The Indian government must regulate microfinance institutions (MFIs) in the interest of the millions of borrowing households that seem to be suffering from the problems of, among others, high interest rates and coercive recovery practices, sometimes allegedly leading to suicide.
There is a difference between microfinance activities undertaken by MFIs and self help groups (SHGs). Being strongly membership-based, small and homogenous, SHGs are controlled by members. Borrowers play a key role in the development of SHGs. They contribute small savings, regularly attend the meetings and participate in making the rules related to loans, interest rates, repayment schedules and mechanisms. These groups are thus characterised by self-management and self-reliance.
The government, civil society and academics had immense faith on capacity of SHGs in improving the access to savings and credit among the poor. This is because, first, there is no information problem as members are known to each other and they use this knowledge to select borrowers, monitor their actions and ensure repayment, leading to efficiency. Second, members’ participation in taking decisions ensures that borrowers are not put to any hardship.
However, SHGs depending only on member savings for carrying out lending operations faced constraints to expand their loan sizes. So, SHGs started borrowing from banks under Nabard's bank-SHG linkage programme, lending the same to members at higher interest rates. Even when SHGs borrowed from banks at about 12%, they did not charge exorbitant rates. The repayment schedule was fixed in consultation with each borrowing member and adjustments were made whenever the borrower faced problems. SHGs, thus, improve financial inclusion without causing borrowers hardship.
MFIs appeared in response to the criticism that SHGs alone would not be in a position to bridge the gap in financial inclusion. MFIs, also considered to be professional in their lending operations, have had considerable growth in the recent years. Although MFIs work with small groups, they do not insist on contribution of small savings by members. As a result, borrowers have not developed a sense of ownership for MFIs. MFI borrowers are referred to as clients rather than members. Lending operations (quantum of loan, disbursement, repayment schedule) are decided by the MFI. In addition, interest rates are decided by taking the cost of funds and administrative expenses into account rather than borrower difficulties. The dominant notion here is that what matters to the borrower is the access to credit rather than cost associated with it. Finally, the repayment terms and schedules are decided by MFIs. Borrowers (or their groups) do not have much bargaining power either to change the schedule or terms as is evident from the excessive use of loan recovery officers and their strong-arm tactics.
The high interest rates and coercive recovery practices imply that there is no arrangement within MFIs that would protect households borrowing from these institutions. There is, therefore, a need for regulatory framework, which not only protects borrowers but also encourages genuine MFIs to improve financial inclusion.
The author is professor at the Centre for Decentralisation and Development, Institute for Social and Economic Change, Bangalore.
The finance minister was recently asked at the Economic Editors’ Conference about the Andhra Pradesh ordinance on microfinance institutions (MFIs). He responded, “I had a talk with the CM and suggested certain corrections in the Ordinance... to see that the harsh provisions are taken care of.” He was also asked whether the microfinance sector requires additional regulation. He responded, “I am not currently thinking of appointing any regulator... we expect there should be a code evolved by the institutions themselves where rates of interest are not abnormally high and there should not be a coercive mechanism to recover the money.”
The FM has thus vindicated the stand of all the responsible MFIs. First, while there may have been sufficient cause for the adverse reaction of the AP government, it could have used existing laws to go after specific incidents of wrong-doing by specific MFIs, rather than demonising the entire sector. Second, the problem should have been reported to and tackled by RBI, under whose purview most MFIs fall, being non-bank finance companies. Third, that given the nature of clientele in microfinance, RBI regulation needs to be supplemented with sectoral self-regulation.
Any financial institution that is involved in retail lending (even without deposit taking) must be regulated by RBI. It prescribes norms for minimum capital, capital adequacy, provisioning for non-performing assets, risk concentration, asset-liability management and financial accounting/reporting. In addition, it lays down “fit and proper” norms for directors and the CEO, and guidelines for dealing properly with customers—in terms of transparency of charges, use of agents and grievance redressal.
If RBI has all these regulations, how would supplementary self-regulation help? First, MFIs are in hundreds, with thousands of branches, lakhs of staff/agents and crores of customers. This is impossible for RBI to supervise. Second, only peer MFIs know the detail of the business well enough to blow the whistle on each other. Thus, a self-regulatory body like the microfinance institutions network (MFIN) is needed.
MFIN has evolved an enforceable code of conduct. To ensure that it is effectively implemented, firstly, MFIN has put in place a mechanism for detection of any violations. Thirty million records of MFIN members’ borrowers have been uploaded in credit information bureaus. From January 1, 2011, no MFIN member can lend without a credit history check. This would dramatically reduce multiple lending and the resultant over-indebtedness. The second mechanism of detection is clients, for which MFIN is establishing a multi-lingual call centre for recording and redressing customer grievances. The un-redressed grievances will escalate to regional ombudswomen. To ensure enforcement, apart from peer pressure, MFIN will report violations of the code of conduct to the SIDBI-convened Lenders’ Forum. Given that 80% of MFI resources come from lenders, they can easily discipline any errant MFI.
Thus, the AP ordinance should be allowed to lapse, having served its cautionary purpose. Instead, the government and RBI should give MFIN a mandate to make its members function in a responsible manner through supplementary self-regulation.
The author is the founder and chairman of Basix, president of MFIN and chair of the board of CGAP, the global microfinance body, hosted by the World Bank.