Money & Banking
Bank business correspondent models need to have controls to safeguard clients’ interests

Client-level controls assumes great importance in the common BC model, as without these banks and BCs could lose control of their operations and be exposed to significant costs and risks

If there was one major learning (at least for me) from the 2010 Andhra Pradesh (AP) and Indian microfinance crisis, it is the fact that strong controls and procedures need to be place (at the grass-roots) with regard to (end-user) clients. Since microfinance institutions (MFIs) did not have good client-level controls, the last mile operations were easily manipulated and the microfinance crisis occurred. Many of the problems-ghost clients and related frauds, multiple lending, over indebtedness, lack of adherence to KYC norms, proliferation of broker agents, burgeoning growth-that were evident (during the 2010 crisis) can be directly attributed to this lack of appropriate client level controls in MFI operations.
 
And given this background, client level controls at the grass-roots, therefore assumes great importance in the common Business Correspondent (BC) model, for which bidding in 20 clusters is underway in India. And without these controls, banks and BCs could (completely) lose control of their operations and be exposed to a variety of risks that can result in significant financial cost with serious implications. So, it is imperative for regulators/supervisors to examine the KYC (know your customer) procedures currently in place and also draw up more appropriate KYC standards specifically applicable to BCs (and their sub-agents)-given the distant and remote physical terrains that they are to operate in, the huge scale of operations proposed for each of the clusters, the large volume of money to be handled by them, the lack of unique physical and locational identifiers at the grass-roots, the money laundering that is likely at the local level and the like. Without question, sound KYC policies and client control procedures will go a long way in protecting the banks and their BCs from problems such as those that occurred as part of 2010 microfinance crisis.

What needs to be better understood and appreciated is that KYC safeguards go much beyond simple record-keeping (which can be tampered with very easily) and require the institutions (banks and their BCs) to formulate a customer acceptance policy and a tiered client identification programme that involves more extensive due diligence and proactive monitoring. And more importantly, the need for rigorous customer due diligence standards should not be restricted to BC headquarters alone. It needs to be followed all through the line, right down to the last mile including sub-agents and further layers of sub-sub agents, where appropriate.

The Reserve Bank of India (RBI) must therefore revisit KYC norms immediately, adapt it in the light of what happened in 2010 in AP microfinance and thereafter attempt to ensure the implementation of the revised KYC norms in a rigorous manner by all concerned institutions including banks and BCs and their sub-agents. This calls for, among other things, the following:
 

  • Customer acceptance, customer identification and record keeping standards to be implemented with consistent policies and procedures throughout the banks and their BCs/sub-agents - the key issue is to ensure that all of this happens all the way down to the last mile. This must also be backed by a well integrated core banking MIS that consolidates geographies, products and the like
     
  •   Where possible, nearest bank branch offices should monitor (physically and otherwise) information on accounts and transactions, at least on a sample basis. This local monitoring must also be complemented by a robust process of information verification and subsequent sharing between the bank head office and all its branches (and BCs where applicable). This information shared between HQs and branches (and BCs where applicable) must also report on any suspicious accounts and activity that may represent heightened risk. A lot of the broker-agent related problems in Indian microfinance could have been avoided if these types of controls had been in place.
     
  • And of course, all of this must be vetted by a strong internal audit function, independent of line management, reporting directly to the Board-both at the level of the banks as well as the business correspondents. It does not make sense for the internal audit team to report to the very line management, whose procedures and controls they are evaluating.
     
  •   Specifically, internal auditors should verify that appropriate internal controls for KYC are in place and that bank branches, BCs and their sub-agents are in compliance with supervisory and regulatory guidance. The audit process should include not only a review of policies and procedures but also a review of customer documentation and their records along with sampling of a significant number of random accounts. Physical verification of clients and in comparison with appropriate photos IDs must also be a part of this random sampling.
     
  •   The role of audit is particularly important in the evaluation of adherence to KYC standards on a consolidated basis and supervisors should ensure that appropriate frequency, resources and procedures are established by banks (and BCs) in this regard and that they have full access to any relevant reports and documents prepared through the audit process.
     

To reiterate, the lack of client-level controls contributed significantly to the 2010 microfinance crisis and it is sincerely hoped that the RBI will not allow such things to happen this time around, with the bank business correspondent model for which bidding is underway. While it was matter of around Rs9,000 crore (still, not a small amount by any means) the last time around (microfinance in Andhra Pradesh was said to have this exposure in 2010), the bank BC model will involve much larger sums of money across the 20 clusters, especially given the pan-India nature of operations. Therefore, if problems were to occur due to the lack of client-level controls at the last mile, the consequences will certainly be more significant from a systemic risk perspective. Something that the RBI can least afford at this juncture.

(Ramesh Arunachalam has over two decades of strong grass-roots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural and urban development and urban poverty alleviation across Asia, Africa, North America and Europe. He has worked with national and state governments and multilateral agencies. His book-Indian Microfinance, The Way Forward- is the first authentic compendium on the history of microfinance in India and its possible future.)

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COMMENTS

nitai chandra ray

5 years ago

KNOWLEDGE ENRICHING GOOD
GUIDE .
SHOULD BE READ BY ALL CONCERNED -- RBI & RESPECTIVE
BANK CONTROLLERS .
ARRANGE TO FORWARD THE
ARTICLE TO ALL BANKS .

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