A Day In The Life of An MFI Loan Officer: Some Insights From The Adapted Grameen Replicators in India…

Ramesh S Arunachalam

Rural Finance Practitioner

The loan officer, by a large margin, has always been a “he” (it is a ‘her”, rarely), at least in the adapted grameen replicators in India - a commonly used metaphor for some of India’s largest MFIs.

The loan officer may simply be called as a loan officer or project assistant or field coordinator etc. The loan officer, typically, as I have seen him over the years, starts his day at around 5.30 AM in the morning, getting up and readying himself to go to the field and meet micro-finance clients. Among other things, the collection sheet and disbursement schedule are critical documents and the loan officer goes through these before setting off on the day’s journey.

In a typical adapted grameen replicator, the branch is located at a central place and the loan officers cover a radius of 25 kms around the branch. They, by and large, stay in the branch in a back room – 3 or 4 or sometimes even 5 of them huddled together. Often, the living conditions are woefully inadequate by any standards. They cook their own food in this small room and also use it to house their things as well as sleep.

The loan officer starts from the branch at around 6 AM and reaches the venue of the centre (a commonplace in a village) typically by 6.30 AM in the morning for the centre meeting. The traditional model, which was by and large followed by many of the adapted grameen replicators in India - starts with a roll call (group attendance) followed by various activities such as loan repayment, loan disbursement, pledge/oath taking and the like. Generally speaking, given that loan officer has various records (including receipts) to update (both for the client/MFI) and also given that discussions may be held amongst the members with regard to which of them will get the loans in subsequent weeks, it should be safe to assume that a center meeting will last at least an hour, if not more.

Box 1: Some Time Consuming Tasks at The Centre Meeting

There is good reason to believe that a center meeting, conducted as per the traditional model, would last more than an hour…The grameen model and the Indian replicators have always prided themselves about the fact that the repayments would be collected first and kept separately and then, any loans would be disbursed, often using the 2:2:1 formula, where the JLG leader receives the loan the last and other 4 members receive the loan in batches of two each, in an interval space of few weeks. The same happens for the remaining 7 JLGs and that is the way the center generates peer pressure, as at any time, there are always some members at the center who require a loan and it is believed that they would exert sufficient pressure on the rest of the members (who have taken a loan) to make prompt and regular repayments. Therefore, the task of choosing members who will receive loans in the subsequent weeks is one that could take significant time - as I have seen members within a JLG and center, argue out competing demands.

Therefore, while nascent field workers (loan officers) may be able to only take care of 1 centre meeting in a day, experienced loan officers can perhaps handle 2 centre meetings daily. Such experienced loan officers, after the 1^st meeting, would typically go to a 2^nd centre meeting at a nearby village/hamlet/slum and get back to branch by 10.30 to 11 AM. Here, they hand over the cash and reconcile the balances. After eating their breakfast, they sit down and complete all the accounting and portfolio entries (either manually or in the computer) in the branch records, pertaining to the centers they visited.

This usually takes up to 1.30 PM or latest, 2PM or so after which they take lunch and rest until 4/4.30 PM. Then, at 5 PM, they leave for the villages to have contact meetings, to form new JLGs/centers and they come back to their room by 9/9.30 PM and eat/sleep so that they can start the next day afresh. This routine is normally followed for the five-week days and on Saturday, the loan officers do work at the branch, either updating records or planning activities with the branch manager. As an aside, actually, the life of a micro-finance loan officer is rather tough and I must confess that, if some one like the ILO would look into it, they would find the living and working conditions very stressful and inadequate…In fact, I came across a complaint (by a loan officer perhaps and I am not sure) on the web and I attach the link[i] of the same here: http://www.complaints-india.com/complaints/3570/EMPLOYEE-TORTURE.html

Okay, back to the topic at hand, there are two points that deserve mention here:

·    Given the efficiency that may have been built into the process and the learning curve experience, at best, experienced loan officers, may be able to handle, not more than 2 center meetings or 16 JLGs in a day – this is equivalent to a maximum 400 clients per week (assuming a five day work week and leaving the weekends for office work) and this is perhaps an outer limit and a very optimistic estimate….of loan officer caseload…

·    Likewise, a nascent loan officer can perhaps manage 1 center meeting per day and this translates to 8 JLGs per day, which makes their caseload in clients/week as 200.

Thus, the above are caseloads that are theoretically possible for nascent and experienced loan officers as I have seen it and I am sure there could be some (marginal) variations to these depending on the context, model and other aspects. In reality, given the adjustments for the terrain/context and other unexpected work, the most optimistic caseload, in my opinion, seems to be 250 - 300 clients for experienced loan officers and 150 – 180 clients for nascent loan officers…

That said, let us now look at some of the case loads based on real time data for 6 MFIs that were the equity leaders in Indian Micro-Finance (because they were the favourites of equity investors) and this data is calculated[ii] from the published data sources like MFI Annual Reports and Mix Market data…

The above table provides some very interesting trends

There was only one MFI (MFI 4) that had a caseload of over 650 in 2006 – around the time of the Krishna crisis and they were, in my opinion, using an agent type methodology, as far as back then.

The other MFIs, barring one (MFI 5), learnt from this MFI 4 on the advantage of using an agent type methodology and that is why, for the rest, we see the caseload increasing over the years – and especially in the years ending 2007 and 2008 the case load is rather heavy. In 2009, the caseloads increased for 4 of the 6 MFIs and the argument here being that the higher case loads were perhaps being managed by using the invisible (hand of) agents.

Specifically, for MFI 3, that had had a very high caseload the earlier year (720 clients per loan officer), there was some corrective (503) in 2009 because, in my opinion that MFI had already started experiencing delinquency in its portfolio due to this and trouble from its agents – as it perhaps went overboard in increasing its field officer caseload from 376 to 760, which is more than double the caseload…again, the flow of equity at a premium to other MFIs and the carrot of (potential) huge equity investments in the future perhaps attracted many of these MFIs to wealth hitherto unseen by them thus far…

These specific numbers aside, the larger point is that whatever be the context, when you have case loads of over 400, I think you must ask questions on how the staff are managing these (unrealistic and heavy) caseloads, especially when using a similar Grameen type methodology…that is the critical aspect…

It is also interesting to note that all of these 6 MFIs grew at a frantic pace between April 2007 and March 2009 when the case loads went up dramatically. Let us look at growth in terms of active clients first and then, by gross loan portfolio:

Growth by Number of Active Borrowers For 6 Equity Leader MFIs:

·    The 6 Equity Leader MFIs grew at a CAGR (over a 4 year period) of 61.19%, adding 12.91 million active borrowers during the period April 2005 to March 2009.

·    Of this, nearly 10.46 million active borrowers (or 81.03% of the total additional active borrowers covered from April 2005 – March 2009) were added during the period of April 2007 – March 2009.

·    This is equivalent to the 6 MFIs adding 0.44 million active borrowers (or 4, 35,971 active borrowers) every month, during the 24 month period.

·    And this is equivalent to each MFI adding 0.072 million clients (or 72661 active borrowers) every month, which is certainly a lot of active borrowers!

·    The above number translates to about 2389 new clients (or about 479 new JLGs or 69 new centres) to be added every day by EVERY MFI (on the average) and that is a huge ask, under any circumstances…

Ask some one who has worked at the grass-roots level and you will surely understand that sourcing clients and developing JLGs (Joint Liability Groups) and Associated Centres’ does take a lot of time…and that is why I would rate the above as very, very rapid growth...by any standards…

Growth by Gross Loan Portfolio For 6 Equity Leader MFIs:

·    The 6 Equity Leader MFIs grew at a CAGR (over a 4 year period) of 88.92%, adding US $ 2.68 billion as gross loan portfolio during the period April 2005 to March 2009

·    Of this, a whopping US $ 2.18 billion (or 81.21% of the total portfolio increase from April 2005 – March 2009) was added during the period of April 2007 – March 2009. That is significant by any standards and is the equivalent to the 6 MFIs adding portfolio worth US $ Million 90.81 (or Rs Million 4177) every month, during the 24 month period. Again, this is a staggering growth statistic, at least for me...

Further, it is interesting to note that the 6 equity leaders also received significant equity infusions during the same periods or a little later as shown in graph below

And of course, as noted above, these Equity Leader MFIs received significant equity infusion during the period April 2007 – March 2009 (US $ 228.87 million) and also thereafter during the period, April 2009 – July 2010 (US $ 287.88 million). The comparative data and specific data on number of active borrowers and gross loan portfolio for the 6 equity leader MFIs along with equity investments is given at the end of this post.

And also, the financials of the 5 of these 6 MFIs are given below, as calculated by Intellecap in the 2010 inverting the pyramid report…

As you can see, the connection between flow of equity[iii], growth of MFI in terms of number of active clients and gross loan portfolio and increased caseloads is no simple coincidence.

That said, several key questions arise here and I leave you with these…

·   How did the staff of these MFIs manage such higher caseloads? What (or who) helped[iv] them in managing such unusually high caseloads?

·   Especially, given that they were adding many new loan officers who could not function at peak performance (capacity), how did these MFIs manage to increase client caseload as significantly as shown in table earlier?

·   What (tangible) changes were made to the operating model to enable this? Were the changes as per the law? Specifically, were agents formally or informally appointed and did their invisible hand share the caseload of the loan officers? That needs to be better understood…

·    What other changes/shortcuts were employed in client acquisition, loan disbursement and loan repayment collection to facilitate management of such high caseloads?

·    What was the impact of all these changes on clients and their well being? That is very critical and again needs to be clarified

·    Overall, given that the KYC norms and RBI outsourcing guidelines came into force during the above periods, how did these MFIs manage the higher caseloads in wake of new staff, burgeoning growth, enhanced regulatory requirements and the like?

Ladies and Gentlemen, I leave you with these questions to ponder and reflect and all that I can say is that I have a very uncomfortable feeling about the Indian micro-finance business model…and its vision, growth strategies, operational methodology and the like...I leave it to you to judge for yourselves...

Adios!

Have a great weekend!

PS: Please note that I have refrained from identifying individual MFIs because the intention is not to malign them. Rather, the objective is to learn from this crisis so that we can take appropriate corrective action going forward...Thanks for your understanding on this...

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[i] Sometimes, the moment you refer to a link, it gets taken off and apologies, if that has happened. Also, the objective here is not to identfy or pinpoint any one MFI but the above example is merely provided as an illustration of MFIs that perhaps take the most out of their employees...

[ii] To the best of my knowledge, the data is correct but apologies if found otherwise, but I think not likely as I have tried to use some internal consistency tests and they worked well for the set of data given above. Thanks for your understanding and even if changes would be there, in my opinion, they should be marginal and not make a material difference to the caseloads

[iii] Data subject to caveats mentioned in specific posts on equity, done in November and December 2010

[iv] And especially, given the fact that technology has, at best, been piloted and not taken to scale in many places in Indian micro-finance. In fact, if you go back and see the organizations that won the CGAP award for technology, many of these technologies have not been operational for a rather long time now…not because they are obsolete technologies but because they lacked the sound business case in the first place and could not be taken to scale

Is An Andhra Pradesh Like Micro-Finance Situation Brewing in Tamilnadu As Well?

Ramesh S Arunachalam

Rural Finance Practitioner

I woke up in the morning yesterday to see MFIs back to front page news in my home state of Tamilnadu for some alleged MFI excesses in Vellore district (which, incidentally, abuts the Chitoor district of Andhra Pradesh). When I spoke to a close friend and colleague, he said that the MFIs were already in the news even a couple of weeks ago - in Salem district of Tamilnadu for coercive repayment collection.

The news items (see images[i] at end of this section) about the Vellore district incident pertained to staff of two specific AP headquartered MFIs, who were supposedly beaten up by the public because they used coercive tactics in loan recovery. The Police were also called and the matter is said to be under investigation.

Let me at the outset state that it is not my intention to malign any of the institutions but it looks like that some of our MFIs have not learnt their lessons despite the AP experience. When several men approach a single woman or set of women clients to collect a loan repayment installment, irrespective whether or not coercive tactics are used, the whole process will itself APPEAR coercive. I hope MFI leaders and CEOs understand this sensitive issue and the fact that it has the potential to get blown up – especially, in small shanty towns and rural areas in India. And unlike in Andhra Pradesh, there appears to be no political support (whet-so-ever) to this issue in Tamilnadu as yet and from what I have heard, the reactions of the public were spontaneous. So, the argument of the public or people acting, because of encouragement by the Government or politicians is neither valid nor appropriate, in the case of the Tamilnadu problem…In fact, when I first started posting in the DFN e group in September, the Andhra Problem had not become political and if the MFIs had handled issues appropriately, I am sure that the present day crisis would not exist…

I really hope that the Tamilnadu headquartered MFIs and their associations (please note that the word is plural as we indeed have many of them today) and state chapters act swiftly to ensure that the problem is nipped (right) in the bud…Some generic suggestions in this regard are given hereafter…for what they are worth and what they are not…

Use of Women Staff For Collections: First, I know that it can be very difficult when several men approach a woman client or a set of clients to collect repayment and that is something that MFIs should avoid at all costs. Even if a larger group is to visit the women clients (either singularly or together), please make sure that there at least a couple of women staff. That should cool the tempers if any and also help in redressing the perceptions about coercive recovery tactics used by MFIs

Plan with Delinquent Clients: A second aspect that can be done is for the concerned MFI(s) to sit down with the client and facilitate them to plan on how to manage their (own) delinquency. A lot of explaining (please see this as part of enhancing financial literacy of clients) will have to be done and clients must be made to realize that there cannot be compromises in loan repayment for financial institutions – otherwise, financial institutions will simply die. I have seen older MFIs, especially the women led MFIs of the 1970s/1980s, engage in such delinquency planning with clients – whereby a delinquent client, is helped to look and analyse her/his cash flows and come up with an assessment of when and how she/he will make the payment. The present day MFIs would do well to deal with delinquency in such a manner…

De-Emphasize Growth and Expansion: A third aspect is that MFIs must not lend indiscriminately and make loose statements about their growth and expansion plans. Even recently, an AP headquartered MFI was seen on Television in Tamilnadu stating that they have already disbursed RS Y000 Crores and that would be disbursing RS X000 crores in the future within a specified time period. The same MFI had talked of adding atleast 5 million clients over a year for the next three year (1.5 million clients in all) and had also stated that equity of RS 1500 crores would be required in addition to loan fund of Rs 40,000 crores. In my opinion, this is the most inappropriate time for an MFI to talk (or rather boast) about its past disbursement and expansion achievements and future disbursement and expansion plan – given today’s problems this is tantamount to Hara-kiri. The MFIs must genuinely focus on clients and would be better off in highlighting REAL measures (not just superficial social performance management issues) related to client welfare that they may be implementing, as part of their operations.

Reach Out to Affected Clients: A fourth issue is that MFIs must show real compassion for their clients, who have been affected by over lending (or multiple lending) and try and reach out to them. It would be a great gesture if the MF industry contributes even contributes a fraction of its earnings to creating a debt redemption fund and/or relief package fund – for those families affected by high levels of indebtedness. Something which I have been advocating for a long time and something that has sadly not happened, despite repeated requests to MFIs bosses, post Andhra Pradesh

Be Sensitive to Genuine Client Delinquency: Another related issue is the aspect of being sensitive to genuine situations that may cause client level delinquency. I was having a conversation with an expert, often called the father of Indian micro-finance – a man who has contributed significant time to building up the Indian MF industry. He gave me an excellent example of sensitiveness to client situations and I appreciated what he said and the organization that is supposedly doing this…there are three unique features according to him… a) If a client is genuinely unable to pay a specific week’s installment, when she comes the next week, make her pay only one week’s installment (although two installments would be due) and instead extend the loan term automatically by one week; b) For a week’s extension in loan term, make sure that there is no commensurate penal interest; and c) Ensure that the staff do not have incentives based on disbursement or repayment or any other such aspect and therefore, reduce/eliminate motivation to over sell or over lend

So what practical steps can be taken by MFIs in Other Places to prevent the crisis from spreading?

As a first step, sit down as a group of MFIs and identify POTENTIAL areas where trouble could erupt – a) areas where there are many MFIs operating and multiple lending and indebtedness are high; b) areas where there is significant sharing of JLGs and clients among MFIs; and c) areas where client livelihoods are very weak and vulnerable and MFIs have been making multiple loans to get back past loans.

Engage with clients in these areas on a regular basis and attempt to ease the situation through various means. This could include MFI consortium based collection, use of larger number of women field workers to collect loans, some loan restructuring on a case by case basis and the like. Of course, while this would be short term in orientation, for the medium and long term, the concerned MFIs must address the crucial issue of how they would apportion the shared JLGs and clients – so that multiple lending and indebtedness are minimized in the future. The state chapters of the concerned associations should take the lead in this regard

Second, the MFIs must also start orientation meetings with civil society at the grass-roots in the various field areas…to clear up perceptions…Where necessary, they must own up past mistakes (without being defensive) and provide a credible assurance (backed by action) that the same will not be repeated in the future…the MFIs could also start to win back the community by engaging in (or at least supporting) activities for the welfare of the community (including clients) and general people in these areas.

Third, the MFIs must refrain from making irresponsible and boastful statements to the media and this is a very critical aspect. Much of what they have said has come back to haunt them and I just did an exercise of compiling statements by MFI and MFI association leaders on the Andhra Pradesh crisis (both Krishna and that of 2010) and I was astonished by what I saw…will post on that separately…

Fourth, for MFIs that are found to be using coercive recovery tactics and engaging in other unsound practices that affect the well being of clients, the associations concerned must take up the matter and ascertain the facts immediately. And then, the associations should take swift action against member MFIs who have violated and/or are violating the agreed codes of conduct. Please note that the 2010 Andhra Pradesh micro-finance crisis happened because the associations concerned did not take any action against the errant MFIs (both in Kolar and Post Krishna in Andhra Pradesh), despite knowing that there were some of their members who were not following the agreed codes of conduct. Therefore, acting against the black sheep in their flock is a must for these associations – that will restore some crediability for them and beleaguered Indian micro-finance industry…

Fifth, reacting to the above post, Mr Hugh Allen (taken from his comments) notes, “The prescriptions for resolving this (Tamilnadu) crisis must take into account two fundamental elements: 1. The importance of savings; and 2. Structuring loan products around flexible repayment schedules. Poor people are better served by savings services because they protect and build assets and reduce vulnerability and risk. Offering loan products that are matched to seasonal household cash flows instead of matched to risk policies determined by an MIS would also be helpful. This is because the latter recognises and adapts to irregular household cash flows (instead of simplistic risk assessment determined by a formula)."

While the above points are well taken and agreed, savings is not mentioned explicitly because currently, there is a regulatory barrier to tap savings. Also, much of what I have suggested above are actions that can be immediately taken to prevent the crisis. Savings is a long-term issue and the central bank needs to convinced first and from my own understanding of the Indian context, the internal control and other systems in MFIs need a serious overhaul before they are permitted to access savings. The idea of flexible re-payment is sort of indicated in my post above (when I talk of delinquency planning and sensitivity to client needs) but I agree that cash flow based products and business cycle loan products would be very appropriate…indeed...and I will post on that separately...

Wishing All of You A Wonderful and Happy New Year!

Please See Relevant News Items...

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[i] The news came in the Vernacular press and has been reproduced as is…apologies for readers who do not know Tamil but much of the issues stated there have been covered in this post…

Client Focussed Micro-Finance: Why Differences Exist Between Intended and Realised Strategies?

Ramesh S Arunachalam
Rural Finance Practitioner

There are many institutions that claim to be client centred and client focused but that is rarely visible on the ground. What I am saying is that there is a huge difference between intended visions (strategy) and realised actions (implementation on the ground). To understand this and various issues related to the present micro-finance crisis, I spoke to some front line and other staff in Indian MFIs and here is what they said (quoted verbatim and after translation in some cases) - I am merely sharing what I learnt to provide a staff perspective on the various happenings. Often times, staff have been blamed a lot for the present crisis but they too have a perspective and their side of their story...Read on...

Staff A – Field Worker in an MFI: The client focused vision is just for speaking at conferences and meetings. What happens on the ground is total different and we, the field workers bear the brunt. We are told to disburse, disburse and disburse so that targets are met, week on week, month on month and quarter on quarter – I have had senior branch and regional managers telling (and yelling at) me (during meetings) - Do whatever you have to but make sure that Y number of clients are enrolled and given loans in this period.

Staff B – Field Worker in an MFI: Who says that incentives systems based on disbursements do not exist. They do in reality, even if not shown on paper and I and several of my fellow colleagues have made a lot of money through disbursement incentives. In fact, there are also repayment incentives and that is why we have to be tough with the clients, under certain circumstances. Sometimes, I feel that we are caught - in between our MFI supervisors/bosses who want us to meet targets and recover at any cost and opportunistic clients who take every loan that comes their way but cannot repay after a certain level. We get shouted at by both groups of people as well...under these circumstances, client driven micro-finance is not possible to implement…

Staff C – Field Coordinator in an MFI: Initially clients used to be reluctant to take additional loans and I have personally coaxed them to do so, citing the benefits of taking an additional loan. I have even bought and given mobile phones to my clients from loan money and given the rest as cash to them...Now, the very same clients tell me that since they did not ask for the extra loan, they cannot pay back all loans together...as it is very difficult...the irony is that they now even ask for additional loan to pay back the earlier loans...the tables are turned now…and we are at their mercy…today

Staff D – Branch Manager of MFI: The pressures on me are so high and it is impossible to move at the very fast pace of growth all the time – I worry what will happen if people do not pay back loans as I know their income stream is weak and unpredictable. I am even more worried because my superiors perhaps understand the real situation and yet want me to disburse– this is a time bomb that is ticking away...

Staff E – Branch Accountant in MFI Branch: Zero PAR is the most important criterion on which our branch is judged and that is why all/most of our branch staff go to the any defaulting/ potential defaulter’s house on the same day and try and get the payment. To us, ZERO PAR is simply about ensuring 100% on-time repayments always and if we cannot get it from clients, we have to make over the delinquent payment from our resources and then recover from clients. Our institution will not accept anything less than 100% on-time repayment and our incentives are tied to not only loan disbursement but also 100% on-time recovery…we cannot afford to be client driven therefore…

Staff F – Former Field Worker in an MFI: It is great to talk about client oriented or client focused micro-finance but how to ensure its implementation on the ground? The performance targets and all other targets are numbers based – faster disbursement, more loan disbursement, 100% on time repayment and such factors. When this is the case, client relationships will naturally suffer and we cannot be doing things in client interest as we are minimising our contact with them to ensure that things get done efficiently and faster and we even did process mapping recently to reduce our lead time for loans. In fact, the past good relationship built with some clients may also be lost as, in the name of efficiency, we are literally running from one place to another disbursing, collecting, disbursing etc

Staff G – Former Regional Manager in an MFI: Post Krishna crisis, the same issues were discussed and many MFIs said that they would focus on the people but see what happened? Code of conduct documents were said to enhance client focus but they hardly got implemented on the ground. In reality, we are doing non-client oriented things that we were always doing - yet we are claiming to be working on client focused micro-finance.

Staff H – Former in House Trainer in an MFI: Self-regulation does not work on the ground…it can work on paper as enforcement is very difficult because of conflict of interest. There is so much of conflict of interest everywhere – for example, I am the CEO of my MFI, I sit on the Board of the MFI association, I am vice president of local chapter, and aspire to be its chairperson, I am on the board of the national banks/international micro-finance bodies and I or my friends are everywhere – So, no one can question me… and when I set this example, enforcing self regulation becomes a very difficult task and that is why the client oriented micro-finance promised in 2006 did not and will not take off…

Staff I – Former Branch Manager in an MFI: It is impossible to have client focused micro-finance without understanding the livelihood situations. And we are not anywhere close to understanding this…without serious livelihood financing…we cannot achieve client focus and be client oriented…so the fundamental micro-finance approach has to change and in favour of livelihood financing…to reduce vulnerability of low income people and enable them to tap economic opportunities in a better manner. Only then can we truly bring in client focused micro-finance…

Therefore, all concerned stakeholders including MFIs must introspect with integrity and try to build a good balance between traditional performance – i.e., so-called efficiency inducing processes, burgeoning growth patterns, enhanced returns and related issues – and client oriented performance measures. However, this cannot simply happen at the superficial level whereby so-called social performance management measures are just included - undoubtedly, the client related issues must AGAIN (they were when micro-finance started out originally) become an integral part of the whole micro-finance delivery process and through that get reflected in performance appraisal, measurement and reward systems in micro-finance (for various stakeholders). When this happens in totality throughout the micro-finance industry, then, we can perhaps see intended strategies being implemented on the ground…and client focused micro-finance really taking shape…


Please look out for the next post -  “Should Indian MFIs Receive Priority Sector Funds: A Critical Analysis” – 30^th December 2010

Never Waste A Crisis - Use It to Get Micro-Finance in India Back on Track: Some Proposals for Incentives As Part of A National Regulatory Framework

Ramesh S Aruanchalam

Rural Finance Practitioner

Given the present crisis, how do we go forward and get micro-finance in India back on track? In the present circumstances, the implications of which for various stakeholders have already been outlined in parts I and II, increased (appropriate) regulation and client protection practices are surely required and will help. Among other things, this would call for a clear regulatory structure that

a)   provides legitimacy to organizations (different legal forms) working as MFIs through a registration process as per a national regulatory framework – such registration is expected to provide immunity to the MFIs from various state level laws on usury and client protection as well as other access to a host of benefits

b)   has certain non-negotiables – enforceable minimum standards - with regard to governance, systems (HR, Portfolio Management, MIS, Finance and Accounting, Internal Audits, Internal Controls etc), client protection/literacy and other aspects (as may be required from time to time) for affording this legitimacy. Such a regulatory framework must try to get rid of conflicts of interest, so prevalent today in Indian micro-finance and bring in REAL TIME accountability and enforceability. Two issues deserve mention here: i) First, let us recognize that MFIs are professional organisations and they cannot and should not shy away from proper and minimum regulatory standards - they are no longer the informal organisations that they were and we need regulation to keep pace with their growth and life cycle. That is where we have failed today...; and ii) Second, as financial institutions, MFIs cannot afford to compromise on governance including related party transactions and they need minimum systems when they intermediate public money. We cannot and should not have a compromise on that...If we do not do this, mark my words, we will have a greater crisis later including more satyam like happenings...

c)   is enabling in nature with the right kind incentives for the concerned stakeholders including MFIs and clients

However, regulation apart (points A and B above[i]), I think the most important aspect is to get the incentives (subject matter of point C) for the sector right as an industry expert identifies correctly in an interview: “So it was basically a situation where the sector’s incentive structures had gone wrong…”. While I think he is right in identifying the cause, a deeper analysis of the incentives of the key players outlined in parts I and II indicates that more needs to be done to get the incentives for the key players in the sector right. Here are some (suggested) proposals towards that:

For MFIs:

1.   Dividend and Bonus Share Issue Cap[ii]: The framework would specify a permanent specified cap on dividends (e.g. it could be 10-15% on shareholder equity and decided through consensus among industry stakeholders) and issue of bonus shares for any MFI that wants to registered under the new national regulatory framework (NRF). The NRF will provide such MFIs with access to priority sector loan funds from a bank, the complete freedom to act as a banking correspondent[iii] and immunity from state level client protection/usury laws. Additionally, the MFI will be required to meet certain minimum standards with regard to governance, systems (HR, Portfolio Management, MIS, Finance and Accounting, Internal Audits, Internal Controls etc), client protection/literacy and other aspects as per the regulatory framework. The framework will also utilize various means (on site and off site supervision etc) to ensure that these non-negotiable minimum standards are indeed met in a dynamically changing micro-finance environment, quarter after quarter.

2.   Compensation Caps: All stakeholders (from senior management upto field level staff and directors/board members, if appropriate) at registered MFIs should be forced to adhere to compensation caps as per the regulatory framework.  At any cost, the compensation should not exceed that of similar positions in Public/Private Sector Banks whichever is higher. Further, for salaries/compensation above a certain limit (to be fixed in the regulatory framework) and certain key positions (like managing director, CEO, CFO etc), approval of the regulatory authority would be required

3.   Disclosure by Promoters/Directors/Senior Management of their Personal Assets and Shareholding in MFI: All registered MFIs would require their promoters, directors and senior management to provide yearly statements of their assets and liabilities as also transparently list their and their family/friends’ investment in the MFI. This would be mandatorily required.

If any MFI does not want to accept the dividend cap, bonus share issue cap, compensation cap and disclosure norms, then they are free to raise funds from banks and/or other sources at commercial rates and carry on the business. In such a case, the loan will not be from a bank’s priority sector quota and so a bank can lend to an MFI at a higher interest rate after factoring in the appropriate risks of this sector. Thus, such MFIs, who would not be eligible to register under the national regulatory framework, will not: a) gain access to priority sector funds; b) be able to act as banking correspondents; and c) enjoy the benefits and/or immunity provided by this national regulatory framework against state level usury and/or customer protection laws

For Banks:

1.   Focus on All Kinds of MFIs: Encourage banks to lend to large and small MFIs (with different models) so that overall risk for the banking sector is minimized. Also, no MFI becomes too big to fail. Thus, it will also minimize the material impact on a bank’s balance sheet in case a large MFI fails.

2.   Loans Made to MFIs – who have a dividend, bonus share issue and compensation cap in place, agree to have certain minimum standards with regard to governance, systems and client protection and provide the mandatory disclosures as per the NRF - will come under their priority sector targets. That these loans have to be reasonably priced also follows naturally. As noted earlier, banks would be free to set a true risk based price for loans made to MFIs who do not have a dividend, bonus share issue and compensation cap in place, reflecting the level of operational and other risks (including political risks)

If we get these incentives right, here is what I foresee for each of the players:

Banks:

1.   Their systemic risk is considerably reduced as their lending is now spread across a much bigger portfolio of MFIs – different types, sizes, scale etc

2.   Political risk is also reduced somewhat – especially for MFIs operating as part of the NRF

MFIs:

1.   Some large MFIs may borrow from banks under priority sector lending while others may not. But that is a choice that each MFI will have to make, based on its vision and mission and the perceived benefit of operating under a national regulatory framework

2.   Large MFIs that do not accept dividend, bonus share issue and compensation caps are likely to become pure play financial institutions. They will be able to give reasonable returns to their investors but they may be more prone to operational and political risks and something, that they may choose to live with...

3.   Large MFIs who have accepted a dividend, bonus share issue and compensation cap and who remain pure financial institutions will start getting surpluses. Thus, they will be able to build their reserves and over a course of time will be able to offer cross-subsidization across different kinds of products to clients - e.g., An Income generating loan at 24% or less, education loan at 8 % etc

4.   Socially focused MFIs will now get adequate funding and be able to become true livelihood supporters where credit is one of the products they offer. They may also offer additional support like health advisory services etc. Thus, these organizations will be able to work on poverty reduction as well as financial inclusion.

Clients:

1.   Their interests will be protected.  They will have true choice. If they want only credit they will perhaps get it from a large registered MFI at a relatively lower rate. If they want livelihood support with credit they will get it from a socially focused MFI.

2.   If they want to increase their loan size slowly they can approach a socially focused/small MFI. If they want to increase a loan size faster, then they go to larger MFIs.

Investors:

1.   They will now have wider choices. They can either invest in truly commercial for-profit MFIs or they can invest in and/or support MFIs that have capped dividends, bonus share issue and compensation that avail priority sector funding and that can act as banking correspondents.  It would entirely depend on their social and commercial goals.

2.   Investors who believe that all problems can be solved only commercially can invest in non-dividend capped MFIs. Investors who believe in the double bottom line can invest in dividend capped MFIs. Donors can support NGO MFIs.

Hope I am clear on my suggestions...and please do write back…I believe a crisis should never be wasted and I also believe that Micro-finance will not die, irrespective of whatever happens now. It is my optimism that makes seek a proper regulatory framework...one that can enable MFIs to grow and flower, one that can protect clients and one that can safeguards public and peoples' money (loans which are public deposits) - all three are important and there can be no compromise on that. I hope the powers that be understand this and attempt to save the industry with such a clear enabling regulatory framework.

Tomorrow’s post would be on governance standards required in the regulatory framework…and I will continue with similar standards for systems, client protection/literacy etc and the actual regulatory framework...All, of course, for the benefit of the RBI Board Sub-Committee...and other stakeholders

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[i] Points A and B will be elaborated through a series of separate posts in the coming days and aspects covered in point C are the subject of this post

[ii] Return on Assets and Return on Equity caps are possible but there will be workarounds to that by bundling products along with the loan. Thus, the MFI will be able to show that their income is now coming from other income streams.

[iii] Dividend capped MFIs with their primary social orientation should be allowed to become banking correspondents since there is minimized conflict of interest. Further they should be encouraged   to open savings banks accounts with banks and eventually the loan size to the borrower by the MFI should be linked to the savings of the borrower with the bank (perhaps the NRF can come with prudential guidelines for ratio of loan to savings). This in essence will do several things: (a) Encourage savings for clients; (b) Simplify regulation: One will be able to allow savings to clients without creating deposit taking MFIs in the short and medium term; and (c) Loan size linked to savings amount will reduce chances of over indebtedness.

The Key to Getting Micro-Finance in India Back on Track Lies with Establishing the Right Incentives for Various Stakeholders…Part II, Client Perspective

Ramesh S Arunachalam

Rural Finance Practitioner

Please recall that two days ago, I started this three-part article where I said I would try to highlight the impact of the current crisis on micro-finance in India and the 1st part was posted on 19th November 2010. The second part relates to the viewpoints of clients and is being posted now. The last part deals with issues of getting the incentives right and will be posted tomorrow…Read on and comments are most welcome…

The current state of micro-finance in India therefore, offers challenges as well as opportunities going forward.  If things continue as they are, here is what I anticipate could (will) happen for clients:

1. Clients will have increasingly limited options and may not be able to easily access credit for various purposes

2. Specifically, an MFI led micro-finance industry - which is on the back foot and fending off strong criticism about multiple lending and coercive collection practices - is not likely to be a easy and quick provider of credit (as in the past). Thus, low income people, many of whom have vulnerable and fragile livelihoods, may find it increasingly difficult to access money from the micro-finance industry.

3. While the SHG model and the banking correspondent are indeed options and can certainly be scaled up further, they may not be able to grow as fast in the short term as the MFI model. They also may require higher maintenance (especially, for the SHG model) and this could manifest itself as increased (overall) costs in delivery. The outsourcing guidelines are rather stringent and therefore, there could be problems with the correspondent-banking model as well, in terms of scaling this up.

4. Thus, clients may be able to access loans only from a few large MFIs and once they start borrowing from these large MFIs it could become difficult for them to switch and borrow from either a banking correspondent and/or (by forming/joining) an SHG. This is especially, applicable in places where the SHG Bank Linkage program is not as well developed as in Andhra Pradesh and/or some other states

5. The clients who get tied into a large MFI could be forced to keep up with group pressure in increasing the loan size. As a result, clients who may want a more gradual growth in loan size will have no option but to succumb to peer pressure and borrow (increasingly larger amounts) from the large MFIs as there will be limited financing options. This could result in many clients getting over indebted in the medium/long run.

6. If for some reason, due to family or other emergencies, clients urgently need money, they will have very limited options to get finance. Because of restrictions on multiple lending which are likely to be enforced in the future, clients may have to borrow (more) from moneylenders and informal financiers. Thus, without question, borrowing from moneylenders will increase if clients have limited choices amongst MFIs and the crisis results in the (inadvertent) favouring of large MFIs

7. If there is a rush amongst large MFIs to grow very fast in non-AP areas, then there could be cases of over indebtedness in these places as well amongst the clients and an AP like situation cannot be ruled in other states

8. For clients in AP, who have not paid back their past loans, getting loans from even large MFIs is likely to be difficult as their past (default) experience may result in their being excluded by the MFIs. This may push them solely to the informal financiers and/or banks/government programs (if they are willing and able to lend). Alternatively, at least, MFIs would become very discerning in granting loans to such defaulters in AP. Thus, while the defaulters (in the crisis) are surely not likely to get further loans in AP from the MFIs, it is the clients who have paid back properly and waiting for the next loan, who could get affected. Again, with little or no option, they would be pushed back (almost) to the door of the money lenders

9. All said and done, from a clients’ perspective, the crisis, would result in rendering them more vulnerable. Thus, they would have very little options to combat family level emergencies and life cycle setbacks/events. Coping mechanisms will get to become more dependent on the moneylender, especially if the crisis results in the smaller MFIs becoming non-operational

10. I am making a huge assumption that banks (or governments for that matter or other types of financial intermediaries) may not be forthcoming in lending directly to low income clients – I hope I am proved wrong in making this assumption and I am sure that many clients will endorse what I am saying…

PS: By pointing out the difficulties that clients could face, I am in neither justifying lesser (or no) regulation for MFIs nor am I rationalising their reckless growth and greed (as Mr Vijay Mahajan correctly said in interviews in November 2010). This should serve to clarify my position

The Key to Getting Micro-Finance in India Back on Track Lies with Establishing the Right Incentives for Various Stakeholders…Part I

Ramesh S Arunachalam

Rural Finance Practitioner

In this three-part article, I try to highlight the impact of the current crisis on micro-finance in India – from reckless burgeoning growth in 2006 to 2009/10 to corporate governance failures, state intervention, deteriorating asset quality because of the above factors leading to a bubble bursting like situation…The first part deals with the perspective of commercial banks, large MFIS and small MFIs. The second part relates to the viewpoints of clients. The last part deals with issues of getting the incentives right…Read on and comments are most welcome…

The current state of micro-finance in India therefore, offers challenges as well as opportunities going forward.  If things continue as they are, here is what I anticipate could (will) happen:

How are Commercial Bank’s likely to View Micro-Finance in India Going Forward?

1.   Banks after having seen this crisis, may (now) perhaps assume that microfinance has serious inherent political and operational risks so much so that a default crisis could occur in flash

2.   The will result in the risk perception of microfinance going (further) up and banks may become very cautious – in fact, some of them may get into a shell

3.   This could result in banks lending only to large MFIs that have a (good) requisite amount of equity.  And these would primarily be the large for-profit MFIs.  

4.   The irony would be that, although a small socially MFI or a livelihood oriented MFI might be doing good work working with the poorest clients in the most remote regions, as far as the banks are concerned, such an MFI could be a risky bet. In case of a crisis in the future in the region where the specific small MFI works, the localized nature of the MFI may make it appear even more risky for the bank. Thus, small socially focused MFIs and their poorest borrowers could get increasingly excluded from the system.

What is the likely perspective of large for-profit MFI’s going forward?

1.   There will be heighted pressure on the larger for-profit MFIs to give the anticipated returns to commercial investors such as Private Equity firms. This will be due to:

a.      Reducing interest rates:  Interest rates will decrease all over India due to the heightened public opinion after the Andhra Pradesh situation and the spread of the same elsewhere

b.      Losses in Andhra Pradesh: Several large for-profit MFIs are likely to report losses in their loan portfolio in Andhra Pradesh because of borrowers not paying back, both due to multiple lending and the political climate.

2.      But since investors are still going to demand their anticipated financial return on MFIs (irrespective of the impact of the AP situation) and especially those who were not directly affected by it could push the large MFIs to consequences that are not going to be very desirable:

a.      The bigger for-profit MFIs will try to expand even more vigorously outside Andhra Pradesh. It they have adequate funds, there could be a rush amongst the larger MFIs to reach out to as many borrowers as fast as possible before other MFIs come in and restrictions are put on multiple lending, interest rates etc all over the country. Such an accelerated growth may will help many large for-profit MFIs to attain critical size and perhaps go for an IPO in the future (if not near future) – unless things and events change even more drastically, I still see MFIs tapping the primary market, although there would be some time gap from the present day (as they say, time would be the best healer)

b.      Pressure to reduce operational costs: While the lending is already reasonably efficient, further reduction in operational costs may well mean less time spent in doing client due diligence and building a relationship with the client.  There goes relationship micro-finance…

c.      Bundling of consumer products to clients to increase margins: It is quite likely that from now on, consumer products such as cell phones, televisions, gold etc. may be bundled with a loan to increase margins for MFIs. While each of these products may have a utility, bundling it with a loan will make the pricing of the micro-loan and the consumer product even more opaque.

3.      To recover the initial cost of client acquisition, large MFIs may create exit barriers for clients and prevent them from going to other MFIs, SHGs or work with banking correspondents. While the SHG model and banking correspondent model have advantages, they are not as easy to scale or as nimble as the microfinance model. Clients will also continue to be attached to their original MFI because of exit barriers and the choice of default option excellently identified in behavioural economics. Thus, the SHG model and banking correspondent model may not reach the critical mass necessary, as compared to the microfinance model.

What is the likely perspective of small microfinance institutions going forward?

1.      Since banks are likely to become even more cautious lending to small MFIs, many of these small MFIs will find it very difficult to get loans from banks.

2.      Small MFIs all over India are likely to be affected severely by the turn of events and as a result the poorest clientele in the most remote regions who are often served by such institutions may be severely affected.

3.      MFIs who also provide livelihood support and other services will be severely affected by this situation.

In summary, I see the smaller MFIs suffering the most from this crisis and tomorrow, I will share the client perspective on the present crisis…

Good Day to All!