Type I Agent: The Local Grass-Roots Politician as The Micro-Finance Agent

Ramesh S Arunachalam

Rural Finance Practitioner

There are several types of micro-finance agents who are operating and they can be classified as follows:

Type I Agent:  The Local Grass-Roots Politician as The Micro-Finance Agent

Type II Agent:  The Centre Leader as The Micro-Finance Agent

Type III Agent:  The Group Leader as The Micro-Finance Agent

Type IV Agent:  The Local Community Member as The Micro-Finance Agent

In a series of posts, I look at each of these agents, their characteristics and roles and also describe their salient features.

This first post looks at “Type I Agent:  The Local Grass-Roots Politician as The Micro-Finance Agent”

Characteristics and Roles of Agent

1.     Agent’s Background: Is typically a member of a political party or organizer/agent for local politicians. I have even know dynamic centre leaders graduating to this kind of an agent

2.     Clout: Is derived mainly from local organizing of people for Political and related work and this person has extreme familiarity with the local political/social milieu. He/she has tremendous local contacts with the powers that be and an excellent and well entrenched local network

3.     Type of Model: The agent model is totally decentralized and the MFI only knows the agent as the last mile. End user clients are rarely known and records may not even exist, let alone be inspected. A lot of KYC violations would occur here and the agent assumes responsibility for completing this, using local educated people, often youth. There is very little control that the MFI has over this kind of agent. Under this model, a lump sum amount is given to the agent and in return, names and ID proofs and other required documentation are collected.

4.     Roles: Loan disbursement and collections are done mainly to agents own clientele, using agents own staff/helpers (Read = Toughies). Such agents initially started to work with MFIs but have also started working with the SHGBLP & other government programs.  The agent is also a good conduit for channeling local money into micro-finance. The agent Kamala mentioned a few days ago is this kind of an agent who collected upfront commissions promising disbursement of loans after elections in Tamilnadu

5.     Compensation: This agent mark ups on interest as well as charges a flat. Additionally, they have as their return the money gained by deploying/rotating (MF) funds in their own business

6.     Credit Risk: The credit risk is huge as the agent carries enormous power and there is very little that the MFI can do to tackle the agent, in case of the agent reneging on their implicit and/or informal contractual obligations

A diagrammatic representation of these agents operations is given in figure below. Please note that the last mile is a black box.

Salient Features

As noted by one of the commenter’s to a previous blog posting of mine on agents and I quote, “this is a more predatory model. Here, a local grass-roots political agent steps in as the financial intermediary. In this case, he becomes the local agent with the intent of converting the loans into political capital. Says an ex-employee of both SKS Microfinance and Spandana: “"In most of the slums, there is usually one gang lord whose permission you need to work in that area."" And this toughie becomes an agent of the MFI overtime.

Several issues are critical here and must be noted from a regulatory/supervisory perspective:

·        The balance of power here is almost always in the agent’s favour and he/she controls the local activity.

·        Often times, the agent claims to disburse at a very fast pace and this burgeoning growth of portfolio could result in failures of established systems at higher levels of the MFI. Also, the complete decentralization in this model often causes deviation from prescribed credit policy and results in fraud, error or manipulation – and much of it is unknown to the MFI. Also, weak integration of information systems at the MFI level may not even permit MFIs to recognize such delinquency

·        Also, there is great difficulty in maintaining portfolio information when the agent is of this kind and having complete control. So, much of the data is what is provided by the agent who have helpers/assistants (including former group/centre leaders) that help them fabricate this data

·        The mandate of efficiency and the desire for lesser controls, procedures, information and  supervision to reduce costs and thereby interest rates, seem to have prompted MFIs to go in for this model initially and this is proving to be a bane for many of them today.

·        The last mile is the agent and the MFI will not know who the actual clients are and any attempt to do so will be taken as a serious loss of face for the local political agent – the end result being loss of money for the MFI and an effective ban on its working in the area

·        If the agent absconds, the MFI will not know who its final clients were. Nor would the clients know who the MFI is – because, as noted above, if the MFI tries to promote itself in the village/locality, it will alienate its agent.

·        Also, if other MFIs come in, the agent will usually play one against each other and/or even start representing the other MFIs as well. The branch staff of the first MFI will rarely be in a position to object and they may not even know of it.

·        Also, if the agent is not able to keep the repayments coming, the branch staff is likely to advance him/her a fresh loan to avoid a default which would expose the distortion. Thus, restructuring (rescheduling and refinancing) of delinquent amounts is an often-used strategy to camouflage portfolio quality

·        Finally, this agent plays a huge role in transferring money during electioneering – something that the election commission in India has woken up to in the last month. It may be worthy to note that huge consignments of cash were confiscated from two major MFIs in Tamilnadu in the last two days – While some of it could be genuine micro-finance money, much of it is money used by the political agent for distribution to political parties

The next posts will provide a similar overview of other kinds of agents in micro-finance…

Have a Nice Day!

Financing Agriculture: What Financial Inclusion Can and Should Do in the Future?

Ramesh S Arunachalam

Rural Finance Practitioner

While a lot of lip service is paid to agriculture financing, in reality, there are very options available on the ground. To redress the current malaise in agriculture financing especially in countries like India, financial inclusion would need to focus on:

1.     Repositioning Agriculture and Rural Life – This calls for priority focus on Agriculture in terms of access to finance including investment credit, risk mitigation products and finance for infrastructure including watershed, extension services, quality inputs, standardisation and the like.

2.     Promoting Innovation, Competitiveness and Growth of Agribusiness – Competition enhancing finance for chain actors (especially middle level) and especially from other kinds of intermediaries; finance for re-structuring of supply chains and the like

3.     Strengthening Agricultural Health and Food Safety Systems – Very critical to do this in terms of inputs, processes and infrastructure and ensure that various standards are adhered to. Finance for infrastructure is very critical here and should not be ignored

4.     Introducing Appropriate Technology and Innovation for the Modernization of Agriculture and Rural Life – Again, innovative financial products can play a major role here in bringing technologies from Lab to Land in a successful manner and facilitating their wide scale adoption

5.     Strengthening Agriculture and Rural Communities – Especially, in terms of their staying and bargaining power is going to be very critical – Finance for reducing vulnerability and risks of small producers would be most useful and this alone will enable them to participate fully as stakeholders and demand and get their due

As several stakeholders have argued, agriculture is indeed at crossroads and a major challenge is to reverse the present trend of slow-medium growth in most developing country contexts including India and push it in the high growth path/trajectory.

The key seems to be to provide an integrated set of services including access to financial services including credit, access to market, value adding technology, training, access to machinery, storage facilities, access to extension, processing facilities and quality control.

Partnership between public and private sector companies/ organizations is needed in order to provide these integrated services.

More important is to improve bargaining power of smallholder producers while also reducing transaction costs for intervening stakeholders through promotion of producers’ groups, associations and cooperatives. Small producers will be able to effectively participate in the changing markets and establish links with new market actors (agribusiness companies, processors, exporters, chains etc.) only if they have access to basic infrastructure, quality inputs and various services, are organized and most importantly, empowered in terms of having more staying power and bargaining power, which of course requires quality, innovative and vulnerability reducing financial services at sufficient scale.

Have A Nice Day!

Micro-Finance Agents in Tamilnadu: A New Class of Local Financial Intermediaries at the Grass-Roots?

Ramesh S Arunachalam

Rural Finance Practitioner

I have been travelling in my home state of Tamilnadu and of course, apart from doing my work, I have also been interacting with micro-finance clients, MFIs and staff, agents, bankers, SHGs, JLGs and other stakeholders involved in micro-finance. Here is what I found…Read on…and much of this is on record…

Micro-finance agents, created by MFIs are still active in many districts in Tamilnadu and I, in fact, met a few agents in the last 10 days, who were using repayments collected from clients (and not paid back to MFIs) for further intermediation amongst the people at fairly high rates of interest (excess of 30% in many cases). Some of these agents have also formed themselves into small NGOs/trusts/societies and are trying to access funds for financial intermediation from various sources including MFI funds, politicians, banks funds…and other sources…They are clearly becoming a new class of financial intermediaries at the local level but with no institutional and/or individual accountability…

An interesting incident was mentioned by one stakeholder and confirmed by women in the field…Three Andhra MFIs operating in Tamilnadu apparently had not paid staff their salary for some months after the MFI crisis in AP and some of the key staff along with agents collected money from clients (without giving receipts) and were now using the same money (running into several crores of Rupees, 1 Crore Rs = 10 Million Rs and 46 Rs = 1 US $) as capital for financial intermediation at the local level. The same is being rotated at the local level at much higher rates of interest. The same stakeholder confirmed that as many of the MFIs are not aware of several of their last mile clients (end user clients), they also could not directly collect the repayments from the clients. This also has very serious implications for KYC norms and the traceability of the money at the grass-roots…some thing that I have been crying hoarse for some time now…

Several clients also claimed to have paid a huge fee to agents in anticipation of a future loan from MFIs – which agents had said that they would disburse after the elections (scheduled for April 13^th 2011 in Tamilnadu) got over. In fact, one group of clients stated that nearly 800 people had paid between Rs 700 – Rs 1000 as fees to an agent (Kamala) in Salem district to get loans of Rs 25000 – Rs 40000 each from various MFIs, after the elections. Assuming an average fee of Rs 850, this works out to more than 1/2 a million rupees in upfront fees paid to the agent

Coercive repayment is also said to continue and a middle aged client said that staff of one MFI took away her child in the morning in Feb 2011 and returned the child only after she was able to make the weekly instalment payment at night by pledging her ration card (for a fee and for use by another client to get a loan from another MFI) and also selling her rice/rations at a distress price. Still others confirmed that staff have now started sleeping in the villages (and sometimes outside the homes of clients) at night, if they could not collect money from the clients during the day.

I also met a few centre leaders who said that they are breaking up old JLGs and forming new ones at the instance of one MFI, so that loans could be provided to these so called newly acquired clients and not old older clients in other JLGs. Overall, the practices at the ground level do not seem desirable with regard to client acquisition, client preparation and the like and this is such a fundamental and critical issue…

Very interestingly, the micro-finance agents also claimed to be working with the SHG – Bank Linkage model, by taking groups to banks for the 1^st linkage. One of them said that they received no commission from the banks but received between 7 – 10% from group members for getting the group a first loan of Rs 50000

Agents also confirmed that bankers are now actively calling them in to help them meet their various targets, including those pertaining to financial inclusion. To reconfirm some of these aspects, I met several bank managers in the same areas and two managers candidly said that since they lacked sufficient staff and were being pushed on targets, they started relying on the agents for bringing in the groups to meet the various targets

One of them even had an interesting observation…the groups brought in by agents typically paid off their first loan within 1 year whereas the loan term was around three years and then, they took the 2^nd loan of 4 times the savings – many of these groups accumulate as much as between Rs 30000 – Rs 40000 and therefore receive a 2^nd loan of Rs between Rs 120000 – Rs 160000 (46 Rs = 1 US Approximately). Managers also confirmed that several groups do not repay the 2^nd loans and that, many of the members migrate to other areas and are not traceable. One manager even said that Rs 40 Lakhs (Rs 4 million) is likely to be written off in the future as the members are not traceable

Yet another startling fact was brought up the managers and they said that Rs 50000 first loan taken is not used towards any income generating activity and that this money sans the commission paid to the agents was used as the corpus for a local chit run by the group members, who divided the interest profit amongst themselves…

Clearly, as far as I can see the burgeoning growth of micro-finance and financial inclusion initiatives, have indeed led to the development of an entire new set of intermediaries – agents – who are best described as a new class of money lenders, especially because of their overall coercive behaviour, the harsh terms that they offer and the strong arm strategies that they employ for collection…I can see some parallels with agents used for personal loans in India, that turned out to be disastrous for many banks

Therefore, it is about time that we as practitioners, begin to introspect with integrity, on what is working on the ground, why or why not and what can be done to salvage the various micro-finance and financial inclusion innovations in India…Otherwise, much of our efforts of several decades could be sadly lost…

I know that many of the proponents of the models may become defensive and try to argue Y versus X and so on. My humble plea to them is to refrain from doing that and rather, take practical steps to enable a serious Nation-wide reality check (conducted by a neutral set of people from Civil Society, with no vested interest or stake) with regard to the micro-finance (MFIs and SHGBLP Models), financial inclusion and other initiatives and the extent to which the ground situation is rapidly deteriorating. In my opinion, I have no hesitation in saying that the current growth, practices and direction of the various micro-finance, financial inclusion and related initiatives is not as was originally desired/planned and if unchecked, these could result in serious damage to the low income economy in India in terms of credit culture, economic transformation and the like…So there is a lot at stake indeed

Make no mistake, the cancer is spreading and spreading very fast and before, it consumes much of the low income economy in urban and peri urban and completely destroys the credit culture, let us do something to salvage the situation. People at the grass-roots need and have a right to access finance and other basic services and therefore, throwing out these initiatives is not the solution. We as a country, need to get the delivery of financial and other services to low income people right and for that, we need to introspect with integrity and not be defensive…

Among other things, this immediately calls for a national strategy and policy on access to finance for low income people, a single supervisory micro-finance authority (created by an Act of Parliament) which understands the nuances and has the wherewithal for SUPEVISING micro-finance and such initiatives, and the creation of a larger ecosystem with enabling services that will help low income people to start, nurture and scale up urban and rural enterprises and livelihoods in a sustainable manner…so that inclusive growth becomes a reality as envisaged by the Government of India

I hope the senior practitioners and all other stakeholders will start on this in full earnest…

Have a Nice Day!

Do We Need a New CGAP - "Consultative Group to Alleviate Poverty"?

Ramesh S Arunachalam

Rural Finance Practitioner

That the delivery of mere financial services (= consumption credit and small production loans) alone is insufficient to reduce or alleviate poverty is perhaps a no brainer, for all honest development practitioners. Despite the lack of serious impact studies, for those, who have worked at the grass-roots and continue to so, it is rather evident that mere access to finance cannot and will not help people out of poverty. Access to finance, is therefore a necessary, but not sufficient condition to poverty alleviation.

While micro-financiers and access to finance advocates can perhaps take comfort in the fact that, while genuine financial services cannot alone make a dent on poverty, there is a caveat in order. They cannot escape the fact that the drive and desire to include low income people with regard to financial services has resulted in the proliferation of financial services focussed on loans and even within loans, primarily consumption lending. The enthusiasm to include low income people has also led to not-so-good practices including multiple lending, top up loans, ghost/benami loans and the like driven by the motivation (some people even call it greed) of some MFIs to generate huge wealth for themselves and their promoters. In fact, one of the major reasons for the on-going Indian micro-finance crisis is the present mindless drive to include people financially, without asking the question (s) of whether the current bouquet of financial services  being offered are appropriate, whether the practices being followed are fair, transparent and ethically sound and whether the other conditions so much necessary for effective use of the financial services exist.

Without question, the onus[i] for this lies on institutions like the CGAP, which lays the claim to being the foremost agency with regard to financially including low income people. A second set of people who are responsible for this are the policy makers (including some Central Banks) who have, encouraged the proliferation of consumption credit and pretended all the time that such loans lift people out of poverty. A third set of stakeholders are the mainstream micro-finance industry practitioners including banks, MFIs[ii] and industry professionals, who have all along, for a large part (there are exceptions no doubt), blown their trumpet (huge and loud) on the fact that micro-finance and financial inclusion can make a serious dent on poverty. And last but not the least, are the hugely enthusiastic donors and international agencies who have played along with everyone, echoing the same old story, again and again...

micro-finance and/or financial inclusion = poverty alleviation

I want to share a recent incident (not to blame anyone and with no Malice what-so-ever), without identifying a large project, for which I led the proposal writing team and unexpectedly (I must be honest), our consortium won the bid. At the inception meeting, in December 2009, even as the micro-finance crisis was quietly simmering in India, I repeatedly made the point that, their (the donor’s) emphasis on enhancing quantity (read large numbers) of financial services through the traditional MFI consumption route is perhaps not appropriate and that the quality of financial services (= wide range of vulnerability reducing financial services including post harvest agriculture and post production financing) and access to other issues like markets and infrastructure will have to go hand in hand. I was really shocked when one of the donor team members dismissed this flatly and said that the delivery of financial services to low income people in India through MFIs is a no brainer and we need no new ideas and we need to push that agenda to scale in the specified underserved areas (This was in January 2010 when the AP crisis was already burgeoning and close to reach flash point over the next few months). I do hope that these people have kept abreast of the recent Indian micro-finance crisis...and understood the real impact of mindless growth of traditional consumption (and/or small production) loans on the low income clients...

For my part, I was disillusioned and I refrained from participating in the same project after the design exercise was - altered significantly and - to be based on whimsical notions and ideas in our various heads, when, in fact, our winning bid had proposed a very comprehensive methodology to understand complex issues related to poverty and inclusive growth in these states. As one of few members of the proposal writing and design team who had worked in every district in the four states where the project was to become operational, I knew for sure that this approach doomed the project for failure. I am now certain that it cannot and will not provide inclusive growth for the thousands, if not millions of low income people, in these states...time will surely prove me right...although, I still wish the project very well and hope my fears are unfounded and wrong…

That said, the larger point that I want to make here is about the role of that donors and various international agencies play and can play in shaping the future of low income people – not to blame any of them but they certainly have to be the watch guards of the poverty alleviation mission and ensure on-course corrections, as and when required. They often get caught in rhetoric and forget grass-roots realities and like hearing what they want to hear. It is about time that they change and encourage honest feedback as well as approaches consistent with peoples’ real aspirations...that alone will ensure real success (of their projects) on the ground...in terms of the fight against poverty…

That said, let us get back to the issue of tackling poverty for which many of us came into the industry...The lessons from the last few decades suggest that access to finance alone cannot have any significant impact on poverty. Poverty alleviation and/or reduction can occur only when peoples’ livelihoods and opportunities (for work, investment etc) are strengthened. And that can occur only when they have access to a broader ecosystem (apart from finance) that provides a range of services that poor people and their enterprises and livelihood systems require – access to information, technology, business development and other skills, markets, product certification and quality assurance, infrastructure and advocacy

And given that CGAP has done a fantastic job of trying to financially include large numbers of poor people, I would very much like them to champion the larger cause of poverty alleviation – They have it in their DNA and in line with their acronym, CGAP must now become The “Consultative Group to Alleviate Poverty” and assume the lead role in fighting and trying to eradicate poverty globally. I am sure they have the wherewithal and resources to do this and let us hope their governing council takes this appeal seriously…

Have Great Day At Work!

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[i] My intention is not to blame anyone. I am merely highlighting what has happened and would like to see course corrections

[ii] Only recently in a BBC interview did I hear a couple of practitioners say that the ability of “micro-finance” to alleviate/reduce poverty is hyperbole.

The Proposed Micro-Finance Bill and Regulating Micro-Finance in India: Getting The Framework Right…

Ramesh S Arunachalam

Rural Finance Practitioner

Yesterday, there was an article in the media that suggested that the proposed MF bill in India is likely to accommodate all kinds of MFIs including NBFCs, which are currently regulated by RBI. And it also mentioned that a special body would perhaps be created to regulate micro-finance. The increased interest for regulating micro-finance is clearly welcome and certainly long overdue. While we have been talking so much about the need for a comprehensive and exclusive regulatory structure for micro-finance, an important question here is: which specific institution is best positioned to perform the given responsibility?

Should it be the RBI or NABARD or a new agency or the industry associations (Sa-Dhan, MFIN or INAFI etc)? There are no easy answers but if the right process is followed, then, I am sure that we can get the framework right and institutions for this complex job… Here are some lessons from past experiences for what they are worth and what they are not and read on…

Comparative Analysis of Assets of Alternative Regulatory Structures: A regulatory system is more efficient if the responsibilities are assigned to the institutions/bodies that have the powers, resources, skills, and knowledge to perform them most effectively. If one uses this framework of analysis, the assets of a new proposed regulatory body (as per the proposed MF Bill) or SRO or similar organization (such as an industry association – Sa-Dhan or MFIn or INAFI) should be compared to the statutory regulators’ assets as they pertain to specific regulatory activities. This is a very critical exercise and must be done objectively and with utmost integrity. A related key question here is whether the proposed new body or SRO or industry association has, or can obtain, sufficient skills, resources, and capacity to perform its responsibilities effectively. If sufficient capacity does not exist or cannot be developed, building a regulatory structure that relies on such new bodies, SROs or industry associations will not yield the desired result. It may be safer to go with the major (primary) regulator in that case.

That said, other factors that should also be considered including the following:

·         Legal Jurisdictions: Which body has the legal jurisdiction to make rules and to supervise the micro-finance industry players involved – especially, given their diverse and varied legal forms?

·         Power and Authority: Which body has the power and authority to investigate, discipline, and impose effective sanctions on the micro-finance industry players involved? For example, most SROs or industry associations may have the power only to collect evidence from and to discipline member firms and their employees.

·         Conflicts of Interest: Do significant conflicts of interest arise/exist? Conflicts of interest always exist in regulatory systems but vary depending on the type of regulation and institution involved. There are obvious trade-offs and these need to be evaluated as well

·         Existing Regulatory Mechanism As A Platform: Is there an existing regulatory structure that can serve as a foundation for the proposed new micro-finance regulatory system? Has it been effective and can it be used as a platform?

·         Industry Specific Knowledge, Skills and Experience: Who possesses the knowledge, expertise, and skills required to regulate and supervise micro-finance?

·         Industry Information and Data: Which body has access to the information and data needed for the task of regulation and supervision? For example, would an SRO/industry association have access to all relevant records and information, or could an SRO/industry association obtain the necessary access?

·         Regulatory Tools: Which body has the necessary regulatory tools (including information technology tools) for the complex task of micro-finance regulation/supervision?

·         Resources Including Finance: Last but not the least, which body has the funding and resources to do a proper job and deliver in terms of regulating and supervising micro-finance in an enabling manner?

I really hope that, the concerned various stakeholders approach the issue of deciding on the micro-finance regulator using an objective and professional process, giving due consideration to issues such as those identified above…

Have A Great Day At Work!

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…