Microfinance Focus , October 2010 : Less than a year ago, Microfinance Focus Senior Analyst, Daniel Rozas, published an article “Is there a microfinance bubble in South India?” which raised a warning flag about a developing bubble in Andhra Pradesh and highlighted the issue of potential over-lending to borrowers. Rozas wrote:

“The spark that sets off a large-scale delinquency crisis can be anything and could come at any time – a rapid drop in economic growth, a populist political movement, a religious decree, or a collections effort gone bad.  One can’t control the spark, but one can control how much fuel that spark can ignite.”

That spark has now been ignited.  Whether the flames can be put out quickly enough to prevent disaster is by no means assured.  We hope they will be.  But it is also deeply disappointing to see the sector having come to this point.   After all, there was no lack of recent examples to learn from:  the US financial market, Bosnia, Nicaragua, Morocco, Pakistan, Kolar, and even Andhra Pradesh back in 2007.  So why are we here?

MFIs were simply too busy to implement real changes. SKS (largest MFI in India) was too busy with its IPO.  Other large NBFCs were too busy trying to catch up to SKS.  Regulators were too busy worrying about profits and interest rates.  Meanwhile, growth has continued unabated, especially in Andhra Pradesh.  As Daniel mentioned, the quest for rapid growth could lead a MFI or industry to be so preoccupied that they do not realize the bubble they have been building up during this growth phase.

We hope that – finally – MFIs will grow up and realize that the status quo is no longer tenable and we hope they will seriously sit down with regulators and find solutions that will finally put an end to fly-by-night operations, unconscionable collections practices, and dangerously weak lending standards.  For if they fail to heed even this signpost, MFIs will deserve the fate that will undoubtedly await them next time around.

Microfinance Focus, September 16, 2010 (by Souren Ghosal) : There is no doubt that the most popular mandate in developing countries is to outreach poor by creating employment opportunities and providing financial support to the poor through state interventions.  Obviously such intermediation often fail to reach the poor as these intermediaries floated by the state are loaded with bureaucrats and politicians who are more prone to exploit the poor and ignorant rather than to outreach the bottom of the pyramid and or to hold their hands in running their farms or firms and to provide succor to overcome calamities they often encounter. Indeed it is widely held view that rural micro- entrepreneurs are not capable to organize themselves to conceive, run and bear risk of any sustainable economic enterprises and therefore they need support and hand holding by the state government and or economic institutions promoted and run by the state and people (PPP). No wonder that state policies and programs for alleviation of poverty are all routed through state political and economic institutions.

 

FAILED INTER-MEDIATION

It is an irony that in practice it has been observed that such intermediation has failed to outreach bottom of the pyramid as because these institutions are found in practice keener to fill their pockets rather than provide succor and support to the poor.  Saibal and Parhasib and Benjamin and Piperek in their research studies (1990 & 1997) have brought out very vividly that the traditional approach of funding the bottom of the pyramid only through state intervention as has been generally practiced due to perhaps the influence of Keynes’s theory of state intervention to prop up the economy need not only revisiting but also rewriting. In fact doles and subsidies provided by the state not only fail to reach through such intermediation by the state but on the other hand weakens the self confidence and initiative of the poor and make them more and more dependent on the state as if state is next to god to ameliorate their misery and poverty. This obviously over the years have made them laggards and fatalistic.

 

ENCOURAGE DISINTERMEDIATION TO REACH THE POOR

It is therefore imperative to conceive tools and technologies to outreach poor with least intermediation and creating direct accessibility to finance and other support services.  In fact the revolution in information technology has created an opportunity to reach directly to the customers irrespective of time and place. It has become possible outreach people residing in far flung rural areas and has access to finance and services at any time i.e. 24 hours.  This has created new paradigm for financial institutions particularly banks as has been portrayed below.

 

EMERGING OPPORTUNITIES

It is obvious therefore that the new paradigm has provided greater opportunity to banks and financial institutions to outreach rural and far flung areas to cater financial services and products to people of those areas. In fact in the last decade banks and other financial institutions have developed the delivery technology dynamically in terms of client outreach and enlarging the space. These institutions particularly banks  have acquired technology support like ATM , biometric security and internet banking along with core banking and electronic money transfer hardware and software. This has obviously led them to consider the possibility and feasibility to introduce mobile banking. In fact some banks have already availed this facility in a limited way to facilitate money transfer and payment system. However the most asked for facility that mobile banking is expected to provide is reach out villagers to enable them to avail financial facilities with ease and least cost. In fact RBI is also keen to introduce mobile banking facilities by banks. In this regard it has already circulated guidelines and has set up a working group under the CHAIRPERSON of a deputy Governor Mrs. Thorat to find out suitable strategy to help banks to introduce this facility.

 

EMERGENCE OF MFIs

It is true that in recent years a paradigm shift has occurred due to emergence of microfinance institutions. However it is facing some challenges of which following may be particularly mentioned as these have blurred the impact and raised eyebrows of social reformers as to the efficacy and transparency of these institutions in their efforts to alleviate poverty. These challenges could be summed up as follows:

 

• How can the micro-finance approach could be harmonized with other basic needs such as  political, cultural , economic sustainability along with the primary objective i.e. social ;
• How such an approach be made to balance the multiple demands and the relationship among the various operators nay actors of the system; and
• How such an institution be sustainable and risk free without asking for some heavy price for its operation.

 

Since microfinance is a community based approach and practice it has to be operated keeping in view community norms,traditions,values and practices and therefore its operation should not only be transparent but also cost effective. But these are obviously appearing to be insurmountable but that should not mean that one should raise hand and ignore these. In fact recent technologies have empowered these institutions including banks to overcome some of these challenges with ease and efficiency.

 

CHALLENGES TO BE ENCOUNTERED

However there are some difficulties in adopting such facilities; of these major one is the non availability of reliable data with regard to the financial health and transactions of rural people. The volume of data the mobile network operators (MNO) usually collect on the basis user’s transaction records are not adequate to assess risk and provide comprehensive banking services though transactions like bill payment could reflect through its regularity, frequency and volume some idea with regard to financial capability and avidity of users of such facilities. In fact that need to be collected should reveal not only the credit worthiness of the customer but also their capability and capacity to take risk and proneness to save and spend within their means.

 

In a recent study made by the POLITICAL AND ECONOMICS RESEARCH COUNCIL (PERC) of the Brookings Institution has brought out that value of non conventional data based on bill payment history etc if put to use could be of some value as follows:

 

1. it would enhance the reliability of measuring credit risk by only 10 per cent;
2. It would also help enhancement of measuring credit score by 22.4% only.

 

HELP BUILDING COMPREHENSIVE DATABASE

It is obvious therefore mobile banking transactions that are presently practiced could help to a very limited extent to measure and evaluate risks of all types banking transactions. The most important challenge therefore is to make it feasible to use data made available through MNO, M banking, and M payment system should be comprehensive and dependable information for credit and other financial risk assessment. To develop the same obviously the first step would be to asses the present gap that could not be filled by the data made available though MNO and Mobile payment facilities that are now available through mobile phones. That would also be necessary to examine the level of interest of all stakeholders to build comprehensive database for their use. This would obviously not just one time exercise as the interest of stakeholders would vary with the growth of volume and customers and also technology to enhance reachable and reduce cost.

 

NEED TO DEVELOP COLLABORATIVE MODEL

However as has been pointed out by K.C. CHAKRAVARTY Dy. Govern or of R.B.I.that indeed it is a great opportunity for banks to outreach the bottom of the pyramid but there is need to develop an effective collaboration between mobile service provider and banks. He also emphasized that it would be necessary to open accounts with the bank before bank could provide banking services and products to him. In fact he has rightly raised some limitations of banks to fast forward this scheme. These are as follows:

 

1. Banking technology is of recent origin and therefore there is need for scaling up the same and that would obviously take some time and investment;
2. Payment facilities are only one area where banks could be active and for that also there is need to develop appropriate delivery model; and
3. The recent initiative taken by RBI to permit banks to appoint correspondents need to be trained to the latest gadgets of mobile telephony and internet banking.

 

In fact he was frank enough to opine that banks are laggards and therefore to expedite the introduction of the system one has to look for alternative non-bank models.

 

OPEN UP OPPORTUNITIES TO MFIs

Even if one may not hold such a pessimistic view, it cannot be overlooked that there exist considerable gap in the technology and database that hinders the development of a suitable model for banks to reach the poor to provide comprehensive banking services to the rural poor. In fact mobile banking is a subset of electronic banking. It may be defined as a method to deliver financial services using mobile communication technologies such as GSM and CDMA including mobile devices such as cellular phones and personal digital assistance. In fact under M banking customer can carry out basic financial transactions like remittances and payments.

 

RECENT MODELS EVOLVED FOR COLLABORATION

1. Presently there are four types of M.banking model viz. wap, sms, and pda and sim toolkit.
2. WAP (wireless application model) is based on micro website and the model is similar to internet banking.
3. SMS banking is based on GSM standard service to exchange text messages that a customer could send to obtain information or to provide an information and or instruction to the banker.
4. PDA model is designed with a mobile phone to provide more access and to store data to enable customer to operate on individual software. It therefore helps processing loan applications also.
5. Similarly mobile phone with SIM toolkits also enhances the capacity of users and banks to deliver more services.

 

COLLABORATION OF INTERNET, MOBILE AND BANKS

 

However to make mobile banking a real tool for disintermediation which is perhaps the prime need in India to avoid corruption and high cost it would be necessary to avail the latest development in mobiles that provide storage and internet facilities. In this regard Google has advanced considerably and one would expect as the present trend indicates the prices of these handsets would come down and become affordable. Further it would also be helpful to strengthen the organizations like Financial information network (FINO) to build necessary financial portals to help banks to draw upon these as and when considered necessary.

 

In fact it would be imperative to develop biometric ATMs along with mobile phones in the initial stage as that would help educating the rural youths to become familiar with these technologies and would not hesitate to contact directly the banks for seeking their services and products. In this regard it is really encouraging news that banks have started exploring the ways to leverage the Unique Identification Number project. In fact it is interesting news that after meeting the officials of UIN 14 banks and telecom companies as well as officials of RBI had a meeting to identify a model to integrate these innovations for inclusive growth.

Microfinance Focus , Oct 19, 2010 (By N. Srinivasan) : The objectives of the ordinance are laudable.  Protection of low income clients from exploitative practices and enhancing levels of transparency are valid public policy objectives of a sovereign government.  High debt levels, multiple operators providing loans as also pressure on repayment rates are legitimate cause for concern.  The remedy being applied does not seem appropriate to achieve the objectives stated for introduction of the ordinance.

 

The drafting of the ordinance leaves a lot to be desired.  The definition of Microfinance institution as it stands in the ordinance includes banks, and even SERP and its federations as these entities are either ‘providing loans to low income clients or offering financial support to them’.  The definition of low income client is not available either in the ordinance or anywhere else.  This leaves wide scope for interpretation. The requirement of display of interest rates does not define ‘interest rate’.  Whether flat rates, monthly rates and other confusing rates can be displayed?

 

The stipulation that ‘interest should not exceed principal’ clearly exhibits the disconnect between the law and ground realities.  Most MFI loans are of one year tenor and the stipulation in the Ordinance is seen willing to allow up to 100% rate of interest!  With practically no loans beyond three years, this stipulation seems redundant for MFIs, but will hurt bank loans of longer duration.  In reality, the stipulation will tend to reduce the duration of loans in all institutions in order to escape revenue loss and incursions in to autonomy of pricing.

 

While the law prohibits a third loan being given regardless of the source of the two existing loans, the verifiability of information on existing loans of borrowers has not been taken in to account.  Given the fact that in AP the numbers of microfinance loans are more than nine multiples of poor households, neither banks not MFIs have any scope of future operation in the state.  A survey made last year on access to finance in AP[1] brought out that 83% of surveyed families had two or more loans and that the median number of loans per family was four. Informal loans had been taken by 82% of surveyed families and how to verify these when institutions have to reckon ‘loans from all sources’

 

The requirement that repayments have to be made in panchayat offices only might hurt the banks as they have visit the panchayat office on due dates.  MFIs have a regular system of collection of loan dues in weekly, monthly intervals depending on the structure of instalments, whereas Banks which lend to SHGs get the repayments made in their branches.

 

The stipulation that effective rate of interest should be made known to the borrower is a valid requirement.  It should also define the term ‘effective rate of interest’ and how it is to be computed.

 

The requirements of the law are that a list of borrowers with details of each loan should be provided to the registering authority at the end of each month.  With more than 23.5 million microfinance clients in the state, information handling is set to become a nightmare.  The capacity of administrative machinery to handle registrations, monthly returns, complaints, no-objection certificates and penal proceedings may need to be increased manifold.  At present the named registering authority (DRDA) is finding it difficult to handle its existing work of district rural development.  Monitoring the programmes and ensuring achievement of intended plan outcomes has not been easy at the district level.  Loading the authorities with a huge volume of work of a very different nature is bound to cause  delays, frustration and generally chaotic conditions around these offices.

 

The stipulation of returning the loans taken from a second SHG within 3 months could be harsh and might cause distress especially where the funds are used to part-finance income generating activity.  If the loan was applied for medical treatment or lifecycle needs such as marriage, the return of money within 3 months would be even more difficult.  When loans of adequate size are hard to come by from any single source, forcing customers to refund the loans already availed might end up as disservice.

 

The threat of fines and imprisonment of directors and staff of MFI for coercive action (which includes repeated visits to the customer for recovery of dues – “frequenting the house or other place where such other person resides or works, or carries on business, or happens to be”) is a sweeping one.  Some directors onboard of banks including senior civil servants in Ministry of finance or RBI can be jailed, if a branch manager or field officer of their bank visits a borrower, say, four times a month.  Professional independent directors may not be willing to take board positions in financial institutions that have operations in AP.

 

The fast track courts are a good idea.  MFIs by and large do not have access to legal remedies against defaulters.  The fast track court mechanism, if implemented well, would provide millions of customers and the MFIs with a judicial option for settlement of disputes.

 

The infirmities in drafting create a void between intent and application of this ordinance.  Lack of definitions or precision in definitions, a disconnect from ground realities of business and inadequate appreciation of the volume of work involved in enforcement of the law would tend make the implementation vexatious for all concerned.

 

A deeper examination of the law suggests that it is intended to keep SHG lending secure from competition of MFIs.  The law creates an uneven playing field by making one of the competitors (the State’s Rural Development machinery that drives the IKP) as the controller and arbiter.  By loosely defining microfinance, it subjects IKP and its mechanisms (VOs, Mandal Samakhyas and SERP) also to the ordinance.  They also need to register, provide monthly information, ask for no-objection and verify whether borrowers already have two loans including from informal sources, etc.  The banks should also comply with requirements of the ordinance as long as they provide loans to ‘low income people’.

 

While the timelines for application for registration, second loan to SHG members, etc., are specified, no time lines have been specified for disposal of applications.  A deemed approval at the end of a certain period from the date of application would have been appropriate.  The application for no-objection for second loans and monthly lists of borrowers provide information to the competing institutions and could potentiality breach customer confidentiality, especially in the hands of banks.  The basis on which no-objection for second loans would be issued is the information provided by MFIs.  The district authority is vested with the responsibility of enquiring in to whether SHGs have understood the loan terms and whether the loan is likely to provide additional incomes before providing a no-objection.  The likelihood that registering authority will have more information than the financial institution to take a decision on the appropriateness of the loan is remote.  But the mischief potential is that the SHGs can be influenced during the process to withdraw the application from the MFI as the registering authority has responsibilities as a department of the government for the SHG linkage programme.

 

The propensity to borrow is very high in AP.  CMFs’ sample survey in AP brought out that 82% of families had loans from informal sources.  The median number of loans taken by households was four.  The chances are that three out four of these loans are from the informal sector.  The ordinance does not have the capacity or mechanisms to deal with loans from informal sources.  High rates of interest and coercive processes are issues associated more with informal lending.  Restriction of members from joining more than one self help group militates against basic freedoms granted to people.  The restrictions on providing loans to willing customers (whether second or third) erode the freedom given citizens to pursue legitimate business or commerce.

 

During a recent visit to AP, discussions with Banks and MFIs as also customers of microfinance revealed that recovery rates of loan dues had fallen to around 85% on bank loans to SHGs even while MFIs posted high recovery rates of above 98%.  SHGs covered under government’s programmes had a comparatively bad repayment record.  Without getting in to a debate on veracity of reported information and underlying mechanics of the recovery effort, the State’s programme is seen to have come off second best.  With an intensely monitored and controlled regime if a State run programme is unable to match recovery efficiency of private sector institutions, it a natural cause for concern.  But the solution to the problem does not lie in the ordinance.  It lies elsewhere.  A critical look at the programme design, capacity of staff, institutional development measures relating to VOs and federations and the exit strategies would provide better answers to the problems.

 

On the part of MFIs the current situation is substantially of their making.  Some did not heed good advice both from within and without.  Multiple lending and associated problems faced in Kolar were not seriously internalised.  High interest rates even in the face of declining operating costs and the resultant high return on assets have been criticised over the last two years.  The proposition that high growth rates and accelerated expansion of outreach require high profitability has been questioned.  The need for patience in recovering investments and the nature of equity (patient capital) that would best fit institutions in the sector have been time and again debated.  Regardless of the ability of customers to pay high interest rates, the underlying political economy issues of doing business with vulnerable customers have been consistently ignored by some MFIs.  Even with the code of conduct in place from two networks, deviant behaviour was in evidence.  While suicides might not be related to loans at all (and not MFI loans either), by the kind of market behaviour exhibited by some MFIs, the sector added grist to the cynics’ mill.

 

Regulation should have focussed on rates of return, governance reforms, transparency in dealing with customers, grievance redressal, ombudsman mechanisms and framework for restructuring of debts of customers under stress.  The state could have brought down the level of debt related stress by making available soft funds to MFIs for on-lending under conditions similar to those under which Banks in the state lend to SHGs.   Instead the State has chosen to adopt a combative stance towards MFIs (may be on account of its perception that MFIs are competitors).  This impacts more than 6 million existing clients of MFIs and Rs 4000 crores of loans a substantial part of which is provided by banks out of depositors’ savings.  The stance against coercive practices, on account of the publicity, is likely to erode the credit culture, placing at risk the already weak portfolio of banks loans to SHGs currently put at Rs 11000 crores given to about 12 lakh SHGs in the state.  Where does this leave the government and the sector?  Whether the ordinance will make things better or vitiate the operating environment of microfinance and reduce choices available to people?  Between the government and the MFIs (both claim being champions of the vulnerable customers) 25 million households have an uneasy time.

 

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[1] Access to Finance in AP, CMF- IFMR for CMR-BIRD funded by NABARD

Microfinance Focus, Oct 29, 2010: The Asian Development Bank (ADB) and the Australian Government will support a $24 million Microfinance Expansion Project to help rural communities in Papua New Guinea access credit and financial services.

 

ADB’s loan, from its concessional Asian Development Fund, covers 54% of the project cost of $24.06 million. The loan has a 32-year term, including a grace period of eight years. Interest is charged at 1% per annum during the grace period and 1.5% per year for the rest of the term. AusAID will provide a grant of $6 million to be administered by ADB. The Government of Papua New Guinea and project beneficiaries will cover the remaining cost of $3.09 million. The project is due for completion around the end of 2017.

 

The project will extend and build on the experiences and lessons learned from ADB’s Microfinance and Employment Project, also co-financed by the Australian Government through AusAID, an 8 year project that began in 2002 and established a solid base for microfinance in Papua New Guinea.

 

ADB estimates that only 15% of the population has access to formal or informal banking facilities, and many parts of the country still use a non-monetary barter system for transactions.

 

“This project will help rural areas move from a subsistence to a modern cash-based economy and in the process it will increase incomes and reduce poverty by stimulating informal business activity,” said Robert Wihtol, Director General of ADB’s Pacific Department.

Microfinance Focus, Oct 29, 2010: Brinda Karat, Member of Parliament and Communist Party of India (Marxist) Polit Bureau member called on Andhra Pradesh Chief Minister K. Rosaiah, urged him to fix a cap on the interest rates charged by the MFIs. “The ordinance promulgated by the State government will not serve any purpose unless such a provision is made.”

 

Criticizing the Union government and the Reserve Bank for not coming to the rescue of vulnerable women who were victims of harassment by micro finance institutions (MFIs), she said that the government had not made any amendments to the MFIs Regulation Bill as suggested by the Parliamentary Standing Committee. The panel had recommended, among other things, a cap on the interest rates. The rates could not be beyond the subsidised rates at which loans were being provided to self-help groups and MFIs should not become vehicles of profits. “The macro loot in the name of micro finance should not be allowed,” Ms. Karat said.

 

The CPI (M) and other parties would insist that the government take steps to check the activities of MFIs in the winter session of Parliament. She lamented that banks were not bothered about their lending to the MFIs as long as they made profits. Moreover, the banks’ claim of continuing lending was not their voice, “but the language spoken at the highest echelons.”

 

Earlier, the Telugu Desam Party president, Mr N. Chandrababu Naidu, has also criticised the Reserve Bank of India for adopting double standards against microfinance institutions. He has reportedly charged the RBI of failing to put a proper policy on interest rates in place, resulting in the MFIs remaining unchecked.

 

Mr Naidu pointed out that the government has lost control on the affairs of MFIs and washed its hands off the affair by just promulgating an Ordinance. Without fixing interest rates and regulatory measures, the Ordinance would not serve any purpose, he said.

Microfinance Focus, Oct 29, 2010: The Sub-Committee of the Reserve Bank’s Central Board of Directors which is chaired by Y H Malegam will examine the prevalent practices of MFIs in regard to interest rates, lending and recovery practices to identify trends that impinge on borrowers’ interests.

 

The Sub-Committee was set up after the Board’s October meeting to study issues and concerns in the micro finance sector. It will review the definition of ‘microfinance’ and ‘Micro Finance Institutions (MFIs)’ for the purpose of regulation of non-banking finance companies (NBFCs) undertaking microfinance by the Reserve Bank of India and make appropriate recommendations.

 

Further, it will delineate the objectives and scope of regulation of NBFCs undertaking microfinance by the Reserve Bank and the regulatory framework needed to achieve those objectives.

 

Applicability of money lending legislation of the States and other relevant laws to NBFCs/MFIs will also be examined and appropriate recommendations would be made. The role of associations and bodies of MFIs for enhancing transparency disclosure and best practices will be taken up.

 

The Sub-Committee will recommend grievance redressal machinery that could be put in place for ensuring adherence to the regulations recommended at 3 above.

 

Conditions under which loans to MFIs can be classified as priority sector lending will be looked at and appropriate recommendations will be made. MFIs currently enjoy priority sector lending status under which they get concessional funds from banks.

 

The Sub Committee was set up by RBI in order to study recent allegations about high interest rates, coercive recovery processes and multiple lending practised by some microfinance institutions. It was formed after the Andhra Pradesh government issued an ordinance to regulate microfinance institutions in the state.

 

The Reserve Bank of India regulates only those microfinance institutions which are registered with it as non-banking finance companies. Although the registered companies cover over 80 per cent of the microfinance business, in terms of number of companies they constitute a small percentage of the total number of MFIs in the country. The Reserve Bank, however, does not prescribe lending rates for these institutions.

 

Other members of the Sub-Committee include, Smt. Shashi Rajagopalan, Shri U R Rao, Shri Kumar Mangalam Birla and Dr. K C Chakrabarty, Deputy Governor. Shri V K Sharma, Executive Director, Reserve Bank of India will be the Member Secretary to the Sub-Committee. The Sub-Committee will submit its report in three months.