Govt to buy back Rs6,945 crore fertiliser bonds

The government will re-purchase bonds from fertiliser companies at a discount and will reimburse 50% of losses, estimated at over Rs700 crore, occurred in the buy back of bonds

New Delhi: The government will buy back the outstanding fertiliser bonds worth Rs6,945 crore from fertiliser companies at a discount and compensate for 50% of their losses, reports PTI.

Unable to take higher fertiliser subsidy on the Union Budget, the government had resorted to issuance of bonds worth Rs27,500 crore to domestic fertiliser companies towards payment of its subsidy bills in 2007-08 and 2008-09.

Out of this, the Centre has already re-purchased bonds worth Rs20,555 crore from the fertiliser companies to provide them with liquidity.

“The government has agreed to buy back the remaining Rs6,945 crore worth fertiliser bonds from next week,” a senior fertiliser ministry official told PTI.

The Cabinet Committee on Economic Affairs (CCEA) has given its nod to a proposal to allow the government to buy back the outstanding fertiliser bonds, the official said.

The government will re-purchase bonds from fertiliser companies at a discount and will reimburse 50% of losses, estimated at over Rs700 crore, occurred in the buy back of bonds, the official said.

The ministry has issued a circular in this regard and intimated as many as 16 companies, including the Indian Farmers Fertiliser Cooperative Ltd (IFFCO), about the buy back of the fertiliser bonds from next week.

According to the circular, IFFCO is eligible to redeem bonds worth Rs3,319 crore. The second biggest possible redemption would be for Indian Potash—Rs 1,432 crore.

The buy back of bonds will improve the working capital of fertiliser companies, who have to import inputs and raw materials such as naphtha, rock phosphate, phosphoric acid for production at skyrocketing prices from the global market.

The fertiliser companies, who are facing financial crunch, are not able take loan from banks by keeping these bonds as collateral due to lack of statutory liquidity ratio (SLR) status.

And the fertiliser makers cannot hold these bonds for their life-period of 18 years and they have no options but to dispose of these bonds at lower prices in the open market for raising cash to meet their investment expenditure.

The government’s fertiliser subsidy bill in 2007-08 and 2008-09 stood at Rs43,319 crore and Rs99,494 crore, respectively.


Increasing frauds, internal lapses at MFIs: Need to strengthen supervisory arrangements to protect the poor

A long list of instances of failures of microfinance institutions holds several important lessons for the RBI and the finance ministry on the regulation and supervision of the sector

SKS Microfinance was in the news recently and this concerned cash embezzlements and frauds for the financial year 2011. As Microfinance Focus notes, "According to auditors, SKS Microfinance recorded 408 cases of cash embezzlements and frauds in the financial year 2011….Company's annual report shows 156 cases of cash embezzlements by the employees, aggregating Rs16,018,106 during 2011. …There were 205 cases of loans given out to non-existent borrowers on the basis of fictitious documentation created by the employees of the company, aggregating Rs45,177,531. Further, 47 cases of loans taken by borrowers under fake identity, aggregating Rs13,786,130, were reported during the year. The Company is pursuing the borrowers to repay the money. The outstanding loan balance (net of recovery) aggregating Rs6,386,267 has been written off.i

Here are some more examples from MFI financial statements and many more can be found at

 "(xxi) Based upon the audit procedures performed for the purpose of reporting the true and fair view of the financial statements and as per the information and explanations given by the management, we report that no material frauds on or by the Company were noticed/reported during the year although there were some instances of frauds on the Company by its employees as given below:

(a)    Thirty-three cases of cash embezzlements by the employees of the Company aggregating to Rs.7,079,683 were reported during the year. The services of all such employees involved have been terminated and the Company is in the process of taking legal actions. We have been informed that nine of these employees are absconding. The outstanding loan balance (net of recovery) aggregating to Rs.5, 377,428 has been written off;

(b)    Eighteen cases of loans given to non-existent borrowers on the basis of fictitious documentation created by the employees of the Company aggregating to Rs.5,645,657 were reported during the year. The services of all such employees involved have been terminated and the Company is in the process of taking legal actions. The outstanding loan balance (net of recovery) aggregating to Rs.4,253,379 has been written off; and

(c)    One case of fraud by an employee of the Company in collusion with vendors has been reported during the year. The aggregate value of transactions is Rs.9,610,755 (including Rs.3,051,510 in respect of the previous year). The services of the said employee and the arrangements with the said vendors have been terminated. The Company has initiated legal action and criminal proceedings against such employee. The financial effect of the loss incurred by the Company is not currently quantifiable."

In fact, even as I write this, I am aware that there is a special committee of the RBI headed by former Deputy Governor, Mrs. Usha Thorat, which is looking into issues related to NBFC supervision and the recommendations of this committee are very critical given that the NBFC MFIs are among the largest MFIs in India, both in terms of number of clients serviced as gross loan portfolio outstanding. It is also pertinent to remember that, the 6 large AP headquartered MFIs who added about US $ 2.076 billion and 9.76 million clients during April 2008 - March 2010, did not attract the supervisory attention of the department of non-bank supervision, RBI, which was supposed to look closely and scan (systemically important) NBFCs with loan assets greater than Rs 100 Crores. Please note that in numerical terms, the above figures are equivalent to each of these (6) MFIs adding Rs 78 Crores every month for 24 months. This apart, we are all aware that the RBI is preparing detailed guidelines for MFIs based on the Malegam Committee Report (MCR) and the Union Ministry of Finance is has recently put out a draft bill for regulation of MFIs. The latter is especially note worthy because it brings greater focus on savings/thrift and perhaps, in the long term it could also facilitate MFIs to offer savings services to the poor. While the need for ensuring that the poor have access to savings is indeed welcome, enabling MFIs to offer thrift is fundamentally unsound because of the several reasons including weak internal controls.

Therefore, I would like to use this opportunity to make a humble submission on what I think are some of the key internal control issues that caused the on-going micro-finance crisis in India. I sincerely hope that these are taken into account and addressed appropriately while formulating the Usha Thorat committee recommendations, preparing the detailed guidelines based on the Malegam committee report and finalizing the draft micro-finance bill, currently on the website of the Union Ministry of Finance.

As given above, 'non-existent clients' and 'borrowers with fake identity' are two very common types of operational frauds that have been (increasingly) occurring due to the turbo charged growth in the Indian micro-finance industry  and the commensurate lack of quality internal controls. It must also be noted that there are several other kinds of frauds  ('misappropriation of client repayments' and the like) prevalent in Indian micro-finance and all of these are highlighted below:

The loan disbursement related frauds typically include: (a) Loan officer  issues loans to "ghost" or non -existent clients; (b) Loan officer issues 2nd or 3rd loan to delinquent clients to facilitate repayment (top-up or greening of loans and this is very evident from cases of clients with multiple loans); (c) Loan officer provides bulk money to agents for onward disbursement and has no serious means to check their actual disbursement to clients. In many cases, these loans are used for non-micro-finance activities; (d) Staff/ cashier/accountant makes loans to themselves and show fictitious names or clients with false identities; (e) Loan officer charges clients an unofficial "fee" (BAKSHISH) from clients to enable them to access a loan from an MFI; (e) Loan officer, staff, accountant, cashier issue larger loans to clients and use some portion of the loan for their own consumption. They however do not repay and expect the client to repay and this is an important reason for delinquency; and (f) Several other aspects.

The loan repayment related frauds normally include: (a) Loan officer collects payment, issues receipt, but does not deposit the money repaid (by the client) with the MFI. This could happen with client prepayments or regular payments; (b) Agents collect loan payments and do not deposit them in a timely manner with the concerned MFI. Agents, who have not lent money to clients but rather used loan amounts from MFI, do not repay the MFI at all; (c) Staff/loan officer charges unofficial delinquency fees to manage delinquency; (d) Loan officer/others collect payments on loans that have been officially written off and keep it themselves; and (e) Several other aspects

Other kinds of frauds that have been witnessed are: (a) Insurance payments do not reach the client nominees, who in course of time forget to ask for them; (b) Insurance premiums are not deposited at the branch; and (c) Higher than required insurance payments are collected in the guise of administrative charges (please do recall that IRDA recently initiated an enquiry against a large Indian MFI)

The most relevant question here is why have these (increasing) frauds occurred and what are the lessons for regulation and supervision? And the answer is very simple: MFIs that have faced burgeoning growth in the last few years have not had commensurate capacity and (internal control and other) systems to manage their turbo-charged growth. Further, as a result of the strong decentralized (agent) model that some of these MFIs have used and are continuing to use, they are increasingly vulnerable to frauds (especially, when their growth is rapid). OK, it is one thing to acknowledge the frauds and isolate reasons for their existence but, given the fact that they have been increasing in Indian micro-finance since 2005 , we cannot afford to let this go on. We need to learn from these internal control lapses and surely, these lessons must be dovetailed into regulation and supervision. This is attempted here below:{break}
Issue # 1 for Regulators/Supervisors: Weakened internal audit function in many MFIs: Boards of directors at MFIs are responsible for ensuring that their MFIs have an effective audit process and that internal controls are adequate for the nature and scope of their businesses. The reporting lines of the internal audit function should be such that the information that directors receive is impartial and not unduly influenced by management. Internal audit is a key element of the overall responsibility to validate the strength of internal controls. This sadly did not happen in many MFIs and, especially, at the large Andhra Pradesh headquartered MFIs. The same weakness continues in many large and fast growing MFIs located in other parts of India.

Issue # 2 for Regulators/Supervisors:  Disregard for internal controls by many line managers: Internal controls are the responsibility of line management at MFIs. Line managers must determine the level of risks they need to accept to run their businesses and to assure themselves that the combination of earnings, capital, and internal controls is sufficient to compensate for the risk exposures. It is clear from the Indian micro-finance crisis that basic tenets of internal control, particularly those pertaining to operating and related risks, were not followed - in fact, as the analysis of many (fraud) cases demonstrate, it is apparent that the line managers in several fast growing MFIs had utter disregard for even the most basic controls, such as the segregation of duties etc.

Issue # 3 for Regulators/Supervisors: Enhanced people risks also causing failure of internal controls: Internal controls and sound governance become even more important when an MFI's operations move into higher-risk areas. Indeed, when changes are happening, control failures often increase significantly. Rapid growth (as happened during April 2008 - March 2010, when the systemically important top 6 AP headquartered MFIs added US $ 2.076 billion and 9.76 million clients), introduction of new products and delivery channels (including business correspondents) are examples of situations that put stress on the control environment. When these types of changes occur, "people risks" rise. These are risks that are related to training employees in new products and processes. Employees who join the MFI need to learn the culture of the company and the control environment. Employees unfamiliar with their new responsibilities - the systems they use, the services they provide customers, the oversight expected by supervisors and members of internal control functions - are all more likely to create control breaks.

This is what is continues to happen in Indian micro-finance, and I have met a number of stakeholders at the grass-roots who state that all and sundry, including some with local criminal records, have been brought in as MFI staff, to meet the burgeoning growth requirements. Let me tell you that I felt personally intimidated by the kind of staff and agents that I met during a recent field visit to a few areas. They appeared to be local toughies often used by local political masters and had no idea of the micro-finance spirit and mission - they just knew how to quickly disburse and recover money as tough moneylenders do and most importantly, had zero tolerance (including for PAR) in performing their duties. With many staff/agents who are not necessarily attuned to the vision and spirit of micro-finance, I am not at all sure that the current on-going efforts to integrate social performance, client protection and the like will get translated at the ground, unless some real fundamental changes are made to the MFI delivery model. And it is the duty of regulation/supervision to ensure that in real time.

Issue # 4 for Regulators/Supervisors: Drive for efficiency causing omission of key controls: Rapid growth and change also modify the relative risks to an MFI. Further, the pressure to beat competitors to the market with new/old products may also result in adoption of shortcuts (in the process) and important controls. This has happened consistently and today, the drive for efficiency and more standardized process in micro-finance is such that no time is being invested in building the client level relationships, which incidentally was the key and hallmark feature in the early success of micro-finance. The proliferation of agents and the shortest lead time to disburse loans as an incentive criterion are as a result of this efficiency drive and, these again have resulted in omission of key controls in many MFIs.

Issue # 5 for Regulators/Supervisors: Irrational expectations and internal frauds: Another form of people risk is internal fraud. When expectations of the market and supervisors or pressures of personal life become overwhelming, key staff may step over the ethical and legal boundaries and cover up errors or purposely commit fraud. This is what has happened in many MFIs that jumped on to the equity bandwagon and were also turbo charged to grow by the misplaced enthusiasm of DFIs (like SIDBI) and commercial banks, that sought to satisfy their priority sector lending targets.

Issue # 6 for Regulators/Supervisors: Greater focus on quantitative versus qualitative risks: Frequent and small losses can generally be absorbed in the operating margin of the product or service and MFIs have tended to focus more on such risks and problems. It is the low-probability, large losses that provide the greatest challenge. And, it is just such risks - the ones that can severely damage, if not kill, an organization - that too many MFIs have not formally take into consideration. And that, in many ways, has resulted in many problems on the ground in the present day Indian micro-finance crisis. Most, if not all, MFIs did not expect the Andhra Pradesh government to act against them and they surely did not factor in the political risk despite the serious problems that they had faced in the last few years.

Issue # 7 for Regulators/Supervisors: Entrepreneurial drive and non-transparent governance results in lack of control infrastructure: Last, but not the least, many of the Indian MFIs, which have been at the centre of the crisis have come under the microscope for their governance failures and they demonstrate similar characteristics. They have been led by hard-charging entrepreneurs whose ability to think outside the box (in all fairness) pioneered growth, advances and innovation in micro-finance. But the personalities of these individuals, in many cases, led to a single-minded focus on growth, profits, equity investments, share valuations at a premium, higher returns and wealth creation for shareholders and this perhaps resulted in very little time being spent on building the control infrastructure so vital for micro-finance.  

To summarise, the burgeoning growth of Indian micro-finance led by a flawed business model (as stated by Dr. Rangarajan) has meant that frauds and control failures have become more common in Indian MFIs. These have serious implications for the regulation and supervision of micro-finance in India. First, under no circumstance should MFIs be allowed to collect savings from poor people as their control infrastructure is very weak and their business model is seriously flawed. Second, hands-off regulation will not work. Therefore, neither detailed regulatory guidelines from the RBI (based on the Malegam committee or the Usha Thorat committee) nor the passing of a Micro-finance bill will help, until and unless, appropriate and local level supervisory arrangements are in place. With all due respect, among other things, it certainly calls for a greater role for the State governments, as much of this supervision will have to occur at the local level - something which neither the RBI nor the Union Ministry of Finance can hope to ensure from Mumbai or New Delhi. If poor people are indeed to be protected, their vulnerability not exploited and valuable money safeguarded, there is no doubt that a constructive role for the State government must be envisaged and provided for in any regulatory architecture. Make no mistake about this! On their part, the State governments must be fair and permit the MFI model to operate normally, as long as legally tenable and sound business models (as Dr. Rangarajan has argued for) are used by them.

I do sincerely hope that the relevant committees and authorities look at these and other issues related to internal controls in the crisis affected Indian micro-finance industry. That is one area, amongst many others, where rebuilding can and must start as soon as possible to put the Indian micro-finance sector back on the rails and this is certainly another good place for regulatory reform to start…

i Source: Quoted from SKS Microfinance faced 408 cases of cash frauds in FY 2011, by Microfinance Focus, July 6, 2011
ii SKS financial statement 2009
iii Please refer to the following link for an overview of frauds in micro-finance as evident from MFI audited financial statements:
iv Please note that there is significant evidence for increasing level of frauds in Indian micro-finance through audited financial statements, e mails, letters and the like available in the public and private domain
v This could be a loan officer or a branch manager or a branch accountant or any other staff. Sometimes, centre leaders, group leaders and other kinds of agents could also be involved in this.
vi Regulation And Areas Of Potential Market Failure In Micro-Finance, by Thorat, Y S P and Ramesh S Arunachalam (2005) Paper presented at the NABARD High level policy conference in New Delhi in May (2005).

(The writer has over two decades of grassroots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural/urban development and urban poverty alleviation/governance. He has worked extensively in Asia, Africa, North America and Europe with a wide range of stakeholders, from the private sector and academia to governments.) 


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