious thought to:

· What we see as part of financial inclusion and/or micro-finance in India and why?

· What has worked on the ground with regard to financial inclusion and/or micro-finance in India and why/why not?

· Going forward, what is our vision with regard to the various financial inclusion and/or micro-finance services in India?

· What do we hope to achieve with scaling up financial inclusion and/or micro-finance in 5 years, 10 years, and 20 years and so on?

· And Other Questions as Appropriate

Unless, we have a clearly defined national micro-finance/financial inclusion policy answering the above and other questions, our responses to delivering/scaling up low-income financial services will continue to be knee jerk and piecemeal. Interim solutions are undoubtedly necessary as life has to go on but we need to critically look at medium and long term issues as well

Therefore, even before we look at building a PERMANENT regulatory architecture for micro-finance/financial inclusion (through some mechanism and/or a bill etc), let us first look towards devising a national policy for micro-finance and financial inclusion - a policy that is holistic, futuristic and yet practical (in terms of satisfying unmet ground level needs of low income and excluded people) and developed through a TRULY bottom up and democratic process with widespread stakeholder input and consultations. The aspect of having a bottom up and democratic process is very critical to create strong ownership for the policy and adherence to its vision during implementation.

Further, such an approach cannot be a mere document – designed in Delhi or Washington (with all due respect) and - produced through field visits by few important consultants/agencies to select field areas. It has to be truly national in character and must be backed by public interactions with low income people in all parts of the country apart from district, state, regional and national level consultations among various stakeholders. It has to be comprehensive enough in terms of bringing together different and competing models with alternative aspirations. And last but not the least, it must be grounded in reality so as to make a SOLID difference to the lives of the people, for whom it is being framed in the first place…In other words, it just cannot be a writing exercise…

It is about time that we follow the lead of many (other and especially, smaller) countries that have genuinely tried to frame appropriate micro-finance/financial inclusion policies through a proper process. That alone can ensure the orderly/sustainable growth of the Indian micro-finance/financial inclusion sector and simultaneously enable low income people to become a REAL part of the inclusive growth story…The key question here is whether we have the commitment and courage to undertake such an important and urgently required task, in a voluntary and selfless manner…Time alone will provide the answers…

Jai Hind!

Have a Nice Day!

A Comparative Analysis of Two Types of Agent Led Micro-Finance Models in India: Imperative For RBI To Build Safe Guards Into Priority Sector Lending Directions…

2011-05-06T09:17:00.002+05:30

Ramesh S Arunachalam

Rural Finance Practitioner

The recent RBI announcement with regard to priority sector being used for Micro-Finance NBFCs is a very welcome one and is much appreciated as I posted the other day. However, safeguards are needed to ensure that agents of MFIs do not misuse priority sector funds. Thus, when coming out with the detailed guidelines, I hope that the RBI takes cognizance of two major agent led models prevalent in the Indian micro-finance sector.

Let me make a few other assertions. While the exact scale of the agent models nationally is perhaps not known with precision, there is enough cause to believe that it is reasonably widespread as it has been observed in several places in AP, Tamilnadu, UP, Orissa, West Bengal, Karnataka and parts of Madhya Pradesh. This again needs to be looked into closely by the RBI, which is best positioned to conduct an objective and neutral national study and assess which kind of MFIs are involved and why and also geographic places where the same is widespread - and this needs to be done before the detailed directions regarding priority sector are promulgated...

That apart, it is also imperative that the RBI looks closely at these models and builds sufficient safeguards against their use through supervision and other means and using various stakeholders including banks. If this (building safeguards) appears difficult, a more practical approach could be for the RBI to consider streamlining and legalizing the Centre Leader Type Agent Model and building greater accountability into this type of arrangement - especially, if the RBI feels that this model can be fitted under the Business Correspondent regulations. However, the political agent Micro-finance model should be banned without question. All of these are aspects that the proposed RBI committee on priority sector could look into and provide guidance on.

Here are the operational details of two agent led micro-finance models as I have seen it on numerous occasions and also heard from several stakeholders. Read on…

Have A Nice Day!

Inclusive Finance As The Backbone For Inclusive Growth: Some Critical Issues for Policy Makers, Central Bankers, Donors and Other Stakeholders…

2011-05-05T08:59:00.002+05:30

Ramesh S Arunachalam

Rural Finance Practitioner

Inclusive growth has always been seen as the imperative for achieving the equity and equality objectives. While that point is well taken, the experience of the last few years and especially during the global financial crisis suggests that inclusive growth is perhaps essential to even sustain the overall growth momentum. There are several good reasons[i] as to why a REAL inclusive growth paradigm will facilitate this in a rapidly emerging economy like India (and other similar environments). Read On…

First, in many of the emerging market economies like India, a huge proportion of the population (over 60% at least) is based in rural areas, where agriculture is the primary source of livelihood. And any further (substantial) increase in demand for manufactured goods and services will have to come primarily from this large rural population[ii], which mainly depends on agriculture and allied sectors. And barring a couple of years (2005/6), by and large, the performance and growth of agriculture has been rather indifferent.

Indeed, what has become more apparent with this kind of skewed growth is the dualistic nature of the Indian economy - where the gaps are indeed deepening and widening across various sections of the society. The classic manifestation of these gaps and the failure of the economy to re-adjust and ensure equitable economic opportunities for wealth creation, especially in relation to the work and inputs, can hardly go unnoticed –one manifestation is suicides by small and marginal farmers, at the grass-roots. That several farmers have committed suicide in the last few years tells us that the causes of these problems are not short-term – they are, mainly due to serious structural weaknesses in livelihoods systems of low-income people that require urgent and systematic attention.

Why is this happening? What are the consequences in a country like India, where over 60% of the population is engaged in agriculture and related activities? The key point to note here is that this case of farmer suicides is neither a cotton specific problem nor a paddy crop germane issue. Rather, it concerns, fundamental problems[iii] associated with one of India’s largest livelihood sectors, agriculture and allied activities – a sector where over 600 million people and a majority of India’s low income and poor[iv] people earn their living. More importantly, it is a sector without whose produce/products, we can neither eat nor survive in the long run. Therefore, without question, agriculture and allied areas as sectors and the low income people dependent on it for their livelihoods must be “included” in the overall growth paradigm. That is an urgent imperative in India today…

Second, as noted above, from the perspective of supply-side management, growth in agriculture is very vital for keeping manufacturing prices under check, ensuring food security and keeping inflation under control. India knows this better from its own experience of the last few years. Price stability is not merely important as an anti poverty measure but also as an instrument to ensure stable and sustained growth. Again, the lessons of the last 5 years should not be forgotten and especially, with regard to prices of essential food items as well as from a food security perspective. That the farmers who grew these commodities hardly got returns/rewards commensurate with their effort, investment and risks taken can hardly go unnoticed and this again point to very fundamental weakness in the structural aspects concerning agriculture and low income livelihood systems.

Third, higher growth in agriculture and rural areas coupled with demographic dividend (i.e. growing proportion of population in the working age group of 15-65) should result in a rise in the savings level, which, in turn, should facilitate financing the increasing level of investments required to maintain the overall momentum with regard to growth. This is again a very crucial aspect and the role of local and small savings should not be discounted in any serious measure. Its potential to support inclusive growth is phenomenal and appropriate incentives must be provided in this regard to encourage local/small savings as a resource alternative in the new growth paradigm

Fourth, the limitations on increasing production and productivity in agriculture are forcing people to migrate to urban areas and this results in increased population pressure in urban areas as well as larger numbers of urban poor. And this burgeoning urbanization has several important consequences for low income people, who tend to migrate and live in slums. As an NSSO survey revealed (a few years ago), nearly 40 per cent of farmers claimed that would like to quit farming, if they have the option to do so. Unfortunately, there is little option for them except moving into urban slums[v].

Thus, in reality, migration to urban areas primarily implies greater growth of urban slums, which hold a lower quality of life for the poor, many of whom have migrated from rural areas in search of better livelihoods. This growth of urban slums, typically, is associated with greater unemployment for the poor living there, harsh living conditions, enhanced crime, greater negative impact on health and several aspects including environmental degradation[vi]. Therefore, the major point to be noted is that the infrastructure in urban areas is simply not enough to cater to the growing needs of these migrants. Huge and appropriate investments are therefore needed in housing, sanitation, water, lighting and power, solid and other waste management, education, health, and so on and so forth. Therefore, we need “inclusive and enabling investment” in the above areas to deal with the huge and increasing numbers of low-income population in urban areas. This also calls for a paradigm shift in urban planning which must also become more inclusive.

Fifth, in countries such as India, the growth process is essentially knowledge-based and primarily services led. These new growth areas that continue to have a lot of potential going forward. Hence, the requirement of skilled labour is rather huge in comparison to the current levels of availability. Therefore, in order to ensure availability of adequate supply of labour skilled to tackle opportunities in new growth areas mentioned above, we also need huge enabling and inclusive investments in areas such as practical education and skill development – so that the vast majority of people who have the latent potential but cannot afford these services – are facilitated to gain access to such practical skills and knowledge, and thereby perform to their potential.

Last but not the least, whenever we talk of rural areas, the sector that comes first to our mind is agriculture. However, there is the (unorganized and informal) non-farm sector which continues to play an increasingly role in absorbing a large numbers of rural people. Make no mistake – taken together, this non-farm sector and value added agriculture enterprises (MSME) sector have huge potential for growth but this again requires investment in “inclusive infrastructure and enabling mechanisms” for ensuring easier/quicker access to assets, skills, appropriate technology, wide range of vulnerability reducing financial services (including credit for post harvest and post production) and fair linkage to various markets and other market development infrastructure (both private sector and government procurement). Without question, such efforts can make these hitherto excluded sectors, an expanding base for wealth creation and generation in a competitive manner in rural areas

Therefore, to reiterate, it is critical to ensure that growth takes place in: (a) agriculture, allied and non-farm sectors as well as secondary and services (enabling) sectors in rural areas; and (b) amongst urban poor so that they have a better quality of life and opportunities for sustainable livelihoods/wealth creation and thereafter, they also serve as a growing market for the goods and services produced by the expanding industrial sector including those produced by various kinds of MSMEs. However, this growth cannot be mere dumping of goods and/or provision of services in rural areas or among the urban poor. It has to be responsible growth and delivered in an ethically sound and transparent manner and this is one of the most important lessons from the present Indian micro-finance crisis/growth story. Otherwise, all the gains will be lost…and we will still be at square one...

To summarise, it is clear that inclusive growth is very necessary for sustainable development and equitable generation of wealth and prosperity. However, achieving this inclusive growth is the biggest challenge in a democratic country like India as it translates to the concern of integrating 600 million people living in rural India and several million living in urban slums into the mainstream economy and facilitating them to create wealth and better quality of life at the grass-roots. And that is a task in which a new paradigm of inclusive finance must take the lead in and show the way forward such that sustainable growth and wealth creation opportunities are available to all excluded sections of the society and in all neglected sectors of the economy and parts of the country.

And this requires that we let go off our narrow conceptualization of inclusive financial services and broaden the paradigm to ensure that financial services play a very vital role in addressing two critical supply-side issues: (i) by creating an effective and fair ecosystem for delivery of a wide range of (financial and related) services to facilitate productive and enabling investment in largely excluded but employment impacting sectors such as agriculture, value added agriculture, MSMEs etc as well as hitherto excluded (geographic) areas and for enabling low income and excluded people (living in rural India and urban slums) to realize their latent untapped potential; and (ii) by driving large scale investment in inclusive infrastructural facilities and enabling mechanisms like watersheds, irrigation, rural/urban reconstruction, social infrastructure such as health care, education and sanitation and the like.

Without question, mere credit[vii] to low-income people can do very little for inclusive growth as has been consistently argued by many proponents of the narrow inclusive finance paradigm. Only a new, braod and enabling paradigm of inclusive finance as mentioned above can help usher in an era of real inclusive growth in India…

Have A Nice Day!

[i] This post draws from several resources including: Inclusive growth – the role of banks in emerging economies by Mrs Usha Thorat and other web based resources as well as papers by this author

[ii] And this issue becomes even more critical when one considers the fact that the average monthly per capita consumption expenditure (MPCE) in urban areas in India is near double that of rural areas. And in some States (like in Central or Eastern India), these disparities are even more glaring.

[iii] “Farming is both a way of life and the principal means of livelihood to 65 per cent of India's population of 110 crore, Our farm population is increasing annually by 1.84 per cent, The average farm size is becoming smaller each year and the cost-risk-return structure of farming is becoming adverse, with the result that farmers are getting increasingly indebted. Marketing infrastructure is generally poor, particularly in perishable commodities. The support systems needed by farmers, like research, ex-tension, input supply and opportunities for assured and remunerative marketing are in various stages of disarray. Small farmers are forced to borrow money from money-lenders at high rates of interest, since less than 60 per cent of the credit requirements of farmers is met by institutional sources.” (Dr M S Swaminathan, Chairperson, National Commission on Farmers, 2006).

[iv] Despite significant progress made by India during the last decade or so, about 30 – 35% of the total population still lives below the poverty line.

[v] INDIA has always been considered a country that lives in its villages. But increasingly rural Ind1a is moving towards the town and the City. The 2001 Census established that almost one- third of India's population, an estimated 285 million people, lived in urban areas. By 2020, half the country's population is expected to be city-based.

[vi] In fact, as the data suggest, almost 50% of country’s population and a large majority of the poor are likely to reside in urban slums in India by 2020. And Noted environmentalist Chandrasekar confirms the above trends and summarises the issues with rapid urbanisation, “Although on paper all cities have some kind of development plan, the actual development follows no particular pattern except that dictated by expediency, patronage and privilege. As a result, every city in India is the epitome of urban chaos - lacking in adequate water and sanitation, affordable housing, all weather roads, decent public transport and clean air. Cities generate wealth but increasingly Indian cities have become home to the urban poor. Every city is marked by the informal settlements where the poor are forced to live without access to basic services like water and sanitation. City administrations are unable to check the flow of poor people into the city and have failed to build affordable housing where the poor can live. As a result, in some cities like Mumbai, for instance, half the population lives in slums. And in Maharashtra, India's most urbanised State, 61 cities and towns have slum populations that together makeup over 27 per cent of the total urban population and a third of the total population of the State. Indeed, the slum has now become an inescapable part of the Indian urbanscape” (The Hindu,).

[vii] Several factors like market imperfections and other factors (like poor infrastructure and production practices etc) severely constrain these low income people in their efforts to build sustainable livelihoods and enhance their economic security - as a result of fragile livelihoods, they often go through a cycle of being financially included and excluded at various times. The key point is that, in the absence of other infrastructure and mechanisms, the use of loans by poor and vulnerable people renders them into greater debt.

2011-05-04T08:22:00.001+05:30

RBI Acceptance of Malegam Committee Recommendations: Great Beginning But Miles To Go Before We Can Sleep…

Ramesh S Arunachalam

Rural Finance Practitioner

The RBI has finally given its view on the Malegam Committee Recommendations (MCR) and it is on the lines expected. In this post, I broadly compare the MCR recommendations with RBI statements in the monetary policy and then comment on what is unfinished with regard to the Micro-Finance regulation agenda in India

I quote from the Monetary Policy document of the RBI, which is re-produced below (http://www.rbi.org.in/scripts/NotificationUser.aspx?Id=6376&Mode=0)

92. “In the wake of the Andhra Pradesh micro finance crisis in 2010, concerns were expressed by various stakeholders and the need was felt for more rigorous regulation of non-banking financial companies (NBFCs) functioning as micro finance institutions (MFIs). As indicated in the Second Quarter Review of November 2010, a Sub-Committee of the Central Board of the Reserve Bank (Chairman: Shri Y. H. Malegam) was constituted to study issues and concerns in the MFI sector. The Committee submitted its report in January 2011, which was placed in public domain.

The Committee, inter alia, recommended (i) creation of a separate category of NBFC-MFIs; (ii) a margin cap and an interest rate cap on individual loans; (iii) transparency in interest charges; (iv) lending by not more than two MFIs to individual borrowers; (v) creation of one or more credit information bureaus; (vi) establishment of a proper system of grievance redressal procedure by MFIs; (vii) creation of one or more “social capital funds”; and (viii) continuation of categorisation of bank loans to MFIs, complying with the regulation laid down for NBFC-MFIs, under the priority sector. The recommendations of the Committee were discussed with all stakeholders, including the Government of India, select State Governments, major NBFCs working as MFIs, industry associations of MFIs working in the country, other smaller MFIs, and major banks.

In the light of the feedback received, it has been decided:

· to accept the broad framework of regulations recommended by the Committee;

· that bank loans to all MFIs, including NBFCs working as MFIs on or after April 1, 2011, will be eligible for classification as priority sector loans under respective category of indirect finance only if the prescribed percentage of their total assets are in the nature of "qualifying assets" and they adhere to the "pricing of interest" guidelines to be issued in this regard;

· that a “qualifying asset’’ is required to satisfy the criteria of (i) loan disbursed by an MFI to a borrower with a rural household annual income not exceeding ` 60,000 or urban and semi-urban household income not exceeding ` 1,20,000; (ii) loan amount not to exceed ` 35,000 in the first cycle and ` 50,000 in subsequent cycles; (iii) total indebtedness of the borrower not to exceed ` 50,000; (iv) tenure of loan not to be less than 24 months for loan amount in excess of ` 15,000 without prepayment penalty; (iv) loan to be extended without collateral; (v) aggregate amount of loan, given for income generation, not to be less than 75 per cent of the total loans given by the MFIs; and (vi) loan to be repayable by weekly, fortnightly or monthly instalments at the choice of the borrower;

· that banks should ensure a margin cap of 12 per cent and an interest rate cap of 26 per cent for their lending to be eligible to be classified as priority sector loans;

· that loans by MFIs can also be extended to individuals outside the self-help group (SHG)/joint liability group (JLG) mechanism; and

· that bank loans to other NBFCs would not be reckoned as priority sector loans with effect from April 1, 2011.

93. Detailed guidelines in this regard will be issued separately.”

What does all of this mean for Indian micro-finance?

First of all, it is great for the micro-finance industry that the broad framework of The Malegam Committee Report (MCR) recommendations have been accepted - as this provides the much needed legitimacy to the sector. That the RBI has recognized loans to low income people as part of priority sector is excellent news and that it has given first cut (but explicit) guidelines regarding the same is very welcome.

As I have been reading the MCR more and more, I am now convinced that the framework of report (forgetting the nitty gritty recommendations and value for different criteria) has a lot of merit because it has used regulation by principles, rules and incentives in appropriate balance. This will be elaborated in a separate post

Second, what is really interesting from the RBI pronouncement is the fact that priority sector is being used as an incentive to shape the behavior of MFIs and provide direction for the orderly growth of the Micro-finance industry. In this regard while the aspect of enhancing overall indebtedness to Rs 50000 is a very pragmatic one, the decision to shift the loan ceiling for the 1^st loan from 25,000 to Rs 35,000 needs careful consideration. I do hope that to be appointed committee on priority sector looks at this and other aspects carefully…Here are some my suggestions with regard to the priority sector… Read On..

http://microfinance-in-india.blogspot.com/search/label/Priority%20Sector%20Lending and

http://microfinance-in-india.blogspot.com/2011/01/regulation-and-supervision-of-nbfc-mfis.html

Third, the Malegam Committee Report (MCR) provided a large number of excellent recommendations regarding several others aspects including minimum systems for MFIs, supervision, client protection, corporate governance and the like and the real time implementation of these aspects on the ground. Please see summary of MCR recommendations here (http://microfinance-in-india.blogspot.com/2011/01/rbi-sub-committee-report-my-summary-of.html).

I do sincerely hope that the detailed guidelines of the RBI do touch upon these aspects in serious measure. Otherwise, priority sector could be misused again… and there are numerous examples in the public domain for the RBI and various stakeholders on how priority sector could be misused (e.g., huge loan to promoter to buy shares in the same MFI as highlighted by Prof Sriram in one case in his EPW article) if the accompanying facets of the Malegam Committee Report (MCR) including Corporate Governance aspects are not considered, while drawing up detailed guidelines…

Hope the RBI ensures that other facets concerning minimum systems, corporate governance, supervision and all other important issues, as mentioned in the Malegam Committee Report, are duly considered and appropriately implemented

Have A Nice Day!

Risk Assessment and Risk-based Auditing At Systemically Important and Large MFIs: Some Practical Guidelines…

2011-05-02T09:03:00.001+05:30

Ramesh S Arunachalam

Rural Finance Practitioner

Risk assessment and risk-based auditing are very critical mechanisms and need to be undertaken at large and systemically important MFIs and this post provides some practical suggestions in this regard…

Risk assessment is a process by which an auditor identifies and evaluates the quantity of the MFIs risks and the quality of its controls over those risks. Through risk-based auditing, the board and auditors use the results of the risk assessments to focus on the areas of greatest risk and to set priorities for audit work. That however does not mean that the audit department can lose sight of or ignore areas that are rated low-risk. An effective risk-based auditing program will ensure adequate audit coverage for all of an MFI’s auditable activities. The frequency and depth of each area’s audit should vary according to the auditor’s risk assessment.

Program Design: Properly designed risk-based audit programs increase audit efficiency and effectiveness. The sophistication and formality of audit approaches will vary for individual MFIs depending on the MFIs’ size, complexity, scope of activities, staff capabilities, quality of control functions, geographic diversity, and technology used. All risk-based audit programs should:

· Identify all of the MFI’s operations, product lines, services, and functions (i.e., the audit universe).

· Identify the activities and compliance issues within those operations, product lines, services, and functions that the MFI should audit (i.e., auditable entities).

· Include profiles of significant operational units, departments, and products that identify business and control risks and document the structure of risk management and internal control systems.

· Use a measurement or scoring system to rank and evaluate business and control risks of significant operational units, departments, and products.

· Include board or audit committee approval of risk assessments or the aggregate result thereof and annual risk-based audit plans (that establish internal and external audit schedules, audit cycles, work program scope, and resource allocation for each area to be audited).

· Implement the audit plan through planning, execution, reporting, and follow-up.

· Have systems that monitor risk assessments regularly and update them at least annually for all significant operational units (regions or branches), departments, and products.

Risk Matrix and Guidelines: An effective scoring system is critical to a successful risk-based audit program. In establishing a scoring system, directors and management must consider all relevant risk factors so that the system minimizes subjectivity, is understood, and is meaningful. Major risk factors commonly used in scoring systems include:

· The nature of transactions (e.g., volume, size, liquidity);

· The nature of the operating environment (e.g., compliance with laws and regulations, complexity of transactions, changes in volume, degree of system and reporting centralization, economic and regulatory environment);

· Internal controls, security, and MIS;

· Human resources (e.g., experience of management and staff, turnover, competence, degree of delegation); and

· Senior management oversight of the audit process.

Auditors or risk managers should develop written guidelines on the use of risk assessment tools and risk factors and review the guidelines with the audit or risk committee. The sophistication and formality of guidelines will vary for individual MFIs depending on their size, complexity, scope of activities, geographic diversity, and technology used. Auditors will use the guidelines to grade or assess major risk areas. These guidelines generally define the basis for assigning risk grades, risk weights, or risk scores (e.g., the basis could be normal industry practices or the MFI’s own historical experiences). They also would define the range of scores or assessments (e.g., low, medium, and high, or a numerical sequence, for example, 1 through 5). The written guidelines should specify:

· The length of the audit cycles based on the scores or assessments. Audit cycles should not be open-ended. For example, some MFIs set audit cycles at 12 months or less for high-risk areas, 24 months or less for medium-risk areas, and 36 months or less for low-risk areas. However, individual judgment and circumstances at each MFI will determine the length of its audit cycles.

· Guidelines for overriding risk assessments. The guidelines should specify who could override the assessments, the approval process for such overrides, and the reporting process for overrides. The override process should involve the board or its audit committee, perhaps through final approval authority or through timely notification procedures. Overrides of risk assessments should be more the exception than the rule.

· Timing of risk assessments for each department or activity. Normally, risks are assessed annually, but they may need to be assessed more often if the MFI or a specific product experiences excessive growth (as between April 2007 – 2009), if MFI staff or activities change significantly, or changes to or new laws and regulations occur.

· Minimum documentation requirements to support scoring or assessment decisions.

Management Responsibilities: Day-to-day management of the risk-based audit program rests with the internal auditor or internal audit manager, who monitors the audit scope and risk assessments to ensure that audit coverage remains adequate. The internal auditor or audit manager also prepares reports showing the risk rating, planned scope, and audit cycle for each area. The audit manager should confirm the risk assessment system’s reliability at least annually or whenever significant changes occur within a department or function.

Line department managers and auditors should work together in evaluating the risk in all departments and functions. Auditors and line department managers should discuss risk assessments to determine whether they are reasonable. However, the auditors, with concurrence of the board, audit committee or risk committee, should have ultimate responsibility for setting the final risk assessment. Auditors should periodically review the results of internal control processes and analyze financial or operational data for any effect on a risk assessment or weighting. Accordingly, MFI management should keep auditors current on all major changes in departments or functions, such as the introduction of a new product, implementation of a new system, changes in laws or regulations, or changes in organization or staff.

I hope that systemically important MFIs including large NBFCs wake up to have serious internal audits as part of their institutions…this alone can help prevent the kind of institutional lapses that led to the present day crisis…

Have a Nice Day!

Designing The Internal Audit Function At MFIs: Some Critical Issues…

2011-05-02T08:56:00.000+05:30

Ramesh S Arunachalam

Rural Finance Practitioner

Internal auditors play a very critical role in any organization and the same applies to micro-finance.

Role of Internal Auditors: The primary role of internal auditors is to independently and objectively review and evaluate an MFIs activities to maintain or improve the efficiency and effectiveness of risk management, internal controls, and corporate governance. They do this by:

· Evaluating the reliability, adequacy, and effectiveness of accounting, operating, and administrative controls.

· Ensuring that MFI internal controls result in prompt and accurate recording of transactions and proper safeguarding of assets.

· Determining whether an MFI complies with laws and regulations and adheres to established policies.

· Determining whether management is taking appropriate steps to address current and prior control deficiencies and audit report recommendations.

Internal auditors must understand an MFIs strategic direction, objectives, products, services, processes as well as clients to conduct these activities and make a judgement on the above. The auditors then communicate findings to the board of directors or its audit committee, who then will brief and discuss with senior management.

In addition, internal auditors often have a role in transformation activities. This role may include such duties as helping the board and management evaluate safeguards and controls, including appropriate documentation and audit trails, during the transformation process at the MFI – this is a very critical issue as many MFIs transform to become for profits from non-profits

Oversight and Structure: MFIs should conduct their internal audit activities according to existing professional standards and guidance. But how the internal audit function is accomplished depends on the MFI’s size, complexity, scope of activities, and risk profile, as well as the responsibilities assigned to the internal auditor by the board of directors.

In larger MFIs, a chief auditor and a full-time internal audit staff may accomplish the internal audit function. In other MFIs, the internal audit function may be accomplished by one or two employees or a holding company or even by an outside vendor. In many small MFIs, the officer or employee designated as a part-time auditor may also have operational responsibilities. In any case, to maintain independence, the person responsible for accomplishing the internal audit function should be independent of whatever area is being audited and should report findings directly to the board or its audit committee.

The audit committee should position the internal audit function in the institution’s organizational structure such that the function will perform its duties with impartiality and not be unduly influenced by managers of day-to-day operations. The ideal organizational arrangement is having the internal audit function report directly and solely to the audit committee regarding both internal audit issues and administrative matters, e.g., resources, budget, and compensation.

Some MFIs place the manager of internal audit under a dual reporting arrangement: functionally accountable to the audit committee for matters such as the design of audit plans and the review of audit scope and audit findings, while reporting to a senior executive on administrative matters. Such an arrangement potentially limits the internal audit manager’s independence and objectivity when auditing the senior executive’s lines of business. Thus, chief financial officer, controller, or other similar positions should generally be excluded from overseeing the internal audit activities even in a dual role. In structuring the reporting hierarchy, the audit committee should weigh this risk of diminished independence against the benefit of reduced administrative burden in adopting a dual reporting organizational structure. Under a dual reporting arrangement, the internal audit function’s objectivity and organizational stature is best served when the internal audit manager reports administratively to the chief executive officer.

That said, the best option of course is to ensure that the internal audit departmental head reports directly to the board or audit committee of the MFI, to ensure that all potential and real conflicts of interests are negated…

Have A Nice Day!