Where Angels Prey

Where Angels Prey is a novel by Ramesh S Arunachalam. Please refer to www.whereangelsprey.com for more information

Friday, July 29, 2011

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

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

Thursday, July 28, 2011

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

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?

Tuesday, July 26, 2011

Local level supervision is critical to ensure consumer protection in microfinance

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

Saturday, July 23, 2011

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

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

Click Here to Read More

Friday, July 22, 2011

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

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

Wednesday, July 20, 2011

Does a five-star board guarantee good corporate governance?

Ramesh S Arunachalam
Rules and regulations are not enough. They must be implemented. Sadly, recent episodes have shown that even independent directors stayed silent when rules were violated
Click Here to Read More

Saturday, July 16, 2011

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

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

Click here to

Wednesday, July 13, 2011

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

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!


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

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 (2nd 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.


Have a Nice Day!

Tuesday, July 12, 2011

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

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.


Have a Nice Day!

Sunday, July 10, 2011

Who Should Regulate and Supervise Micro-Finance in India?

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

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?

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

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 12th 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 1/3rd 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.
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 6th 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.
[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.’