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

Ramesh S Arunachalam

Rural Finance Practitioner

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

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

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

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

·         How to ensure that the industry best supports economic development?

·         How to enable the industry to foster market development, competition, and innovation to better meet the needs of clients in micro-finance?

·         How to alter/raise/revise standards of regulation and conduct to ensure that clients and other stakeholders (including investors and other participants) are treated fairly?

·         How to improve integrity of the micro-finance market in general?

·         How to achieve an appropriate cost level for regulation of the micro-finance industry?

• How to ensure that the MFIs, FIs and various stakeholders have the business focus, competitive positioning, systems, and governance standards required to succeed in their missions?

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

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

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

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

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

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

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

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

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

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

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

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

Making Micro-Finance Associations More Effective as Self-Regulatory Organisations: Lessons From The Indian Experience

Ramesh S Arunachalam

Rural Finance Practitioner

A lot of questions have been raised about the effectiveness of micro-finance associations as Self-Regulatory Organisations (SROs). While it is true that these associations may have tried hard, the fact of the matter is that this self-regulation has not worked and here are some reasons why. It would useful for the RBI and The Malegam Committee to look at some of these aspects and address them, as the Malegam Committee Report (MCR) does provide a fairly important role for micro-finance associations as SROs. The various reasons are briefly highlighted below:

(1)   To be effective, MF associations that act as SROs must have a common set of public policy objectives including the enhancement of market integrity, market efficiency and client/investor protection with regard to micro-finance;

(2)   They must be actively supervised by government regulators and in the present instance by RBI, IRDA and other such regulators;

(3)   They must have (official) statutory regulatory authority and/or authority delegated by the government regulator(s). This would give them the much-required legitimacy and this is a very critical aspect because, then the SROs will act (on behalf of the government regulators and also) along with them in maintaining decorum and order in the micro-finance industry

(4)   They must establish simple and practical rules for MFIs and individuals to follow and this must be subject to their official regulatory authority and it should also be in line with the objectives in the larger regulatory framework;

(5)   They should monitor compliance with these rules, without any conflict of interest and irrespective of whether the member MFI is a pioneer, founder, largest MFI and the like;

(6)   They must have the official authority and more importantly, administrative will to discipline MFIs and individuals that violate these rules. Clearly they must show intent to self regulate rather than provide a lip service;

(7)   While they should have industry representatives on their Boards and also ensure that industry representatives have a meaningful role in governance, the board must have the equivalent of independent directors from civil society and/or official regulators. That alone will make them more accountable; and

(8)   They must maintain structures, policies and procedures intended to ensure that all conflicts of interest between their membership (commercial) and regulatory activities are appropriately managed.

Along with the core characteristics outlined above, MF association SROs also need to carry out a variety of other activities that are consistent with their mandate to enhance market integrity, market efficiency and client/investor protection. These activities would need to include the provision of: (1) Consumer redressal services for the end user clients; (2) Dispute resolution services for and among their members; (3) Client literacy and education for end user clients as well as educational services for staff of their members in special areas like gender etc; and (4) Reliable and valid market data for their members and other market participants.

Within the above broad continuum of services and characteristics, MF associations as SROs can then start to occupy a unique position and play an important role, using their official regulatory authority as well as their special relationships with government regulators and their members. I hope that the RBI and Malegam Committee look at this aspect closely and work out the relevant details…

Have a nice day!

Legal Notices to Delinquent Clients and Insolvency Petitions by Delinquent Clients: Where is The Indian Micro-Finance Sector Really Headed?

Ramesh S Arunachalam

Rural Finance Practitioner

It is raining (legal) notices in the Indian micro-finance industry. Please see the enclosed attachment below (Exhibit B) and it is the notice issued by one MFI to a client who owes it Rs 810 (about 16 US $). While I am not sure of the number of clients who have been issued such notices (authoritative sources however put it at around 15000 clients at least), I am really appalled by the behaviour of MFI field staff as evident from this e mail conversation between two fieldworkers of MFI 1 and MFI 2. Read on…Exhibit A…below

 As the e mail (in Exhibit A) suggests, clearly, what is happening on the ground is neither financial inclusion nor poverty alleviation. It is organized money lending as Dr Y V Reddy has remarked.

From the above attachment (I have the originals), it is very clear that codes of conduct don’t work on the ground – much to the chagrin of MFIN and/or Sa-Dhan. Please see adjoining piece, which enumerates some of the reasons for this. The above attachment (Exhibit A) even talks of scars on the face of the clients husband and police complaints and I am not sure that this is the type of financial inclusion that we all wanted in the first place…I leave it to you all to judge for yourselves…

And I do have some unanswered questions here:

a)      Why did the 7 MFIs lend to the same client?

b)      Where was their due diligence? What about the correct lending processes and methodologies that many of them claim?

c)      What about SIDBI and/or banks? Did they not spot this in their field visits?

d)      What about the rating agencies? Did they not spot this and note it in their reports?

e)      Where are the SROs and many of the MFIs are members of either Sa-Dhan or MFIN? What are these associations doing? Why has self regulation not worked?

f)        Is this the inclusive finance we want?

g)      And finally, this is not AP? There is supposedly no govt interference in Tamilnadu in terms of a law or bill. So, how come this is happening? 

h)      Will someone help me find the answers please?

Please also see the legal notice sent by an MFI to a client who owes it Rs 810 – Exhibit B and over 15000 such notices are supposed to have been sent to clients. The notice is in Tamil but the contents are simple: Please pay up or we will take legal action to recover Rs 810 from you...Juxtaposed with Exhibit A above, it is clear that Micro-Finance is now becomming organised and registered money lending.

·         When I went through the 1^st CGAP ToT course on Delinquency in 1998 (With Mr Sanjay Sinha, Mr Ron Chua, Mr Jith was there as an observer and several others), I remember Ms Brigette Helms, Ms Janet and Ms Joyita Mukherjee of CGAP telling us regularly, there are no bad clients, there are only bad loans and institutions alone are responsible for delinquency

·         I would like all of you to remember this…and going by the number of notices and tough measures employed for collection, there seem to be a lot of bad loans that have been made in the Indian micro-finance sector. That is the REAL growth story of Indian Micro-Finance folks. Read on…

From the 2^nd attachment (Exhibit B), it is clear that MFIs are facing serious collection problems in places other than Andhra Pradesh (and the letter alludes to the member neither attending meetings nor paying back properly) and I really hope that people are listening…I have already put out several e mails in this regard and have many more in possession that can stand scrutiny in a court of law.

Very interestingly, I also came across a legal notice by a client’s lawyer to 13 MFIs stating that the borrower YYYYY had filed for insolvency and was unable to pay back the 13 MFIs – Exhibit C

The above raises several issues:

a)      How did these 13 MFIs lend to the same client?

b)      Is this the real method of larger outreach in Indian micro-finance?

c)      What were the banks and SIDBI doing? What were their officers doing?

d)      What were the associations doing?

e)      What were credit rating agencies doing?

f)        Is this what we want in inclusive finance?

g)      Given that many clients are in the process of doing this, where is the Indian MF sector headed?

From the 3^rd attachment (Exhibit C), it is clear that the inclusive finance paradigm used micro-credit to multiple lend to same person several times. The attached notice is to 13 institutions and again, I want people to tune in please. There is strong evidence that clients are starting to do this more and more…

Honestly speaking, the growth story of Indian micro-finance will soon be known as one of multiple lending to shared clients in (same) JLGs, who lack the income sources to repay multiple loans. Now, is that not a sub-prime like situation? Was not Dr Y V Reddy, former RBI Governor, correct in stating that MFIs are registered money lenders and micro-finance is India’s sub-prime?

I leave you to judge things for yourself…

Have a Nice Day!

Indian Micro-Finance Industry Update: The Unfolding Mess in Tamilnadu, India

Ramesh S Arunachalam

Rural Finance Practitioner

I woke up today to hear three disturbing pieces of news[i] about the Indian micro-finance industry and Read on…

(1)   I just heard from a close friend that an MFI client, who had taken (13) loans from 13 MFIs in Salem district in Tamilnadu, has filed an insolvency petition. She wants her loans written off and there are supposed many others like her in the offing;

(2)   There is also wide spread discussion in Tamilnadu with regard to an MFI that is said to have sent legal notices to several thousand clients (another friend put the number of notices sent at close to 15,000), who have been unable to make payments (on their multiple loans) to this and other MFIs. Other MFIs are likely to follow suit; and

(3)   I also heard that when MFIs go back to collect money from these several thousand clients who have been served a legal notice by the above MFI, the women are telling the other MFIs – “now that a legal notice has been issued by one MFI, we are not willing to pay any of you back. You will have to collect the money through the same legal route only”

A lot of these problems can be attributed to the growth and client acquisition strategies pursued by the MFIs during the last three years. Given the large-scale ramifications of the present situation, who is responsible for this situation and who needs to be held accountable?

There are several stakeholders including the following who need to answer for the mess created in India’s rural and urban low income economy

a)      Large and fast growing MFIs who desired to have supernatural profits and artificial growth numbers to attract equity investments at a premium and create wealth for themselves and their investors,

b)      Investors, who paid a premium and hence, perhaps pushed MFIs to grow recklessly and mindlessly, using the bait of further and larger equity investments to get MFIs to show better results and offer artificially high returns,

c)      Banks, who had a great time in making supernatural profits from micro-finance, often piggyback riding on MFIs/Equity Investors. Without question, the banks ably led by SIDBI irresponsibly threw their (public deposit) money in the garb of financial inclusion, knowing fully well that greening and other strategies were being used to repay loans,

d)      International Agencies like CGAP and others who have pushed the agenda of hardcore commercialization, without for once thinking whether inclusive access to finance was being implemented as envisaged and/or whether it made any real difference on the ground,

e)      Policy makers who strongly pushed the vision of financial inclusion without realizing that this concept primarily translated into small consumption credit (and perhaps some small production credit) being channeled to the very same borrowers multiple times, and

f)        Last but not the least, the so-called SROs (Self-Regulating Organisations like MFI associations), which have not been able to bring a semblance of order to the chaotic growth of the Indian micro-finance industry in the last few years.

As the Indian micro-finance mess continues to unfold, I would like to use this opportunity to (humbly) caution my Dear African and Latin American friends and request them to learn from India’s large scale micro-finance mess that promises to stay that way for a long, long time ahead. The credit culture in our ‘low income economy’ appears as good as dead. And make no mistake, irrespective of any regulation and/or bill that is going to be passed, the mess on the ground is very severe as I have always been saying and it is sure to take long to clean up – there are many many shared clients/JLGs with multiple loans and these clients have no real means of repaying the multiple loans that have been literally consumed over the years. I am sure that some stakeholders will continue to say that all is well but there are very clear signs emanating that things are going from bad to worse in many places in the Indian micro-finance sector and much of this is not necessarily in Andhra Pradesh (AP)

Without question, the low income economy in rural and urban India has been shredded in many places and the people are the real sufferers…as many of them are not seen as credit worthy even by their traditional financiers (informal money lenders)… so much for the inclusive finance agenda being pushed world wide. I really hope that CGAP and others including UNCDF or UNDP or USAID learn from the Indian micro-finance crisis - even as they are implementing and furthering the inclusive finance agenda globally elsewhere[ii] – and alter their approaches and strategies accordingly!

Have a Nice Day!

---

[i] There is strong evidence with regard to the above

[ii] Please see the proposed e conference on March 29^th and 30^th being organized by World Bank, IFC and USAID

‘Good Policy and Regulation’: What Is It and How Can It Be Developed in Micro-Finance?

Ramesh S Arunachalam

Rural Finance Practitioner

An often-asked question is: How is ‘good’ policy and regulation best defined and how should it be developed? Unlike what people generally believe, less regulation does not equal better regulation. In fact, as has been noted by several people, many laws that might appear to hinder the growth of a sector may in fact be essential for the sector’s growth. For example, labour law regulations, which may seem ‘troublesome’ for many MFIs to comply with, in fact, promote legal security within employer employee relationships and therefore have the potential to stabilize these businesses from a long-term perspective.

That said, a key challenge for policy making is, therefore, one of developing appropriate and sound policy, sensitive to the existing ways of doing things and to the compliance costs of organizations with somewhat limited resources for such compliance.  

To meet this objective a number of criteria can be used for the development of effective policy and much of this is based on the recent policy making assignments that I and others have been involved with in Asia and Africa. Read on... and the same could be used to look at the plethora of micro-finance regulations, likely to emanate from the Malegam Committee Report and associated efforts (Micro-Finance Bill):

• Lesson # 1 – Policy Must Have Wider Stakeholder and Civil Society Support: Policy and associated regulation must have broad stakeholder and public support. Without this, compliance is likely to be low and cannot be enforced in reality.
• Lesson # 2 – They Should Be Enforceable: The regulations must be enforceable on the ground. They must not conflict (too much) with existing ways of doing business and on-going methods of operating. An additional practical rule here is do not regulate anything that cannot be supervised
• Lesson # 3 – Policy Must Be Simple and Clear: All relevant stakeholders must easily understand the policy and associated regulations. Complexity in policy/regulation undermines their effectiveness and often leads to difficulty in compliance. Therefore, simplicity and clarity are very critical and necessary attributes of good policy/regulation
• Lesson # 4 – It Must Be Balanced, Sensitive and Enabling: Regulation must be balanced and sensitive to needs of those being regulated and there should be an awareness of the possible costs of compliance while making the broad policy and associated regulation. Oppressive regulations may infact encourage institutions (MFIs etc) to move out or even drive cause their ultimate death. This is a very crucial aspect that needs to be focused on while developing policy and associated regulation
• Lesson # 5 – It Should Not Be Paternalistic: Policy and regulation should not be overly paternalistic. In other words, it should not remove all decision making from institutions (or individuals) who could decide for themselves
• Lesson # 6 – They Must Aim to Resolve Conflicting Objectives: Regulations should attempt to resolve potentially conflicting policy objectives - for example they could encourage the growth of employment in MFIs but at the same time, protect the rights and working conditions of employees, which may be rather inadequate in most contexts
• Lesson # 7: They Should Have Clear Accountability: Policy and associated regulations must provide clear and identifiable accountability when things go wrong. The buck must stop somewhere and clearly…
• Lesson # 8 – They Must Reduce Competitive Disadvantages: Regulations should be designed in a way that competitive disadvantages are reduced in favour of those (institutions) being regulated without creating new disadvantages.
• Lesson # 9 – They Should Foster Innovation and Entrepreneurship And Enhance Access to A Wide Range of Services for End User Clients: MFI policy and regulations must seek to promote access to a wide range of (financial and non-financial) services required by their clients for growth and development.
• Lesson # 10 – They Should Encourage Inclusive and Sustainable Economic Growth for End User Clients: Regulations must enable end user clients to take advantage of opportunities for economic growth in the environment in an equitable and sustainable manner.  They must also strengthen the various systems to attract capital flows and manage increased levels of investment and create the environment to promote viable and competitive MFIs that can contribute to employment, income generation and poverty reduction.
• Lesson # 11 – They Must Regulate and Supervise What Has to Be Regulated and Supervised: Overall, the policy and associated regulation must ensure that all aspects to be regulated and supervised (like Governance, Systems and other operational aspects in MFIs) are indeed regulated and properly supervised. They should not leave the onus for this regulation/supervision of mandatory aspects (non-negotiables) on the very institutions that need to be regulated and supervised. The incentives for self-regulation to work are rather low in many contexts and this must be clearly recognized and addressed by policy/regulation
• Lesson # 12 – They Should Be Capable of Adaptation: The policy and associated regulation must be reviewed (perhaps not too frequently) and adapted to suit changing circumstances, using the outcomes of an embedded monitoring and evaluation system in the policy framework

Cheers

Have a nice day!

Let Us Not Be Pennywise And Pound-Foolish in Regulating Indian Micro-Finance!

Ramesh S Arunachalam

Rural Finance Practitioner

I was away for three weeks in Africa working with senior policy makers and hence, my silence on the blog. As soon as I came back to India, I came across a news item yesterday that said that the RBI is going to implement most of the Malegam committee recommendations from April 1^st

I have serious reservations about some of these recommendations and would humbly request India’s Central Bank and the Malegam Committee to get deeper into these recommendations before implementing them. There are several issues here and I highlight them sequentially:

First, while the spirit and overall approach of the Malegam Committee Report (MCR) is commendable, its attempt to provide client protection through ‘artificial barriers’ must be strongly questioned.

While aspects related to Corporate Governance, Systems and other such aspects for NBFC MFIs are non-negotiables and need to be solidly enforced through a regulatory stipulation and also supervised diligently, the aspect of artificially restricting client level of borrowing, placing emphasis on the household income as an eligibility criterion and such aspects are practically untenable. As someone who has worked in over 550 districts in India and several other countries over the last 23 years, I can vouch safe that such measures cannot be enforced on the ground. And also, as these aspects cannot be supervised with any degree of reliability, they should not be regulated at all. And if this still needs to be done, it may be better to influence these by incentivising the appropriate behaviors through provision of preferential priority sector credit (and/or other incentives) for livelihood loans, loans lesser than Rs 50000 and the like 

Client protection will not and cannot occur through restrictive regulation and the RBI must seek to regulate and supervise institutions for their governance, minimum systems, use of agents and the like rather focus on such client level issues. Client protection is best achieved through a program of enhancing financial, other literacy and empowerment of clients and making sure that clients understand what they are getting into when they borrow such large amounts from (many) MFIs

A second issue is the aspect of the Malegam Committee Report (MCR) trying to artificially scale up the Indian micro-finance industry and the associated presumption that this scaling up will automatically reduce interest rates and solve other problems. I would like to re-emphasise that much of the colossal damage that occurred in AP and other parts of India were caused by the large and fastest growing MFIs and the interested reader may want to look at the blog posts (given below) in this regard.

I have already provided solid data on how these large and fast growing MFIs grew and the havoc that they caused on the ground. Ignoring this (hard evidence) certainly spells doom in the long run for the Indian micro-finance sector

Therefore, it seems that the MCR is sort of self-defeating when it espouses the argument of “artificially” pushing MFIs to scale up. While being large may not necessarily be bad, let us not forget recent micro-finance history in India which suggests that very fast paced growth and bulldozed commercialization led to much of the problems in Indian micro-finance. Therefore, I clearly feel that the shortsightedness of the MCR in merely encouraging scaled up micro-finance - as a one stop shop solution - is a recipe for disaster. I sincerely hope that the committee and RBI take a re-look and focus on all necessary aspects of the regulation (= Governance, Systems in MFIs, Use of agents etc) and try and weed out those (like artificial client protection and scaling up measures) that could prove counter productive…

Have a great day!

Some relevant blog posts

http://microfinance-in-india.blogspot.com/search/label/Equity%20Investments

http://microfinance-in-india.blogspot.com/2010/10/microfinance-crisis-failure-to-learn_22.html

http://microfinance-in-india.blogspot.com/2010/12/is-micro-finance-indias-sub-prime.html

http://microfinance-in-india.blogspot.com/search/label/Micro-Finance%20Growth%20Story

http://microfinance-in-india.blogspot.com/search/label/Client%20Acquisition%20Strategies

http://microfinance-in-india.blogspot.com/search/label/Micro-Finance%20Agents

http://microfinance-in-india.blogspot.com/search/label/Microfinance%20Lessons

Implementing The Rs 100 Crore Proposed Equity Fund Through SIDBI: Some Lessons for Consideration...

Ramesh S Arunachalam

Rural Finance Practitioner

The recent budget announcement that Rs 100 crores of equity is to be channelized through SIDBI is an excellent proposal for which the Hon Finance Minister of India must be wholeheartedly congratulated. That said, there are several lessons and issues that need to be considered while/before setting up this fund and facilitating equity investment in the nascent and small MFIs through SIDBI. I hope that the concerned people ask the right questions and do the required home work before establishing this very important initiative. Again, the purpose here is not to be critical of any institution, but rather to learn valuable lessons from the past, which is perhaps a great teacher in some ways...Read On...

First, SIDBI's record in carrying out the obligations of being an equity investor is rather poor and the case of SKS Micro-Finance Ltd is an excellent example of where a senior SIDBI officer on the board of SKSML permitted the founder/promoter to lend a substantial sum of money to himself to enable him to buy shares of the same company (SKSML). This huge related party transaction can be viewed as the starting for the current problems in Indian micro-finance. A related aspect is the reckless and mindless growth of the Indian micro-finance sector between April 2007 and March 2009, for which SIDBI has to hold itself hugely, if not solely, responsible – as the following blog piece suggests and reveals with solid data, SIDBI played a no mean role in encouraging this burgeoning and irresponsible growth of Indian MFIs.

http://microfinance-in-india.blogspot.com/search/label/Role%20of%20DFIs

Second, the aspect of providing equity does not stop with merely making the investment and especially, when you talk of valuable Government of India money being challenelised. Along with it comes the solid obligation to ensure that the MFIs that are recipients of this ‘special’ equity investment are indeed worthy of the same and continue to stay worthy of the same – in terms of their practices in several areas including governance, management systems and the like – and are more importantly held accountable for their accessing these privileged funds.

Third, given the past experiences where related party transactions and other not-so-good practices were perhaps authorised by institutional nominee directors, it becomes important to strengthen and streamline the processes by which such nominee director’s report back to their parent organisations. It may be useful to ensure that they mandatorily write physical reports and submit the same as part of their obligation to serve on the boards of these MFIS and there must also be a process of vetting these reports and making the directors accountable. Such directors must also not sign minutes with regard to issues that have not been deliberated – this is a very common practice in the Indian micro-finance sector

Fourth, there is a tendency for such directors to encourage vast amounts of borrowing from the parent organisations and this again causes the devastating supply side growth. In short, these officer nominee directors appear to be more loyal to task of encouraging greater loan off take from their parent organisation by the concerned MFIs (and thereby causing huge supply led growth) rather than ensuring appropriate growth of the MFI commensurate with their systems and governance and actual client demand on the ground. This conflict of interest must be guarded against in some manner...

So these are some of the key issues that need the attention of the concerned people establishing this fund and I would be grateful for their kind attention to these matters as otherwise, we will again see the use of equity resulting in a lot of problems for the Indian micro-finance industry and its clients...

Other key lessons and issues relating to this can be found in the following posts...

http://microfinance-in-india.blogspot.com/2011/01/does-five-star-board-guarantee-good.html

http://microfinance-in-india.blogspot.com/2010/11/role-of-independent-directors-in.html

http://microfinance-in-india.blogspot.com/2010/11/governance-of-remuneration-in-indian.html

http://microfinance-in-india.blogspot.com/2010/10/corporate-governance-in-indian-mfis_20.html

http://microfinance-in-india.blogspot.com/2010/10/corporate-governance-in-indian-mfis.html

http://microfinance-in-india.blogspot.com/2010/10/corporate-governance-in-indian-mfis.html

Happy Weekend

Cheers

Ramesh