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

Ramesh S Arunachalam

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

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



 
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Building The Internal Audit Function at MFIs: The Need For Independence, Authority and Competence For Internal Auditors…

Ramesh S Arunachalam

Rural Finance Practitioner  

Internal auditors (at MFIs as well as other entities) must be independent of the activities they audit so that they can carry out their work freely and objectively. They must render impartial and unbiased judgments. The internal auditor or the manager (director) of internal audit should report directly and regularly to the board of directors.

While many MFIs still have very nascent internal audit operations, in some large MFIs, the internal audit function is made a part of a group that manages or controls the MFI’s risk management activities. This arrangement may be satisfactory as long as the audit function functionally reports directly to the board and retains its independence. If the internal audit manager reports to a senior executive on day-to-day administrative issues, then, the board must take extra and special measures to ensure that the relationship does not impair the auditor’s independence or unduly influence the auditor’s work. And in micro-finance as well other fields, this has proved difficult and therefore ensuring that the internal audit department head reports directly to the board or a board sub-committee (like audit committee) is perhaps the best option.

In reality, the board should be and is responsible for delegating the authority necessary to effectively allow internal auditors to perform their job. Thus, internal auditors must have the power to act on their own initiative in all departments, functions and units in the MFI; to communicate directly with any MFI personnel; and to gain access to all records, files, or data necessary for the proper conduct of the audit. Clear communication between the board, the internal auditors, and management is critical to timely identification and correction of weaknesses in internal controls and operations.

Internal audit staff should also possess the necessary knowledge, skills, and disciplines to successfully implement the audit program at the MFI in a proficient and professional manner. The evolving roles of internal auditors require that they expand their skills in analysis, technology, decision-making, and communication. At a minimum, members of the audit staff should:

·         Have appropriate education and/or experience, relevant to micro-finance and social development

·         Have organizational and technical (financial) skills commensurate with the responsibilities assigned and they should be familiar with micro-finance models and operations

·         Be skilled in oral and written communication

·         Understand accounting and auditing standards, financial principles, and related techniques

·         Recognize and evaluate the materiality and significance of deviations from sound micro-finance practices, and 

·         Recognize existing or potential problems and expand procedures as applicable

Thus, it is important for each member of the internal audit staff, including the audit manager or director, to commit to a program of continuing education and development, especially in line with the new developments in micro-finance. Hence, deputing them to courses and seminars offered by special institutions like CGAP (and others), industry associations or audit industry groups is a must and should afford them the required opportunities for maintaining audit skills and proficiency, especially with regard to the evolving micro-finance industry. In-house training programs, work experience in various departments and field areas at the MFI, and reviewing current literature on auditing and micro-finance/banking are also means to maintain and enhance auditing skills.

To summarise, internal auditors play a very fundamental role in ensuring the integrity of the various systems at MFIs and therefore, it is important that they are given the necessary authority, independence and skills/knowledge to effectively perform their crucial tasks.

Have a Nice Day!

Human Resource Systems in MFIs, Social Performance, Client Protection and Responsible Micro-Finance: What Is The Relationship?

Ramesh S Arunachalam

Rural Finance Practitioner

I have been seeing a very interesting pattern in the present Indian micro-finance crisis with regard to MFI staff. Many places where serious problems  - like multiple lending, frauds, high levels of willful default, use of agents – exist on the ground, a common denominator can be usually found and it is the fact that “Staff” turnover is (has been) very high.

As observed, Staff A from MFI A have usually moved to MFIs B and C (within a short time) and also got promoted through the hierarchy to occupy a much higher position in MFI D. In many ways, I see these (fraud perpetuating moving) staff as the primary cause of the various problems:

1)      They use their past knowledge of other MFIs to enable new MFIs to lend to the older JLGs and cause multiple lending in the areas. Entire branches of older MFIs have been closed because of this as I have observed;

2)      They tell clients to not repay older MFIs and promise them higher/fresh loans from their new/other institution and thereby set the trend for wrong (defaulting) behavior by clients

3)      They get well known center leaders and local opinion leaders to come away with them and act as agents for forming new JLGs, especially by breaking up past JLGs/SHGs and the like.

4)      They collect loan dues of their past MFIs and do not repay these to the concerned institutions. They often abscond with this collected money and move to another area and join to work with a new/other MFI

5)      They network with similar peers and form a nexus ring leader type operation that can sometimes cause large scale problems like witnessed in Vellore, Salem, Karur and other belts of Tamilnadu as well as in many districts of Andhra Pradesh

6)      They are primarily responsible for unleashing local toughies through agents for collecting loan repayments and the like

7)      And Plus more…

So, while a lot has been written about the not-so-good practices in MFIs in this Indian MF crisis, one of the main drivers of the same, in my opinion, is the fact that all and sundry are hired as staff and especially, without sufficient background checks (due diligence) and placed on the job without requisite training and the like. And much of this has happened as the drive to grow quickly and reach scale has prompted many MFIs (and especially, some of the newly established commercially oriented entities) to use all possible methods to achieve the same. Some specific comments are in order here:

The lack of background checks has meant that staff who have committed frauds in one place (MFI) have got into higher positions in other MFIs and naturally, they also re-socialise new staff at the other (new) MFI and attune them towards not so good practices. The lack of background checks also has resulted in people with criminal records entering the MFI roster and moving on from one MFI to another, often engaging in increasing frauds at the various levels…

The lack of training has meant that the staff do not understand the mission of micro-finance or that of the MFI and this has again resulted in the excessive drive towards growth, scale and profits – as a result, several MFIs have moved towards using agents for loan disbursement and recovery and also have lent for purposes, that need not be strictly called as micro-finance {I came across a few cases of illicit arrack (liquor) production and the like}

And a lot of this has to do with the overall incentive system for staff at MFIs – where the unsaid (or widely proclaimed) rule is to either ‘disburse a lot quickly or perish’. No matter how much of denial that MFIs provide with regard to the existence of such incentives on paper, in practical terms, at the grass-roots and branch./field worker level, they are very apparent and this observation was also made to me by a journalist from the international media, who also extensively toured the field areas in India in 2010/2011.

So, the above are some of the issues that the regulators, industry associations, MFIs and other stakeholders must focus on and attempt to redress immediately through various mechanisms 

In fact, before I sign off, I would also like to present the perspective of many genuine MFI staff and draw the attention of the RBI and other stakeholders to dismal working and living conditions of many such staff in the Indian micro-finance industry. In many places, there are no service rules and often, it is very high pressure 24 x 7 work. Also, usually, there are no contracts issued by many institutions and the hiring/firing is done verbally and at the whims and fancy of the superiors. Grievance procedures also do not seem to exist in many MFIs and faced with such a situation, it is hardly surprising that the level of frustration among many genuine staff is rather high. In fact, some (good) staff have crossed the line because of such an environment...and moved towards behaviors such as those listed above...

Given the above situation, it is therefore imperative that the Indian micro-finance industry starts looking inward so as to immediately address the prevalent HR problems and also help build professional and ethical HR systems at (many) MFIs. Until that is done, neither can social performance nor client protection nor responsible micro-finance be achieved in any significant measure…on the ground…

Have a Nice Day!

Responsible and Fair Micro-Finance in India: What are the Key Issues?

Ramesh S Arunachalam

Rural Finance Practitioner

Recently, according to The Microfinance Focus, January 31, 2011,

“A group of 40 global investors met at a recently concluded Responsible Finance Forum in The Hague for promoting responsible finance for Investors in Inclusive Finance. The event was organized by the Dutch Ministry of Foreign Affairs in The Hague, Netherlands, BMZ, CGAP and IFC. The United Nations Secretary-General’s Special Advocate for Inclusive Finance for Development, Her Royal Highness Princess Maxima of the Netherlands was among the ones present at the event.

The event saw investors stating their commitment towards a fair treatment and protection of the interests of the clients in inclusive finance- low income households and small and medium-enterprises. They also asserted their goal of supporting and investing in those financial service institutions that offered responsible micro-finance, including a wide range of quality services to clients together with embracing transparency and sustainability.

James Gifford, Executive Director of Principles for Responsible Investment, said “Micro investments are one of the most important mechanisms to help us achieve the UN Millennium Development Goals. Principles for Investors in Inclusive Finance make an important first step to mainstream microfinance in a way that safeguards all stakeholder interests.”

There are several issues that I would like to bring to the attention of the Responsible Finance Forum and other stakeholders in Micro-Finance and my objective is not to find fault with anyone but rather to continue highlighting critical issues…

First, many of today’s MFIs are perhaps getting to be more and more transparent about their interest rates and that is perhaps evident from the fact that they have cooperated with MF Transparency to publish their effective and all inclusive interest rates. Congrats to all the MFIs and MF transparency for this wonderful effort. Where some of these MFIs are perhaps unfair to their low income clients concerns the aspect of related party transactions, governance of compensation (both salaries and stock options) and burgeoning growth achieved through multiple lending and other not-so-good practices. I will highlight these aspects in a series of posts with hard evidence from the financial statements of Indian MFIs

Second, in a few cases, I have observed that the stated interest rate is not what is actually collected on the ground and people like Mr Al Fernandez have talked about this in a recent CGAP post. In fact, my experience at the grass-roots and published client level data indicate divergence in interest rates between those stated on records and that actually collected. Part of this could be the result of internal control failure and part of this may relate to use of centre leaders and others as agents.

Third, please recall that I reported on an APMAS study of effective interest rates in Andhra Pradesh (in 2010) and the data from the study appear not to be in consonance with some of the interest rates published for the same organisations (as per publications from the concerned MFIs and also as per data published by MF Transparency recently). I am not finding fault with MF transparency’s excellent work (which needs to be really appreciated given the hugely difficult task) but the excel sheets with raw data, as sent by APMAS to me via e mail, show some divergence in interest rates for some organisations. I would like to humbly record it and I will be providing the specific examples in a post later

So, I would like to humbly submit that fairness and transparency should not be equated with merely providing information on and/or stating the inclusive interest rates. It must reflect in actual (and not theoretical) Governance practices at MFIs and should not manifest itself as related party transactions (loan to promoter to buy shares in the MFIs), high compensation for promoters and their families especially involving huge equity, using multiple lending and other such means for achieving growth and the like. As long as the above (not-so-good) practices remain and continue to be used, no amount of transparency on interest rates may really help…the Indian micro-finance sector...become fair and responsible to its clients...