Ramesh S Arunachalam and Bhalchander Vishwanath[i]
The last time around we had a similar but not so severe micro-finance crisis (2005/6) in Andhra Pradesh – and some industry well wishers argued for the (Sa-Dhan) code of conduct, so well intentioned but not implemented adequately on the ground. Fast forward to the Kolar micro-finance crisis (2009) and industry observers argue that the situation had a different association but similar strategy and result – MFIN and its code of conduct, again well intentioned but not well implemented. Come to the present and there is the current Andhra Pradesh crisis (September 2010 onwards) and industry experts say that this time around, one of the solutions could really be ‘high tech’ - i.e., the proposed credit bureau to be set up by The Micro-Finance Institutions Network (MFIN). Could the proposed credit bureau (indeed) be a solution to the present crisis? Read on…
First, despite the most sophisticated credit bureaus, the sub-prime crisis in the US could not be avoided and therefore, no credit bureau - irrespective of the manner in which it is designed and implemented - is likely to be a foolproof strategy with regard to avoiding such crisis. Make no mistake about this please! Believing that a credit bureau could indeed prevent such a crisis from recurring would be as naive as one could get. There can no replacement what-so-ever for sound lending, based on an objective assessment of a client’s (likely) cash flows and his/her loan absorption capacity. Further, there can also be no substitute for the relationship banking that most of us get and without question, micro-finance clients deserve the same as well.
Second, when we talk of micro-finance clients, there is so much information asymmetry with regard to their loans and lives and we are not sure that the proposed credit bureau would be able to acquire such information. We do not have access to any reliable and valid information on informal sources of finance and getting them at the scale required for the proposed credit bureau, should be next to impossible in the Indian context. We cannot also easily track the lending that an SHG does to its members – it could become cumbersome to do so and very difficult task from a record and data management perspective
Third, when many MFIs (including the large ones) have not been able to set up and run appropriately designed and aggregated management information systems (MIS) across geographies, products, states etc at their own individual MFI level, how can we expect them (and their association) to accomplish a more difficult task with significant complexity and scale? There are serious issues with record keeping, portfolio management, internal control and finance/accounting systems in many MFIs and the integrity of the ground level data is very questionable. Therefore, expecting the MFI association to do something that is much, much more advanced, when the basic foundations of record keeping and data management are itself very weak is going to be a stretch.
Fourth, establishing a credit bureau even with limited functionalities takes an enormously long time. In India with multiple models of microfinance - MFIs, Banks, RRBs, SHGs, Cooperatives - lending to clients, integrating information from all these entities and making them available with a reasonable degree of reliability will be an enormously complex project requiring significant investments. Please note that huge investment in terms of money and effort would be required to build the central credit bureau and also implement it at the individual MFI level.
Fifth, studies on efficacy of credit bureaus indicate that they do have risks of financial exclusion of the poorest clients. That needs to be noted and before embarking on such an initiative, we need to mitigate the risks of financial exclusion due to new techniques that focus on impersonal means of making credit decisions.
"The results therefore bring both good news and a cautionary note. They are positive in that they show that credit bureau information allows MFIs to more effectively service the poor. Yet, they highlight that a number of poor individuals are initially screened out as credit bureau information is utilized. It is important that we understand which poor individuals are no longer offered loans.
If they are indeed bad clients, in the sense that they are likely to default because they refuse to pay even though they have sufficient resources or because they make overly-risky investments, then there is little cause for alarm. However, if those who are screened out are individuals whose bad repayment record is a result of idiosyncratic shocks and not moral hazard, then MFIs must be careful in using credit bureau information.”[ii]
Sixth, there are also significant investment and operational costs involved in setting up a credit bureau. These include:
a. Cost of setting up and maintaining the credit bureau
b. Cost of capturing additional information for credit bureau purposes and making changes to the MIS systems of participating organizations, which may have differing designs and standards (thereby, posing numerous problems for integration as well)
c. Cost of training the staff
d. Cost of client education: Clients who are mostly poor should be able to get their credit status and report for free. They should be entitled to this information, as it is theirs alone. They should also be educated on what a credit report means and what they need to do to improve their credit (rating or score). There should be also an independently monitored appeal process at no cost to the client so that clients are not inadvertently excluded due to improper credit approval systems.
A robust financial model that takes all of these into account should be built so that it does not lead to additional costs for the client or handling fees for the MFI.
Seventh, the efficacy of setting up specialized microfinance credit bureaus has also been questioned in a few studies in Latin America. It perhaps makes more sense to set up a general credit bureau through the main banking system (for the middle class and upper middle class) and extend the same to lower middle class and the poor. With CIBIL operational, the same could be done in India and that would also not burden the poor with bearing the costs of setting up the infrastructure of a credit bureau.
"The country case studies reviewed in this chapter lead to the preliminary conclusion that it is unwise to develop very specialized credit bureaus that by their nature fragment the credit information market. Whether in El Salvador or Bolivia, the specialized sectorial bureaus do cater to their institutional subscribers, but their databases miss a wealth of information on clients who have not yet fallen under the purview of that particular sector. Efforts to create specialized MFI credit bureaus have been based on the assumption that the market niche of MFIs is completely separate from the market niche of other lenders. This assumption is proving to be false, at least in many Latin American countries, where microfinance clients access a variety of sources of financing, including the corner store.
Pursuing quick-fix solutions, such as endowing an MFI association with equipment, software, technical assistance, and operating expenses to run a small MFI credit bureau, is tempting for donors. As has been illustrated by the cases of INFORED and FINRURAL, however, setting up a credit bureau is not a simple matter. It requires superior technology, business marketing sophistication, and the ability to attract as subscribers large and multiple clients. With a large subscriber base, a bureau can have something useful to offer, in addition to securing its financial sustainability.[iii]"
Eighth, currently micro-finance (or rather micro-credit) is going through a phase of limited relationship building with the client. A credit bureau will perhaps depersonalize the client-loan officer relationship even more. What is needed at this time is deeper involvement and knowledge of the client's life and business and stronger relationship building with clients. A credit bureau may end up doing the reverse and thereby increase the risks to the micro-finance sector.
Ninth, such a bureau should be mainstreamed and housed with CIBIL or any other independent body, and MFIN should (perhaps) limit itself to playing the much needed facilitating/coordinating role. This alone will enable the credit bureau to be viewed as a reliable and valid data source with regard to low income people. It will also allay concerns of poaching of bank clients by MFIs and vice-versa.
Therefore while a credit bureau is a good medium to long-term solution, it is certainly not an immediate solution for the current set of issues. It has and will continue to have operational challenges for several years, if not decades in the context of a country like India that has a huge variety and complexity of financial services. Let us not overburden it with unrealistic expectations – that would surely be a recipe for disaster. A credit bureau is a great idea by itself and it should be made to succeed. Let us incubate it in a favourable environment and not let it face baptism by fire at its very birth…
[i] Mr Bhalchander Viswanath is CEO of United Prosperity.Org and the views expressed are purely personal. Ramesh S Arunachalam is an India based Rural Finance Practitioner.
