Understanding The Role of Wholesale Lenders Like SIDBI in The Present Indian Micro-Finance Crisis: Some Unanswered Questions…

Ramesh S Arunachalam

Rural Finance Practitioner

As I have been traveling in the field and seeing first hand for myself, the HAVOC caused by the agent led micro-finance model in India and especially, in the near micro-finance saturated states, I was always confronted by some basic questions:

ð     Where did the MFIs get the funds to grow as fast they did?

ð     How did wholesale financiers (DFIs and Banks) provide so much funds to MFIs and yet allow the kind of not-so-good practices that are currently prevalent on the ground?

ð     Are they in some ways responsible for the kind of (not-so-good) practices (like use of agents), which we currently find in Indian Micro-Finance?

The idea is neither to blame anyone nor find fault with any institution. The objective solely is to learn from past experiences and ensure that similar things do not happen on the ground again in the future. This is especially critical because the same wholesalers and banks may be involved in implementing important micro-finance projects (like the Responsible Micro-Finance Project with The World Bank) and large scale projects with a huge micro-finance component (like DFID’s Poorest States Inclusive Growth Program)

I have already written a lot about equity investors and banks in Indian micro-finance and while equity investments may have enhanced the confidence of lenders, there is no doubt that MFIs were able to leverage their enhanced equity to a great extent – thanks to the generosity and enthusiasm of Banks and DFI lenders like SIDBI, which was one of the real stars in the Indian micro-finance growth story of the last few years.

Without doubt, in my analysis, the single largest financier of the MFIs was/is SIDBI and the data given below are very revealing. A close look at this data suggests that SIDBI had abandoned its slow growth trajectory somewhere in 2007 and in fact, turbo charged the growth of the Indian micro-finance industry by 2008. The data given below are self-explanatory…

 

At this juncture, let me clarify that SIDBI’s work in the Indian micro-finance industry is phenomenal and I have greatest regard for their contribution to the micro-finance industry and the development sector prior to 2007. I would also rate them as one of the most responsible institutions prior to 2007. However, their role from 2008 onwards raises a lot of discomfort and I hope that the New Chairman of SIDBI (who has just taken charge recently) does a dispassionate and objective analysis of - what happened and why in - the SIDBI Micro-Finance Saga. The idea is not blame or penalize any of the officers, many of whom are very committed and have great talent and knowledge – however, the time is surely ripe for SIDBI as an institution to introspect and learn from its past experiences. This is something that I would to reiterate again

And accordingly, with all humility and utmost sincerity, I provide some starter questions (not exhaustive) for the New Chairman, so that he can initiate the task of learning from the past experiences at SIDBI/SFMC:

1.      Fast Growth Strategy: Why did SIDBI’s micro-finance portfolio grow at the frantic pace at which it grew? Who (Senior Management or Board or Who Else) authorized this strategic change and especially, given SIDBI’s very conservative approach prior to 2007 and Why? How did SIDBI hope to manage its very fast growing SFMC (SIDBI Foundation for Micro-Credit) portfolio? What mechanisms were in place at SFMC and were they adequate? Was there a proper risk analysis of the above fast growth strategy and were the PROS and CONS evaluated?

2.      Due Diligence At SFMC: What due diligence was employed at various levels to expand the SFMC micro-finance portfolio several fold, both cumulatively as well as individually? How were credit decisions made (at SFMC) on an individual case by case basis for the larger loans sanctioned to MFIs? What was the lead time for such sanctions and what due diligence was followed and was it sufficient?

3.      Process Adopetd For Higher Loans: Given that SIDBI was not used to sanctioning loans in excess of  Rs 100 crores to individual MFIs (at least until 2004), what process was adopted in the subsequent years when loans worth or in excess of Rs 300 crores were sanctioned to individual MFIs? Were they sufficient? Were there any conflicts of interest? On what basis were such higher loans sanctioned by SIDBI to the MFIs?

4.      Monitoring By SIDBI/SFMC: How did SIDBI monitor the end use of its loans? If so, did it not sense the early warning signals with regard to huge and rising indebtedness, rampant multiple lending, ghost clients and the like at the field level? Was it aware about the use of agents in the Indian micro-finance market and the prevalent decentralized micro-finance model? Were the monitoring mechanisms adequate and what do field level reports indicate with regard to the above practices? Were any lessons learnt from the crisis in Krishna (2006), Kolar (2009) and other places and were they applied in practice to the credit program at SFMC in reality? In the wake of its rapidly burgeoning portfolio, how did SIDBI/SFMC assure itself of the deployment of its funds in REAL micro-finance assets?

5.      Equity Investments and SIDBI Nominee Directors: Given that SIDBI has made equity investments in several MFIs, what did SIDBI’s nominee directors do on the board of MFIs and what mechanism was in place at SFMC/SIDBI to monitor their roles/work on the MFI boards? Did they not alert SIDBI to the various not-so-good practices prevalent on the ground? Were there any conflicts of interest in terms of nominee directors being offered/granted ESOPs and the like, by the concerned MFIs?

6.      Implications for Future Projects: Given what has happened on the ground and especially in Andhra Pradesh, Tamilnadu and other states, what are the implications for the responsible micro-finance project of SIDBI to be conducted in cooperation with the World Bank? What is the guarantee that things will indeed be responsible on the ground, this time around? What safeguards are there in this SIDBI-World Bank project and what safeguards need to be built into it to ensure that enthusiastic senior management does not derail the natural and responsible course of the so-called responsible micro-finance project?

These and other questions become very relevant as institutions like SIDBI intermediate public funds and having seen the HAVOC that micro-finance agents have created on the ground, I cannot help but ask the above questions. I hope SIDBI’s management takes these in the right spirit[i] and introspects with integrity…And that alone should be able to provide practical guidance to the perfectly timed SIDBI-World Bank “Responsible Micro-Finance Project in India”…

Have a Nice Day!

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[i] The idea is neither to blame anyone nor find fault with any institution. The objective solely is to learn from past experiences and ensure that similar things do not happen on the ground again in the future.

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

Ramesh S Arunachalam

Rural Finance Practitioner

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Happy Weekend

Cheers

Ramesh

DFIs and Their Role in The Burgeoning Growth of The Indian Micro-Finance Industry: Some Critical Issues for Self-Introspection…

Ramesh S Arunachalam

Rural Finance Practitioner

While we looked the role of equity in detail, here are some statistics that I have put together on DFIs (and banks) who supported this growth during the period 2007 – 2010 in Andhra Pradesh and other states of India. Please see tables below

As you can see the SIDBI, has led the group and has consistently been ranked 1^st among all DFIs/bankers in terms of loans disbursed (for last 2 years) and loans outstanding, in the last 3 years. As Mr Srinivasan (2010) argues in the State of The Sector Report[1], “ 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. “

This post is devoted to SIDBI and a companion post looks at the role of banks in the burgeoning growth of micro-finance. At the outset, let me clarify that the objective of this analysis is not to malign any stakeholder (s) – as I have repeatedly said, SIDBI and banks, have been very well intentioned in their support to the micro-finance industry and it is very unfortunate their well intentioned supported has been taken for granted by some MFIs. That said, it is however important that we learn crucial lessons from the happenings so that adequate safeguards can be built, going forward…that is the primary motivation in making this post…

While year on year, SIDBI has increased its outstanding portfolio and disbursement, what is interesting to note is that the growth in year 2008-09 has been phenomenal for SIDBI, both in terms of loans disbursed as well as loans outstanding. What makes SIDBI’s loans even more powerful is that it is real long term funding!

While SIDBI, has indeed played a fantastic role in the development of the Indian micro-finance sector – yet, at the same time, it was always a conservative DFI and that is why it is somewhat surprising to see that SIDBI experienced such growth. It would be therefore good for SIDBI management to introspect and understand the motivations for such unbridled growth during the last few years – especially, because of the consequences of huge indebtedness of the further onward lending by MFIs. They would certainly need to look into their processes and methods of sanctioning and disbursement and also their due diligence checks with regard to end use of loans – that SIDBI has not able to spot the on-going (multiple) lending spree in the Indian micro-finance industry and the associated indebtedness is indeed something to introspect about…

Another issue relevant here is that SIDBI is investing as a social equity investor in many MFIs and the impact of SIDBI’s investments is such it gives tremendous legitimacy to the concerned MFI. In other words, apart from the quantum of investments, the real additionality of SIDBI’s equity investments in MFIs lies in it associating its well established and highly regarded BRAND name with the concerned MFIs. Therefore, its nominee directors are under serious obligation to diligently perform their roles - as independent directors - in a professional and objective manner.

That SIDBI’s nominee director remained a mute spectator when the founder promoter MD of a large MFI gave himself a huge loan to buy shares in the same MFI is indeed a cause for some concern. That action is certainly not acceptable in any financial institution and is unquestionably an act of not-so-good governance. That the SIDBI nominee director again remained a mute spectator to the hurriedly convened board meeting of a large MFI - that too on a Sunday - to sack an immensely successful CEO who led the MFI through a spectacular IPO – is something that is again worrisome. Without question, as a social investor, SIDBI is expected to ensure appropriate and good governance of the MFIs and more so, among the ones where it has invested (its funds as well as its BRAND name) and has a nominee director on board. The above happenings clearly call for a serious review of the process by which: a) SIDBI makes equity investments into MFIs; b) it appoints nominee directors to MFIs; and c) it ensures accountability of these directors. This is another issue that requires deep introspection by SIDBI’s management.

Going forward, it would be very important to ensure that SIDBI provides the right kind of leadership for responsible (micro) finance – a recent world bank collaborated project - that SIDBI is currently implementing under its aegis.  The mechanism of the lenders forum envisaged in this project is welcome but it needs to be operationalised carefully, after incorporating lessons from the present AP micro-finance crisis and building necessary safeguards against any real and/or potential conflicts of interests.

Without question, SIDBI is legitimately one of the pioneers of the micro-finance (especially, the MFI model) movement in India and it has produced several wonderful innovations and contributed significantly to the development of the micro-finance industry – its staff have their heart and soul in micro-finance and they are among the most sensitive and experienced with regard to micro-finance and micro-enterprises. It is up to SIDBI and its staff to develop necessary safeguards to ensure that the micro-finance industry that they helped create does not collapse…under the weight of well intentioned and perhaps sometimes, over enthusiastic support for MFIs…This is something that SIDBI definitely owes this great nation…

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[1] State of Sector Report is an annual report brought out by Access Development Services (New Delhi) and Published by Sage Publications (India)…