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

Ramesh S Arunachalam

Rural Finance Practitioner

While the earlier post looked at the substantive policy issues with regard to regulatory reform, significant process issues must also be considered, as outlined below:

Design risks: The authorities should articulate the key drivers for changing the current approach to regulation (say for example, introducing self-regulation as has been done in the Malegam Committee Report which uses the SRO/industry approach as one of its pillars) and should assess the importance of achieving the objectives of reforming the system. Those objectives should be compared to the risks involved in designing changes to the system. Major changes carry risk, and the broader the scope of the planned changes, the greater the risk of problems or even failure. The major risks are:

·         Increased conflicts of interest

·         Ensuring that the SRO/industry association operates with real and effective independence

·         The potential for “regulatory capture” of the SRO/industry association system by regulated MFIs or by one powerful segment of the industry (say for example NBFC MFIs or large MFIs etc)

·         Disruption of standards of regulation and supervision during the transition period because of organizational conflict and uncertainty

·         Reduced standards of regulation and supervision under the new system

·         Overloading the SRO/industry association system with new responsibilities that it does not have time to build the capacity to address. This has to be also seen in the light of the past track record of the SRO/industry association.

·         Excessive interference by the statutory regulator in the governance and operation of SROs/industry associations

·         Failure to design the new system properly, leading to excessive duplication of activities and cost and the like

Transitional risks: Transitional risks are temporary risks that arise from the process of implementing changes in the case of regulatory systems, among a group of organizations. Whenever structural changes are made to a regulatory system (as has been proposed in the MCR), important transitional issues must be addressed. These include ensuring that:

·         Regulatory processes continue uninterrupted, especially supervision of the micro-finance industry players and intermediaries. I am not sure of what is happening in the present period

·         Regulated entities/persons remain within the legal jurisdiction of a regulator at all times.

·         The transition to new institution is as seamless as possible.

·         Dispute resolution mechanisms are agreed to address any unforeseen issues that arise during the transition period.

If major changes are contemplated, the industry and the authorities might consider taking an evolutionary or staged approach to implementation so they minimize the transitional risks involved. I am not sure if any of these aspects are being addressed currently.

Stakeholders’ views: In considering any changes to the present system of regulation, it is important to understand and consider the views of various stakeholders. Stakeholders include a broad range of participants:

·         Intermediaries (banks, MFIs and others)

·         Clients of the above institutions

·         Retail and institutional investors

·         Government and statutory authorities,

·         Existing SROs

·         Stock Exchanges, if applicable

·         Industry associations

·         Other Related regulators

This is indeed a critical issue and I am not sure of what is the degree of support for the changes proposed compared with the resistance to change? Building consensus among the various stakeholders on a “common vision” for the regulatory structure with regard to micro-finance is highly desirable and I hope the RBI/MCR engage and take this process forward quickly

Legal and regulatory risk: If institutions’ regulatory responsibilities are changed in the new structure, plans to minimize legal and regulatory risk are needed. Transfers of responsibilities will likely require (1) transfer of rules from one body’s rulebook to another’s, (2) transfer of responsibility for supervision programs, (3) transfer of experienced officers and staff, and (4) transfer of infrastructure including information

All of the above process issues will also have to be considered and dealt with by the RBI and the Malegam Committee before finalizing the regulatory and supervisory arrangements for Micro-Finance in India…