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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:
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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