Published in arrangement with Solution Exchange ]
Compiled by Navin Anand, Resource Person and Monika Khanna, Research Associate- Solution Exchange
Issue Date: 29 December 2010
From Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai
Posted 27 October 2010
I am independent microfinance practitioner, analyst and researcher and I am interested in knowing the views of the community with regard to a (legitimacy providing) national regulatory framework for microfinance in India.

As microfinance moves to a large scale roll out stage, it becomes imperative to establish fair rules for conducting micro finance. An analysis of the microfinance regulatory situation in India reveals multiple mechanisms for regulation of various entities engaged in the microfinance space. At one end, NGOs, Trusts and other not-for-profit institutions functioning as financial intermediaries are out of the purview of any direct supervision by the financial regulatory mechanism. On the other hand, some MFIs focused on fast growth and high profits seem to be going off track – especially with regard to good governance and ethical practices of business.
Experts and senior practitioners like Mr Al Fernandez, Mr Ramakrisha, Prof Sriram, Prof R Srinivasan, Mr Vijay Mahajan, Ms Shashi, Rajagopalan, Journalist M Rajsekhar, Dr Thorat, Dr N R Narayana Murthy and many others have given their views on the present crisis in microfinance. (Details available at:ftp://ftp.solutionexchange.net.in/public/mf/cr/res26101001.doc; Size: 52 KB). Some of the key areas of concern relate to: over-indebtedness; private investors looking for quick growth, high profits, high cost and its impact; multiple loans; investors putting pressure for returns; corporate misgovernance and lending irregularities including coercive repayment techniques and harsh repayment schedules etc.
Hence, in context of safeguarding interest of customers at one level and giving functional clarity to MFIs/MFOs on the other, it seems necessary to have clear National Regulatory Framework for Micro-finance in India. This is becomes even more essential, when one considers the recent ordinance passed by the Andhra Pradesh Government. As quoted in many newspapers, banks appear to have halted disbursements of sanctioned and approved loans to MFIs. Further, it has been reported that the despite the Hon Court’s interim relief, MFIs are still finding it very difficult to lend and/or recover their dues.
In fact, in 2005, Dr Thorat (Former Chairperson, NABARD) and I, in a paper (Available here, please see pages 26 – 36 and other pages) presented at the NABARD high level policy conference at New Delhi, had forewarned that the burgeoning growth of micro-finance could result in a number of not-so-desirable practices being adopted. We had therefore argued for a single (super) regulator to provide the much needed legitimacy to the Indian micro-finance industry as well as help prevent some of the very (unfortunate) events that are occurring today..
Therefore, given the present crisis and urgent need for a regulatory framework of Micro-finance, I would like members to highlight their views on regulation and supervision of Micro-finance in India and provide some answers to the following specific questions:
Need of a Regulatory body
Is further regulation of micro-finance necessary? If yes, what kind of institutions should be regulated? And who should be the regulatory body and why?
What about the idea of self-regulation? Will it work? What are members opinions on these issues in the light of their own experiences with self-regulation (codes of conduct by Sa-Dhan and MFIN) in India?
Regulatory Framework
Do we need a national regulatory framework for micro-finance encompassing all types of MFIs?  What aspects (prudential, non-prudential etc) should be focused in the framework? Should the framework have any non-negotiable in terms of specific things to be done by the regulated bodies?
What kind of supervisory mechanisms (On-site, off site, third party etc) are envisaged?  What checks and balances would be required for the proposed framework to be effectively implemented on the ground?
Capacities Required
What capacities would be required to effectively implement such a regulatory framework?
Besides the need for a National Regulatory Framework from micro-finance, I also feel that we need to ensure that MFIs adopt good Corporate Governance Practices, if they are to be viewed positively. I would also request members to provide their suggestions regarding this:
How to enable MFIs get to implement in practice good corporate governance in full earnest?
Dr N R Narayana Murthy defines good Corporate Governance as: ‘Corporate governance, to me, is about maximizing shareholder value legally, ethically and on a sustainable basis, while ensuring fairness to every stakeholder - the company’s customers, employees, investors, vendor-partners, the government of the land and the community.’
Based on the responses received from the members, I would like to compile these responses as a paper and share it with the RBI Sub-Committee that is looking into current crisis in micro-finance, especially in the backdrop of the AP ordinance for MFIs.
Responses were received, with thanks, from
Aparajita Agrawal, Intellectual Capital Advisory Services (Intellecap), Mumbai
Ritesh Dwivedi, Amity School of Rural Management, Amity University, Noida
Malay Dewanji, Liberal Association for Movement of People (LAMP), Kolkata
Umesh Chandra Gaur, Confederation of Community Based Organizations of India, Delhi
Subrata Sarkar, Kalyani, West Bengal
Subhash Chatterjee, AXIS Bank Limited, Mumbai
Srinivas, Independent Consultant, Hyderabad
Sreedharan Nair, Initiative for Social & Economic Transformation (InSET), New Delhi
Smita Premchander, Sampark, Bangalore
Ravi Chandra, Bihar Development Trust, Patna
Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai (Response 1; Response2;Response 3; Response 4; Response 5; Response 6)
K. Rajendran, Research Scholar, Chennai
Radhika Jha, Independent Consultant/ Researcher, New York, USA
Jaipal Singh, Centre for microFinance, Jaipur
George E. Thomas, Mumbai
G. Bhaskara Rao, Enable – APMAS, Hyderabad (Response 1; Response 2)
Badri Nath Tiwari, Grameen Development Services (GDS), Ajmer, Rajasthan
Arabinda Mitra, Ghoragacha Swanirvar Samiti, Kalyani, West Bengal
A P Fernandez, MYRADA, Bangalore (Response 1; Response 2)
Toms K. Thomas, Mutual Assistance Resource Group (MARG), Trichur, Kerala
T Vanitha, BASIX, Andhra Pradesh
R. Ramachandran, Association for Development through Integration and Cooperation (AICOP), Cuddalore, Tamil Nadu
Savita Shankar, Lee Kuan Yew School of Public Policy, National University of Singapore, Singapore
Harish Chotani, Resource Consultant - Microfinance and Livelihoods Promotion, Gurgaon
N. Jeyaseelan, Hand in Hand, Chennai
Navin Anand, United Nations Development Programme, New Delhi
Further contributions are welcome!
Summary of Responses
Related Resources
Responses in Full
Summary of Responses
In the present microfinance scenario, members showed their concern about some of the key problems emerged due to the mission drift in MF sector. These problems include over-indebtedness, private investors looking for quick growth and high returns, high costs for clients, multiple lending, improper governance, harsh repayment schedules and coercive repayment techniques used by some of the MF service providers. Keeping in view client’s interests at one level and giving functional clarity to a variety of MF service providers for successful and ethical implementation of microfinance activities, a good regulatory framework is a prerequisite.
Referring to the present crisis in the MF sector, members expressed that ‘mere access’ is not the only objective but other critical factors mutually perceived between the service providers and clients are also to be taken into account such as up scaling, affordability and sustainability.
Diversities in the MF Scenario and Appropriate Regulatory Framework
A high level of diversity is seen in the microfinance sector in context of - range of MF organizations having different legal forms, variation in MF products and services and extent of mF operations, variety of regulatory bodies, type and level of intermediation of MFIs, economic and social status of the target population and geographic spread of poor. Members envisaged that the MF regulatory framework can be developed considering all these complexities of the sector that can address the information asymmetries, encourage healthy competition and protect the interests of all the stakeholders. Members find it a right time to introduce a regulatory mechanism through regulatory bodies like RBI, NABARD, Securities and Exchange Board of India (SEBI), IRDA and a variety of other regulatory bodies.
Scanning of present regulatory scenario reveals that different kinds of banks such as commercial banks, RRBs, Cooperatives Banks, local area banks and other private banks are covered under Banking Regulation Act and also RBI/NABARD regulations related to microfinance. The Non-Banking Finance Companies (NBFCs) engaged in microfinance are being regulated by RBI whereas  the NGOs, Trusts and other not-for-profit institutions functioning as financial intermediaries are out of the purview of the direct supervision of the RBI. The scenario of financial cooperatives is more complex as these institutions are being regulated by Registrar of cooperative societies and also by NABARD/RBI. This situation demands for a regulatory framework that can encompass different types of MF service providers.
Design Problem
Analyzing the present crisis in the microfinance sector, members identified MF Project Designs as one of the important factors responsible for the present crisis in MF sector. They find some links between the funding models or capital generation arrangements and the present crisis of the MF sector. The funding models differ from each other in context of sharing of risks by different stakeholders and also form of financial support like bulk loans, grants, quasi equity, equity capital and loan guarantee funds received by the MFIs. Hence, this provides logic for the coverage of investments in the regulatory frame work.
On regulatory framework, member suggested the following -
National Framework - A well defined MF regulatory framework at the macro or national level applicable for all types of MF service providers (NBFCs, Section – 25 companies, Public Listed, Trusts, Societies, and Cooperatives etc.)
Single Regulator at the National Level - All MFIs can be regulated by one regulator while complying with the Acts in which they are registered.
Primary and Secondary Regulators - Different legal entities can continue to be regulated by one or more primary regulators depending upon their registration and portfolio of activities. Secondary regulator can watch the activities at the macro level in specific context of microfinance operations. This forms two boundaries for microfinance institutions in terms of regulations.
Individual Service providers - Individuals functioning as service providers such as Business Correspondents /Business facilitators and Money lenders may also be taken up under the ambit of MF regulatory framework.
Regulations for those opting for mobile phone banking – MFIs providing remittances services and using mobile phone banking are to be regulated by appropriate regulatory bodies in addition to RBI.
Monitoring of MF activities – The regulatory framework needs to incorporate provisions for monitoring of MF activities at the grassroots level.
No dilution of banking standards – Banking standards need not to be diluted so as to save poor clients, especially illiterate women who require financial literacy
Supervisory Mechanisms – A combination of different supervisory mechanism (On-site, off site, third party etc.). and checks and balances are required for effective implementation of the regulatory framework
New Regulatory authority – Since there has been no consensus on a particular regulatory body for MF, Government shall form a new Regulatory authority with officials taken from RBI, NABARD, SIDBI and also from Market
Coverage of Regulation up to Investors’ Level: The investment made by a variety of investors in MF also needs to be covered under the regulatory framework
Regulatory Body
While members recommended for establishing a single regulatory body at a national level, they also suggested the following to be taken up by the regulatory body –
Conducting periodical audit of all the MFIs by the regulatory body
Periodic Rotation of the officials of the regulatory body and keeping officials up to five
Making registration mandatory for all the MFIs/MFOs based on MF mapping so as to minimize the incidence of overlapping and cross financing
Ensuring strict adherence to KYC norms by MFIs followed by ensuring code of conducts
Using macro level controls and ensuring long-term financial solvency
Regulations for Urban Micro financing
Referring back to the recommendation of the Task Force (1999) for including Urban SHGs under NABARD - SHG Bank Linkage programme, members expressed the need of focused MF initiatives in urban areas and a policy framework with flexible norms for including heterogeneous groups.
Micro Finance Interest Rates
In context of interest rates, members mentioned about the total cost of delivering financial services to the low income people includes transaction/financial costs at three levels – Institutions, intermediaries and at client level. This delivery cost varies across the models. Besides models, there are factors like economies of scale, life cycle stage, fixed and variable costs, products strategy, type and efficiency channel partners/intermediaries and competitive strategy which affect the rate of interest charged by the MFIs. Mentioning about the Andhra Pradesh crisis, members strongly recommended for a study covering issues like interest rates being charged by the MFIs, implications of adopting ‘full cost recovery from clients’ and benefits of opting for ‘partial cost recovery from clients plus subsidies’ model. A rational decision by the Government on the regulating the interest rates has become essential at this juncture.
Self Regulation
Expressing their doubts about the applicability of self-regulations in MF sector, members expressed that self regulation requires very high ethical framework and ability to control the temptation of earning quick buck. It is only possible when the institutions involved are committed to upliftment of the poor. A frame work for self-regulation can be developed to advocate measures like assessing the debt capacity of the borrowers, overseeing the utilization of loans etc.
Capacities Required
Members highlighted about the importance of “Human Element” in MF sector and recommended for engaging focused resources by service providers. Capacities in the relevant fields of micro finance i.e., Micro Finance Principles and Theory, economics, sociology, human rights, leadership development and marketing etc. would be required to effectively implement the new regulatory framework. The regulators must have the technical capabilities to assess and evaluate MFI practices and control systems.
Savings Mobilization
The present regulations restrict a variety of MFIs including NGO-MFIs for taking savings from the public. The regulators perspective of not permitting numerous small institutions to mobilize savings has been to give protection to poor. RBI has introduced Business Correspondent (BC) model so that through banks, adequate safety to the deposits of poor is provided. Recently, RBI has also allowed BCs to appoint sub-agents thereby addressing financial inclusion agenda.
Savings mobilization by CBMFIs and other MFIs from their clients would reduce the cost of capital to a significant extent and it will influence the change in the interest rates in a positive way. There are regulations for the type of organizations that can collect savings.  Small savers need more, not less protection. Besides strengthening the regulations for permitting collection of savings, members also suggested for transformation of NGOs or creation of sister organizations so as to undertake savings activity, legally. Similarly, NBFCs comply with RBI norms and get the requisite approvals to start getting savings and deposits. Members were not in favor of diluting norms related to collecting savings.
Suggestions for Tackling the Microfinance crisis
Short Term Measures – Identify shared Clients and JLGs with Multiple loans; engage with stakeholders to deal with clients having multiple loans; ensure regular MF business for clients not having multiple loans; create a uniform practical code of conduct for MFIs; integrate credit bureau with CIBIL.
Long term Measures – Create Single regulatory regime; enable regulators to perform crucial roles of legitimizing microfinance; regulate and supervise MF through appropriate prudential and non-prudential regulations, protect MF consumers and MFIs (provide Literacy/ education to MF Clients on consumer rights, undertake actions on complaints of clients through ombudsman, protect MFIs from state level usury interest ordinances, if required); and give special emphasis on MFI governance.
Overall, members analyzed the existing regulatory situation and recommended for a comprehensive MF regulatory framework that can cover all MF service providers including BCs/BFs as well as money lenders. Members envisaged an environment of Ethical Microfinance Services (EMS) wherein the interests of the ‘Service Providers’ (SP), and the ‘Service Users’ (SU) can be balanced and protected.
Related Resources
Recommended Documentation
Indian Microfinance Crisis of 2010 -Turf War or a Battle of Intentions (from Aparajita Agrawal, Intellectual Capital Advisory Services (Intellecap), Mumbai)
Paper; Intellecap; October 2010
Available at ftp://ftp.solutionexchange.net.in/public/mf/cr/res27101001.pdf (PDF; Size: 101 KB)
Analyzes crisis in AP, revisits fundamentals of business, and questions the effectiveness of radical approaches to multiple bottom-line business by the State and the media
Microfinance Developments: Let Good Economies and Sound Regulation be Good PoliticsSavita Shankar, Lee Kuan Yew School of Public Policy, National University of Singapore, Singapore ) (from
Article; by Savita Shankar and Mukul G Asher; DNA; 24 November 2010
Available at http://epaper.dnaindia.com/newsview.aspx?eddate=11/24/2010&pageno=10&edition=9&prntid=129512&bxid=30696276&pgno=10
Highlights that Microfinance sector needs decisive policy direction from the Government to restore the confidence of stakeholder
From Monika Khanna, Research Associate
Andhra Pradesh 2010: Global Implications of the Crisis in Indian Microfinance
Focus Note; Consultative Group to Assist the Poor (CGAP); November 2010
Available at http://www.cgap.org/gm/document-1.9.48945/FN67.pdf (PDF; Size:277 KB)
Note provides background and context on the situation, which raises important questions about the evolution of microfinance markets more broadly
The Andhra Pradesh Crisis: Three Dress Rehearsals and Then the Full Drama
Note; by Graham A.N. Wright and Manoj K. Sharma; MicroSave; December 2010
Available at http://www.microfinancegateway.org/gm/document-1.1.8919/IFN_55_The_Andhra_Pradesh_Crisis.pdf (PDF; Size: 44.7 KB)
Examines the build up to the Andhra crisis, future prospects for Indian MF, implications of interest rate caps and lessons that should be learned by the mf sector worldwide
Recommended Organizations and Programmes
From Malay Dewanji, Liberal Association for Movement of People (LAMP), Kolkata
National Bank for Agriculture and Rural Development (NABARD), Mumbai
Plot No. C-24, "G" Block, Bandra-Kurla Complex, P. B. No 8121, Bandra (E), Mumbai - 400051; Tel.: 91-22-2653 9244; Fax: 91-22-2652-8141; nabmcid@vsnl.com; http://www.nabard.org/
Apex institution providing loan funds for microfinance services in the form of revolving fund assistance to NGO-MFIs, SHG Federations and NGOs to lend to SHGs
Reserve Bank of India (RBI), Mumbai
Rural Planning and Credit Department, Central Office Building, 13th Floor, Mumbai 400001; Tel.: 91-22- 22610261; Fax: 91-22- 22658276; http://www.rbi.org.in/scripts/AboutUsDisplay.aspx?pg=Depts.htm#RPCD
Rural Planning and Credit Department of RBI formulates policies relating to rural credit and monitors timely and adequate flow of credit
Sa Dhan, New Delhi
12 & 13, 2nd Floor, MPTCD Building, Special Institutional Area, Shaheed Jeet Singh Marg, New Delhi-110067; Tel: 91-11-47174400 ; Fax: 91-11-47174405; info@sa-dhan.org; http://www.sa-dhan.net/Default.aspx
A forum for organisations and individuals engaged in the field of community development finance to meet, share and exchange their experiences, expertise and resources
Khadi and Village Industries Commission (KVIC), Maharashtra
"Gramodaya", 3, Irla Road, Vile Parle (West), Mumbai 400056; Tel: 91-22-26714320-22/4325/6323/2324/3527-29/1073/3675; Fax: 91-22-26711003; dit@kvic.gov.in;http://www.kvic.org.in/v4/homepage.asp
KVIC is charged with the planning, promotion, organisation and implementation of programs for the development of Khadi and other village industries in the rural areas
From Srinivas, Independent Consultant, Hyderabad
Insurance Regulatory and Development Authority (IRDA), Hyderabad
3rd Floor, Parisrama Bhavanam, Basheerbagh, Hyderabad – 500004, Andhra Pradesh; Tel: 91-040-66820964/789768; Fax: 91-040-66823334; http://www.irdaindia.org/
Insurance regulatory body set up to protect the interests of the policyholders and to regulate, promote and ensure orderly growth of the insurance industry
Pension Fund Regulatory and Development Authority, New Delhi
First Floor, ICADR Building, Plot No. 6, Vasant Kunj Institutional Area, Phase - II, New Delhi - 110070; Tel:91-11-26897948/49; Fax: 91-11-26897938; kamal.chaudhry@pfrda.org.in; http://pfrda.org.in/index.asp
Acts as a regulator for the pension sector with the mandate of development and regulation of pension sector in India
Telecom Regulatory Authority of India (TRAI), New Delhi
Mahanagar Doorsanchar Bhawan, (next to Zakir Hussain College) Jawaharlal Nehru Marg(Old Minto Road) New Delhi – 110002; Tel: 91-11-2321 1934, 2323 3466, 2322 0534, 2321 3223,trai@del2.vsnl.net.in, trai@trai.gov.in; http://www.trai.gov.in/
TRAI aims to ensure fair and transparent policy environment, which facilitates fair competition in the telecom sector and protects the interests of consumers
Securities and Exchange Board of India (SEBI), Mumbai
Plot No. C4-A,'G' Block, Bandra Kurla Complex, Bandra (East), Mumbai 400051 Maharashtra; Tel: 91-22-26449000/40459000; Fax: 91-22-26449016-20/40459016-20; sebi@sebi.gov.in; http://www.sebi.gov.in/
Autonomous body, drafts regulations, conducts investigation and enforcement action and passes rulings and orders in its judicial capacity
Small Industries Development Bank of India, Lucknow (from N. Jeyaseelan, Hand in Hand, Chennai)
SIDBI Tower, 15, Ashok Marg, Lucknow - 226001 Uttar Pradesh; Tel: 91 -522-2288547; sfmc@sidbi.in;http://www.sidbi.in/Micro/index.htm
SIDBI Foundation for Micro Credit (SFMC) provides bulk loans and technical support to MFIs
Society for Elimination of Rural Poverty (SERP), Hyderabad (from G. Bhaskara Rao, Enable – APMAS, Hyderabad; response1)
4th Floor, Hermitage Office Complex, Huda Building, Hill Fort Road, Nampally, Hyderabad – 500004; Tel: 91-40-23298981; Fax: 91-40 -23211848; http://www.serp.ap.gov.in/SHG/
A microfinance programme supported by the State Government of Andhra Pradesh which promotes SHGs with an emphasis on capacity building

Credit Information Bureau (India) Limited, Mumbai (from Radhika Jha, Independent Consultant/Researcher, New York, USA)
Hoechst House, 6th Floor, 193 Backbay Reclamation, Nariman Point, Mumbai 400021; Tel: 91 -22 6638 4600; Fax: 91 -22 6638 4666; info@cibil.com; http://www.cibil.com/
Provides comprehensive credit information by collecting, collating and disseminating to both commercial and consumer borrowers and to a closed user group of member
Recommended Portals and Information Bases
Candid Unheard Voice of Indian Microfinance (from Ramesh Arunachalam)
Blog; Contact Mr; Ramesh S Arunachalam; Independent Micro-Finance Practitioner;r_arunachalam@hotmail.com
Blog focuses on the issues emerging in the microfinance sector ranging from Andhra Pradesh Microfinance Crisis, governance, transparency and regulatory issues in MF sector

Related Consolidated Replies
Draft Document on Regulation and Development of Microfinance Sector, from Ratnesh, UNDP - India, New Delhi (For Comments). Microfinance Community - Solution Exchange - India,
Issued 31 March 2010. Available at ftp://ftp.solutionexchange.net.in/public/mf/cr/cr-se-mf-22021001.pdf(PDF, 249 KB)
Seeks comments and suggestions of the stakeholders on the draft document on Regulation and Development of MF Sector proposed by NABARD and Ministry of Finance
Aparajita Agrawal, Intellectual Capital Advisory Services (Intellecap), Mumbai
Intellecap, the social investment advisory firm based in India, has drafted a white paper in response to the ongoing microfinance crisis in India. The paper analyzes the buildup to the crisis in Andhra Pradesh, attempts to revisit some fundamentals of the business, and questions the effectiveness of radical approaches to multiple bottom-line businesses by the Government and the media. To read the paper, please visit: ftp://ftp.solutionexchange.net.in/public/mf/cr/res27101001.pdf. I hope you will find the paper to be thought-provoking and informative.
Ritesh Dwivedi, Amity School of Rural Management, Amity University, Noida
I think this is the most important discussion as it is relating with the problems of crores of poor people. Today Microfinance has become quite popular with some private investors but they don't know the ethical foundations of this sector. This is the root cause of present crisis. It has been reported in different newspapers that excessive interest rates are being charged by few Microfinance Institutions which has caused serious damage to the already weak financial health of poor people. This situation has resulted in some serious introspection for all stakeholders of this sector and as well as reflected a strong need of a Regulatory body.
I do propose that a separate legislation on whole Microfinance activities (saving, credit, remittances, lease etc.) covering all important issues, dos and don’ts should be passed by parliament. Sector has become so vast that a regulatory body is a must. In the present condition, I don’t think self regulation will work. There are so many MFIs which are working honestly and serving to the poor but again some money-minded and market driven MFIs are vitiating the atmosphere as they are focusing only on profit maximization.
There should be clear and strict investment norms regarding investor’s experience on poverty eradication, capital limits, return time limits, interest limits for clients. Monitoring of these norms should be always on-site and only by third party.
Malay Dewanji, Liberal Association for Movement of People (LAMP), Kolkata
I would like to highlight my views on regulation and supervision of Micro-finance in India. Through this response I will try to provide specific answers to the questions raised in the discussion:
Need of a Regulatory body
I feel that regulation of micro-finance is necessary. NABARD should be the regulatory body of all the non-profit making NGOs/CBOs only, working in the micro finance as a means of development of the poor. As NABARD has been working for the development of the poor for many years and supporting Self-Help Groups throughout India, they with the participation of RBI, Ministry of Finance and Ministry of Rural Development and prominent NGOs should be the regulatory body.
Reserve Bank of India should regulate the NBFCs. Many NBFCs have been claiming to come under the proposed Micro Finance Bill meant only for NGOs/CBOs, and their argument is that they are also working for the poor in the field of micro finance.
In this case, we can compare the situation, regarding the operations of small and micro industries in India. There are many NGOs working in the Khadi and small industries sector throughout India that are governed by the Societies Act and affiliated and regulated by the Khadi and Village Industries Commission (KVIC) and all the State Khadi and Village Industries Boards. All these Khadi and Village industries organizations have been making businesses and surpluses, as they are not profit-motivating organizations, but they are not making profits and therefore, not paying any dividends to their members. At the same time, there are many profit-making companies, who are registered under the Companies Act and doing businesses in the micro and small industries sector, and they are regulated by the Companies Board.
The same principles are to be followed in the Micro Finance sector too. The undersigned is associated with both the NGOs and NBFCs, who have been actively working in the field of Micro Finance, and from the dual experiences the above suggestions are given for regulating and supervising the Micro Finance sector.
Finally, it should be mentioned here that all the big NBFCs must not be allowed to get the same kind of benefits like the NGOs/CBOs. Moreover, most NBFCs are directly or indirectly regulated and governed by the foreign capital and therefore, they should not be equally treated with the development NGOs, otherwise, injustices will be done on the development NGOs of India.
The idea of self-regulation sounds good, but it will not work. In the light of our own experiences, self-regulation does not work in our country. In fact, codes of conduct finalized by Sa-Dhan and MFIN are not followed by many of their members in India.
Regulatory Framework
No, we do not need one national regulatory framework for micro-finance encompassing all types of MFIs. We have already mentioned our opinions in this regard, at the above. In our opinion, there should be two different types of regulatory bodies (NABARD for NGOs and RBI for NBFCs) for two different categories of organizations, these aspects (prudential, non-prudential etc) should be focused according to the organizational ownership and framework.
There should be combination of different supervisory mechanisms (On-site, off site, third party etc). Checks and balances by the different regulatory bodies and the beneficiaries would be required for the proposed framework for effective implementation on the ground.
Capacities Required
Capacities in the relevant fields of micro finance i.e., economics, sociology, human rights, leadership development and marketing etc  would be required to effectively implement such a regulatory framework. There must be a balance of work-orientation and people-orientation in operations of regulatory framework.
Regarding your opinion about the need to ensure good Corporate Governance Practices, by the MFIs, we opine that NBFCs only must adopt it, if they are to be viewed positively. The reason is : you have mentioned the idea of Dr. N R Narayana Murthy, who  defines good Corporate Governance as: ‘Corporate governance, to me, is about maximizing shareholder value legally, ethically and on a sustainable basis, while ensuring fairness to every stakeholder - the company’s customers, employees, investors, vendor-partners, the government of the land and the community.’  From this write-up, it is very clear that "Shareholders of the Companies i.e., NBFCs should get highest priority" and in our opinion, Good Governance of the NGOs, means maximizing SHG members value legally, ethically and on a sustainable basis  and thus community comes first.
Finally, I should mention here that our efforts should be focused on serving the community rather than the interest of few individual businessmen.
Umesh Chandra Gaur, Confederation of Community Based Organizations of India, Delhi
Microfinance is defined as a provision of thrift, credit and other financial services and products of very small amount to the poor in rural, semi-urban or urban areas for enabling them to raise their income levels and improve their living standards. A series of policy measures of the Government of India have facilitated intensification and deepening of microfinance. These initiatives include - nationalization of commercial banking sector in 1969, setting-up of Regional Rural Banks (RRBs) in 1975, reforms of financial sector (since 1991), implementation of pro-poor schemes/programmes through credit delivery system etc. Similarly, Reserve Bank of India (RBI) (the Central Bank of the Country) has also taken up a number of initiatives for expansion of rural bank branches, priority sector lending and financial inclusion. All these initiatives by the Government of India and RBI have positive bearing on microfinance development. In the last two decades, a variety of MFIs have expanded their outreach through SHGs, Joint Liability Groups (JLGs) and individuals. These MFIs have also made innovative experiments in providing microfinance services at the doorsteps of the poor.
 
For successful implementation of microfinance activities, a good regulatory framework is a prerequisite. In context of the same, I would like to suggest the following -
First of all, we have to make people aware about microfinance services so that they can take advantage of various programmes and projects of microfinance. Hence, focus on financial literacy is the step towards financial inclusion.
NGOs/CBOs/SHGs are playing important role in implementation of microfinance schemes and programmes. They can organize seminars and knowledge melas at the local level to create awareness about microfinance. Media can also play a good role in spreading awareness about microfinance.
 
Regarding Regulatory framework, I want to recommend that the regulations in microfinance should be focused towards –
 
Bringing orderly, holistic and integrated development of microfinance sector
Enlarging and facilitating financial inclusion of the poor and disadvantaged
Protecting the interests of the small savers and depositors
Eliminating the scope of exploitation of the vulnerable and disadvantaged clients
Facilitating universal and easy access of credit, thrift and other financial services to the women and disadvantaged
 
 
Subrata Sarkar, Kalyani, West Bengal
I really appreciate the Solution Exchange MF Community’s timely effort to put the captioned topic for the e-discussion. Here I have the following feedback on the MF regulation in India:
 
It would be wise to keep the option for savings mobilization for the CBMFI, MFI from their clients, which would reduce the cost of capital to a significant extent. Moreover exclusion of Savings component some cases causes a huge drop out in the borrowers, especially for the SHGs/CBMFI transformed in to MFI. This option might minimize the issue of” usurious interest rate” to a great extent, as I opine.
In most of the cases, we are concerned for rural SHGs only and their Credit linkage through Banks. What about the Urban Bank linkage? Many thought provoking discussion were there in the past in this regard, but frankly speaking no such serous attempts have been made to bring the urban SHGs in the financial inclusion framework, except the co-operatives. I still remember that during 1999 Task Force recommendation, strong suggestions were there to include the Urban SHGs under NABARD SBLP (especially in the peri urban areas). Although some commercial Banks have taken some effort for extending the credit support to Urban SHGs, but still it is very sporadic. Some broad based policy framework needs to be evolved for the Urban SHG credit linage (Bank), based on developing the flexible norms for the urban heterogeneous groups.
Registration of MFI/MFOs is must under a regulator, but a judicious balance needs to maintained between the small thrift and credit groups and the NBFC (because some times we say that as they are already been regulated by RBI why then to include them again). Registration of Small Thrift and Credit Groups/CBMFIs should not only to be registered but all MFI players should be considered for this case otherwise the conducive environment would not be there, as it is happening in some States.
Registration of MFIs under the regulator should be based on MF mapping (location, client’s loan portfolio) in order to minimize the incidence of overlapping, cross financing and cross financing. Although there is one school of thought that perfect completion reduces the rate of interest, may be true, but unless managed effectively it may lead MF in to a macro mess, as it has happened in some cases.
Strict adherence to KYC norms followed by ensuring code of conducts for recovery needs to taken in to consideration in view of creating an enabling environment of MF. Moreover, synergy between different MF service delivery models must be evolved to ensure the provision of financial services by maintaining quality, accountability and relevance of the same.
 
 
Subhash Chatterjee, AXIS Bank Limited, Mumbai
The inputs have been great and would certainly help in formulation of a central level framework which would help all the concerned agencies to act and produce positive results.
 
A few of the points which I would like to comments on are as under:
 
Regulatory Body: A formation of a national regulatory body seems imperative to oversee that all the activities carried out under Microfinance, does bring out the desired outcomes. The body may be formed with officials from RBI, NABARD and MFIN or any other such Institution. As the activities are varied, the representatives should be well versed in all aspects of Microfinance and of course with the basic requirement i.e. a samaritan’s heart. No government official other than mentioned above should be included in the body as otherwise it would influence the functioning or effect the desired outputs.
 
The body should be able to carry out periodical audit of all the MFIs based on the norms formed by them. Audits may be carried out by audit firms/people deployed by the body (ex -bankers/retired personnel who have worked/have experience in such activities.
 
The officials of the body should be rotated on a term, acceptable to all stake holders.
 
The body would approve/disapprove, the entry of any institution based on their capabilities, resources available, infrastructure, human resources, knowledge and of course the basic requirement i.e. to improve/wholesome development of the rural people, by their actions.
 
The number of officials in the regulatory body should not be more than five, to arrive at agreement than at disagreement.
 
Self Regulation: I don’t think that in the present scenario we are ready for self regulation, it would not succeed as there are many institutions which would like to come in the Micro Finance just to earn profits. It is only possible when the Institutions involved are committed to upliftment of the poor/rural masses.
 
Ethics: Altruism is the fundamental requirement for any individual who really wants to help others to grow. So any Corporate Governance Practices would emanate from within the Institution which would see not only financial growth of the people it serves but overall change in the outlook of the community. There could not any fixed barometer for the same. It is based on the fact that if there is a will, there is a way.
 
As have been rightly pointed out by one of the members, Yearly Growth should not be the only scale against which an institution should be mapped or scaled. The amount of impact it has been able to make on the community it is serving should be taken into account.
 
Strengthening the MFI community as whole would help to leverage their point of view not only in front of the Government but it would help to forge dialogues with Banks, donor agencies and other stakeholders. It would also be a force against such institutions which come in garb of welfare organizations just to get the profits.
 
 
Srinivas, Independent Consultant, Hyderabad
Please find below my response to the query on A National Regulatory Framework for Microfinance Sector.
 
Need of a Regulatory body
 
Is further regulation of micro-finance necessary? If yes, what kind of institutions should be regulated? And who should be the regulatory body and why?
As all the members are aware, MF is offered by variety of institutions - Banks, MF NBFCs, NGOs (Societies / Trusts) and Cooperatives.  The flow of credit to these institutions, either through Banks by way of Term Loans or through other financial instruments like NCDs, ECBs or Savings, is critical for effective functioning of these institutions.  Each structure has its pros and cons.  In the absence of a regulation, the bigger ones become bigger and the smaller ones become smaller.  By virtue of mobilizing equity, the NBFCs have advantage of growing at a scale whereas the NGOs the founding pillars of the SHG movement find it difficult to mobilize credit as they do not have reserves and surpluses, whereas the cooperatives have the advantage of mobilizing the savings.  Income Tax rules also vary with each structure.  A regulation is therefore required:
 
To bring a legitimacy to the work done by all the legal structures
Barriers for growth to be kept on par for all legal structures
Encourage flow of credit to all the legal structures, probably a policy may be derived wherein out of the total exposure of a bank to the microfinance sector, exposure to each legal structure and each institution may be limited (Currently NBFCs attract higher exposures in view of the favorable legislation, equity contribution etc.). It makes the life of a banker easy to sanction a Rs.200 crore or 300 or Rs.500 crore to one institution rather than a number of sanctions for the similar amounts (This does not mean that the banks should not sanction that amount to the institutions). I think we should draw some line.  Probably assigning higher risk weightage if the sanctions cross above the prescribed limit or removing them from Priority Sector Lending etc. may be thought of. The objective is that there should be orderly growth of the sector. After all, financial inclusion does not mean that we exclude the institutions that have originally highlighted this issue. I think we should have an inclusive policy. We should protect all the legal structures, if we see the value in the services that these legal structures provide.
 
Who should be the regulator?  Can we think of having an independent microfinance regulatory authority (mFRA) drawing expertise from RBI, SEBI, IRDA, TRAI and PFRDA.
 
What about the idea of self-regulation? Will it work? What are members opinions on these issues in the light of their own experiences with self-regulation (codes of conduct by Sa-Dhan and MFIN) in India?
 
I don’t think self regulation will work there is nothing which is self regulatory. Every body has some external regulation without which there will be uneven growth. Even a big tree which bears fruits had to be cut down if there is an uneven growth or obstructing the growth of other trees which bear different kind of fruits. Similarly, unnecessary plants / trees need to be weeded out if they are not bearing any fruits for the benefit of the community at large or obstructing the orderly growth of the sector.
 
Regulatory Framework
 
Do we need a national regulatory framework for micro-finance encompassing all types of MFIs?  What aspects (prudential, non-prudential etc) should be focused in the framework? Should the framework have any non-negotiable in terms of specific things to be done by the regulated bodies?
 
I think a regulatory framework wherein the information asymmetries are addressed, the flow of credit to the institutions is encouraged, healthy competition is encouraged and at the same time protecting the interests of all the stakeholders - Government, Clients, Investors, Philanthropists may be thought of.
 
I think, we can take the clues from the existing regulators i.e. RBI, IRDA, PFRDA, SEBI, TRAI.  The recent AP ordinance is also a good example, barring few exceptions and also with lot additions that are required. The regulation should allow a level playing field for all the legal structures.
 
The draft regulatory framework may be widely circulated for feedback, not just to industry leaders or industry associations, but to a large number of institutions and networks with clear cut timelines.  We should bear in mind that those who respond to the mails or part of the industry networks are very few in comparison to the actual numbers present and also those who respond to the mails may not be the actual practitioners.
 
Besides the need for a National Regulatory Framework from micro-finance, I also feel that we need to ensure that MFIs adopt good Corporate Governance Practices, if they are to be viewed positively. I would also request members to provide their suggestions regarding this:
 
How to enable MFIs get to implement in practice good corporate governance in full earnest?
 
I think one of the best way to enable MFIs to implement in practice good corporate governance in full earnest is first to define what exactly does it mean, then encourage MFIs who follow it and punish those who do not follow. Unfortunately, we have not seen in India the stricter implementation of rules and regulations. In India we have good rules but still there are many road accidents reported due to lack of strict implementation of the rules.
 
 
Sreedharan Nair, Initiative for Social & Economic Transformation (InSET), New Delhi
The query raised by Mr. Arunachalam is very relevant and timely. I have been of the view that there should be some regulatory framework to control the sporadic malpractices of certain MFIs. In fact, in the meetings of Microfinance Community, Solution Exchange held at Bhopal in 2009 and the one held in Jaipur in 2010, I have vociferously argued that there appeared to be some irrelevant growth of MFIs in the country.  I also questioned the standings of certain MFIs in charging high interest rates coming to more than 36% and their methods of recovery of the loans.  I also stressed that the real objective of establishing a MFI has been deliberately forgotten by certain MFIs in the name of maintaining financial sustainability, the result is incidents like SKS’.  It would be timely to remember now that the MFIs are meant for helping the poor by enabling them to break the strong clutches of poverty and not to intimidate them in the name of maintaining profitability to have sustainability for the organizations.  I do agree with the fact that to have sustainability, any organization should earn some profit but it does not also mean that organizations have to cut the throat of poor and the disadvantaged.  Hence, it is now become essential that the Government come forth with a proper set up to help the poor with cheaper loans so that they are able to enjoy the benefits of financial inclusiveness.
 
As long as some organizations are allowed to frame their own law and practice it without being asked to be answerable for their misadventure  or extremism in financial matters the incidents that happened in states like Andhra Pradesh are bound to repeat elsewhere in the country.  Hence establishment of a regulatory framework in the Microfinance sector has become drastically essential.
 
 
Smita Premchander, Sampark, Bangalore
Thanks to Ramesh for initiating this very useful discussion. Do we need a regulatory framework for microfinance sector?  The answer depends on an evaluation of the framework that exists. As far as regulation is concerned, Banks, Cooperatives, NGOs and NBFCs all are regulated.
What are MFIs?
Microfinance can be provided, according to Indian law, by any of these above organisations.  They can all extend credit.
Can they all take savings deposits?  Only the former two can.  There are regulations for the type of organizations who can collect savings.  These are to protect the savers.  Small savers need more, not less protection.  I believe that the standards here should not be diluted.  If NGOs want to collect savings, let them transform and/ or start sister organisations, as many have done in the past decade.  There is no harm in that.  If NBFCs want to take savings, let them comply with RBI norms and get the requisite approvals.  I am not in favor of diluting norms for collecting savings.  The strict regulations for banks is the one single factor that saved India from the financial crisis in 2008, we need to appreciate that and safeguard the safeguards!  The Reserve Bank of India is often made out to be a villain, all regulators face this, I am sure, and RBI has faced it well, it has not diluted norms, at least not yet.
Similarly, NGOs should not be permitted to offer insurance.  Nor should they be permitted to do remittance transfers.  These are operations for which financial organisations are created.  Let them do it.  If we are concerned about these banking organisations not reaching the poor, then let us exert the pressure for them to do so, as RBI does, through moves towards financial inclusion.  The other option is to create more banking organisations whose mandate is to reach the poor.  Let the donors who want to create this outreach support real banks to come up.  Why do they want to put in less money than is needed?  Why can't we see donors creating women's banks?  Why do we want to dilute norms?
In the name of a 'new regulatory framework' for microfinance, what is often demanded is a dilution of banking standards. Let us first have a debate on what standards are we willing to stand by. There may be a few gaps, we can fix them. If there is no reason to dilute standards, then there is no rationale for new types of organisations.  Then the current regulatory framework is fine.   But no separate regulations are needed for microfinance than for any other size of financial services.  Those who are poor, particularly women who may be illiterate, they deserve high banking standards to be upheld in this country.  They need financial literacy, financial inclusion, and they need banks with positive attitudes towards lending to them.
Lets get more donor funded full fledged banks, that meet current banking standards, and not talk of different standards for microfinance sector.  The recent developments show that MFIs do not, in fact, deserve any such treatment.
Ravi Chandra, Bihar Development Trust, Patna
I am co-founder of microfinance and livelihood institution named Bihar Development Trust in Bihar. We are a small MFI with portfolio of 1.6 crore with 3000 active borrowers. We have cumulatively disbursed Rs. 450 lakhs to 5000 borrowers till date in three years. I found the query of Mr. Arunachalam very appropriate and timely.
Need of a Regulatory body
Regulation of MFIs is very necessary. In fact, small players like us feel more need of it for legitimacy purpose rather than any other. Self Regulation requires very high ethical framework and ability to control the temptation of earning quick buck. I think the self regulation has failed. The operations people in MFIs are forced to grow fast ignoring the control system and policies as incentives are biased towards growth rather than control systems. Who is asking the national MFIs to grow at 100-200% CAGR or pressing the second tier between 20-100 crore bracket to grow at such a fast and unnatural pace.
Regulatory Framework
All MFIs (NBFC, Section 25, Public Listed, Trust, Society, Coops etc) should be regulated by one regulator while complying to the acts they have been registered. My only fear is that even with the crisis, many MFIs representatives are not going to learn and may block the MF bill in parliament this winter. Some of the NBFC MFIs have distorted the healthy policy debate on MFI bill and singing the tune that we are already being registered with RBI.
Capacities Required
The regulator must have the technical capabilities to assess and evaluate MFI practices and control systems. I feel there must be a strong technical panel with people having 20-25 years of experience of Microfinance in Banks, Academics, MFIs, Donor Agencies and Multi lateral bodies. They must be adequately staffed to handle regulation of a large number of MFIs. It must have people of high repute and ethical conduct.
How to enable MFIs get to implement in practice good corporate governance in full earnest? It is totally dependent on promoters and founders’ intent and will. Any amount of guidelines and statutes may not help. There are enough guidelines in place. The founder/promoter will always found a way out if s/he wishes to.  Let’s pray that promoters/Founders wish to implement good governance practices and implement it within their own organisations.
We being a small MFI were worried about growing fast. The high growth of MFIs has put lot of mental pressure on small MFIs to grow fast. I believe that our decision of taking up livelihood programmes along with Micro financing has proved to be a right decision in this situation of crisis.
Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai (response 1)
Greetings and many thanks for the wonderful and highly informative postings towards the regulation query. I am writing to inform you of a recently established blog in micro-finance and you may find it useful to look at some of the posts which are relevant to the current Solution Exchange query on national regulatory framework. This is a very critical time for Indian Micro-finance and we need to work closely together to help build a vibrant micro-finance industry in India that puts CLIENTS FIRST (as Dr Robert Chambers would say) and an appropriate National regulatory framework would go a long way towards that.
The Weblinks of some of the recent posts are given below (the latest posts are at the bottom)
Indian Micro-Finance: Time for RBI to Get the (Legal) Framework Right!
http://microfinance-in-india.blogspot.com/2010/11/indian-micro-finance-time-for-rbi-to_02.html
The Andhra Pradesh Micro-Finance Crisis: Time to Clean the Stables and Start Afreshhttp://microfinance-in-india.blogspot.com/2010/11/andhra-pradesh-micro-finance-crisis.html
Zero PAR Policy in Some[1] Indian MFIs: Satyagraha, Staff Pressure and Other Methods
http://microfinance-in-india.blogspot.com/2010/11/zero-par-policy-in-some1-indian-mfis.html
Multiple Loans to Shared JLGs/Clients by MFIs: How Widespread is this Phenomenon, Why Has it Happened and Is it the Major Cause of the Present AP Crisis?
http://microfinance-in-india.blogspot.com/2010/11/multiple-loans-to-shared-jlgsclients-by.html
Understanding The State of Management Information Systems (MIS) in Indian MFIs: Critical Issues For The RBI Board Sub-Committeehttp://microfinance-in-india.blogspot.com/2010/11/understanding-state-of-management.html
Sa-Dhan Members (Re) Adopt The Code of Conduct in Andhra Pradesh: A Positive Step but what is the Guarantee for Implementation this time around?
http://microfinance-in-india.blogspot.com/2010/11/sa-dhan-members-re-adopt-code-of.html
Building A Transparent MIS for Micro-Finance: Key Design and Implementation Lessons from The Indian Experience http://microfinance-in-india.blogspot.com/2010/11/building-transparent-mis-for-micro.html
Tackling the Indian Micro-Finance Crisis: Some Practical Short and Long Term Measures that RBI Could Look At Implementing
http://microfinance-in-india.blogspot.com/2010/11/tackling-indian-micro-finance-crisis.html
It is about time that MFIN starts and delivers on the Promised Self-Cleansing!
http://microfinance-in-india.blogspot.com/2010/10/it-is-about-time-that-mfin-starts-and_9513.html
Has Burgeoning Growth Caused Increasing Frauds in Indian Micro-Finance: Do the Regulators and The RBI Sub-Committee Need to Carefully Examine this Relationship?
http://microfinance-in-india.blogspot.com/2010/11/has-burgeoning-growth-caused-increasing.html
It is Easy to Confess Today but Why Did MFIs Engage in Such (Over) Lending in the First Place?http://microfinance-in-india.blogspot.com/2010/11/it-is-easy-to-confess-today-but-why-did.html
MFIN Requests for Formulation of Comprehensive Package for Micro-Finance Sector in India...http://microfinance-in-india.blogspot.com/search/label/Microfinance%20Associations
What is Coercion in Repayment; A Client Perspective from Indian Micro-Finance http://microfinance-in-india.blogspot.com/2010/11/what-is-coercion-in-repayment-client.html
I also request all the members that for candid and objective views on Indian Micro-Finance, Please Visit -http://microfinance-in-india.blogspot.com/
Rajendran, Research Scholar, Chennai
It is the right time to introduce framework for the Micro finance sector. Regulations by NABARD or its guidelines are not able to watch the MFIs. MFIs are charging high interest rate without emphasizing empowerment or development of people. It is the right time to frame guidelines for micro financing and introduce a regulatory mechanism through regulatory bodies like RBI and Securities and Exchange Board of India (SEBI) so as to cover a variety of MFIs.
Radhika Jha, Independent Consultant/ Researcher, New York, USA
The micro finance (MF) sector has been witnessing a rapid expansion globally and has been extremely successful in catering to the needs of the lower income- bracket borrowers. Whenever a sector grows, so does the need to better regulate it, so that the problems and downside risks associated with its rapid growth can be surmounted. Currently, one of the biggest challenges in the way of long term sustainability of the micro finance sector is its poorly regulated and un-supervised state. The microfinance industry undoubtedly needs better supervision and regulation for the smooth functioning of micro lending operations. The big question here is which type of regulation will be more favorable to MF industry: should it be regulated by government or semi government agencies or it is better off with self regulations?
Since restrictive and formal banking type regulation as imposed by the government could stifle the growth of this sector and limit its maneuverability and competitiveness especially in such a dynamic environment of micro financing, the adoption of self-regulation seems the better option. Self-regulation means self proclaimed codes of conduct and ethics, self enforcement, and adherence to such practices instead of regulations by an outside agency. The current measures being instituted by Microfinance Institutions’ network (MFIN) are important steps towards self regulatory reforms of the MF sector.  Following are some suggestions for streamlining the operations of the microfinance industry.
Creation of a central database: A centralized database accessible to all lenders should be created which would allow members to share borrowers’ identification details, credit records and default information. A collaboration with national credit bureaus can be helpful too if they allow microfinance industry to leverage their existing database and updating facilities. A profitable partnership with mobile phone manufacturers and service providers would allow microfinance applications to run on mobile phones allowing field level workers to access and update this database timely. This would definitely make the process of credit checking, verification, lending and repayment smooth, fast and very effective.
Standardization of Practices: Standardization of the practices of microfinance would be very helpful in bringing uniformity in the business operations of the microfinance institutions. The various practices of micro lending regarding the financial assessment of the borrowers, interest rates charged, loan disbursement, and repayment operations should be standardized so as to make the procedures more transparent and uniform. This would also promote the best business practices among multiple micro finance lenders. Other supporting industries such as information technology shall be able to develop IT applications and related processes profitably if they can serve the whole industry uniformly rather than a few individual players.
Encouragement to all micro lenders to become organized members of MF industry: All the micro finance providers would be encouraged to become registered members of national organizations like MFIN and other organized networks if they clearly see the advantage. An educational program should be developed by MFIN to educate the members of micro finance community about the benefits of abiding by the self regulations and adopting the uniform practices. Other benefits should be full support and platform for its grievances, lobbying at all fronts and helping to bring down the cost of operations by profitably partnering with other service providers such as IT industry etc. Other benefits are no brainers as all members would benefit in cutting the default losses if they share the defaulters’ data among themselves. Together they can influence government to enact laws healthy for their operations. All this would encourage healthy competitions among good lenders and weed out the bad ones to save the industry from getting bad image and publicity.
Major areas in need for Self Regulation
The major focus of self regulatory measures could be in the following areas:
Financial assessment of Potential Borrowers: The MF institutions should assess the debt capacity of the borrower by proper guidelines as suggested by code of practices. Such a practice would even help the borrowers to avoid getting into bigger debt issues and avoid the recent repayment crisis resulting in suicides by some borrowers in India.
Lending for productive purposes:  The lending institutions should also ensure that the loans given for productive purposes are utilized for the productive purpose only and not for consumption purpose. This would also avoid repayment problems as the productive loans would help in generating money for the borrower.
Reasonable Rates of Interest:  Micro finance institutions have been known to charge very high rates of interest. Codes of ethics and conduct regarding imposing the cap on interest rates charged from the borrowers, is highly desirable. The MFIN has been taking corrective measures to reduce the interest rates in the sector and would be beneficial to the whole community if respected by all the members.
Administration of the outstanding Loans:  Emphasis should be on effective management of the outstanding loans & loan servicing costs as well as on the timely disbursement of the loans. Proper monitoring of lending practices should help identifying the flash areas early on.  This would also enhance the profitability of MF industry.
Recovery operations: The micro finance institutions need proper guidelines on the recovery norms to ensure the smooth and effective recovery operations and avoid the recent incidents of coercion in recovery of loans.
Financial Sustainability of the MF Institutions: The regulatory code of conduct should also include measures for assessing the financial sustainability of the lender institutions i.e. the capacity of a MF institution to manage its costs against the revenue earned and its sustainability during the crisis period.
Refinancing:  Regulation and measures regarding the refinancing of microfinance loans would help in keeping the current loan rates in sync with that charged by banking institutions to higher credits thus curbing the predatory practices in micro lending and keeping the healthy competitions among micro finance institutions. This would also allow the borrowers to access better rates via refinancing as their financial situation improves resulting in credit cure. These practices need to be borrowed from residential mortgage industry. The overall effect would be the expanding the credit operations of the microfinance institutions.
Conclusion:  The birth and the growth of the micro finance industry has been a major breakthrough in serving the financial needs of the poor people across the globe. To protect the positive image of Microfinance sector as the savior of the needy and un-served poor, the micro finance institutions need to create some mechanism of self regulatory reforms and abide by those regulations to ensure the long term sustainability of the industry.
Jaipal Singh, Centre for microFinance, Jaipur
It is very timely discussion and interesting too. Hope it will also be useful.
Many friends have put their valuable ideas and I am sure the discussion is at least contributing towards educating all of us on the ‘technical subject’ like Regulation. I also have been thinking about it and wish to share my thoughts.
I feel that before deciding about the regulations for MF sector, it would be good to look at existing regulatory bodies like RBI, SEBI, TRAI, IRDA and others. How effective they have been to protect the interests of clients and what are the existing gaps. If these regulators are effective then how come there are still such large scale financial exclusion, how come 2G spectrum is sold at 10% of its market value, how come Harshad Mehta could play with ‘intelligent investors’?. And we should remember that clients whom these regulators are protecting are largely literate and middle class people who can make noise and demand their rights.
Who is asking for the regulation of MF sector? Is it the investors in MFIs, or the MFIs themselves or the clients? I do not think MFIs are interested that someone should regulate them. In fact no one likes to be regulated. If they are willing to be regulated, it is only because they want the permission to mobilize public deposits. Clients want only protection from harassment from the staff of MFIs.
In my opinion there are four issues that need to be dealt with (through regulation or no regulation)
Rate of interest charged by MFIs - now do we expect that the interest rate can be regulated? When the demand is so much and so urgent, and banks have largely failed to provide credit to poor, they will take loan at whatever cost they can afford. Almost every state has their own ‘Money lenders Regulation Act’ but it is hardly enforced. Considering the vastness of country, it is not possible to regulate it by a single national agency. In my view, state governments should gear up to enforce the money lenders act and they should make necessary changes in the act if needed.
Governance of MFIs- Every MFIs is already registered under some Act or other. All these Acts have necessary provisions to keep errant MFIs in check. So the need is again ‘effective enforcement’ of existing regulation.
Behavior of MFI staff – there is a civil procedure code, criminal procedure core and Indian penal code. If a bike rider without helmet can be booked, why can’t a MFI staff abusing poor women be booked and put behind bars. What will a regulator do on this? Have they stopped recovery agents of so many private banks?
If MFIs are to be permitted to collect savings from clients or public then there will be need to ensure that the public money is safe and is invested in secure and safe place. For that RBI is already in place.
In my opinion, there is a need to safeguard poor clients of some MFIs. There are large numbers of MFIs who are working with good motive and with zeal to help poor. They should be protected from the regulator. The MFIs that are charging usurious rates, giving exorbitant returns to investors (at the cost of poor) and their owners are accumulating wealth, in any case are on the wrong side of laws. Existing rules can punish them if there is administrative and political will. I am afraid that by having a regulation, we may give such rogue MFIs a safe passage of escape. Many of these MFIs are saying that they are already regulated by one or other regulator.
I would suggest that in every state there should be an office of ‘ombudsman’ where complaints about MFIs can be taken and the ombudsman also takes suo moto action against errant MFIs. Also in RBI, Companies Registrar Office and in Home Department of every state, there can be a special cell/ or a nodal person to deal with such MFIs where problem emerges.
George E. Thomas, Mumbai
The world has seen enough of principle-based-regulation over the last decade and how lax rules/ lax implementation have shaken the mighty US market and created ripples the world over. We should not forget why the financial sector needs regulation!!
To keep all players healthy enough to perform their contractual obligations, regulators have to use macro level controls and ensure long-term financial solvency.
Products need to be standardized to help customers in evaluating players’ promises of performance. This is important in the context of micro-finance and micro-insurance because the target population cannot easily evaluate the products.
There is an inbuilt opportunity for fraud and financial speculation when large amounts of public money are pooled up in a few hands for long periods. While entrepreneurs have to be adventurous for their own existence, excessive adventurism and speculative dealings are checked by regulators by insisting on prudential investment norms, transparent balance sheets, audit of accounts etc. Unregulated competition can weaken both the players and the system; players can be constantly reaching for other players’ throats and finding ways of punching one another below the belt. Regulators prescribe common norms for valuation of assets, grievance handling systems, codes of ethics etc. to prevent such situations.
The two ultimate objectives related to microfinance are – the market grows and develops so that the society gets the desired benefits; and all the stakeholders get their due rewards for investing their money, time and efforts and also taking the risk as entrepreneurs.
Once the importance of these fundamentals is appreciated by the stakeholders, many other aspects of the discussion become only matters of detail and implementation issues
G. Bhaskara Rao, Enable – APMAS, Hyderabad (response 1)
I complement Ramesh and the MF community for initiating this timely discussion. Now I am responding specifically on AP - MFI Ordinance. I may send more comprehensive response on all aspects of regulatory framework later on.
Andhra Pradesh has been the pioneer in both models of microfinance, i.e. SHG – banking model and commercial microfinance model. With issuing of an Ordinance to control the activities of MFIs in the state, AP became pioneer to initiate the much needed debate on various aspect of microfinance. I personally believe that any administrative controls on development activities would result in many costs to the society. The best way to control the MFIs is through competition. SHG – banking emerged as a wonderful model for effective financial inclusion. SHG – banking could have been a credible competitor for MFIs. But due to variety of reasons, it could not take off in many states and is facing number of challenges, wherever, it reached certain maturity. This is high time to introspect by all stakeholders in SHG – banking. As the present Ordinance was issued for AP, I have described briefly the current AP situation and some suggestions for the Ordinance in the following paragraphs.
The Government should work on completion rather than command and controls
Andhra Pradesh is known as the pioneer and hub of MFIs and SHG movement. With this Ordinance, AP also became the pioneer in MFI regulation and much needed discussion about various aspects of microfinance in India, including the alternative channels for microfinance, especially the SHG – banking. The purpose of this note is to raise certain questions for the debate on the subject and put the Ordinance in a perspective. The AP Ordinance does not address the real issues - (1) high interest rates, and (2) SHG women’s compulsions for going to MFIs.
High interest rates
It is well known fact that MFIs are charging effective interest rate in the range of 30% to 40%. MFIs, which claim that they are working for poverty alleviation and for the poor, should explain, in which enterprises the borrower can earn 40% to 50% margins to repay their loans, without jeopardizing their financial well being. In the Ordinance, there is no cap on the interest. Perhaps it is beyond the jurisdiction of the State government. However, it did mentioned not to charge any hidden charges. Of course, as in all Government orders, there are some exemptions. The MFIs could add all their hidden charges to their rate of interest. The Ordinance has no provisions to prevent such practice. One potential benefit of having one interest rate, without any riders, is that it would enable the borrowers to know, what they are doing. The Ordinance could also insist for quoting the diminishing interest rate instead of quoting the flat interest rate, which is very common practice in MFIs. It, again, may enlighten the borrowers about the gravity of their borrowing from MFIs. The Ordinance did not touch this problem. However, the Ordinance has restriction that total interest amount should not exceed the principal amount. As almost all major MFIs collect their loan in fixed 52 weekly installments, the interest amount may not exceed the principal amount in normal cases. However, collection of loan in fixed 52 weekly installments, irrespective of loan size and purpose, itself might cause severe pressure. Loan repayment terms should be based on loan size and purpose.
SHG women’s compulsions for going to MFIs
It is really surprising to any person, who is monitoring the progress of SHG – banking in AP that SHG members (of SERP & MEPMA) are going in large numbers for MFI loans. As per the macro data provided by NABARD, AP is far head of other states in SHG banking. In 2008 – 09, SHGs in AP got about 45% of total credit disbursed to SHGs (over Rs.12,250 cr.) by all banks in the country.  Further, as per SERP reports, SHGs in AP are getting more loans and amount than reported by NABARD. e.g. As per SERP progress reports SERP SHGs alone got over Rs.6,684 cr. credit from the banks in 2008 - 09 vis-à-vis Rs.5,509 cr. reported by NABARD for the entire state.
Further SHG federations in the state have about Rs.1,500 cr. corpus for lending to SHGs/ members. SHGs have about Rs.2,500 cr. of their own savings. But SHG members are still going for MFI loans at very high rate of interest. It implies that present available funds are quite inadequate compare to the needs of SHG members. Apart from this basic factor, there are many other factors aggravating the funds availability to the members. These include:
To meet target pressures, the banks and field staff of promoting agencies (SEPP & MEPMA) are going for new loans for SHGs, well before complete repayment of old loans. They recover the balance of old loans from new loan amount. In this way the actual available funds for SHGs/ members are quite low compare to the reported macro data. Further, some banks are forcing SHGs/ members to purchase some insurance or other, every time a new loan is sanctioned. In facts some banks are directly deducting the insurance premium from the loan amounts. Some banks are also forcing the members to make a part of loan as fixed deposit. Because of these practices, the actual loan amount reaching the SHG/ members is substantially lower than sanctioned loan amount. Further, some banks, mostly RRBs, are not allowing the withdrawal of loan amount for 2 to 4 months, may be due to shortage of funds. However the fact is that credit – deposit ratio in the state is well over 100%. In RRBs, it is even higher, thanks to thriving SHG lending.
In many federations, the primary members/ Board members are not able to manage their microfinance operations. They are heavily dependent on project staff to manage their microfinance. As there is little control by, and, involvement of, primary members in management of their microfinance, there are so many mismanagements and misappropriations. There are also issues of repayment.
Though SHGs were started on the principle of ‘saving first’, over the years, the SHGs, effectively became credit management groups. There is no regular rotation of internal funds. Whoever, most probably the leaders borrowed first and are just repaying the interest part regularly. In some instance, even the interest is not being repaid. In overwhelming majority of SHGs, members do not know - what is their saving amount, where their savings are, etc. There is no return on members’ savings. As a result members are just saving minimum amount regularly. There are no voluntary savings. Many SHGs return the savings to their members periodically. Some banks are forcefully impounding the SHG savings.
Despite above described problems, SHG banking in AP is a resoundingly successful story, worth emulation in all other states. Members have been getting loans year after year without fail. This assured source of credit encouraged the members to invest higher amounts on their lives and livelihoods e.g. SHG members have admitted their children in quality/ high cost educational institutions. Many members have acquired assets like tractors, tempos, autos, bore well, land, housing, etc on credit. They need larger cash inflows (including credit) to meet their enhanced cash outflows. Last year, due to rumors of loan waivers, there was marked decline in repayment rates. It in turn resulted in low bank credit to SHGs. SHG members are forced to borrow from MFIs to meet their enhanced cash outflows.
Apart from above described cash flow related problems, there are many non-financial issues compelling the SHG members for going to MFIs. As per the available evidence, some of advantages perceived by members in MFI linking vis-à-vis AP/ SERP SHG model are described below.
 

Parameters

MFI model

AP/ SERP SHG model
 

Meetings and time required

No meetings and no thrift are required to get loans
 

In SHGs, SERP has imposed weekly meeting and notional thrift rate of Rs.10 to Rs.20 per week. The field staff used to recommend bank loans only to those SHGs, which opted for weekly meetings. SHG members are being used for all kinds of works like watershed, NREG, distribution of pensions, agriculture products procurement, NTFP trade, etc. and all kinds of meeting like celebrations of state functions, visits of ministers, higher officials, foreign delegates, VIPs, etc.

Loan processing

Simple

Complicated, lengthy and needs a number of person days

Quality of service

Door delivery of loan amount and recovery of loan installments. What SHG/ members need is the clarity about their loan amount and timeliness

SHGs, even in AP/ SERP have many uncertainties about their bank loans. These are:
Completion of documentation required professional support. There is an uncertainty about the availability of that support.
Bank loan amount and timeliness are not certain.
SHGs have to pay some money to many stakeholders every time to get their loan

Loan installments

Weekly

Though majority of SHGs in the state have weekly meeting, they have monthly installments. Some members, who have daily cash flow, want to repay their loans in very small and more frequent installments.

Savings

No saving is required

SERP has weekly nominal thrift rates. SHGs have to pay additional amounts for weekly book keeping. There are no internal controls and checks and balances to protect members’ savings. There are no interest payment on members’ savings

Ownership over people’s institutions

No institutions to own

Though there is a network of about a million SHGs and federations, the sense of ownership is conspicuously missing on the part of primary members. The institutions from SHGs to district level federations are by and large externally driven institutions. A small proportion of leaders are also driving the institutions without real internal democracy.

 
Without addressing the above mentioned crucial issues, the Ordinance proposes to put restrictions on the functioning of MFIs and borrowers. Like most of the administrative control measures, this Ordinance may result in throwing out the baby with the bath water. The Government should focus on competition or strengthening of alternative channels to overcome the monopolistic and exploitative practices of MFIs. However, any democratic Government can not be a mute spectator to the exploitation of the poor and vulnerable sections. It is laudable that the Government has acted promptly to the problem. But given limitations of the State Government, the Ordinance has several limitations. At the same time, the Ordinance does not look fair and practical. Compliance of various provisions of the Ordinance may result in a steep increase in the cost of operations of MFIs, which may further add to the burden of borrowers. Some of shortcomings and possible suggestions are discussed below.
 

Existing Provisions

Suggestions

Appointment of PD of SERP and MEPMA as implementing authority at district level

PDs of SERP/ MEPMA have stakes. Appointment of them as controlling authority over their rivals is not justifiable. Further appointment of district level registering authorities is too cumbersome to comply. An Independent Authority may be created at state level to implement the Ordinance/ regulations over microfinance. The Authority may be empowered to review the restrictive practices of banks, SERP, MEPM and other stakeholders.

Restrictions on multiple loans and membership in multiple institutions

These are the strategies adopted by the poor to get minimum/ sufficient financial and other services. Without addressing the supply side bottle necks, as discussed above, restrictions on borrowers only add to their woes.

Prior approval from the Registering Authority for lending to members, who have active loans

This is cumbersome process, may fillip corruption. MFIs may force the borrowers to get those permissions.

Freezing of lending and recovery until MFIs get registered with district/ town authorities

Freezing of recovery may lead to the collapse of the MFIs in the state. Therefore, recovery may be allowed. If registration is not done within stipulated period, they may be prosecuted

Exhibiting of interest rates

The Ordinance must have provision to exhibit the diminishing rate of interest instead flat rate which is widely prevalent in the sector and potential to mislead the borrowers

Covers only SERP and MEPMA SHG members

It should cover all borrowers of MFIs

 
G. Bhaskara Rao, Enable – APMAS, Hyderabad (response 2)
I totally agree with Smita that the regulatory frame should not be diluted for microfinance. Since the MFIs operate in the monopolistic conditions and deal with illiterate and gullible clients, the regulation should be more stringent. Such regulation should also be made applicable to banks and other financial institutions, which resort to restrictive practices (as mentioned in my previous posting) with their rural/ microfinance clients.
We should understand why our mainstream financial institutions are not able to reach majority of Indian people and provide MF services. According to me, there are two basic reasons -
Banks are forced or compelled to cross subsidize their rural/ microfinance operations. Instead banks should be allowed to charge interest rate sufficient to cover their actual economic cost including average profit margin they get in other operations/ areas. I believe, those interest rates may not be so high, no where close to current MFI rates. Further the Government could subsidize the interest rate, as practiced in SHG – banking in AP, linking it to disciplined repayment. If the Government is providing subsidies worth lakhs of crores to oil marketing companies to keep down oil prices and fertilizer companies to keep down the fertilizer prices, why not subsidize the rural interest rates?  Affordable credit is far more crucial to the poor to tie over lean periods and emergencies without jeopardizing their future. It will also fillip their economic activities.
We all know that rural credit, (be it cooperatives, be it loan waivers), became a victim of political manipulations and power games. Instead of loan waiver, farmers could have been helped through ‘direct cash transfer’. Hopefully that the governments and politicians, in the future, will resist from measures which may result in larger social costs in the long run.
Badri Nath Tiwari, Grameen Development Services (GDS), Ajmer, Rajasthan
As we know that only small percentage from poor families are able to reach banks for their requirements related to microfinance services. But I am not sure that if our mainstream financial institutions will charge more rate of interest then delivery system will improve. I think, first of all we have to understand why banks are not proactive in financing the poor.
The procedures, formalities and accessibility norms of the banks are not in favor of poor. The product designs also need to be customized to the requirements of the poor. I agree that subsidies from Government should be given to Banks for micro finance services provided to the poor. The support from government will help banks to reduce the burden of operational cost. The investors in MFIs look for high returns on their equity at minimum risk.
I think that some sort of national regulation for MFIs should be there. The mainstream financial institutions are required to be liberal in the case of poor in order to make them Bankable. If we analyze the data of Non-Performing Assets (NPA) of any bank branch we will find that the maximum amount is blocked by the non-poor families. I suggest that the bankers should be more accountable to make the poor bankable and RBI should put a cap related to interest being charged by banks or MFIs.
Arabinda Mitra, Ghoragacha Swanirvar Samiti, Kalyani, West Bengal
MFIs are commonly run by NGOs or private bodies. Many of them have the permission of RBI for operating lending, deposit, savings operations, while others are doing business without RBI's permission. RBI stipulates certain norms for lending/depositing business. Many MFIs avoid those norms by applying various tricks. There should be some sound network to oversee the activities of MFs. I would like to mention that MFIs are not pro-poor rather they are friendly to middle class people who are having capacity to repay loans. In many cases they also serve the poor but after safeguarding their own interest. The reason of their presence is because banks or governmental institutions are not able to serve the poor in time.
Recently, I visited Chalaberia, North 24-parganas which is under MEPA program. I met several rural entrepreneurs in Chalaberia, who are engaged in pottery business. Those entrepreneurs often take loans from various MFIs paying high interest rates. When I asked them why they are not keeping touch with banks, they answered that it is easy and simple to take loans from MFIs. They can avail loan at right moment and of what ever amount they require. Our Banks are not competitive. They must be accessible to rural poor in time of need. I hope, if Banks become aggressive in their operation then MFIs will also reduce their rate of interest. I feel that stringent regulations will limit the access to funds available for the poor.
I am not against regulatory framework, but would like to stress more on the functioning of rural financial institutions.
A P Fernandez, MYRADA, Bangalore (response 1)
As a response to the query, I would like to share my article on the subject of Microfinance Regulations -
Is Micro Finance leading to a Macro Mess - the AP Ordinance
Micro finance started in 1966-67 with the Integrated Agricultural development Program and was adopted in several Govt. sponsored programs during the 80s and 90s culminating in the SGSY which amalgamated several of them. If several of these programs did not deliver as expected, the reasons were related to inadequate support services – especially in animal husbandry and agriculture , inadequate investment to support scaling up through aggregation, grading, adding value and marketing – AMUL being a major exception, corruption and poor targeting. Yet micro finance continued. The title of this article really refers to micro finance driven by pressures resulting from venture capitalists and other private investors which is characterized by quick growth, high profits, high cost (interest and remunerations especially for senior staff), IPOs and quick exits. This model is promoted aggressively by International Financial Organizations and is now rooted in India with the tacit support- so far - of financial authorities. I shall refer to this group as the Neo NBFCs involved in micro finance since they share a great deal with the neo liberals and International Organizations which promote their strategy. These Neo-NBFCs have become the dominant micro finance model between 2000 and 2010.
The justification for this Neo-NBFC model are primarily these: a) it is sustainable; b) it encourages self help; it is based on the neo liberal principle that the poor should lift themselves up by their bootstraps and by inference Govt. should keep at a distance; c) it has reached the hitherto excluded sector where the official financial institutions have not penetrated and do not show any signs of doing so due to increasing corporate pressures arising from amalgamations, core banking, shortage of staff at the Branch level and a focus on a single bottom line namely profit (there are no champions of the SHG-Bank Linkage model at high levels); this reason is the main one behind the hands off approach with regard to Neo NBFCs of some sections in Government at the National level; the flip side of this is that official financial institutions have quietly shifted their social responsibilities to the Neo-NBFCs; this is the prevailing sentiment especially at the lower levels; d) it attracts private capital- private capital directly or indirectly amounting to Rs. 2000 crore has flowed into the Neo-liberal sector ;this may be only 15%-20% of the total investment a large part coming from Commercial Banks but the influence of private investors on the Boards of these Neo NBFCs is far greater than that of the banks; and of late e) the share market supports the one Neo - NBFC that is listed and as long as this support continues, the investors also will do so.
High interest costs are justified because micro loans have high transaction costs and high risks. The best talent is required, hence high remunerations need to be paid which makes the Neo-liberal model a high cost one which the borrower finally has to bear. We are told that high interest costs can be reduced through technology and scale. All this sounds good - the right mix- especially since these Institutions were projected at least in the initial years as the real strategy for poverty alleviation. But suddenly the picture is becoming clouded due to several reasons which the media has highlighted.
The AP Ordinance, which is the Government’s reaction to the changing scenario, refers only to the SHGs. In fact the Neo-NBFCs do not lend to SHGs; forming and training SHGs is too slow and requires up front investment in the form of grants or long term loans. They have instead formed Joint Liability Groups (JLGs) which experience has shown are neither joint or mutually liable or groups. Several policy makers in Government have supported the JLGs in preference to the SHGs since, the evidence shows, the JLGs are by far the quickest and cheapest way of disbursing credit. The SHGs require investment in institutional capacity building - which NABARD has supported since 1992; but it takes time - at least 6-10 months during which savings are promoted and internal lending starts before the Banks advance a loan. But today the name SHGs is a veil used by the neo NBFCs that covers (and justifies) many animals. In the long run however, the SHG model together with the SHG Bank Linkage is more sustainable especially for the borrowers.
To explain this a little further, we need to briefly trace the history and the concept of what a real SHG is. This history has been buried under media coverage promoting the fast growing Neo-NBFC model. Between 1984-1986 Myrada (an NGO) worked with the primary Cooperative Societies as the base institution. It realized that far from fostering the interest of all, the benefits went to a few powerful families including the President, Secretary and a few others. They borrowed at the official rates (6%-8%) and on lent to others at rates ranging from 30% to 40%. The poor were dependent on the powerful for jobs, immediate loans etc. Myrada encouraged them to challenge this situation., They broke away and formed small groups - the members were self selected; we later realized that the groups were based on affinity among the members. Affinity in turn was based on relations of trust and mutual support which existed before we entered. This was later called social capital and was the strength of people on which Myrada built. After several rounds of discussions they decided to return the loans they had taken from the Cooperative to their respective group. Myrada encouraged them to meet weekly; each member contributed to the agenda which comprised issues related to health, domestic problems, need for credit etc. They were encouraged to save and Myrada staff kept records of meetings and accounts. When they wanted money, they were encouraged to take loans from their savings which meanwhile had been deposited in a local Bank. These groups were the real cooperatives. Myrada approached NABARD in 1986 with a request to support this complimentary/alternate model.
NABARD provided Myrada with a grant of Rs 1 million in 1987 to train the groups how to meet, to participate, to analyze the society around them, to arrive at a consensus – it was called institutional capacity building (ICB). After several studies NABARD and Myrada came up with three recommendations for policy change to support the groups. The first policy decision was to allow Banks to lend to unregistered groups – this was based on the survey conducted by Myrada of its groups. They assured Myrada that they would function like registered groups but did not want to be registered – the reason? They feared harassment by petty government officials. Policy change in this area was difficult since the legal departments strongly supported lending only to registered groups. It was Dr Rangarajan, as Governor of the RBI, who in 1992 decided to accept this. He said: “let Banks lend to unregistered groups”. By this one stroke he liberated the SHGs.
The AP Ordinance completely overturns this historic decision. It requires all SHGs to be registered. However this is the result of the confusion cause by neo NBFCs between the JLGs and SHGs. I fully agree that the quality of the SHGs has declined due to Government’s policy of achieving time bound targets to form and disburse funds to SHGs. The pressure to lend fast together with the total failure to provide ICB has caused this deterioration in SHG quality. The SGSY allotted Rs 10,000 for ICB but it was never used for training a group. The solution is to invest in ICB, not to register SHGs in order to control them and impose standardized norms; after all the Cooperatives are registered; this has not improved their governance. The AP Ordinance primarily intends to control alleged excesses that have emerged in some of the Neo NBFC management; but it will throw the baby out with the bath water and in this case the wrong baby.
The second policy decision was to allow Banks to give one loan to the group allowing the group to decide whether and how to lend to its members. This was easier to push through in official circles. It reduced transaction costs - this encouraged the Banks. NABARD and Myrada welcomed this because it promoted the SHGs members skills and confidence. This was accomplished because the group was free to discuss and decide on individual loans. The dialectic of this discussion together with the ICB training increased their confidence to talk and gradually their skills to lobby for their rights and entitlements without resulting in open conflict with the power structure. However, it is necessary that the members of SHGs self select themselves on the basis of affinity. Unfortunately this policy of one loan to the group has been forgotten. Loans are given to individuals who happen to be in groups. The Neo NBFCs do not advance one loan to the group; they advance individual loans and claim that the members are jointly responsible even though they are not inked by affinity. In most cases they are selected by the NBFCs often from various existing SHGs; further no ICB has been given – because this is time consuming and costly. Government policy to give different subsidies to SCs, STs and Minorities has further divided several genuine SHGs which comprise all these communities and undermined social capital which still prevails in Bharat.
The third policy decision was to lend without physical collateral; the affinity and training was considered adequate. This did not meet with much opposition. These three policy decisions have not been taken anywhere in the world. Due to them the SHG-Bank Linkage which was launched in 1992 by NABARD and nurtured by it thereafter progressed.
The need for supervision
Any financial institution especially the private ones using public funds from Banks need to be supervised. Concerned individuals have set up an apex organisation called MFIN - a self regulating initiative. But MFIN at most can black list those Neo NBFCs which do not fall in line with accepted norms relating to multiple lending resulting in large amounts which drive the client into deeper debt, to transparency in reports and acceptable behavior in ensuring repayments.
As long as the share market supports the Neo NBFC, MFIN can do little to enforce norms though they may have all subscribed to them. The RBI is the next possible institution that can play a supervisory role. But do the Neo NBFCs want to morph into Banks? They originally lobbied for this on the grounds that credit would become cheaper but of late they are silent. Is this because they are hesitant to have officials on their Board or to be subject to RBI supervision? The RBIs position on this matter is ambivalent. The Govt. of AP has come in perhaps as the supervisor of last resort with the ordinance; but experience has shown that Government intervention especially in the financial sector has had negative consequences all around- including a fillip to corruption - in spite of the good intentions of senior officials.
What can one suggest? All three perhaps have a role to play. MFIN can collect, aggregate and analyze data but it must also be free to meet the borrowers and verify reports. One sees no reason (apart from the costs in terms of time and personnel) why RBI cannot ensure that larger NBFCs in the micro finance sector conform to all requirements required of Banks. The State Government could intervene but not through the District Authority that the Ordinance proposes but through a fast track court (which the 0rdinance also proposes). The approach taken by NREGS to appoint Ombudsman at District levels could be an approach to adopt.
The AP Ordinance does not touch on interest rates. Flat - declining- effective interest rates are terms floating around. Each Neo NBFC interprets these differently. Yet flat rates of 26% are common among them. Official Financial Institutions hesitate to set a limit since they are apprehensive about being branded as supporters of non sustainable models or because it is difficult, they say, to monitor. But to be honest, if the clients are in the poor category can they really invest and manage businesses which earn a return of at least 80% to 100% if flat rates of 26% are to be paid. Are there any takers from the private organized sector for loans over 15%. Not for Profit MFIs with a low cost model have broken even and earned adequate surpluses at interest rates of 16% - 17% declining; why cannot the Neo NBFCs do the same?
A subsidized model not just for credit but also for creating wealth through up scaling, value addition etc., is required for inclusion in growth not just into the financial sector which is largely reduced to opening no frills accounts in Banks. Among the neo NBFCs and their institutional supporters, self help ideology has been interpreted to mean that the poor must pull themselves up by their bootstraps without any subsidized support. The burden is entirely on them. This model needs to be seriously questioned. Another emerging model in Vietnam which this author had the privilege of visiting is decried as non sustainable since it is heavily subsidized by the State. Vietnam based its approach on promoting financial institutions to cater to the credit needs at household level for better inputs, appropriate mechanization as well as at the secondary level directed at creating value through small scale processing, storage and packaging - these were small scale enterprises. These institutions were owned by the people or in partnership with government and they were low cost (no high salaries etc). Interest rates hovered around 13% declining. The impact has been a fall in poverty. It is not necessary to subsidize the cost of the assets but surely subsidized investment is required to provide the skills to manage then and for adequate support services for the asset to realize its potential for income generation. Subsidized credit is required to lower the risk to the borrower not to reduce the cost of asset.
Toms K. Thomas, Mutual Assistance Resource Group (MARG), Trichur, Kerala
I should congratulate Mr. Arunachalam for posting this important query to the community. As Microfinance is one of my interest areas and, I have been associated with a number of MFIs, I would like to share my views on the issues raised by Mr. Arunachalam.
In principle, Microfinance is the provision of a variety of financial services to low income families or solidarity lending groups including consumers and self employed people who traditionally lack access to formal banking related financial services. Microfinance covers not just credit as some perceive, but also the affordable appropriate financial services for the poor/low income families. Microfinance also keeps the belief that provision of financial services to the poor is the best way to address the issue of poverty. An analysis of micro finance history in India suggests that it had three major phases –
 

Phase

Period

Theory

Mission

Institutions

I

1980’s

Profit. No Subsidy. High Interest. Individual Lending.

Credit to the Financially Excluded, Emergency Cash. Exploitation of Financial Need.

Private Money Lenders, Chit Funds.

II

Early 1990’s

Profit + Social Transformation+ Trickle Down+ Subsidized Credit, Commercial Interest, Bank Interest. Individual and Group Lending.

Financial Inclusion. Cheap and affordable credit to the poor, Enterprise Development, Poverty Reduction.

SHGs, Commercial Banks, NABARD, Credit Linked Poverty Reduction Schemes like IRDP, DWCRA.

III

Mid 1990’s & 2000’s

FOR PROFIT, NBFC. Alternative Banking (New Breed as an alternative to Private Money Lender and Commercial Banks)

Mission Unknown! For Profit? Financial Inclusion? Poverty Reduction?

SHG, Grameen Bank Model, Micro Finance Institutions.

Need of a Regulatory body
Is further regulation of microfinance necessary? If yes, what kind of institutions should be regulated? And who should be the regulatory body and why?
Regulation is not an adequate solution for the present crises since regulation alone can not solve the present problems with in the Microfinance sector. Some questions connected to this argument are;
What need to be regulated?
Who should regulate? Is it RBI/NABARD or a newly formed independent entity?
Do we have a competent entity to regulate the micro finance sector?
Do we need to initiate a new competent entity?
Can we call Micro Finance a Non Banking Financial Activity?
If no, then what is the feasibility of NBFC framework for MFIs?
A Framework for Regulation
It is important to say that all the finance delivery channels are presently regulated in one way or the other. Both NBFC and NGO-MFI are somewhat regulated in one way or the other. Instead of regulation, I strongly feel that there is a need to sensitize MFIs about the principle of micro lending and its relevance in financial inclusion and national development, as an alternative bank. The question also remains unanswered that whether micro finance is a pure commercial business activity or a Social Enterprise / Social Business. What is Micro Lending all about? Is it a part of the requirement for Equity? These questions need to be answered before talking about regulation. Probably there is a need for a Reform in the sector since the sector some how is loosing its original mission and vision.
Regulation Levels
a) Regulation at Investor Level: Is this also a matter for consideration under MF regulation? Since financial inflow is important therefore the investment made by a variety of investors in MF also needs to be regulated and there should be a framework for investment which will adhere to the broader Micro Finance goals of the Country.
b) Who should regulate? NABARD was made as a regulator of MFIs in the former Micro Finance Bill. But I think there should be an independent agency under RBI that should regulate the MF Sector. A lead MFI needs to be identified on a rotating basis under the regulator who will monitor the adherence of regulations. Do we need a different legal frame work as such different from NBFC? Can MF be categorized under non banking activity?
Is MF Movement in Indian context an effort to eliminate Money lenders? Do we need to think of strengthening the actors like private money lenders who are still a close to heart casuality lender for the poor.
Where is the Money Lender? Are we saying that the regulatory frame work should bring in all rural lending / financial activity like private money lending, savings and credit cooperatives, Chit Fund etc. under a common legal and regulatory framework? Are they also needed to be brought under the broader micro finance sector?
What about the idea of self-regulation? Will it work? What are members’ opinions on these issues in the light of their own experiences with self-regulation (codes of conduct by Sa-Dhan and MFIs) in India?
Self Regulation – What? It is important to develop a frame work for Self-regulation. Organization like Sa Dhan could play a vital role in formulating a national framework provided Sa Dhan undertakes a role of an independent policy formulating organization. Self regulation at what levels as a financial retailer? What about the banker or the investor?  What investors or the donors look for is also important since MFIs sustainability depends on provision of finance on a sustainable basis. Is there a need to develop a funding framework for MFIs?
Do we need a national regulatory framework for micro-finance encompassing all types of MFIs?  What aspects (prudential, non-prudential etc) should be focused in the framework? Should the framework have any non-negotiable in terms of specific things to be done by the regulated bodies?
Yes. This might solve many of the present problems. The framework should include;
Interest Base – there is a need for rating the MFIs Operations with regard to the location and clients.  This will be a little different from the present rating mechanisms. PAR and the repayment should not be the sole determinant of MFIs success. Other social and economic indicators need to be brought in. We cannot blindly blame MFIs for being some times strict (or harsh) on repayment since it is insisted on them by the rating agencies which play an important role in raising funds (Investment). So an investment framework needs to be developed with in the goal of Micro Finance in the country frame work.
What Could Be The Base Of Interest Rate?  How to Reduce It?
Categorizing of Operational area – Rural, Urban and Semi Urban. Since the operational cost is different for different areas, an area rating might help in suggesting a feasible interest rate.
Lead MFI: In each of the district, an MFI could be selected as a lead MFI. They should control other small MFIs in the district. If there is none, a Rural Bank could be authorized to act as a lead MFI.
Packaging and Innovation: Packaging of Micro finance products could be a mechanism to reduce cost of operations. Introducing innovative delivery channels will also be useful. I think in packaging the operational mix, organizations like Hope Foundation in Palakkad (Kerala) is worth studying.
Joint Operations: Is it possible? This is another method to reduce cost.
Cost of Transformation, Rating and Training: NGO-NBFC Transformation is an expensive activity. Organizations like Sadhan should think of technical support to MFIs in this at a reduced cost. This cost also is ultimately transferred to the clients. Is NBFC is the appropriate legal framework for MFI?
What is the role of SHG Federation? What is their stake? Could they be a reliable economic delivery channel for MFIs where cost could be considerably reduced? How to build the capacity of SHGs federation?
What kind of supervisory mechanisms (On-site, off site, third party etc) are envisaged?  What checks and balances would be required for the proposed framework to be effectively implemented on the ground?
The supervisory mechanisms needs to be developed at following three levels –
Client level
Provider level
Investor level
Different mechanisms required to be developed at these three levels.
Capacities Required
What capacities would be required to effectively implement such a regulatory framework?
Capacities required may include:
Knowledge of Micro Finance Principles and Theory
Efficient network and data support with regard to the MF clients
Decentralized regulatory framework
A Common Channeling of Funding
A Lead MFI at the district level
Besides the need for a National Regulatory Framework for micro-finance, I also feel that we need to ensure that MFIs adopt good Corporate Governance Practices. I would also request members to provide their suggestions regarding this. Since I do not see MFIs operations from a pure corporate angle, the sector is in needs of good governance rather than corporate governance along with promoting the best financial practices. We all know that corporate governance is not the same as Good Governance. There is dearth of documentation on Best Practices in Rural Finance / Microfinance.
Some Final Observations
Another question regarding regulation is that whether regulating the MFIs is sufficient? What about other channels like Money Lenders? What about the interest rates with in the commercial regulated banking framework? A car loan is easier and less expensive (8%) compared to education loan (12%). We need to sensitize the big brothers the role of banks in national development. Are the so called Regulated Banks, regulated enough? Are they transparent? I can give you my own story of a housing loan which I availed a few years back. I borrowed home loan on flexible interest rates. Bank is now providing new loans at 8% while I am paying over 9% interest on my loan. Although, any increase in interest however is immediately affected.
Emergence of MFIs suggests the over all failure of formal banking system across the globe in larger inclusion. It is unethical to bluntly blame MFIs in the name of regulation since government is more or less unclear on how to regulate. It is important to note here that MFIs and private banks together made banking more or less accessible to the poor. Within a high risk lending framework the micro finance sector is doing its best.
Finally if no MFI, do we have an alternative banking channel ready with us? Is our formal banking system capable (or committed) to provide access to finance to all? It is definite that Micro Finance sector require innovation where packaging of different subsidiary / complementary products is explored to reduce the operational cost.
Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai (response 2)
You may find this of special interest. Some proposals towards incentives as part of the regulatory framework in India: Never Waste a Crisis - Use It to Get Micro-Finance in India Back on Track: Some Proposals for Incentives As Part of A National Regulatory Framework: http://microfinance-in-india.blogspot.com/2010/11/never-waste-crisis-use-it-to-get-micro.html
You may also be interested in looking at:
The Key to Getting Micro-Finance in India Back on Track Lies with Establishing the Right Incentives for Various Stakeholders…Part II, Client Perspective: http://microfinance-in-india.blogspot.com/2010/11/key-to-getting-micro-finance-in-india_21.html
Expectations Rise as the Hon Finance Minister of India, Shri Pranab Mukherjee, Waits for The Report of RBI Board Sub-Committee on Micro-Finance: http://microfinance-in-india.blogspot.com/2010/11/expectations-rise-as-hon-finance.html
The Key to Getting Micro-Finance in India Back on Track Lies with Establishing the Right Incentives for Various Stakeholders…Part I: http://microfinance-in-india.blogspot.com/2010/11/key-to-getting-micro-finance-in-india.html
The Zahera Bhee Case Study: http://microfinance-in-india.blogspot.com/2010/11/can-we-bring-back-ayeshas-ammy.html
Effective Interest Rates in Andhra Pradesh: Results from an April 2010 Study: http://microfinance-in-india.blogspot.com/2010/11/effective-interest-rates-in-andhra.html
Analysis of APMAS April 2010 Study on Effective Interest Rates: Further Evidence For Multiple Borrowing in Andhra Pradesh: http://microfinance-in-india.blogspot.com/2010/11/analysis-of-apmas-april-2010-study-on.html
APMAS Study in Nellore District Indicates Significant Borrowings by (Default) SHGs From MFIs:http://microfinance-in-india.blogspot.com/2010/11/apmas-study-in-nellore-district.html
MFIs May Seem to Have Lost the Battle But They SURELY Can Still Win the War!: http://microfinance-in-india.blogspot.com/2010/11/mfis-may-seem-to-have-lost-battle-but.html
Evaluating MFI Internal Control Systems: Some Strategies for Regulators and Supervisors:http://microfinance-in-india.blogspot.com/2010/11/evaluating-mfi-internal-control-systems.html
Strengthening Internal Controls During Turbulent Times: What Should MFIs and Regulators Do?:http://microfinance-in-india.blogspot.com/2010/11/strengthening-internal-controls-during.html
What is Coercion in Repayment; A Client Perspective from Indian Micro-Finance: http://microfinance-in-india.blogspot.com/2010/11/what-is-coercion-in-repayment-client.html
Thanks again for your valuable replies and please do offer some comments on the proposed (suggested) incentives.
T Vanitha, BASIX, Andhra Pradesh
I agree with Mr. Jaipal, now a days every body is asking about MFI regulation, already MFIs have self regulation (created MFIN) and serving according to that mission. However, in MFIN also few companies are working for only their profit, not for the service.  Because of these companies others are facing so many problems at the ground level.  Especially AP Ordinance is a very big issue for the sector. As per the ordinance there is a lot of emphasis on the Government’s interference in day to day transactions of the MFIs. This in return will effect the smooth functioning of the MFIs as they will not be able to serve their customers.
Moreover, because of this MFI staffs are facing lot of problems in villages and our staff is also demotivated. Nearly 25,000 people are working in this sector and no body is thinking about their lives and livelihoods. Even media (paper and electronic) is reporting the negative side of the microfinance, despite its benefits and lot of positive work.
R. Ramachandran, Association for Development through Integration and Cooperation (AICOP), Cuddalore, Tamil Nadu
I am a founder and secretary of a small NGO. With available resources our organization is working in two blocks in Tamil Nadu under Mahalir Thittam having more than 2000 SHGs. But now days many MFIs are entering in to lending the women without keeping in mind the requirements of the loans in the area. Because of such methods we are suffering in linkages with banks. Earlier the groups that were linked with the banks have started taking loans from the MFIs as well. This has disturbed the activities of the organizations that had 10-20 years of field work in development activities. While looking at the aspects of regulating the MFIs we should also look towards the need that MFIs while expanding their work should not disturb the existing NGOs.
Savita Shankar, Lee Kuan Yew School of Public Policy, National University of Singapore, Singapore
Further to the query on National Framework for Microfinance Sector, I would like to share an article on the recent developments in Indian microfinance. To read the article, please visit:http://epaper.dnaindia.com/newsview.aspx?eddate=11/24/2010&pageno=10&edition=9&prntid=129512&bxid=30696276&pgno=10
Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai (response 3)
Many thanks for the very useful suggestions and analysis. I would be grateful if the community members look at the aspect of governance and regulation specifically and send in some replies. Thanks and the following may be of interest to you in this regard.
The Governance of Risk Management in MFIs: Lessons from The Andhra Pradesh and Indian Experiencehttp://microfinance-in-india.blogspot.com/2010/11/governance-of-risk-management-in-mfis.html
The Governance of Remuneration in Indian MFIs: Lessons from The Indian Experiencehttp://microfinance-in-india.blogspot.com/2010/11/governance-of-remuneration-in-indian.html
Who Are The ‘Rogue MFIs’ That Have Supposedly Caused The Andhra Pradesh Micro-Finance Crisis?http://microfinance-in-india.blogspot.com/2010/11/who-are-rogue-mfis-that-have-supposedly.html
The Emergency (Liquidity Bailout) Fund for The Indian Micro-Finance Industry: A Great Chance for The RBI to Take CONTROL!!! http://microfinance-in-india.blogspot.com/2010/11/emergency-liquidity-bailout-fund-for.html
Harish Chotani, Resource Consultant - Microfinance and Livelihoods Promotion, Gurgaon
The roots of microfinance and poverty are connected whilst the stem of both is “Human Element”. It’s the compound of social and economic deprivation that needs attention of various stakeholders from the government, private and non government sectors to employ focused resources that must be ‘outcome and impact’ oriented focusing on the poverty.  On this accord, it becomes even more demanding upon MFIs (NBFC, NGOs and others) to provide products and services with conscious mind that is ‘catalysing in uprooting poverty among its cliental. This conscious mind among the providers of microfinance services must ensure that ‘mere access’ is not the only objective but other critical factors mutually perceived between the service providers and clients are also taken into account such as ‘affordability and sustainability’ by clients i.e. ability to pay back and still allow growth in business/household assets for safety nets, are part of the service spectrum.
 
Although ongoing discussion on ‘National Regulatory Framework’, is indeed pertinent for ensuring standards, controls and perceived seriousness to allow regulated growth in the microfinance sector. The need for this is long over due as so many countries including our neighbours from the Central Asian region have already gone ahead with the legislation. Hope the recent revelations happened in Andhra Pradesh will prompt our government to take quick and prudent steps rather than limiting these discussions over the media.
In the back drop of the growth and immense experiences that the microfinance sector has demonstrated, we must very seriously take into account the demand and supply as well as critical elements emerging from the SWOT spectrum, so that the final version of the regulatory measures are not just limiting to reporting statements with enormous transactions, but is based on the core of microfinance for the poor which is unique to regular commercial based financing. It is also pertinent to note that there are various forms of MFIs e.g. NGOs, NBFC, Cooperatives specific to urban and rural, Federations driven by SHGs membership, Credit Unions etc. However, the following principles may also be essential for objective regulation:
1. Statutory Accountability is regular and comprehensive that leads to transparency and good governance;
2. Regulate the outreach  in terms of geographical growth, financial deepening, regularity of services, other qualitative aspects including seeking clients’ feedback so that to service delivery is well balanced on the demand and supply elements and is not mere an ambition to grow in scale (number of clients, branches, across states, sum of portfolio etc;
3. The trends emerging out of the regulatory practices are also interwoven to policy reviews, structural adjustments and financial resources mobilisation including venture capital funds, resources allocations, and interfacing with the larger poverty agenda.
4. Finally, the above three principles enable establish Ethical Microfinance Services (EMS) where the interests of the ‘Service Providers’ (SP), and the ‘Service Users’ (SU) are balancing the demand and supply with poverty focus rather than mere scale focus.
Along the sphere of the regulatory framework and mechanisms, the emerging trends in the microfinance sector also take us to a number of hard core and soft core factors for micro review with “Full Conscious Spirit” than egoistic belief of “All is well”. As we all know that the first rule of any game is ‘Ethical Engagement’ (EE). One essential question to put it upfront in this case would be: Has the poverty been impacted along the enormous scale up that the microfinance sector has experienced especially in the last one decade? i.e. to critically review the intrinsic relationships between and among the aspects such as:
Upscale -  Number of clients, portfolio valuing Crores of rupees, Number of branches in relation to outcome and impact achieved at clients and households level;
Accessibility based on the poverty spectrum i.e. rural, urban, vulnerable, poor;
Affordability- financial elements in terms of opportunities to get return on investments through viable livelihoods; and
Sustainability of clients’ financial and non financial health is as important as quality of portfolio for MFIs ( in the present context former is nearly non entity)
Unless the above are appropriately balanced with specific focus on the ‘Poverty Lending Service Delivery’ the MFI may have achieved operational and financial sustainability, usual regulatory prudence may have also been complied with when enacted, but the vision and mission of microfinance would remain unaccomplished. As we all know that formal financial institutions given the mandate of delivering products and services, some directly and others through the MFIs, are periodically regulated, but we are still experiencing the core gaps of scale and outreach, financial deepening, outcome and impact issues etc. Surely, we do not want similar regulation for the MFIs that becomes statutory event only.
I would like to share with you a short story of a moneylender and his client. A money lender offered to his client two options- (i) he will pardon his loan if he (client) marry his daughter with him (moneylender), (ii) if not, he has to pay the loan as per schedule. To decide this, the money lender also offered a so called democratic process which was to pick up one of the two stones from a bag. One of the stone was black that attached to option one (daughter marry and loan waiver) and the white stone attached to option two. Daughter was asked to pick up one of the two stones. Whilst picking up the stones, the moneylender had picked both the stones in black, but the daughter had noticed the cunning trick. However, she decided to go along with the preposition and picked one stone but purposely tumbled and fell on the ground and opened her palm to let the stone mingle with other stones on the ground. So, she asked the moneylender to decide the deal based on the second stone which was black and option one prevailed. So, she saved her own life as well as of his father’s debt.
The moral of the story is that we need to ensure that service providing is well regulated and ethical; and that the user of the services are “adequately literate”.
N. Jeyaseelan, Hand in Hand, Chennai
I would like to share the following with regard to the MF regulations.
Only one regulator for the sector: MFIs of all legal forms (societies, trusts, co-operatives, Section 25 Company and NBFC) be brought under one Regulator for Microfinance.
Formation of regulatory authority: The MFI practitioners are not able to come to a consensus on who should be the regulator either RBI or NABARD. The earlier bill suggested NABARD as the regulator and NBFCs were kept outside its purview. Hence, the Government shall form a new Regulatory authority with officials taken from RBI, NABARD, SIDBI and also from Market. The Regulator should be made as a full professional body.
Governance of Regulatory authority: The board should have majority independent Directors apart from nominee directors from RBI, NABARD and SIDBI.
Registration of MFIs: As the NABARD is having its District Development Manager (DDM) office at every district and the DDM are well aware of the SHGs and NGOs, the Bill shall mention NABARD DDM's office as local authority for registration of MFIs.
Risk based supervision may be put in place. Those offering credit only will be under lesser supervision. But, those offering credit and savings will be required to undergo more prudential norms.
Regulatory capital: The draft bill prescribed a limit of Rs.5 lakh so as to give space to smaller MFOs. But, as mobilizing thrift is a risky one, higher net owned funds may be prescribed as follows.
For MFOs doing only mf services other than thrift- Rs. 5 lakhs
For MFOs doing any mf services including thrift service-Rs.25 lakhs.
Governance: The Regulator should bring out guidance on Constitution of board of MFIs. Board of MFIs should have varied expertise ranging from Banking, Finance, HR, Legal, Strategy, gender, community development. Adding Nominee directors from financial institutions should be made as compulsory.
Credit Bureau: Right now, credit bureau access is open only to MFIN members, which are NBFCs. The Government and IFC shall invest on a common Credit Bureau that will take care of the entire sector including the small NGO MFIs. Credit bureau with the participation of just big players will not serve the real purpose. Banks also should share their data on SHG direct linkage to CB
Redressal mechanism: The draft mentions that if deemed necessary, MFDC may appoint MF ombudsman. It should be changed so as to appoint MF ombudsman to every state level, as the problems that will come to ombudsman will be diverse from regional context.
The regulator should impose the interest rate ceiling. But, the cap should be based on the average cost of funds, cost of operations of a typical MFI in a specific regional context. Two set of rates may be prescribed i.e. one for MFIs below 3 years and another one rate (slightly lower than the first one) for the MFIs of 3 years and above.
District and State level Steering Committees: The regulator shall provide for formation of district level and state level committees. In district level, all NGOs operating in the district will be the members in the Steering committee, where bankers and Government officials also will be coming. The meetings will be monthly. The forum will discuss the problems and will take up the disciplinary cases regarding the MFIs violating the code of ethics.
State level forums will have selected NGO-MFIs, Bankers and Government officials meeting once in 3 months and will address policy issues.
Regulator will come out with a Code of Conduct for MFIs.
The above suggestions, if taken into account in the bill, will enable the sector to overcome the challenges.
Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai (response 4)
Thanks for all of your responses and also addressing the Governance issue. I look forward to more responses on the same. You may be interested in looking at this:
Outsourcing and The Use of Agents in Indian Micro-Finance and Regulatory Implications:http://microfinance-in-india.blogspot.com/2010/12/outsourcing-and-use-of-agents-in-indian.html
The Role of Independent Directors in Enhancing Corporate Governance in Indian MFIs: Specific Issues That Need To Be Examined By The RBI Board Sub-Committee: http://microfinance-in-india.blogspot.com/2010/11/role-of-independent-directors-in.html
Why Did Several Top Indian MFIs Grow Very Rapidly During April 2007 to March 2009: 4 Scenarios for Hypothesis Testing By The Reserve Bank Of India Board Sub-Committee on Micro-Finance!:http://microfinance-in-india.blogspot.com/2010/11/why-did-several-top-indian-mfis-grow.html
 
Improving The Governance of Compensation in MFIs: Four Practical Strategies Based On The Indian Experience: http://microfinance-in-india.blogspot.com/2010/11/improving-governance-of-compensation-in.html
 
The Proposed Credit Bureau for Micro-Finance in India: A Great Idea But Let It Not Be Baptism by Fire!:http://microfinance-in-india.blogspot.com/2010/11/proposed-credit-bureau-for-micro.html
The Governance of Risk Management in MFIs: Lessons from The Andhra Pradesh and Indian Experience:http://microfinance-in-india.blogspot.com/2010/11/governance-of-risk-management-in-mfis.html
Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai (response 5)
Many thanks for the wonderful and highly informative responses on the regulation query.
I have compiled some lessons for regulation from the current crisis and this may be of interest and use to you all.
Views, Issues and Initial Lessons on The Regulatory Front From The 2010 Andhra Pradesh and Indian Micro-Finance Crisis: http://microfinance-in-india.blogspot.com/2010/12/views-issues-and-initial-lessons-on.html
Ramesh S Arunachalam, Independent Micro-Finance Practitioner, Chennai (response 6)
The issue of interest has always been a debatable one and I think that policy needs to look at several issues before deciding on what interest rates are appropriate.
I would be grateful if community members respond to the interest rate issue from a regulatory perspective and please look at the following as well
Understanding Micro-Finance Interest Rates: Some Fundamental Issues For The RBI Sub-Committee to Consider...: http://microfinance-in-india.blogspot.com/2010/12/understanding-micro-finance-interest.html
There is also the issue of some level of regulatory failure in every crisis and you may be interested in looking at this as well.
Learning From Crisis Situations: A Comparative Analysis of 2010 Indian Micro-Finance Crisis With Two Past Crisis Situations...: http://microfinance-in-india.blogspot.com/2010/12/learning-from-crisis-situations.html
Views, Issues and Initial Lessons on The Regulatory Front From The 2010 Andhra Pradesh and Indian Micro-Finance Crisis: http://microfinance-in-india.blogspot.com/2010/12/views-issues-and-initial-lessons-on.html
A P Fernandez, MYRADA, Bangalore (response 2)
The focus of concern during the recent past has been on the risk to MFI-NBFCs. Several articles have appeared on the need for MFIs to give priority to risk assessment and management, to insurance, to provide for political risk and to securitize their portfolios, but very little has appeared on the risk borne by the clients - until the reported suicides brought their risk squarely into the political domain. This note focuses on the risk borne by clients.
But first I would like to make my position clear and distinguish between two groups: The first group consists of the poor who need credit plus other opportunities for livelihood activities to survive. These activities largely include a mix of dryland agriculture, farm and plantation labour, small trading, animal husbandry, cottage industries and collection of forest produce. My position is that the poor need some extra investment in order to go beyond survival and enter into the growth trajectory. These opportunities are provided by all round growth in the area due to investment by private or public sector and by NGOs to reduce risk and increase productivity in agriculture related livelihoods, to provide health, education, infrastructure and industry etc. This extra investment also has to take the shape of institutional support- like the SHGs at the base which provides the poor with the space to set their agenda to support their livelihood strategy which comprises several activities, as well as with the skills, confidence and linkages to use the opportunities provide by all round growth and to neutralize oppressive power relations arising from local power structures and gender. This extra support cannot be given as a short term credit at commercial rates where repayments are fixed by outsiders. It requires a degree of subsidy not of the assets but of the services required to support the livelihood strategies of the poor and for institutional capacity building (ICB) so that the SHGs function as genuine participative and membership institutions. This requires a long term perspective.
I do not think the business model of the MFI NBFCs which is driven by venture/private capital, quick disbursements, weekly repayments, high profits and remunerations for senior staff, a focus on valuations and IPOs and a quick exit in appropriate for this group. It increases their risk, often beyond a level that they cannot bear. The SHGs and the SHG-Bank Linkage Model (as it was originally conceived) is to me the appropriate strategy for this group. The affinity among the members provides the pressure for recovery and their savings provides the space to adjust repayments when a member has a genuine problem with cash flow. In Myrada’s experience, interest rates from groups to members also fall from 20-24% to stabilize between 12 % to 14%.
The second group is not poor; their livelihood strategy largely includes non farm activities; but they cannot grow to meet their aspirations without access to credit even at market rates. They cannot get this credit from banks because they do not have land records or fixed assets like houses to provide security and no credit history. They do not have the confidence and skills required to negotiate with banks if they need credit for activities in the non-farm sector and do not have access to working capital from official financial institutions. Unlike in the agricultural sector, there are a few Government sponsored schemes which are really working that support this group.  They rely on private credit from relatives, friends and finally moneylenders –all at differing interest rates. Of course borrowing from relatives involves an obligation to lend them when their need arises. The business model of MFIs can meet the needs of this group provided profit is not maximized at which level there is little difference between them and the moneylenders. In maintaining a balance, good governance of the MFI can play a greater role than regulation; but evidence indicates that good governance is in short supply. The major problem is that MFIs will need security to back their loans to this group. The MFIs and the borrowers do not have the time or resources to invest in forming SHGs where internal pressures to manage and repay loans operate. The JLGs will not function for long if one member fails to repay. The security will have to take the shape of assets. Most of the families in this group have some gold which they pledge against loans. This is why those Financial Institutions dealing in gold loans are growing so fast.
The words “marginalized” and “excluded” in this paper include both groups the poor and the not poor who have no access to credit from the official system. Of course there is a group that does not fall clearly into either of these categories but in a way has features of both. We will leave this group out for the moment.
This distinction between the two groups is relevant to the current debate due to the following: Over the past few years the MFI NBFC model was held up as the most effective in promoting rapid financial inclusion of the marginalized. Both groups mentioned above were included in this term.  The current crisis shifted the focus to the SHG approach and the SHG-Bank Program. Some say that this is the only approach. To me it is the appropriate strategy to address the hurdles that are in the way of the poor to be full included into growth (not just into the financial system). The SHG model has features which do not make it an effective model for fast disbursement of credit. It is not appropriate for this second group which needs credit. The hurdles in the way of the second group do not arise from lack of confidence of skills or linkages; they arise from lack of infrastructure water roads and power, from a corrupt government service delivery system and from lack of working capital. The MFI loans to this group are used both for investing in income generating activities as well as to purchase consumer items including gold. The temptation to borrow in excess of their capacity to repay is strong, especially when there is sales pressure from several MFIs who come to their doorstep.
Others say that both models (MFIs and SHGs) as well s the third - the moneylender are appropriate without making this distinction between the groups This is a “chairman’s approach”. They are appropriate but to respective groups.
Let us now revert to the risk for borrowers - primarily borrowers in the first group of the poor but also in the second group where the borrowers have succumbed to the temptation to borrow from several MFIs - multiple borrowings. They are locked into a cycle of regular repayment. Together this excess borrowing and cycle of repayment also increases their risk considerably especially when their cash flow is interrupted.
Risk and the official policy promoting inclusion:  Inclusion of the poor (the first group) into the formal financial system of the country involves considerable risks and costs on their part. The SHG model was an attempt to lower this risk and costs for the poor by providing an intermediary institution which the poor managed. Profits to the Banks were low; they were satisfied since the program was categorized under the priority sector and repayments far exceeded those under previous programs like IRDP.  But the MFI/NBFCs have not included the marginalized into the country’s financial system as they claim. They have in fact included them directly into the international financial system which is not only inappropriate as a first step but raises the level of risk that clients have to bear. The international financial system is driven by venture and private capital whose DNA is characterized by high profits, high cost (interest, salaries and commissions), IPOs, quick exits and frequent and regular repayments on the part of the borrower. These are the features of the MFI/NBFC business model.  This raises the level of risk to both categories of clients considerably.
Between 2003-2008 integration of the country’s trade and financial sectors with the world economy grew steeply and quickly. The main concern of the RBI during this period was to manage this integration. The RBI cautioned that it should go slow; words like “calibration”, “a road map”, “step by step “were used. Alongside, initiatives were taken to strength the country’s institutions before this integration was speeded up in order that they could cope. The RRBs were consolidated, efforts to revive the Cooperatives rural and urban were taken, a Working Group was set up and a plan drawn up for restructuring long term lending institutions for agriculture. The pressure from other Government sources in the country however was to move faster with this integration on the belief (mistaken, I think) that the impressive growth rates achieved were almost exclusively due to opening up of the trade and financial sectors to the world economy.  The RBI’s step by step approach gave time for the country’s financial and trade institutions to cope with the pressures of integration.
Unfortunately the RBI did not take the same approach with regard to the MFI-NBFC’s in their rapid growth on the grounds that it was urgent to integrate the poor into the international financial sector. The RBI took actions- but they related to plans for extending financial services into the interior (Business Correspondents and Facilitators and use of technology), removal of caps on interest rates (Banks could charge commercially viable rates for priority sector loans below Rs. 2 lac) etc. The RBIs focus was on pushing the official financial system further into the interior on one hand and, on the other, a “hands off” approach as far as the MFI-NBFCs were concerned, encouraging them at most to “self regulate”. “Soft regulation” of MFIs was the policy that gained ground, because it was assumed the MFIs are local, community based organizations which they are not. This lack of regulation/direction increased the risk of the marginalized that were “included” by the MFIs.
The induction of venture and private capital into the MFIs in a major way during the past three years is primarily responsible for raising the level of risk to clients. Venture/private capital seeks to maximize profit and to do it quickly. Their mission is to take high risks and they expect to be rewarded with high and quick profits. The investors argue that since they do not use debt, they should not be regulated. None of them in the US has asked to be bailed out. This makes good sense. But by including the marginalized into this sector the pressures created by these features (high risk /high reward) are passed on to the client which raises the level of their risk. Multiple borrowing is resorted to as a first step out of this situation but this cannot last and there comes a stage when the client can no longer bear it. The SHG Bank Linkage program was brought under the priority sector to encourage the banks to promote the flow of credit to the poor, but the SHGs provided a safety net. Once Banks lent directly to MFIs they ended up pushing money and going along uncritically with the culture and practice of the MFIs which used Bank’s finance to include the clients more deeply into their neo liberal model.    The Banks were only concerned with the level of repayment which was good and which gave them the leverage that their performance in the priority sector provided. As long as the repayments were good, the MFIs were encouraged without any attempt at regulation.
Risk and focus on speed to ‘include’ by disbursing credit (and by implication to include). Speed to disburse is  the dominant feature both of the neo liberal model  of the MFIs and  also of the SHG model after it was adopted by the Government as part of its official strategy to mitigate poverty, fortunately high profits and remunerations  were not part of the Government’s  strategy.  The SHG Bank Linkage Model grew slowly till 2000 and with adequate investment in building the institutional capacity of the SHGs before Banks loans were extended. When it became part of Govt. policy in 2000, pressure was exerted by dedicated Government officers at the District to grow fast and achieve targets.  As a result, the quality of SHGs declined and so did their performance in mobilizing savings, in deciding on loans (equal distribution became common), managing repayments (NPAs increased) and in building a supporting environment for a livelihood strategy. SHGs were formed to achieve targets, with the wives of the Panchayat president and secretary dominating proceedings; they borrowed from Banks and lent outside at higher rates; other members did not benefit while repayments to banks was good. Official reports focused only on disbursements; corrective measures were taken to balance the spread in areas where growth was slow but no investment was made to add value or to support increases in productivity and diversification. No priority was given to form SHGs on the basis of affinity where the poor members were identified in public and then had the freedom to form SHG by self selecting their members. Very few SHGs were provided with institutional capacity building so that all members participated in decision making.  All this took time; the Government was in a hurry to disburse and include.
The SHG is not a good model for speedy disbursement of credit; but it is a good model for lowering the risks of the borrowers as well as the lenders. The SHGs have savings which they use to cushion irregular cash flows; they are able to adjust to urgent and unexpected situations, yet Myrada’s analysis of its SHGs shows that their common fund increases year on year.  The MFIs do not work with SHGs as forming and nurturing them takes at least 3-6 months before loans can be extended. This is too slow. They claim that they work with Joint Liability Groups. If the members are jointly liable, why does the staff of the MFI have to exert pressure on clients for repayments?  One MFI when asked which groups it was working with came up with a new one “SHG-JLG”; it had promoted 20,000 in one year!  Speed is the order of the day and the message from the Govt. supports a faster level of integration in both systems – national and international.
The impact of the focus on speed on the MFIs operations is logical. The velocity of money plays a major role in generating profits. So they insist on weekly repayments. This increases the borrowers risk and vulnerability to local power groups. Incomes from agriculture are lumpy not weekly; incomes from animal husbandry are usually monthly. Clients are forced into activities earning daily like labour or shops or into a pattern of multiple borrowing where they have space to borrow from one and repay to another. In fact my experience is that both multiple borrowers and MFIs who are lending to the same individual are happy to continue. The former use multiple borrowing as a safety net and the latter finds that it keeps the velocity of disbursements and repayment high. One practice that contributes to this is that borrowers hardly ever repay the entire loan before their loans are topped up. However if their source of income collapses, if their borrowings are largely used for consumption ( as is the case with MFI loans since the clients cannot find investment opportunities to absorb the credit flow) and if the pressure to maintain the schedules of repayment continue as before, the pressure can become unbearable.
Risk and Interest rates: High interest rates are justified, the MFIs argue, because the risk of lending to small borrowers is high, the cost of delivery at the doorstep is high and finally the rates are far less than those of the private moneylenders. But high interest rate to the poor in the first group increases their risk. More significantly, the claim that there is high risk involved does not seem to fit the over-all picture which shows high profitability. The State of the Sector report 2010 (N. Srinivasan) indicates that out of 60 MFIs which reported on profitability, six had ROAs over 7%; thirty five had ROAs over 2%. In contrast the public sector banks in 2009 had average ROAs of 0.6% with the best being 1.6%, while the best private bank had ROAs of 2%. The yield on portfolio confirms this picture; in the case of 23 MFIs it was above 30 %( the highest being 41.29%). Further the report says that the assumption that economies of scale will result in drop of interest rates resulting in lower yields was not confirmed. Obviously the DNA drove the MFI to maximize profits and competition did not decrease rates as it was expected to.
The poor are boxed in a high interest rate regime. Yet the MFIs did not agree to reduce their interest rates even when it was clear that the risks had become unbearable, On the contrary their spokesperson said:” The basic fact is that providing credit is expensive, difficult and risky. If MFIs have to be sustainable, society will have to get accustomed to the interest rate”. (The Week Nov 14,2010 pg 24)
As a result the largest MFI recorded a 116% jump in net profit at Rs. 81 crore in the second quarter ending Sept 2010 as against the corresponding period last year. No one questions that profits should be made, but the level of profit required to meet all costs, cover risks and expand operations is different from the level of profit required to meet all these costs plus attract venture and private capital, pay salaries and commissions higher than the remunerations of the CEO/MDs of the largest private banks. Valuations not values seem to drive the sector. While this again can be justified, it does not seem to be an appropriate business model for the poor where values are required to guide the governance of these institutions. The MFIs can provide credit to the non-poor but regulation by the RBI is required; self-regulation was tried in 2005 but no one bothered to comply.
And the major question - What should be the interest rate? The figure of 24% is floating around in official circles. The problem is that the effective interest rates of MFIs are far from clear. There appears to be a difference of 5% to 10% between the rates as provided by the MFI and the rates that emerge from an analysis of the books of the clients. Professionals in this field say that the MFIs do not know how to calculate effective interest rates.  No wonder one representative remarked that the MFI made profits by accident. The management of add-ons like insurance also adds to the credibility deficit.  MFIs argue that the cost of credit form banks is high and that they should be allowed to mobilize public deposits if interest rates are capped. Interviews with clients show clearly that they do not have an idea of what they actually pay over and above the capital.  They are satisfied if credit keeps coming preferably through the practice of “topping up”. In fact interviews with those clients who had succumbed to the temptation of multiple borrowings showed clearly that they wanted to borrow from several MFIs to maintain a cash flow which coped with repayments as well as their expenditure. Multiple borrowings and topping up serve the same purpose as far as they are concerned. In turn this increases their risk substantially.
To get some guidance about interest rates let us go to the SHGs. We find that interest rates of SHGs in Myrada stabilize after two years or so between 12% and 14%, which is about 3% to 4% above cost of credit from Banks. Non for profit MFIs which do not pay high salaries but adequate to attract experience and capital from Banks manage to make a surplus at interest rates between 17% to 19% where the average cost of credit is around 9% -10% and annual  growth rates are 40% to 50%.  For Profit MFIs should be able to manage their affairs and attract capital (not venture capital and high valuations) by charging effective rates ranging from 15% to 17% above the average cost of credit. This would put interest rates for the For Profit MFIs in the range of 24% to 29%.  At present they are charging about 20% to 30% above the average cost of credit. Commissions on add ons like insurance need to be biased in favor of the client and not to maximize profit of the MFIs.
 
To conclude: The poor in the SHGs  manage with interest rates of 12% -14% and they have managed with interest rates higher than these in the initial period till they built up their  groups common fund. They can therefore cope with interest rates of around 17% which Not for Profit MFIs are levying. The risk involved in manageable; the cushion provided by the SHG will help them to tide over urgent needs.  The not poor in the second group can cope with higher interest rates levied by For Profit MFIs but the rates should not exceed 30%.
 
Competition among MFIs has not had an effect on reducing rates, neither has self regulation.  The bottom line is that interest rates, commissions, salaries, profits have to be regulated by the Board.  It has to come from good and value based governance which seems to be in short supply. The decision by the Board to go in for an IPO will surely force management to focus on the coming quarterly figures as the logic of the financial markets dictates it should.  This will further integrate (include) the marginalized into the free market system of which the share market is perhaps the best expression of high risk and profits. This will in turn increase the risks of the clients who are particularly vulnerable.
 
The exorbitant hike in airline fares attracted quick reaction from government- first to reduce the fares and later to ensure that they are transparent. This case is similar to the one related to the interest rates because the reasons put forward by both the parties are similar. The result in the case of the airline fares is that fares have been reduced. But airlines tried their best to avoid transparency in exhibiting the real fares. In fact the first attempt was so confusing that one had to be in the travel industry to unravel them. Ditto for interest rates. Why is the Government hesitating to regulate interest rates? Years ago I was asked by senior official whether the liberalization policy would affect the poor. My answer was that the poor have survived in a liberal economy – their wages rise and fall on demand and supply, they pay above market interest rates; they are not subsidized. Those around are the table may have difficulty in adjusting. If Govt. can move so swiftly in the case of airline fares, why the delay in the case of interest rates – both to set a ceiling as well as to ensure transparency?
 
Are MFIs really better than moneylenders? To begin with in neither of these groups is the effective interest rate transparent.  The objective of moneylenders is to ensure repayment of interest not of the capital and they are flexible as regards the amount of repayment. But they can adopt this approach since they have long term relationships with the client and no software to conform to which requires standardization in repayments.
 
In the late 80s I asked a group of village people in Bidadi to select symbols to describe their sources of credit. First they pointed out to a large boulder –“that” they said, “is the bank; we cannot move it”. Next they placed a small boulder in the middle with some pieces of newspaper beneath. “This” they said is the Cooperative; the paper is the money we have to pay for a loan”. Third they placed a twig of parthenium. (Popularly called congress grass); “once this comes in the field we cannot remove it”. Then I asked “In which do you have the greatest trust”. Without hesitation they pointed to the twig of parthenium. (A Year later they add a flower to symbolize their SHG). The moneylender lives among them or closes by and is involved in several other activities in the life of the village. In the MFI the speed involved in dealing with borrowers fails to build sufficient trust and understanding between the two – this is where the moneylender scores over the MFI. One MFI staff has to cover several borrowers who are usually asked to come to one place at a fixed time.  The time for the next group to meet is fixed.  It is very much like a private bus which has to stop   at fixed times and for as short as possible over the route. If the staffs delay, another MFI will reach the group and secure their dues just as the private buses have to rush in order to keep ahead of the competition.  If the borrowers are late they are fined in many cases; trust is not built in this business model.
 
Once again our experience with SHGs as well as with MFIs indicates that the interest rates operating in SHG model is the most appropriate for the poor, while the interest rates operating in the For Profit MFIs is appropriate for the not poor but who are in need of credit. In keeping interest rates within limits, the governance of MFIs has a greater role to play than any regulation since it involves other costs related to salaries, commissions as well as over all institutional values.
 
 
Navin Anand, United Nations Development Programme, New Delhi
Many thanks for your valuable contributions on the issue of MF regulations. Following are my views on the MF regulatory framework-
 
Complexity of the MF Environment in context of Regulations
 
The microfinance milieu in context of regulations looks complex today due to the diversities in context of the MF organizations, their legal entities, variation in MF products and services Microfinance institutions, different variety of regulatory bodies, diversity of target population in terms of their economic and social status as well as geographic locations and level and extent of mF operations etc.
 
In such a complex environment, it is definitely difficult to come out with a single regulation that can cover all the microfinance service providers. Hence in such a situation, it is pertinent to have a regulatory framework that simply specifies the boundaries of different regulatory bodies and relevance as well as importance of compliance to different regulator by the service providers of the microfinance Sector.
 
An analysis of the regulatory scenario for MF reveals the fact that the commercial banks, Regional Rural Banks, Cooperatives Banks, local area banks and other private banks, are covered under Banking Regulation Act and also RBI’s regulations related to microfinance. The National Bank for Agriculture and Rural Development (NABARD) supervises and regulates the banks working in rural areas and also play a key role as promoter and wholesale financer for banks and MFIs.
 
The Non-Banking Finance Companies (NBFCs) engaged in microfinance are being regulated by RBI whereas  the NGOs, Trusts and other not-for-profit institutions functioning as financial intermediaries are out of the purview of the direct supervision of the RBI. The scenario of rural as well as urban financial cooperatives is more complex as these institutions are being regulated by registrar of cooperative societies and also by NABARD/RBI. Since the status of regulations and cooperative Acts are varying in different states the provisions in the Acts are not similar in all the states. Within a state the provisions depends on the Act in which the financial cooperative is registered.
 
Primary and Secondary Regulators or no Regulators/Self Regulators
 
Keeping in view the above mentioned scenario we need a MF regulatory framework which can answer the question – How a particular microfinance institutions/ service provider will be regulated/monitored.
 
In context of the above, the first option could be that different legal entities can be continue to be regulated by a primary regulator i.e. cooperatives are being regulated by the Registrar cooperative societies who regulates under the ambit of relevant cooperative Societies Act.
 
A secondary regulator could be common to all the legal entities who can watch the activities at the macro level in specific context of microfinance operations. In this way there will two boundaries of the microfinance sector in terms of regulations.
 
The decisions regarding the fact that whether any MF institution is to be regulated by Primary regulator or primary as well as secondary regulator or it will be self regulated will depend on various parameters. The extend of regulations will depend on the following factors –
Formal and informal characteristics of the organization
Legal entity of the origination
Product and Services provided by the organizations (It can be one or combination of product and services i.e. savings, credit, Insurance, Remittance/ transfer of money, micro leasing, Micro pensions.  The portfolio of activity will play a decisive role related to regulations applicable for an organization. Similar legal entities will be regulated differently if one is taking savings activities and other takes up insurance)
Delivery mechanism adopted by the organizations (Organizations doing mobile phone banking will be regulated in a different way compared to other organizations)
Direct financial intermediation or indirect intermediation (i.e. The regulations applicable for the organizations working as Business correspondent and business facilitator will be different from the NBFC or a bank or a pure MFI)
 
In addition to the organizations, there will be individuals functioning as service providers of microfinance such as Business Correspondents /Business facilitators and money lenders who will also come under the ambit of MF regulations. Hence the Regulatory framework and Mf regulations need to consider individual service providers in the regulatory frame.
 
The regulations for savings has due importance in the present scenario of microfinance. The present regulations restrict a variety of MFIs including NGO-MFIs for taking savings from the public. The regulators perspective of not permitting numerous small institutions to mobilize savings has been to give protection to poor. RBI has introduced Business Correspondent (BC) model so that through banks, adequate safety to the deposits of poor is provided. Recently, RBI has allowed BCs to appoint sub-agents thereby addressing financial inclusion agenda. The regulations in context of NGOs and other MFs functioning as BCs will be very different compared to those who are collecting money directly from the public and utilizing the same for undertaking other activities.
 
Remittances services have become important for the MFIs dealing with migrant labour and people living in remote areas. This demands a clear regulation related to the technologies and mechanisms for it. RBI’s clear guidelines facilitate MFIs to accelerate mobile banking activity for faster financial inclusion. Here regulations will depend on the type of institution taking up mobile phone banking.
 
Design Problem
 
Besides products and services which are related to the delivery of MF services, mechanisms for generating capital and funds is also required to be regulated. It is important due to the reason that it affects the implementation mechanism and norms of the providing MF services. Ultimately it is a project implementation cycle. If an MFI generates capital from the funders or individual investors then the MFI is accountable to the fund providers at one side and on the other the beneficiaries or clients.
 
There have been various funding models or capital generation arrangements such as a ‘Debt funding model’, ‘Partnership Model’, funding arrangements used by apex Government institutions. Besides this, there are funding models based on socially motivated venture capitalists and the fund generation model adopted by community based MFIs including financial cooperatives. These models differ from each other in context of sharing of risks by the funding institutions, form of financial support like bulk loans, grants, quasi equity, equity capital and loan guarantee funds. Regulations are required for the mechanisms adopted by the different MFIs and the commitment assured to the funding agencies or capital providers (organizations as well as individuals).
In the nutshell, we need a well defined standard MF regulatory framework at the macro or national level whereas at the state level the regulations will vary as per the situation as well as different Acts applicable in the particular states. Cooperative and money lending are state subjects so there can not be single regulation related to MF in all the states.
Central and State Governments can play vital role in standardizing the MF regulations in the country which has become important in context of saving poor clients who ultimately need microfinance services and on the same hand also needs protection.
Many thanks to all who contributed to this discussion!
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