Microfinance institutions showing signs of maturity

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Alok Prasad, chief executive officer (CEO) of the Micro Finance Institutions Network (MFin), a lobby group for India’s Rs.30,000 crore microfinance industry, is a happy man. The Reserve Bank of India (RBI) last week gave his organization the status of a self-regulatory organization (SRO) for those microfinance institutions (MFIs) that operate as non-banking financial companies (NBFCs). There are around 50 such companies, less than one-fourth of the MFIs that exist in India, but they account for at least 90% of the business. More than 200 not-for-profit MFIs account for the rest. Sa-Dhan is an association of such lenders.

RBI’s decision to give MFin SRO status is the culmination of a process that started in 1998 when the National Bank of Agriculture and Rural Development (Nabard) set up a task force for framing regulations for the MFI industry. Recognizing that MFIs are an important vehicle for giving loans to the self-employed women in rural India, the task force suggested creation of a special cell within RBI to coordinate between MFIs and Nabard and the promotion of SROs for setting performance standards and training the industry.

More than a decade later, a committee headed by Y.H. Malegam suggested putting in place an SRO structure for the industry to ensure greater compliance to regulations. The committee was set up in October 2010 following the turmoil in Andhra Pradesh’s microfinance sector, where a spate of suicides were linked to alleged coercive methods adopted by certain MFIs to recover loans. Against the backdrop of high interest rates charged by some MFIs, strong-arm tactics to secure repayments and instances of multiple lending, the state government passed a law regulating microfinance operations in the state. It mandated MFIs to specify their area of operation, rate of interest and recovery practices. It also became mandatory for the MFIs to seek the state government’s approval before issuing any fresh loans. Recovery of loan instalments as well as fresh lending to borrowers in the southern state, which accounted for a over a quarter of the total microfinance business in India, came to a grinding halt following this.

In November 2013, RBI announced that it would accord SRO status to an industry association. The functions and responsibilities of such an SRO would include formulating a code of conduct for the industry, setting up a grievance and dispute redressal mechanism for the borrowers and their protection and education. The SRO should have at least one-third of the for-profit or NBFC-MFIs and adequate representation from both large and small companies.

Theoretically, an SRO is an organization that exercises some degree of regulatory authority over an industry. The four key aspects of self-regulation are designing the rules, adopting them, monitoring compliance and achieving the objective following the rules put in place. There are three kinds of SROs—independent statutory organizations set up by an Act of Parliament such as the Institute of Chartered Accountants or the Medical Council of India; recognized voluntary organizations such as the Indian Banks’ Association and the Association of Mutual Funds in India; and voluntary organizations such as the Advertising Standards Council of India and the Institute of Engineers. Till RBI’s recognition, MFin was a voluntary platform. The recognition is no surprise as India has the largest MFI industry in the world with 32 million accounts, three times the accounts handled by the regional rural banks, and roughly one-fourth of the total small loan accounts in the financial system.

Set up in December 2009, months before the Andhra Pradesh law was enacted that dealt a blow to the industry, MFin has 48 members accounting for at least 28 million low-income borrowers with about Rs.23,000 crore loan outstanding. Two key initiatives of MFin are creation of a code of conduct for the industry and development of a credit bureau. The code of conduct ensures governance and client protection and creates an ethos for responsible lending, something many MFIs did not do till the Andhra Pradesh crisis broke out. The credit bureau, I am told, is now a repository of at least 100 million loan records and entertains two million credit queries every month. This is a tool to create an ideal echo system where no borrower can access multiple loans that could lead to default.

Indeed, MFin has been acting as a de facto SRO for its members and the RBI recognition merely represents a shift from de facto to a de jure positionm but the task ahead is arduous. In India, often an SRO overlooks its real objectives and tries to play the role of a lobby group. MFin should refrain from doing so as the biggest challenge before it is put its house in order. Nobody else but the MFI industry is to be blamed for the crisis that followed the promulgation of the Andhra law as many companies deviated from the primary job of giving small loans to poor.

Instead, they aggressively expanded their loan books with the sole objective of drumming up their valuation. In the process, many borrowers were given multiple loans which they could not service. At the next stage, collection agents harassed them for repayment which they were not in a position to do as their income stream did not support exposure to multiple lenders. When the issue was politicized, the borrowers refused to pay back loans and quite a few MFIs got buried under pile of bad assets while others wrote off their Andhra portfolio and focused on other states.

Wiser with the experience, the MFIs have started showing a degree of maturity both in disbursement and loan pricing. An SRO’s job at this point would be nursing the industry back to health. With most banks still wary of reaching out to the poor in rural India, MFIs will remain relevant for years, provided they stick to the rules of the game

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