Has MFIN, one of the self-regulatory bodies in Indian microfinance, been accountable for its actions and statements?

Ramesh S Arunachalam

The MFIN enquiry initiated in February 2011 (on governance & transparency) is still not in the public domain. The MFIN-sponsored NCAER study, that suffers several serious shortcomings, makes one wonder whether MFIN can function as an objective association—without conflicts of interest—and as an effective self-regulatory body for Indian microfinance

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Building Safeguards Into the Malegam Committee Report (MCR) Proposal for Using Industry Associations in the Indian Micro-Finance Regulatory Framework

Ramesh S Arunachalam

Rural Finance Practitioner

The Malegam Committee Report (MCR), if accepted as it is by the RBI, has a significant role for SROs (and in the present case, for the Industry Associations) and media reports strongly suggest that the proposals of the MCR may come into force from April 2011. While using SROs (Industry Associations) may seem as a practical step, especially given the scope and scale of supervision required in micro-finance in India, the fact that these industry associations were not even able to implement their respective codes of conduct over the last few years needs to be clearly recognized. And more importantly, this critical aspect must be suitably addressed, in case the RBI is going to rely on the use of industry associations as SROs, in the overall micro-finance regulatory framework.

Here are some suggestions in this regard for the RBI, based on good practices and lessons from global experiences…for what they are worth and what they are not…Read on…

The primary regulator (whoever it is) must have an appropriate oversight program for the SRO/Industry association and thereby ensure that:

·         The SRO has appropriate corporate governance policies and procedures and that it follows them in practice. This is very critical as many institutions have great governance policies and procedures on paper but rarely follow them in implementation.

·         The SRO’s functions and rules cover its regulation/supervision responsibilities and are fair and balanced.

·         The SRO’s regulation, supervision and risk management responsibilities have been met, including that its systems and processes meet appropriate standards. The regulator must also ensure that the SRO has effective compliance, supervision and enforcement programs.

·         Any identified conflicts of interest, within the SRO, have been squarely and appropriately addressed. This is a very critical aspect as there have been huge conflicts of interest in the Indian micro-finance sector and this is one of the main reasons for the Sa-Dhan and MFIN codes of conduct not having been implemented on the ground.

·         Shortcomings or needs that require a response from the SRO are identified and adequately addressed periodically.

In addition, the regulator, through appropriate supervision, must ensure that the SRO continues to meet all the conditions of its license[i] and other obligations imposed on it by law and/or regulation. Some of the main processes that regulators could use in these oversight programs with SROs/industry associations are given below:

Process # 1: Review Corporate Governance Standards in SRO

1.      Ensure that the SRO meets high standards of corporate governance required for being a part of the overall regulatory system and this would include consideration of all aspects including functioning of board of directors (or equivalent), their independence and the like

2.      Ensure that the SRO is responsive to all stakeholders including clients and also meets its public interest/civil society mandate in terms of transparency and disclosure

3.      Ensure compliance and consistency with the law and conditions of license.

4.      Ensure that the SRO’s internal functioning and management systems are consistent with its regulatory mandate and objectives and with overall regulations.

5.      Ensure that SRO rules and processes are fair and balanced, having regard to the interests of all stakeholders and most importantly, that of clients

Process # 2: Periodically Monitor The SRO and Its Reports

1.      Periodic review of the status of SRO’s monitoring and other programs, activities, and financial condition, as well as current regulatory matters.

2.      Provide ongoing supervision and practical advice, to ensure that the SRO is able to discharge its functions effectively. This is especially critical because the industry associations in India have not had any such regulatory/supervisory experience

3.      Help in coordination of activities with an SRO, as may be required

Process # 3: Enable Self-Assessment of its Own Performance and Operations by the SRO

·         Independently review SRO performance in line with its supervisory and related duties

·         Provide input to the SRO and enable it to develop its (own) targeted examination of its performance with regard to supervisory and other duties.

·         Help the SRO establish an objective process of self-evaluation and related measures for assessing its performance.

·         Identify areas of risk in SRO’s operations and suggest strategies for improvement with regard to the same

·         And finally ensure that the SRO itself has a code of conduct that it follows in its own functioning. This is very critical and it has often been a major reason for (industry associations) not being able to enforce their codes of conduct with their respective members

The larger point I am making is that, given that the Malegam Committee Report (MCR) has provided for some level of self-regulation in micro-finance in India, let us try and ensure that there are core criteria to make this self-regulation work and work well. When effective, self-regulation, offers benefits to industry and consumers, but it must be consistent with the overall regulatory framework and accountability must be strong. In fact, accountability is most critical in this context and having good regulatory outcomes, whether legislated or self-regulatory or a combination of both, depends on the government, micro-finance industry, various stakeholders and clients being prepared to become accountable in the overall regulatory structure and framework. Unless this accountability is built into the system, no amount of regulation will help the beleaguered Indian micro-finance industry…

Have A Nice Day!

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[i] I presume that the operationalisation of the MCR report will result in the provision of a license (or official sanction) for acting as an SRO

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

Ramesh S Arunachalam

Rural Finance Practitioner

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

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

·         Increased conflicts of interest

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

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

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

·         Reduced standards of regulation and supervision under the new system

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

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

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

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

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

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

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

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

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

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

·         Intermediaries (banks, MFIs and others)

·         Clients of the above institutions

·         Retail and institutional investors

·         Government and statutory authorities,

·         Existing SROs

·         Stock Exchanges, if applicable

·         Industry associations

·         Other Related regulators

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

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

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

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

Ramesh S Arunachalam

Rural Finance Practitioner

The Malegam Committee Report (MCR) has proposed a self-regulatory mechanism, through SROs/Industry Associations, as part of its four pillar approach. While the idea is fundamentally a good one, when ever one considers introducing a new self-regulatory system (or for that matter, reforming such an existing system), a number of important issues must be addressed. These are highlighted in the present post and hope the RBI and/or the Malegam committee looks into some of these issues.

Basically, the concerns include both (1) substantive policy issues on the design of the self-regulatory system and (2) process issues that arise in implementing self-regulatory reform. We take up the former in this post and look at the latter (process issues) in a separate post.

And policy makers should consider the following substantive policy issues in addressing whether self-regulation is appropriate for the concerned micro-finance markets and, if it is, how the system should be designed.

National Strategy for Development of Micro-Finance: What is the government’s (and prime regulators) strategy for developing the nation’s micro-finance industry? Any strategy should consider the structure and competitive position of the micro-finance industry, nationally, regionally and internationally. A strategy should encompass the following:

·         How to ensure that the industry best supports economic development?

·         How to enable the industry to foster market development, competition, and innovation to better meet the needs of clients in micro-finance?

·         How to alter/raise/revise standards of regulation and conduct to ensure that clients and other stakeholders (including investors and other participants) are treated fairly?

·         How to improve integrity of the micro-finance market in general?

·         How to achieve an appropriate cost level for regulation of the micro-finance industry?

• How to ensure that the MFIs, FIs and various stakeholders have the business focus, competitive positioning, systems, and governance standards required to succeed in their missions?

·    Commitment to self-regulation: Do clients, investors, lenders, MFIs and other stakeholders have a sufficient degree of confidence in self-regulation to make the system viable, both today and going forward? Are the members of the SROs/industry associations committed to the concept of self-regulation, and are they prepared to invest the requisite time and resources? Do the regulatory authorities believe that use of self-regulation in the micro-finance industry is indeed appropriate?

·    Size and complexity of micro-finance industry: Does the micro-finance industry need, and can it support, multiple layers of regulation as has been proposed in the Malegam Committee Report?

·    Effective and efficient regulation: What approaches, according to the authorities and industry stakeholders (including clients), are likely to deliver the most efficient and effective regulation of the micro-finance industry? Do the benefits of self-regulation outweigh the potential extra costs and disadvantages? What about the issue of regulatory efficiency and costs - is it likely to be significant? Finally, can the conflicts of interest that arise be managed appropriately?

·    Regulatory priorities and key risks: The authorities, MFIs and other stakeholders should determine and agree on what regulatory issues and risks (the MCR lists several risks and provides some suggestions to tackle them) need to be prioritized. Does the existing system adequately address those issues and manage those risks? If not, how should the system be reformed to respond more effectively to the issues, and what role should SROs/industry associations play? This should particularly look to address in practical and feasible manner, some of the key issues that have caused the present day micro-finance crisis. With all due respect, it is the blog writer’s humble opinion that some of the proposed solutions in the Malegam Committee Report do not meet the criterion of practicality and feasibility.

·    Fairness and consistency: In choosing a particular SRO/industry association structure, the fairness and the consistency of regulation for different segments of the micro-finance (for profit, mutual benefit and not-for-profit) and larger financial services industry need to be maintained. This means that players in different segments of the industry that offer similar services should be treated equally. This is critical and the omission of not-for-profits and other legal forms in the MCR can perhaps be addressed at the SRO/Industry association level, even if the banking regulation act cannot absorb regulating these legal forms. This again requires close analysis and redressal perhaps

·    Funding: Who should pay for the cost of regulation? While industry players may fund government regulators to a significant degree in many countries, can MFIs and other stakeholders do that in the present context? Which groups of MFIs/stakeholders should fund a self-regulatory system, and how should the costs be allocated among groups or members of a group? Those issues are invariably contentious but need to be addressed as well and this is again something that has not been exhaustively dealt with in the MCR

·    Legal framework: Does or will an SRO/industry association have sufficient powers to perform the responsibilities allocated to it? If not, is changing the applicable/related laws possible in practice and feasible from an implementation sense?

First, in many contexts, most SROs/industry associations often have the statutory authority to perform their regulatory responsibilities, but they can also obtain or reinforce jurisdiction by specific contracts with its members. Second, because SROs/industry associations are private bodies, the countries’ civil code legal systems will also need to be examined for any limits that they may place on SRO’s/industry associations rule-making authority or regarding the extent to which the regulator can delegate activities to an SRO/industry association. Both of these need to be looked at by the MCR in the present context and addressed accordingly.

Some obstacles may however be addressed rather easily: (a) by relying on SROs/industry associations mainly to supervise compliance with regulations (this is a critical aspect of regulation versus supervision); (b) by designing effective working agreements; and/or (c) through MOUs to clarify the role and working relationships of SROs/industry associations with the regulator.

·    Supervision of an SRO/Industry Association: Does the regulator have the powers and the capacity to effectively oversee an SRO/industry associations operations? In some cases, a more limited role for self-regulation may be appropriate; for example an SRO/industry association that is mainly made responsible for supervision of compliance with regulations set by the regulator.

These and other issues will have to be looked at by the RBI and the Malegam Committee before finalizing the regulatory and supervisory arrangements for Micro-Finance in India…

PS: The above paper is based on various ideas and resources available and there are far too many resources to mention here but they are all gratefully acknowledged