Microfinance Institutions – A Discussion on Proposed Norms

I recently joined GlobalRisk Community, a B2B platform for risk managers. I started a discussion on the proposed norms for the Microfinance Institutions (MFI) in the India Risk forum.

My question was in continuation of the previous topic “Microfinance Institutions- Entitled to Torture”. I had written that finally the Government of India has woken up to the plight of Indian farmers. Andra Pradesh government has established a new law to monitor MFI. Reserve Bank of India has formulated a committee to establish new norms applicable to the country. SIDBI has taken responsibility for not effectively monitoring MFI. Now the proposal is that NABARD will monitor MFI. How is this move being perceived by bankers and risk managers in India?

I am presenting here excerpts of the discussion. Mr Sheshadri Chari and Mr. Deepak Kumar Shaw presented excellent viewpoints.

Mr. Sheshadri Chari is a senior banking and risk management consultant with + 25 years of experience. He has worked in many banks in India, namely Bank of Baroda, Lakshmi Villas Bank and City Union Bank.

Mr. Deepak Kumar Shaw has +8 years of experience in banking and financial services industry. He has worked in various capacities in private sector banks and mutual funds.

Sonia Jaspal : In the current situation what should be done and what will happen according to you?  

Mr. Deepak Kumar Shaw: Till MFI will run for profit it’s not going to follow its core object of social uplifting of low-income groups. Basic idea behind establishment of these MFI was to save poor from moneylenders. But now they are no different from moneylenders in terms of interest charged by them and recent cases of forceful recovery strengthen this argument. With profit motive first there is pressure to distribute loans then to recover and these lead to malpractices. If this sector has to survive and wants to prosper then they have to do stick to their core objective i.e. helping the poor. In my view the following should be done:

First profit making MFI should not be allowed to operate as this will always lead to malpractice in the industry and if that is not possible then major percentage should go back to borrowers as relief or rebate. Benefit of priority sector interest rate enjoyed by MFI should be passed on to its borrowers.

Licensing should be stricter and only a few MFI should be allowed to operate in a region avoiding unnecessary competition between them.

Financial discipline should be brought to the sector in terms of reporting correct numbers. This could be done by introducing strict audit controls, preferably C&AG allotted audits. Finally a strict regulator like RBI should manage the MFI. This will help the industry to win back respect.

Sheshadri Chari : Government has been doing a lot – both on disbursement and waivers – which has been a contentious issue with commercial bankers. While the disbursements to weaker sections have been encouraged by a carrot and stick approach, using targets and subsidized interest rates, the waivers have been a dampener in terms of repayment psychology of the borrowers.

The MFI domain is a sensitive and challenging area. As Deepak points out, if social uplift is the primary objective of MFI, the profit motive becomes an anathema.

For a healthy growth of MFI sector, I believe there is a need for a balance between the social objective and profitability to ensure sustainability of MFI operations. That, first was the basis for certain target oriented lending approach – a policy stance adopted by the RBI. It is also not fair to ask the poor to bear the cost of their uplift by charging a hefty margin, though they should be morally inclined to pay back the society during their prosperity. Setting up of the committee by the RBI to review the position, in my interpretation, reflects this stance.

NABARD is the natural choice for regulatory role as it is the key player in formulating the schemes for social uplift in the context of rural poverty. In fact, the legislation on MFI should necessarily include tenets of financial inclusion that also touch base with urban poor.

At the end of the day, if MFI are able to reach out to the rural poor, energize them to achieve liberation from the debt trap and still make a decent margin through improved reach, business processes and a commitment to sustained service, such MFI should be allowed to flourish within the accepted banking practices for credit delivery and recovery.

MFI is essentially engaged in a banking activity and thus required to be brought under the purview of RBI regulatory framework keeping in view the specific objectives for which the MFI are established in the first place.

Sonia Jaspal: Deepak and Seshadri, thanks for sharing your viewpoints. I agree with you. I especially like your point that the poor should not bear the cost of their own uplifting by paying higher interests.

My concern is that though it looks like the government has finally acknowledged the problems, they will again issue paper policies and there will be no change at the farmer level.  We will be back to square one and see many more farmer suicides.

What is your opinion regarding it?

Sheshadri Chari : My use of the term “sensitive” was to emphasize the nature of challenges in this sphere of financial activity and risk taking.

This segment is a good market – in the sense that it is a felt need. At the same time, given the Indian culture, particularly , political, it is a challenging task. Your concerns are shared by the states like Andhra Pradesh, West Bengal, and Kerala where the problem of higher interest rates and employment of recovery agents for debt recovery have drawn official responses resulting in the review by RBI.

I believe the solution lies in strengthening rural markets so that the rural poor have chances for poverty alleviation within their command area than relying on increasing the cost of marketing by looking to urban markets. In India, we need to move from Metropolitization to Ruralization – providing self-sufficient communities, who can expect to achieve a reasonable standard of living. Development of SEZ will provide a good market for the farmers – but this will, initially, at least need government intervention.

There are connected issues here as well. Such as the inflationary trends in basic food prices.

Well, are there solutions that do not create fresh problems?

I am veering round to the conclusion that life is one of managing solutions, not problems

Sonia Jaspal : Thank you for sharing your viewpoint. The takeaway is that stricter controls and monitoring process should be established by Government of India. Reserve Bank of India and NABARD should play an active role in monitoring MFI. The rural poor should be supported in their efforts for better standard of living. Benefits of lower interest rates, waivers and profit-sharing should be given to them. 

As per World Bank estimates 42% of the Indian population is still below poverty line. Interconnections between low-income groups, volatility of food prices, and dependency of agriculture on monsoons should be considered while devising solutions. Government intervention and private participation is required to bring up farmers standard of living. Sincerity and commitment are essential to resolve this situation.

In invite you to share your opinion on the actions which Government of India should take to improve the standard of living of the poor farmers.

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4 comments on “Microfinance Institutions – A Discussion on Proposed Norms

  1. @ Deepak Kumar shaw
    ” Till MFIs will run for profit, it’s not going to follow its core object of social upliftment ”
    Dear learned ‘risk’ friends.. Hearty Greets.
    Important issues and complexities concerning MFI Sector have been in-depth analysed by all experts for a lot of learning and knowledge-sharing here.
    It’s gratifying to note that the sector is receiving close attention globally today. The G20 Toronto Declaration of 26 / 27 june 2010, has graphically drawn out 9 Basic Principles on which future standards and practices including revisions to the prevailing Legal and Regulatory frameworks, should ride this sector from now onwards. RBI in India should require to have a renewed closer look casting off its age-old apprehensions and searching for non-existent ghosts in the dark and wilderness thereon. KYC and AML are pressing issues in the context of our Asian Region coming under close scrutiny for mushrooming growth of terrorism-centered activities. Poor MFI sector by small and insignificant values should not be subjected to ‘wild goose’ chase. Definitely, some loose Regulatory dispensation would follow but strictly not on the lines of restrictions and disciplines imposed on the mainstream banking sector. Costs and enforceability of myriad tiny institutions located in far flung areas, in which the mainstream bankers would deter to tread with their ‘urban’ demeanour and comfort, will be the limiting parameters. Some Legal and regulatory structures are in vogue in some of the countries but standardisation of practicers and definitions are wanting in several respects. In a similar vain, the MFI Regulatory Reforms Bill pending with the Indian Parliament for regulation of the sector, seems to place some faith in NABARD, as stated by experienced Seshadri Chari. But, I look at NABARD more or exclusively as a development-oriented Apex entity for rural credit but not at all as an effective Regulator. NABARD has failed to convince me on several counts as I had strong lien with that organization for nearly four decades as an Ex-Senior Central Banker…!! Be that as it may, my review of NABARD’s role is kept for another dry day for more elaboration, if need be,
    2. Pardon me, Dear Deepak, apologies to you..I breathe less comfort and rather detest the idea of social responsiblity in a free-market oriented economy. No discounted or free lunch can be made available as it would not uplift the poorest of the poor to a bare minimum of livelihood sustenance for long. My understanding and experience with UN doctored MDGs, does not support such views and so also my organization targeting support to African financially, economically and or socially excluded persons. The poor themselves detest the idea of free doles. Food Security, NREGS, and CSR are not devised as charitable activities and programmes. They are the vehicles on which, viable Financial Inclusion policies can be woeven around. Chari again has rightly cited about sustainable and viable MF Sector. It’s happening even with ‘For-profit’ players like Basix, Equitas, etc. funding at benign rates within the sector. What has not been happening is the correct and equitable distributuion of cross-subsidisation of various interest rates and exchange rates, pricing, profitability sharing, etc through currently positioned free-market economy mechanism. These would be possible through the policy framework of ‘Inclusive Growth and equitable distribution’ based on merits, local opportunities, local skills and efforts. GOI has been attempting to address such issues but not able to successfully translate into reality at the farther ‘Tail-ends’..!! Even, G20 countries, have now realised the folly of ‘Growth and Exclusions’ and opened their eyes towards the un-tapped potential for consumption in support of industrial and service sector productions that can be enhanced with several attendant advantages, MF sector is another goldmine and nurturing will bring about all round sustained growth. As regards my averments that CSR is not for charities, has been dealt with by eminent Dr.Bandhop[adhyay, Secretary, Min. of Corporate Affairs, GOI, in his speech with rich contents made in the London School of Economics in March 2010, copy of which is available in the webs. Reluctance of commercial banking globally has to be squarely addressed.
    3. MF sector with many innovations in conception and delivery of specially packaged retail and micro financial products and services including related technologies, is certainly poised on the verge of a global revolution, which also would address to some extent the repeated invasion of economic and financial sector crisis and unwanted macro cyclical weaknesses.

    With love and very best personal regards
    Prof.S.Subramanian
    Chairman, ACMFI
    (www.acmfi.org)

  2. When we started out in development a couple of decades ago, we instinctively targeted to reduce the influence of money lenders, if not eliminate them completely. Why? They were the traditional oppressors and exploiters in society. Micro-savings and revolving loans worked very well until the most fancied MFIs burst into the scene. MFIs operate under these two beliefs: “Having access to expensive credit is better than no credit” and “the observed rate is where demand equals supply”. These two beliefs were ironically the very same fulcrum the traditional money-lenders operate with.

    The result is an “Animal Farm” situation where we are now not able to distinguish between “pigs” and “humans” and vice versa. In fact, money-lenders have got a make-over by packaging themselves as MFIs. A good example is Mohd Yunis of Grameen Bank comes from a traditional money-lending caste. And of course, he got the Nobel Prize and so did Al Gore & Pachauri. Thank God the Nobel Committee did not confer Gandhiji the same distinction, by clubbing him with these scamsters.

    The IPO of SKS, one of the largest MFIs in India, saw it over-subscribed by 15 times; their Ten-Rupee share was priced at a premium of Rs 985 – showing how much the market had confidence on their profitability while “banking with the poor”. MFIs argue that they have to charge high rates to maintain profitability. Profitability, which even private banks couldn’t match! Profitability that permits SKS to pay Rs 1 crore as bonus to their just fired CEO!

    And how do they attain profitability?

    A month ago, SKS in the state of Andhra Pradesh was accused of a series of farmer suicides that prompted the state government to introduce new restrictions on the microfinance industry by seeking to cap lending rates and end coercive means of recovery. Last week alone, Andhra Pradesh police arrested three loan agents of SKS Microfinance and Spandana Sphoorty Financial Ltd. after borrowers complain that they were illegally pressured by the agents to repay their small loans around $1,300. For those of us in the field, this conduct of MFIs is no surprise.

    MFI research puts irinterest rates between 25-30%. But my experience (and this is my 30 years in the field) put this figure several times higher. Even if we take this range which they described as the lowest in the world, the only benefit of such loans is for working capital and not capital formation. What is the kind of subsidies Rata Tata gets to produce a one lakh car? We all are aware that a mere 0.5% rise in banking rates can crash the stock market, so sensitive is their profitability linked to interest rates. Compare this with those the poor is asked to bear.

    AP’s share of outstanding microfinance loans represents nearly 40% of the sector’s total portfolio, according to CRISIL. Now if MFI is all about access to the poor, we can ask the question, why the clamour to be concentrated in a state which belong to top-five in development in the country? We would have thought they would have gone to the five lying at the bottom rung of the country. But no, they avoid it like plague. It is easy to see they do this on repayment potential of states. The interests MFIs pursue are interests of self sustenance and their own growth. The poor is hardly in the radar except for rhetoric. In fact, it is on the blood and coercion of the poor, MFIs like SKS can giveaway Rs 1 crore as bonus to the CEO.

    The sooner MFIs are seen as profit enterprises, the better. The longer they pretend they are pro-poor, the longer they discredit the NGO sector that gave birth to a Frankenstein. Rather than regulate MFIs, I for one will welcome the day of their demise.

    • Rajan and Prof Subramanian, thank you for sharing your insights on the topic. It provides food for thought, while considering the age old battle between pur capitialisitism and moderate socialism.

      The second aspect is whether earning profits at the expense of livlihood and life of poor farmers can be considered ethical. It may be legal to charge such internests, but is it the ethical way to make profits.

      Interesting points for the debate.

      Kind regards,

      Sonia

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