The hype of the moment in microfinance is undoubtedly to subscribe to all kinds of code of conducts, client protection principles, social performance and other self-regulating initiatives. To set the record straight, had all the stakeholders really subscribed to these in the first place, there would have not been such a crisis in Indian microfinance

The ongoing Microfinance India Summit has a special session titled, ‘Client protection and Code of Conduct: From principles to practice and compliance’. The session is to be held on 13 December 2011 (1.30 - 3.00 p.m - Breakout Sessions). As the session introducer notes:

“One of the key factors that precipitated the AP (Andhra Pradesh) crisis was the accusation that microfinance institutions (MFIs) were employing coercive measures with clients, were not transparent in their pricing and largely profiteering from the poor. While for several years, there has been a growing concern on the issues of client protection, the AP crisis significantly helped in exacerbating the issue. Since the AP ordinance in October 2010, the efforts in the sector towards ensuring client protection have gained primacy. Industry associations Sa-dhan and MFIN have developed their own Codes of Conduct (CoCs), but their compliance has been a major issue. In recent months, through an IFC effort, a Responsible Finance Forum has been instituted which has been working on harmonizing the two COCs. The Codes go beyond client protection and incorporate standards for governance, staff and recruitment policies, data sharing etc. SIDBI has been conducting Code of Conduct assessments of MFIs as a pre-requisite for lending, thereby emphasizing the importance of adherence to code by the institutions. The panel will discuss the next steps towards supporting translation of the codes and principles into practice including building awareness and capacities of MFIs to enforce CoC, raising awareness of clients of their rights and responsibilities, uniformity in compliance assessment, consequences of non-compliance, role of investors and other stakeholders etc., drawing from good examples in India and globally both within the microfinance industry and in the mainstream.” (http://www.microfinanceindia.org/content/35/63/blog.php)

The hype of the moment in microfinance (especially, in India) is undoubtedly to subscribe to all kinds of code of conducts (Sa-Dhan, MFIN), client protection principles, social performance and other self-regulating initiatives.

To set the record straight, had all the stakeholders really subscribed to these in the first place, there would have not been such a crisis in Indian microfinance. What happened is that there was a strong disconnection between policy/strategy and practice at MFIs and many stakeholders including bankers, investors and others (perhaps) did nothing to clean up the stables! They simply turned a blind eye and pretended that all was well and so it seemed until the crisis blew up in Andhra Pradesh. How else could their silence be interpreted? And in the urge to grow, make profits and get investments at a premium and/or tap primary markets, MFIs did not practice what they had supposedly subscribed to in terms of ethical practices and good governance. And the MFIs associations just watched as the situation deteriorated as did the commercial bankers and DFIs like SIDBI (which undoubtedly played a predominant role in the whole Indian microfinance crisis of 2010).
 
As always, the industry and various stakeholders have attempted, post crisis, to salvage the situation through code of conduct assessments. In fact, an advisory company (M2i) has even launched the Code of Conduct Assessment (COCA) Tool in India. According to industry sources, this is a pioneering initiative—a global first in the microfinance domain. It must also be mentioned that SIDBI has commissioned eight such assessments perhaps as part of the SIDBI- World Bank Responsible Microfinance Project and also made them public (http://www.sidbi.com/micro/WorldBankInitiative.htm).
 
The Code of Conduct Assessment (COCA) tool of M2i is said to involve a “comprehensive review of MFIs policies and systems and whether these translate into ethical microfinance practice’. It utilizes the ADDO framework developed by M2i” (http://www.m2iconsulting.com/m2i_coca.htm).

At the outset, the World Bank, IFC, SIDBI and M2i must be congratulated for their desire to bring such a tool. However, given the strategic importance of these code of conduct (CoC) assessments, it also seems imperative to analyse them and examine their objectivity and effectiveness. This is done in a series of articles and should certainly help to focus Tuesday’s session at the Microfinance India Summit with greater precision.

Let us get the context of the COCA tool first as all COCA reports are based on the tool. The COCA tool measures the adherence to the Code of Conduct on four basic parameters:

1.    Approval at the policy level from the board (of the MFI or institution)
2.    Documentation of the guidelines and procedures that emerge from the policy
3.    Dissemination of the guidelines and procedures across the organization
4.    Observance in practice of these guidelines and procedures.

• An immediate observation is that the for-profit fast growing NBFC-MFIs receive the highest COCA-scores. (A higher COCA score signifies a high degree of organisational adherence with regard to the Voluntary Code of Conduct)
•  The two not-for-profits (a section 25 company and a charitable trust) and low growth MFI’s receive the lowest COCA-scores. (A lower COCA score means that organisational adherence to the Voluntary Code of Conduct is low)
•  The COCA results —which show that the fastest growing for profit MFIs have the highest COCA scores—seem to be contradictory to the well accepted idea that the fast growth of the microfinance sector has contributed to the 2010 AP microfinance crisis. Surely, something counter intuitive is happening here as the relationship between fast growth and the AP 2010 Microfinance crisis is now well recognised, established and documented. In fact, by November-December 2010, many MFIs had begun to admit that growth caused by over lending was responsible for the crisis and this is evident from the quote of the then CEO of BASIX, one of the pioneering Indian NBFC MFIs:

“That (following sound lending practices) is where we failed,” says Sajeev Viswanathan, CEO of Basix. MFIs lent liberally to individuals who didn’t have a corresponding ability to repay. The mismatch had to hurt sometime, and that’s what is happening now. ...Mr Viswanathan says MFI lending in Andhra rose from Rs5,000-Rs6,000 crore in 2009 to Rs9,000 crore this year. ” (From Microfinance: What's wrong with it, by M Rajshekhar, Economic Times, 2010)

Likewise, Professor M SSriram in his article has noted:

“In about a decade, microfinance has moved from helping the poor to access finance to an interesting business at the bottom of the pyramid. This paradigm shift happened with the entry of funding, initially from Silicon Valley and then from the people who funded and fuelled the growth of Silicon Valley. Somebody from Silicon Valley would typically be an entrepreneur who started small, scaled up fast, used the asymmetries in the market and logically and legally became rich. Many were first-generation entrepreneurs and did not forget their roots. It was logical for them to invest their surpluses into the business of doing good. However, their own success and growth experience dictated that while they do good, they should also do well. Doing well translated into good business plans, targets and also growing at a scorching pace.

All was well for us, within the industry, when the base was small. There were several 100 percents in the microfinance sector. The growth rate was in excess of 100%, recovery was 100% and the sustainability indices quickly crossed 100%. Voila, we had found a magic mantra where the poor could be served, we could look good and put “eradication of poverty” as our mission statement and of course, lead a comfortable life. The alternative sources that were funding the poor made us look like messiahs.

The problem was that we were dealing with people and not processes and systems. This involved group formation and dealing with behavioural patterns of people. But we got addicted to the heady growth target. And when we chase targets without logic, we cut corners. We became cut-throat in competition and we lost a sense of balance. ...The question is whether the lender knows the absorption and repayment capacity of the borrower. It is impossible to know this if we are doing a group meeting in 20 minutes and moving on. It is impossible to address this when we have standardised products and offer a higher loan each cycle. Our credit officers are trained to be robots following a process mechanically and are prohibited to think. Therefore multiple lending is a problem of the MFIs. We clearly do not know our customers enough, and do not have the time to know them.” (What is Wrong With Indian Microfinance by MS Sriram, Forbes, 2010)

A third comment on the relationship between growth and the 2010 AP Microfinance crisis uses a great metaphor—in the words of Alok Prasad, chairman of MFIN, who spoke at the Responsible Finance Forum in the Hague in January 2011, the AP crisis occurred mainly because MFI growth was burgeoning. His analogy was brilliant when he said that

“it was like driving a Ferrari at more than 200km/h on Indian roads which is asking for trouble.” (From comments by Jan Postmus at http://www.microfinancefocus.com/content/global-investors-meet-promote-new-principles-inclusive-finance)

And there are many more such quotes and I could go on but the larger point is that, given the above relationship between burgeoning growth and the AP crisis, I find it rather strange that the COCA scores are highest for the NBFC-MFIs that grew at a scorching pace and they are the lowest for the non-for-profit MFIs that grew a snail’s pace.

The results seem weird, are they not?

http://www.sidbi.com/micro/COCAUjjivan.pdf, http://www.sidbi.com/micro/COCA%20ASA.pdf, http://www.sidbi.com/micro/COCA%20Samruddhi.pdf, http://www.sidbi.com/micro/Bandhan.pdf, http://www.sidbi.in/micro/COCA%20Arohan.pdf, http://www.sidbi.in/Micro/CASHPOR.pdf and http://www.sidbi.com/micro/COCA%20SKDRDP.pdf

This peculiar finding has prompted me to take a closer look at the SIDBI-World Bank sponsored COCA tool (and the results therein) in a series of articles that follow shortly. That notwithstanding, I do hope that tomorrow’s session and panel discussion (at the Microfinance India Summit 2011) focus on the aspect of how the fastest growing MFIs managed a much better (higher) COCA score than their low growth and not-for-profit MFI counterparts? All in all, this session, undoubtedly promises to be an exciting one given the peculiar results from the SIDBI-World Bank sponsored COCA assessments and I hope that the regulators and key industry stakeholders are watching this controversial session closely...

(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)