Representation to the Malegam Committee
Dear Chairman and members of the committee,
You have been entrusted with a challenging task; you must be faced with different and
often conflicting expectations from several quarters. As a sector observer, I have a few
comments to make for your consideration.
Microfinance institutions took roots in the crags and fissures of the formal financial sector –
they never had a clear policy space. (For example, dormant companies registered with RBI
as NBFCs were bought and retooled for commencing business as MFIs – because it was
difficult to register a new NBFC with RBI!) The result is that they grew haphazardly and in a
manner that is not altogether appealing. They struggled for survival and did anything to
secure their future. And what they did was not always good.
The formal financial sector’s efforts to meet the demand for financial services had not been
entirely successful – and left a market void which the MFIs have tried to occupy. Even with
the MFIs and the larger SHG movement in place, the demand for financial services is
nowhere near being satisfied. A complete appreciation of the extent of the market and
design of strategies for meeting the market demand in a given timeframe are required – the
committees work in proposing a policy relating to microfinance and MFIs is just one part of
this larger effort. Actions such as in AP should be stopped through a central legislation.
Such actions might be disastrous in other states where MFIs serve more excluded people
(Karnataka for example) and might cut the only link to finance they have (even if the link is
a sub-optimal and extortionate one).
1. Fragmentation of regulatory effort and each state having a regulatory regime will
cost the sector dearly and provide wrong precedents that might affect the larger
financial sector in future. The resultant regulatory arbitrage is something that the
sector can do without.
2. What is good as a solution for today need not necessarily be good in the long run.
Today’s problems which necessitated the set up of this committee may not be the
real ones to solve in microfinance. If the customers’ interests are to be served, we
should look at the causes – not the symptoms.
3. The sector direly needs a well articulated rural and microfinance policy
rather than just microfinance regulation. What do the government of India and
RBI think of delivery of financial services to the excluded? Are the financial
inclusion efforts that exclusively focus on banking system the only means of
achieving inclusion? If so we need not bother too much about the temporary
arrangements such as MFIs or SHGs. The can be told the future picture and asked
to conform or quit.
4. Systemic stability considerations that underlie prudential financial sector regulation
are not relevant in microfinance sector with its tiny foot print in terms of financial
volumes. Customer protection is a more legitimate and relevant concern in
regulating Microfinance.
5. The principles that would serve microfinance regulation well are – social mission,
transparency, fair practices, inclusive processes and social audit by customers:
Social mission: Institutions that want to enter microfinance should have a clear
social mission that prioritizes customer interests. Institutions that do not have a
social mission should be denied entry.
Transparency: Relates to placing in public domain information on prices, product
features, ownership of the MFI, executive remuneration, regulatory action faced,
violation of any law pointed out and pending investigations of any kind and
regulatory/audit reports. The information on interest rate, effective price paid by
the customer and product features should be provided to each concerned customer
in a form and manner suitable and understandable.
Fair practices: Relates to sales and marketing of products and services (avoidance
of mis-selling, cross selling, bundling of unwanted products such as insurance),
recovery practices (avoidance of stressful coercion), customer based loan appraisals
(including lender’s liability for wrong credit decisions that result in excessive debt),
avoidance of use of agents, centre leaders, etc., in credit processes and incentivizing
responsible staff behavior.
Inclusive processes: Enabling participation of customer groups in credit decisions
to group members in group based lending methods, grievance handling procedures
that have customer groups as part of the redressal mechanisms at block/district
levels, annual meetings in each branch of MFI to provide information about
performance of the institution in that branch and invite customers’ observations and
reactions.
Social Audit: Annual audit of the MFIs operations by a group that comprises select
customers and also renowned NGOs to get a customer perspective of the MFI’s
effectiveness and relevance.
Regulation should consider setting limits on extent of private ownership,
limits of profits (in terms of ROE and ROA), restriction on accessing capital
markets for equity in the initial years (say 7 years) and limits on executive
remuneration. The enforcement of these should be through funding banks. The
transparency in disclosure could be implemented through organizations such as
Microfinance Transparency which is working on pricing transparency in the country.
What regulation should not do:Regulation should not introduce interest caps, prefer some
institutional forms over others, encourage state sponsored microfinance programmes or
engage in micro-regulation.
Enforcement of regulatory guidelines:Given that more than 80% of funds deployed by
MFIs are borrowed from the banking and financial institutions, the guidelines can be made
financing conditions and monitored through the lending institutions.
A board of
supervision of microfinance can be set up. This body should not engage in microregulation, but should reviews the annual reports given by lending banks. The board
should take up cases of those MFIs that are reported as being ‘non-compliant’ or ‘deviant’.
The principal lending bank should be charged with providing an annual report on all their
borrower MFIs describing compliance with regulatory guidelines and conclusions of the
social audit exercise. This might require some specialization within the banking sector
which could be created and sustained with ongoing training. As a further measure, rating
agencies could be asked to include “quality of compliance with regulatory guidelines” in
their standard reports.
Other matters
The microfinance sector should be formally represented in the SLBC and DLCCs. Their
performance (and problems) should be part of the review in these bodies. Governments
should provide a level playing field for the MFIs. There is no point in highlighting the fact
that MFIs charge high interest rates even when banks are provided subsidies to keep
interest rates low to farmers, SHGs, etc., and permitted to charge separate service charges
in they engage BCs to deliver services to customers. MFIs could be used for delivery of
government programmes on the same terms as that of banks. Well run MFIs should be
allowed to function as business correspondents so that costs of financial intermediation come
down for banks, MFIs and customers.
With regards,
N.Srinivasan
Author, State of the Sector Reports 2008, 2009, 2010.
24 December 2010