Monthly Archives: February 2011

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An Open Letter: Malegam Committee Recommendations have a fatal flaw

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By Dr. Ramesh Bellamkonda, Managing Director- BSS Microfinance,

Microfinance Focus, January 25, 2011:

One Fatal Flaw In Malegam Committee Recommendations:

1.    Summary Recommendation 10, (11.12 (c)), that says “Field staff should not be allowed to make recovery at the place of residence or work of the borrower and all recoveries should only be made at the Group level at a central place to be designated” is a recommendation that is  absolutely fatal to microfinance.  If adopted, this will be a “Death Sentence”, nothing short. If this recommendation is adopted by the regulator, all that a borrower has to do to not repay, is to stop coming to the central designated place of collection of repayment.  If the MFI staff go to borrowers’ homes or work places in such a circumstance, the MFI staff would have violated the applicable regulations and the borrowers or others around them can call the police and have such MFI staff arrested.  In a relatively short time, people will figure out how to not repay MFI loans.  Some borrowers or their families or their neighbours or third parties will surely want to exercise this option.  Once exercised by some people here and there, this would have an extremely contagious effect on just about every one else and every where else.  Soon, all collections will collapse.  What is in Andhra State now, will be all over India. 

Loan repayment takes conscious effort and discipline on the part of the borrower.  It often feels a little painful to most people.  It does not happen automatically.  If the above recommendation is adopted, the loans are guaranteed to go bad, in a relatively short time.  If I were a banker, I would not have the courage to lend to any MFI which would be bound by such a regulation!  The bank’s loan will be guaranteed to become NPA if this regulation is in place!

A Major Theme That Flows Through Malegam Committee Recommendations:

Background To the Theme: There has been a major hue and cry in the recent months and years about all the “horrible things” that MFIs have supposedly done.  The fact that some large MFIs have struck it super rich for their promoters and their private investors, has earned a lot of ill will for the microfinance sector amongst bureaucrats and politicians and other influential people in the country.  As an aftermath of this, the Andhra Pradesh state problem in microfinance has been precipitated.   It is in this background that the Malegam Committee had to come out with its recommendations.

The Theme: The theme that flows through the recommendations is an apparent feeling of taking for granted, the near 100% repayment rates that MFIs have managed for several years.  There is also a feeling of taking for granted, ready availability of microfinance facilities to the poor people.  The recommendations as a result, appear to be severely restrictive to the functioning of MFIs.  To say that MFIs are being put in a straight jacket, would not be an exaggeration.  In addition to the one fatal recommendation above, the recommendations raise a lot of very difficult operational questions, which are listed below.  While the intentions of this committee are undoubtedly good, they seem to have completely dropped the ball in terms of understanding or providing for intricacies, complications, and challenges, of all the day to day operations.

A Sincere Appeal: Let us not forget the abysmal repayment rates of IRDP of past years, low repayment rates of most government credit programs even today, all over the country.  Even in Andhra Pradesh, a recent news report said, that the Government run micro credit program had repayment rates of 70% as of October 2010 and are falling.  My sincere appeal is that near 100% repayment rates should not be taken for granted.  Neither should credit availability for poor people, be taken for granted, regardless of any and all the government credit programs put together.  Let our memories not be very short and let them not be selective either.  Non-Government provision of credit is very important in the long run.  It would be good to remove the fatal flaw in the recommendations and to substantially loosen the straight jacket that is evident throughout the recommendations.  This would be in the interest of the poor people of India who genuinely need credit in the long term.

Some Difficult Questions That The Malegam Committee Recommendations Raise:

1.    With regard to recommendation 7, (9.7 (b)), does it mean a borrower can be a member of one SHG and one JLG or does it mean a borrower can be a member of either one SHG only or one JLG only?  I am guessing it is the second way and not the first way.

With regard to the same recommendation, What if a borrower misleads an MFI?  What would be the practical real time mechanism by which it can be determined which SHG / JLG that a particular person, is a member of?  This could be a very daunting operational task.    Will there be a central registry or a reference data base to show which person is a member of which SHG or JLG?  In the absence of such an infrastructure, there will be problems and MFIs can be unfairly blamed.

2.    In Summary of Recommendations, serial number 11, 12, and 13 are missing, where as serial number 6 & 7 are repeated.  There might be a problem in the PDF format that has been made available for downloading at the RBI website.

3.    With regard to recommendation 7 (9.7 (a)), does a poor person (whether an active borrower or not) have the freedom to leave one JLG and join another JLG, or leave one JLG and join a SHG instead?  Similarly, if a person (whether an active borrower or not) is a member of a SHG, does such a person have the freedom to leave one SHG and join another SHG, or leave one SHG and join a JLG instead?  If the borrower does have an option to leave an existing SHG or JLG, what happens to the loans outstanding in the hands of other SHG or JLG members, which would have been guaranteed by this borrower?  If a borrower is not allowed to leave a SHG or JLG, would that not be a violation of her basic human right to make her own choices from time to time?

4.    With regard to recommendation 6 (8.7 (g)), Should it be a standard form of loan agreement across all MFIs or standard form for each MFI?  If it is to be a standard form across all MFIs, who will create this standard form of loan agreement?  Further, what if the MFI is working in different areas, and one or more areas have special circumstances which necessitate a change in the loan agreement for the respective areas?  How about any changes that may be necessitated from time to time even within the same MFI?

5.    With regard to recommendation 6, (8.7 (e)), I am assuming that insurance coverage will be provided by an insurance company, and therefore computing the insurance premium will be done by the insurance company, is that right?  Or, if it is envisaged to be something different, what exactly is envisaged?  Further, who should make these regulations?  RBI or NABARD or IRDA or somebody else?

Further, insurance companies want premium payments to be made in advance.  Is it that the insurance company will make these calculations and communicate to the MFI, the MFI will then communicate this to the borrower and collect premiums in instalments and then deliver such instalments to the insurance company, and till then the borrower will not have insurance coverage?  Further, if a borrower fails to make a timely payment of an insurance instalment, would her insurance coverage lapse?  Also, insurance companies typically want to issue policies with coverage for one year only, not more & not less.  At the end of the policy period, it reserves every right to not continue coverage.  Unless there is a good mechanism to prevent lapse in coverage during this transition, there can be substantial gaps in coverage when one insurance company is withdrawing from providing coverage and another insurance company is considering to provide coverage.  How exactly is this whole thing supposed to operate?

6.    With regard to recommendation 6, (8.7 (d)), How is effective interest rate defined and how is it expressed and how is it calculated?  They should all be standardized by the regulator and there should be one national standard, in order to make such rates comparable.  I have observed quite often in the past that the stated rates are expressed differently and they are calculated differently as well, due to the fact that there is not one national standard published by the regulator.  Further, should the effect of ALR (Advance Loan Repayment) be included in this?

Further, there are two caps for the allowable maximum effective rate, namely 24% or average yearly financial cost plus 10%, which ever is lower.  Each lender to MFIs has different rates and terms and conditions, and even the same lender has different terms and conditions and rates for different loans to the same MFI.    The average yearly financial cost of all borrowings from different banks for each MFI, will therefore be known only after the year is over.  Given this reality, how is the MFI to know what interest rate to charge at the time of making a loan to an individual borrower?  Further how is the MFI to print such a chargeable interest rate before even the MFI can itself figure out what the allowable charge is?  Further, if a loan from an MFI to a borrower extends across two or three different financial years, and the cap for each financial year on what the MFI can charge is different (based on what the MFI’s average yearly financial cost is for each year in question), how is the MFI to charge the end client for that loan?  Will it be different during each financial year for the same continuing loan (from the MFI to the end client)?  How is this supposed to work?

7.    With regard to recommendation 6, (8.7 (b)), Is insurance administrative cost not part of actual insurance cost?  Or, is it that the administrative cost is to be fully in the form of subsidy by the MFI to the end borrower?

8.    With regard to recommendation 6, (8.7 (a)), presently one or more large MFI/s routinely allow ALR (Advance Loan Repayment) which effectively acts as a temporary interest free deposit from the borrower with the MFI, which the borrower can apply towards loan repayment instalments at a future time.  This also effectively decreases the net loan amount advanced by the MFI to the end client, net of ALR, even though interest is collected on the full gross loan amount outstanding, before adjusting it for ALR.  Such ALR amount typically has been very substantial in relation to the loan portfolio outstanding of the MFI/s in question.  In such a scenario, should the net amount of interest chargeable by the MFI on the borrower be correspondingly decreased? Or is that not necessary?  Presently, the recommendations are silent on this aspect, but this aspect does need to be addressed by the regulator.

9.    With regard to recommendation 10, (11.12 (a)), What is the definition of “coercive methods “?  This must be clearly defined, keeping in mind, all practical aspects.  Without such a definition, the MFIs can  be falsely accused of using coercive methods and on the contrary, the MFI may be fearful of using even perfectly reasonable methods to avoid getting into difficulty, and all this can damage the MFI.

10.    With regard to recommendation 10, (11.12 (c)), What happens if a group does not come to a central designated place and/or does not make payments due as scheduled?  What is the MFI supposed to do?

11.    With regard to recommendation 9, (10.5 (b)), If the MFI is misled by the borrower and thus grant a loan which should not have been granted had the MFI known the truth, then would the MFI have to suffer for granting a loan in what would be a violation of the new regulations?

12.    With regard to recommendation 7, (9.7 (e)), If an MFI mistakenly makes a loan to a borrower who is beyond the limit of total indebtedness, while such an MFI will be prevented from recovering its loans until the earlier loan/s of the borrower are repaid in full to the earlier lender/s, Is it ok to recover interest only in the meantime?  Or, is interest recovery also barred?  Further, is this MFI required to show such loans as overdue in its books and make suitable provisions, or is it allowed to reschedule the loan and show it as not being due till the earlier loans of the borrower are repaid to those earlier lenders?

13.    With regard to recommendation 5, (7.11), What happens to an MFI whose administrative costs and loan loss provisions and loan losses together exceed  10% of the average loan portfolio in any financial year?  Such an MFI would have to incur losses and therefore banks can stop further lending and may possibly recall loans already made.  Overall, any MFI whose all costs other than financial costs exceed 10% of the average loan portfolio outstanding (net of any loan loss provisions) in any financial year, would be in danger of collapse.  Is that what is intended to happen?

14.    With regard to recommendation 3, (5.9 (b) (i)) (income limit of Rs.50,000/- for a microfinance borrower household), How is household defined?  Does it include members of a joint family or a semi-joint family (as when one or more close relative/s live in the same house and happen to be earning members)?  Further, should this figure be indexed to inflation?

Further, how will we ensure the accuracy of this income figure?  Most of the figures we can realistically obtain are very approximate at best.  What happens if a loan is made to a household and then somebody disputes that its income annually is in fact more than Rs.50,000?  For a salaried person, the salary can be exactly known, but not for most poor households where unless the household keeps accurate accounts, there will be no way to know, and most poor persons will find it nearly impossible to keep accurate accounts of their net income.

15.    With regard to recommendation 3, (5.9 (b)(vi)), Would the MFI have any say in whether the repayment will be weekly, fortnightly or monthly, or is it entirely left to the borrower’s choice?  If it is entirely a matter of borrower’s choice, can the borrower change her mind on the frequency of repayments from time to time?

16.    With regard to recommendation 12.6, When a bank lends to an MFI, the MFI would be the bank’s client.  Is the bank required to observe the same code of conduct in dealing with the MFI as the MFI is required to do with the end client?  Does the MFI get any benefit of the client protection code when banks interact with the MFI?

17.    With regard to item 12.3(b) (about avoidance of over-indebtedness), While this is acceptable as a principle of intent, how is this to be operationalized?  It is essentially subjective and very open to being disputed, particularly if and when the borrower defaults or complains at a later date, of being over indebted or of being unable to make instalment payments.  I am concerned about MFIs being unfairly blamed.

18.    With regard to item 12.3(i), What does this mean to protect privacy?  Does it mean when a third party asks for loan details of a borrower, the same will not be given?  Does it mean that enquiries about the living and working of a person cannot be made from neighbours and those around the borrower?  Does it mean information cannot be given to a credit bureau or to another MFI or to another lender?  Does it mean we do not share information about a difficult borrower with another MFI?  Does it mean we cannot talk about a borrower with other JLG members of that borrower?  There should be clarity about this requirement so that MFIs will not be unfairly blamed.

19.    With regard to item 10.5(b) (about existing borrowings of the potential borrowers), What happens if the information given by the borrowers is misleading and/or the information reported by MFI staff is faulty or erroneous?  Will the MFI be penalized for that?

20.    With regard to item 5.9(b)(ii), After taking Rs.25,000/- loan from one or two MFIs, what if the borrower borrows from other (non-MFI) lenders and traders who give credit etc?  What can the NBFC-MFI do?  People routinely get into debts far in excess of this amount for reasons of ill health in the family, marriage, etc.  Also, would this not actually severely stunt the small business of a poor entrepreneur from growing?  A single milch cow could cost Rs.25,000/- or more.  What happens if a borrower with a loan of Rs.25,000/- sustains a loss of Rs.25,000/- either in his/her business or due to death of a milch cow or ill health in the family etc?  Say, his indebtedness meets or exceeds the Rs.25,000/- limit, which he is unable to repay due to this loss.  Will such a person be condemned to a life without credit for the rest of his life?

Also, what happens if there are two different borrowers from the same household?  Will the Rs.25,000/- limit be per borrower or per household?  This should be addressed.

Also, should this figure of Rs.25,000/- indexed to inflation?

21.    With regard to item 5.1, Does this mean that a NBFC can either have >90% of its loan portfolio in microfinance or it cannot have more than 10%?  Why should it not be allowed to have 20% or 50% or any other percentage between 10% and 90%?  Whether it will be called a NBFC- MFI or not is a separate issue, but this sounds like it is not even allowed to have anything between 10% and 90% of its portfolio in microfinance loans.  what would be the benefit of such a restriction?

Does it also mean that all NBFCs will be asked to declare that they do not have >10% of its assets in microfinance loans?  Will this be one of the items they will be audited on?  What happens if the NBFC has not measured the household incomes and therefore does not know if a loan it has made has to be called a microfinance loan or not?

Some Other Question/s That The Recommendations Raise:

1.    With regard to item 17.5, by definition, is it not true that net owned funds is the same as Tier I Capital?  Is there ever a possibility of Tier I capital not being net owned funds or a possibility of net owned funds not being Tier I capital?  If Tier I capital and net owned funds are one and the same, then what is the significance of the second portion of recommendation no. 17 (17.5)?

2.    If an MFI or a NBFC does not wish to take advantage of priority sector lending status for small value loans to poor people, would all of the above regulations still apply? (I am assuming ‘Yes’, but it will be good for the regulator to clarify).

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Disclaimer :

THIS IS AN OPEN LETTER TO ALL CONCERNED WITH THIS MATTER

Written By Dr. Ramesh Bellamkonda, Managing Director
BSS Microfinance Private Limited, Bangalore.
Tel: +91-80-6573-2387, 3271-1266, 4175-0976, Fax: +91-80-2347-1884
swamukti@swamukti.com, bss@bssmicrofinance.co.in

(The Opinions Expressed Here Are Solely Those Of The Author)

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Indian Budget 2011-2012 and Microfinance

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Microfinance Focus February 28, 2011: Finance Minister, Pranab Mukherjee on Monday presented to the Parliament India’s Union budget for the year 2011-2012. Mukherjee made important statements relating to Microfinance and Financial Inclusion.

Union Budget of India

Here are some relevant points from the Union Budget 2011-2012 relating to Microfinance and Financial Inclusion.

Micro Finance Institutions
The finance minister stated that Micro Finance Institutions (MFIs) had emerged as an important means to financial inclusion.   Creation of a dedicated fund for providing equity to smaller MFIs would help them maintain growth and achieve scale and efficiency in operations.

He proposed to create in the course of the year, ‘India Microfinance Equity Fund’ of Rs 100 crore with SIDBI.

He also said that to empower women and promote their Self Help Groups (SHGs), he intended to create a ‘Women’s SHG’s Development Fund’ with a corpus of Rs 500 crore.
The Committee set up by RBI to look into issues relating to micro finance sector in India had submitted its report. The Government was considering putting in place appropriate framework to protect the interests of small borrowers.

Financial Inclusion
The minister in his last budget speech had advised banks to provide banking facilities to habitations with a population of over 2000 by March, 2012.  The Banks identified about 73,000 such habitations for providing banking facilities using appropriate technologies.
A multi-media campaign, “Swabhimaan”, had been launched to inform, educate and motivate people to open bank accounts. During the year 2011, banks will cover 20,000 villages. Remaining will be covered during 2011-12 stated the minister.

Unorganized sector
Mukherjee had announced a co-contributory pension scheme ‘Swavalamban’ in the Budget of 2010-11. The scheme had been welcomed by the workers in unorganized sector. Over 4 lakh applications had already been received and on the basis of the feedback received, he relaxed the exit norms whereby a subscriber under Swavalamban would be allowed exit at the age of 50 years instead of 60 years, or a minimum tenure of 20 years, whichever was later. He also made a proposal to extend the benefit of Government contribution from three to five years for all subscribers of Swavalamban who enroll during 2010-11 and 2011-12. An estimated 20 lakh beneficiaries will join the scheme by March 2012 said the minister.
Under the on-going Indira Gandhi National Old Age Pension Scheme for BPL beneficiaries, the eligibility for pension was proposed to be reduced from 65 years at present to 60 years. Further, for those who are 80 years and above, the pension amount would be raised from Rs 200 at present to Rs 500 per month.

Financial Sector legislative Initiatives
The Finance Minister said that in his last Budget speech, he had announced that Reserve Bank of India would consider giving some additional banking licenses to private sector players.  Accordingly, RBI had issued a discussion paper in August, 2010, inviting feedback from the public. RBI proposed some amendments in the Banking Regulation Act. He intended to bring suitable legislative amendments in this regard in the session. RBI was planning to issue the guidelines for banking licenses before the close of the financial year of 2011.

Micro, Small and Medium Enterprises

Micro and Small enterprises play a crucial role in furthering the objective of equitable and inclusive growth said the minister. He explained that last year, Rs 4,000 crore was provided to SIDBI for refinancing incremental lending by banks to these enterprises and for the year 2011-12, he proposed to provide Rs 5,000 crore to SIDBI for the same purpose out of the shortfall of banks on priority sector lending targets.

Handloom weavers have been facing economic stress he said. Consequently, many of them have not been able to repay debts to handloom weaver cooperative societies which have become financially unviable. He intended to make provision of Rs 3,000 crore to NABARD, in phases for the cooperative societies. The initiative would benefit 15,000 cooperative societies and about 3 lakh handloom weavers. The details of the scheme would be worked out by the Ministry of Textiles in consultation with Planning Commission

Housing Sector Finance

Speaking about housing and finance sector, the minister stated provision of housing finance to targeted groups in rural areas at competitive rates and enhancing the provision under Rural Housing Fund to Rs 3,000 crore from the existing Rs 2,000 crore was required.
Credit enablement of Economically Weaker Sections (EWS) and LIG households was a serious challenge he said. To address this issue, the minister made a proposal to create a Mortgage Risk Guarantee Fund under Rajiv Awas Yojana. The scheme would guarantee housing loans taken by EWS and LIG households and enhance their credit worthiness.

Agriculture Credit
The Minister explained that to get the best from their land, farmers needed access to affordable credit. Banks had been consistently meeting the targets set for agriculture credit flow in the past few years.  For the year 2011-12, he spoke of raising the target of credit flow to the farmers from Rs 3,75,000 crore this year to Rs 4,75,000 crore in 2011-12.  Banks had been asked to step up direct lending for agriculture and credit to small and marginal farmers.

In view of the enhanced target for flow of agriculture credit, the minister proposed to strengthen NABARD’s capital base by infusing Rs 3000 crore, in a phased manner, as Government equity.  This would raise its paid-up capital to Rs 5,000 crore. To enable NABARD refinance the short-term crop loans of the cooperative credit institutions and RRBs at concessional rates, he intended contribution of Rs 10,000 crore to NABARD’s Short-term Rural Credit Fund for 2011-12 from the shortfall in priority sector lending by Scheduled Commercial Banks.

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Microfinance Media Buzz: February 28, 2011

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Microfinance Media buzz brings a compilation of industry headlines broadcasted by other news media from across the world.

1. BS: Charge high rates, but be transparent, MFIs told

Microfinance institutions have finally got some support, with the Survey defending the high interest rates charged by them. While pointing out that interest rate caps are necessary, the Survey says there are enough reasons for MFIs charging 24-30 per cent to poor borrowers, but emphasised the need to disclose the interest rates in a transparent manner. (Read More) News Published by Business Standard

2. BS: Policy first defence against inflation: RBI

Price rise largely driven by supply-side factors and monetary policy has limited impact. Reserve Bank of India (RBI) Governor D Subbarao today reiterated that monetary policy remained the first line of defence against rising inflation even as much of the pressure had been from the supply side. (Read More) News published by Business Standard

3. SD: British citizen helps MFI victims

A British citizen, Mr. Steve, residing in a North American country donated US $ 1,000 to families of persons who committed suicide unable to repay the loans they had taken from micro finance institutions (MFIs). (Read More) News Published by The Siasat Daily

4. mydigitalfc: Credit risk threat for global MFIs

Credit risk constitutes a major threat for the global microfinance industry, which reflects the fast growing problem of over indebtedness among millions of microfinance customers, according to Microfinance Banana Skins 2011 survey. (Read More) News Published by mydigitalfc.com

5. The Citizen: A new bank opens doors in Dar as access to services still limited

Dar es Salaam. Advans Bank, a microfinance financial institution, has launched its activities after being granted the permission to operate by the Bank of Tanzania.Advans Bank Tanzania’s first branch is located in Manzese, one of the busiest areas of Dar es Salaam. The bank has a staff of 18 people. Bank management say by the end of 2011 they expect to have hired 69 employees and opened a second branch in the city. (Read More) News Published by The Citizen

6. BS: Firms wary of basic banking licence model

The finance ministry’s plan to offer basic banking licences may find few takers because of doubts over the commercial viability of the proposed business model. The Economic Survey released on Friday had proposed two types of licences to set up banks in India: One for basic banking activities and another for full-fledged banking. It said non-banking financial companies (NBFCs) and microfinance institutions should be considered for basic banking licences. (Read More) News Published by Business Standard

7. livemint.com: 2012: year of high interest rates

The Economic Survey 2010-11 released on Friday made it clear that in the short-term India will have to live with high growth, high inflation and high interest rates. This means the Reserve Bank of India (RBI) has very little choice, but to continue with its tight monetary policy in fiscal 2012 that begins in April. (Read More) News Published by livemint.com

8. Nigerian Tribune: CBN raises concern over non-performing loans in micro finance banks

The Central Bank of Nigeria (CBN) has expressed concern over the non-performing loans in micro finance banks (MFBs) as it  directed the operators  to embrace information technology infrastructure and shared services platforms in the conduct of their operations. (Read More) News Published by Nigerian Tribune

9. next: Microfinance bank sells property to pay off debts

Following the final collapse of microfinance banks across the country, a bank known as Classic MicroFinance located in the Onikolobo area of Abeokuta has commenced the sales of its properties. Hundreds of eager and prospective buyers stormed the bank’s premises to take advantage of the giveaway prices of the sale monitored by the National Deposit Insurance Company {NDIC}. (Read More) News Published by next

10. Vanguard: Eagle Flight MFB makes giant strides

WHEN the Central Bank of Nigeria, CBN, late last, year announced the revocation of operating licences of some 224 microfinance banks (MFBs) in the country as part of its statutory functions of regulating the banking industry, one of the names that featured was the Eagle Flight Microfinance Bank. (Read More) News Published by Vanguard

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Sierra Leone’s Microfinance inst Hope Micro to offer mobile money services

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Microfinance Focus February 28, 2011: Hope Micro, a microfinance institution based in Sierra Leone has partnered with Kopo Kopo and Splash Mobile Money to bring mobile financial services to their 16000 microfinance customers.

mobile-money-services

Hope Micro plans to scale the service in order to offer both loan disbursement and repayment through Splash Mobile Money to all of its 16,000 customers. Hope Micro is the first microfinance institution in Sierra Leone and one of the first in West Africa to offer mobile financial services.

Hope Micro customers may now repay their loans using Splash Mobile Money, a service allowing users of the top three mobile networks to load cash to their phones, send money, pay bills, withdraw cash, and buy goods.

SD Kanu, the Executive Director of Hope Micro said, “Making payments at our office takes the client away from their business. We partnered with Splash and Kopo Kopo in order to make our services as convenient as possible and put more money into the pockets of our customers.”

Kopo Kopo, a US-based organization offers a software-as-a-service platform that enables microfinance institutions to integrate one or multiple mobile money systems with their core banking software on a pay-as-you-go basis.

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M-CRIL’s Comments on the Malegam Committee Report

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Microfinance Focus, January 27, 2010: The Malegam Committee was established in an environment of crisis in Indian microfinance, against the backdrop of the AP Microfinance Institutions Ordinance (now Act) instituted apparently as an emergency means of protecting microfinance clients. Seen in the context, of the political backlash against microfinance, the recommendations of the committee are broadly appropriate. In particular, the committee’s clear recommendation that the RBI creates a specific category of NBFC MFIs and regulates them directly recognizes such institutions as an integral part of the financial system. It is, thereby, a measure that could have a far‐reaching beneficial impact in furthering financial inclusion in India. However, in some of its other proposals the committee’s focus on crisis management has perhaps diverted it from the opportunity to take a potentially broader view of financial inclusion.

In that sense this is an opportunity missed. The following are some specific comments within this broad framework.

1. Definition of microfinance clients as those with annual income of less than Rs. 50,000 – will exclude large numbers of low income families

According to NSSO survey data, and allowing for inflation, this measure limits the outreach of microfinance to 50% of the population in rural areas and 20% in urban areas at 2008‐09 prices. At March 2011 prices, with food inflation running at 15‐20% over the past few months, this brings the proportion of population likely to be covered by the definition down to about 45% and 18% at best. Yet, we know from estimates by organisations such as the World Bank that the level of financial exclusion in India is of the order of 60%. What then, is to happen to the 20% or more of the population that is classified as non‐poor but is still financially excluded? Recent research, and not just in India, has conclusively established that microfinance provides its greatest service in facilitating the lives of the financially excluded non‐poor and the upper layer of poor just below the poverty line. The poorest sections of the population are widely believed to need asset transfers and extensive handholding to raise their incomes closer to the poverty line. With inflation always an uncertain factor in economic policy making, it would be far better to classify microfinance by loan size, index linked to consumer price indices. To assess the depth of outreach of MFIs, they could be required to undergo the social performance ratings that are now offered by M‐CRIL and others as a product that covers (amongst other aspects of responsible finance) the Progress out of Poverty Index (PPI) to assess access by poor households and focus groups to obtain client feedback on products and services.

2. Cap of Rs. 25,000 as the maximum loan amount – needs to be customized regionally and adjusted for inflation

The limit of Rs25,000 on the extent of borrowing by individual households appears to be very low. If microfinance borrowers today take 3‐4 loans each from different MFIs, it is because their financial needs are not fulfilled by the loan size restraints of individual MFIs. Borrowing to the extent of Rs30‐40,000 found in areas like Kolar and other districts of southern Karnataka indicates that this is the level needed by many microfinance borrowers. The key is not the loan size but the loan appraisal. Routine disbursements of Rs12,000 each by 3‐4 MFIs to a single client vitiate the credit environment in that there is no loan appraisal, only a loosely applied group guarantee. The same overall amount provided by a single MFI would need a proper loan appraisal resulting in a better assessment of customer needs.

A loan size cap is further complicated by the fact that client needs differ in different parts of the country; a Rs7,000 monthly income in Mumbai may well be less in real terms than a Rs4,000 monthly income in Jharkhand. The needs of microfinance borrowers in each region would also be different. In this age of computers, it would not be so difficult to fix a loan size cap at, say, Rs25,000 in the poorest state, Bihar, while using state rural and urban per capita incomes to revise it upwards for other states with a special dispensation for the top 15 cities in the country. These numbers could be index linked to the consumer price index for agricultural labour for rural areas and for urban manual workers for urban areas. A once a year revision would be sufficient to ensure that MFIs adequately address clients’ needs.

3. Cap of only two lenders (1 MFI + 1 SHG or 2 MFIs) – should not be necessary

Given the need for larger loans than have been given by MFIs until now, clearly the number of lenders to an individual client needs to be limited. The ideal is for a single MFI to undertake a proper loan appraisal and give larger loans that satisfy the needs of the client. This will entail changing the business model and will need staff training (in loan appraisal) and adaptation of control systems to implement. With the establishment of credit bureaus, individual client needs will become clearer and it is for the regulator and industry networks such as MFIN/Sa‐Dhan to implement their codes of conduct to persuade their members to change their business model and certainly to establish that they are not causing over-indebtedness.

In the short term, such a low cap (Rs 25,000 proposed) will result in credit rationing and consequent loss of business for significant numbers of micro‐borrowers.

4. Pricing cap (lower of mark‐up of 10% / 12% and 24% interest) – is restrictive and difficult to implement

All over the world, pricing caps have become discredited as a means of consumer protection. India’s own experience shows that such caps result in no more than credit rationing leading to increasing financial exclusion of the small customer who is more costly to serve. We know that commercial banks never lent to the poor because of pricing caps. It would be ironical if within a year of RBI removing interest rate caps on priority sector loans, the caps were to be re‐introduced for MFIs. Even commercial banks, have 24‐30% interest rates on small size personal loans even though they do not provide the convenience of doorstep collection and loan amounts are usually above Rs. 25,000.

As a rating agency, M‐CRIL is acutely aware of the fact that attempts to introduce such caps can result in significant manipulation of loan terms and membership conditions. This situation will lead to less transparency in pricing than there is today rather than more.

The key is for there to be transparency: the RBI should establish a standard method of calculating effective interest rate (EIR) and administrative charges on other financial or nonfinancial services should also be fully revealed so that all MFIs are put on a comparable platform. As a rating agency, M‐CRIL has been calculating EIR on an internationally acceptable formula for years and has also insisted on a transparent presentation of other charges in its rating reports. This could be standardized across MFIs.

5. Net Own Funds of Rs. 15 crores and the requirement that smaller NBFCs not undertake microfinance beyond 10% of their assets – does not conform with the spirit of financial inclusion

There is clearly a conflict between this provision and the Committee’s intention that microfinance be undertaken by socially minded professionals. Such a large amount of startup capital is generally not available to this class of people. This provision effectively closes the door on new entrants with a social purpose and becomes an invitation to commercially minded large companies to enter the business. The net result would be a totally commercial approach to microfinance with no social or developmental intent. The removal of smaller NBFCs from the industry would both cause a setback to microfinance in both the less well served areas of the country and would also reduce competition, strengthening the existing tendency to oligopoly. The recommendation does not conform with the spirit of financial inclusion.

6. Customer protection and recovery only at Centres, not at home or workplace – unnecessarily micro‐manages a business relationship

This recommendation goes against the interests of both the MFI and the borrower. Doorstep collection is one of the key facilities that the MFI offers to a low income customer. To confine microfinance to collection centres is to negate this benefit for the customer. It will only hamper the business model and retard financial inclusion. The issue in collections is not the collection venue, it is over indebtedness; the committee has made sensible suggestions on the implementation of codes of conduct, grievance redressal and establishment of ombudsmen. It is important for customer protection that Industry Associations and the Bankers Forum play a more proactive role to ensure that MFIs are being socially responsible. Not visiting clients at odd hours is already part of the RBI guidelines for banks and NBFCs. Regulation and codes of conduct should focus on these consumer protection measures not micro‐management of the business relationship between borrower and MFI.

As an additional measure, MFIs could be required to conduct annual independent Customer Satisfaction Surveys through well known social / qualitative research agencies with the report to be published on their websites and submitted to the RBI.

7. Loan tenure vis a vis loan amount – affects the business model

This is again a case of micro‐management and affects the business relationship between the lender and borrower; what if a borrower needs a four month loan? Most loans in the more developed urban microfinance market in Latin America have a four month tenure.

Regulation should focus on transparency of communication so that a conscious choice of loan size, loan tenure and other loan conditions is made by the borrower. It should not mandate the business relationship.

8. 75% of loans for productive purposes

It is a simple law of economics: money is fungible, it is impossible to monitor this condition. It should, therefore, be dropped.

9 . Centralized loan sanction and disbursement

No significant purpose is served by this condition. The key to good lending is to provide an adequate loan size based on good loan appraisals. The MFIs need to provide for individual lending, to train their staff to undertake good appraisals and introduce control systems that are designed to address the changed business conditions that this will result in. 10 Limitation on income from non‐credit business avenues – is unnecessary at present Microfinance should, first and foremost, be about financial inclusion not just credit. NBFC MFIs should ideally be allowed to collect deposits (up to strict limits and under restrictive conditions suggested by M‐CRIL in its submission to the Committee). They should also be encouraged to expand the coverage of insurance services though this activity should not become a conduit for collecting substantial administrative charges. Insurance companies using MFIs as their distributors and/or agents could be required to ensure that the additional charges are not excessive but are commensurate with the service provided by the MFI for distribution. MFIs should also be encouraged to introduce other financial services such as remittances and payments to facilitate the lives of low income families. As to non‐financial services, there has been much talk of MFIs becoming distributors of large companies; some trials have been conducted but there has been little success. In practice, financial services are sufficient to keep MFI staff occupied, the scope for learning additional marketing skills is quite limited. The limitation is unnecessary at the present time as nonfinancial services are unlikely to be provided by MFIs in any significant way.

 

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SKS Microfinance welcomes Finance Minister’s budget speech

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Microfinance Focus February 28, 2011: The 2011- 2012 Union Budget presented by Finance Minister, Pranab Mukherjee on Monday was welcomed by SKS Microfinance, India’s largest microfinance lender.

CFO, S. Dilliraj of SKS said, “We welcome the Honorable Finance Minister’s statement that “MFIs have emerged as an important means of financial inclusion.”

“We are particularly pleased that this reconfirmation that microfinance is a national priority is backed by concrete measures that will augment the flow of credit to the sector, such as:

•    The provision of Rs 5,000 Crores to SIDBI for refinancing MSME exposure of banks.
•    Increasing the agricultural credit target from Rs.3, 75,000 crores to Rs.4, 75,000 crores and the credit target to minority communities to 15%. Banks can meet these targets by buying the agricultural and weaker sections receivables (which accounts for 68% of SKS’s portfolio) from microfinance institutions. 
•    The creation of ‘India Microfinance Equity Fund’ of Rs 100 crores with SIDBI, which will help the microfinance institutions to meet capital requirements. In addition, we are pleased to see the Economic Survey’s recommendation of considering basic banking license for MFIs.

“Generally, we welcome the increase in rural and social sector allocations like rural housing, which will enhance rural cash flows and improve the credit standing of our micro borrowers. We welcome the increase in rural and social sector allocations like rural housing, which will enhance rural cash flows and improve the credit standing of our micro borrowers.” He said.

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Indian Government to bring appropriate Microfinance framework: FM

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Microfinance Focus February 28, 2011: Presenting the Parliament India’s Union budget for the year 2011-2012, Finance Minister, Pranab Mukherjee on Monday said that the Government is considering appropriate framework to protect interests of small borrowers.

Mukherjee said, “The Committee set up by RBI to look into issues relating to microfinance sector in India has submitted its report. The Government is considering putting in place appropriate framework to protect the interests of small borrowers.”

The Sub-Committee of its Central Board of Directors set up by the RBI, under Chairmanship of   Y H Malegam, had earlier addressed important concerns in the industry relating to regulation, transparency, coercive methods of recovery and funding.

The Sub-Committee recommended creation of a separate category of NBFCs operating in the microfinance sector to be designated as NBFC-MFIs. To qualify as a NBFC-MFI, the Sub-Committee had stated that the NBFC should be “a company which provides financial services pre-dominantly to low-income borrowers, with loans of small amounts, for short-terms, on unsecured basis, mainly for income-generating activities, with repayment schedules which are more frequent than those normally stipulated by commercial banks” and which further satisfies the regulations specified in that behalf.

The Sub-Committee cautioned that while recognizing the need to protect borrowers, it was also necessary to recognize that if the recovery culture was adversely affected and the free flow of funds in the system interrupted, the ultimate sufferers would be the borrowers themselves as the flow of fresh funds to the microfinance sector would inevitably be reduced.

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FM proposes to create SHG’s Development Fund of Rs 500 crore

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Microfinance Focus February 28, 2011: Finance Minister, Pranab Mukherjee on Monday presenting the Parliament India’s Union budget for the year 2011-2012 made a proposal to empower women and promote their Self Help Groups (SHGs).

He said, “I propose to create a ‘Women’s SHG’s Development Fund’ with a corpus of Rs 500 crore.”

Last year’s budget of 2010-2011 saw the programme for linking Self Help Groups (SHGs) with the banking system, re-designated as the ‘Micro-Finance Development and Equity Fund’ in 2005-06 with a corpus of Rs.200 crore (INR 2,000 million) being doubled with the allocation of Rs. 400 crore (INR 4,000 million).

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Proposal to create Rs 100 crore India Microfinance Equity Fund: Indian Budget

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Microfinance Focus February 28, 2011: Presenting the Indian Union Budget for the year 2011-2012, Finance Minister, Pranab Mukherjee on Monday said that he proposed to create in the course of the year ‘India Microfinance Equity Fund’ of Rs 100 crore with SIDBI.

He said, “Micro Finance Institutions (MFIs) had emerged as an important means of financial inclusion. Creation of a dedicated fund for providing equity to smaller MFIs would help them maintain growth and achieve scale and efficiency in operations.”