If SEBI’s new norms on investment advisors come into force, mutual fund sales will decline even further and mis-selling of insurance products will increase!
When UK Sinha took over as the chairman of the Securities and Exchange Board of India (SEBI), small distributors were elated. As the head of Unit Trust of India, he had after all felt the impact of a series of harebrained decisions by SEBI under the previous regime relating to mutual funds (such as abolishing upfront commissions abruptly). Small distributors hoped that Mr Sinha would reverse the previous decision or at least make sure that distributors are incentivised in some way. He stunned them by coming out with a more harebrained idea-a small charge to first-time investors. Polite criticism pointed out a simple flaw-how do you define "first-time"? It was no surprise that SEBI had not thought about it. It usually doesn't.
SEBI under Mr Sinha has now a gone a step further which would create major headwinds for the fund industry, especially after an 22nd August circular which asks mutual funds to implement a segregation between an agent and an advisor. SEBI now wants to regulate investment advisors and that too through the completely failed concept of Self Regulatory Organisations (SROs). No matter that its grievance redressal system is not exactly pro-investor, no matter that there is no surveillance worth talking about and market manipulation is rampant, no matter that its consent order system allows crooks to get away, investment advisor regulation seems to be a priority for Sinha.
SEBI has just released a concept paper, which lays down how an SRO would be formed to regulate investment advisors who will be registered under SEBI. The crux of the regulation is: "No financial incentives/consideration would be received from any person other than (an) investor seeking advice". What does this innocuous-sounding rule mean?
First, distributors simply cannot provide advisory services for a commission; they will have to sell for a fee. This means that if one wants to earn a commission and not a fee (since investors don't want to pay fees) he would have to identify himself as an 'agent'. Unfortunately, this means getting a letter signed from an investor that he is buying the product out of his own free will and that the agent has not done any due diligence. Few investors are willing to give such letters. No distributor is asking for it, either.
Second, the only mainline investment product that comes under SEBI is mutual funds. Issues related to other financial products will be dealt with the respective regulators. As such, there would be no single body regulating investment advisors. Is there mis-selling of mutual funds? Well, there has to be selling first! Mutual funds are struggling to add assets-SEBI's August 2009 decision has ensured that interest in mutual funds has totally waned.
In August 2009, SEBI had banned entry load for mutual fund investments. Investors were free to decide the upfront commission to be paid to the distributor/agent, based on factors like assessment of the service of the distributor. The effect has been disastrous. From the time of the ban till August 2011, there has been huge outflow of money. SEBI simply was out of touch with reality when it assumed that investors and distributors would negotiate for the service. Even the healthiest financial services don't sell by themselves. That's the lesson from all around the world. It takes a lot of hand-holding and convincing to get someone to invest in volatile products like mutual funds. Devoid of upfront commissions, the agents simply did not want to take the trouble to sell mutual funds after August 2009. Many distributors were happy to push insurance products, which earned them higher commissions.
Under the new proposal of SEBI, this would not change. This would get aggravated. While very few people would be interested in selling mutual funds for a fee, an "investment advisor" selling only insurance products does not come under the proposed Investment Advisor Regulations. Therefore why would an existing advisor pay for a certification to become an "Investment Advisor" when he is "better off" selling ULIPs (unit-linked insurance plans) as investment products?
The media is full of stories of mis-selling of insurance products. From those nearing their retirement to 80-year-olds have been sold retirement products where they would have to pay a substantial amount for annual payment across 10 years. Sadly, even if the proposal of SEBI comes into force, such cases would continue. Incidentally, the biggest mis-sellers are large banks and SEBI's regulation will not affect them one bit.
Of course, one could argue that the intermediaries would find a way to get around these rules. That is the subject of part two of this series.
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A good MIS is absolutely necessary for MFIs to manage the interface with clients and conduct activities/processes in a manner that is efficient, effective and transparent
Understanding the state of management information systems (MIS) in Indian microfinance institutions (MFIs) is very important for all stakeholders involved in Indian microfinance, and many of the issues that came up in the 2010 crisis concerned data, or the lack of it. Therefore, it is especially critical for the proposed microfinance development and regulation bill to ensure that MFIs meet certain minimum MIS standards in order to get accredited and/or licensed.
So what then are the various aspects that need to be emphasized as part of the minimum MIS requirements in the proposed microfinance bill?
Let us first understand why MIS is very important in microfinance. At the MFI level, building an efficient/effective MIS helps to manage data, information processes and activities and this is especially crucial given that microfinance involves a large number of clients with small loans with miniscule and highly repetitive repayments. An appropriate MIS also helps the institution better understand client needs, and thereby enables it to serve them with appropriate products, tailored to their cash flows. A good MIS is, therefore, absolutely necessary for the MFI to manage its interface with clients and conduct its activities/processes in a manner that is efficient, effective and transparent.
While many MFIs claim that they have an appropriate MIS in tune with global best practices, there are examplesi to the contrary, and I quote Anna Somos Krishnan, a seasoned microfinance professional, who wrote in a candid article (21st August 2010), soon after the first Indian microfinance IPO:
"Interestingly, the authorities, this time, have given the green signal for an entity that can't prove its operational strength beyond, perhaps, its head office and a couple of system generated reports. Let's face it. SKS, till date, manually reconciles the majority of its 2,000-odd branches data and its seven million clients at the end of each month, despite the unprecedented IT investment that it made four years ago. These are the three-four years when we see the largest scale of growth in an entity. What is thought-provoking, though, is the virtually non-existent digital and automated management information systems (MIS) for trustworthy record-keeping (this means that, with one or two exceptions, MFIs have no IT systems to reliably track customer transaction data)."ii
If what Anna Somos Krishnan has written is indeed true, then, the situation is very serious. It certainly merits the attention of various stakeholders, including the Reserve Bank of India (RBI), which is to become the sole regulator of microfinance. Without question, the regulators/supervisors would need to analyze and understand the actual state of MIS in Indian MFIs-as they are intermediating increased sums of money and dealing with a larger number of clients-in order to prevent crisis situations in the future. The key questions that need to be asked in this regard are:
1. Given that microfinance involves large numbers of small repetitive transactions, how are Indian MFIs currently managing data and information on their clients, products, processes and activities?
2. Do they have a fully automated MIS, or are they still completely manual, or are they using hybrid systems? Are there differences between larger and smaller institutions, for profit and not-for-profit institutions, etc? Are there challenges that Indian MFIs face with regard to implementation of robust MIS systems? What are these and how can these be addressed?
3. Are management information systems (in Indian MFIs) integratediii in real time across products, processes, client segments, branches and functions (like accounting and portfolio data)? If yes, how do these systems perform in real time in terms of reliability and validity of data used/generated as well as time taken for analysis and production of reports? If no, how are the MFIs, and especially those with a large number of clients and rapid growth rate, managing the crucial integration and the reliability/validity of their integrated data?
4. Are all features/aspects of all products, for all clients in all locations available in the MIS (manual or computerized or hybrid)? What is the reliability and validity of this primary data and/or analyzed information in terms of reflecting the ground reality (accuracy mainly)? For example, there were news reports in November/December 2010 that the Andhra Pradesh government claimed, that one of the MFIs was supposedly charging 60.5% and the MFI replied saying this could have been due to an error in the conversion of data. This concerns the reliability and validity of the MIS.
5. Is the data provided (or information/reports generated) by the MIS sufficient (for various stakeholders) in terms of content, frequency and timeliness, so as to give a meaningful picture of the MFIs' true financial position/condition and prospects? Is it suitable for decision-making and risk management from an institutional perspective?
6. Is the data/information/reports in the MIS comparableiv to that in other institutions and as per good practices (as well as regulator/supervisor) norms?
7. Is data from the MIS consistent with financial and other statements that the MFI generates and uses internally to measure, manage and monitor its portfolio and other risks?
8. Is the data from the MIS consistent with the financial and other statements that the MFI generates and files with concerned regulators on a periodic basis?
9. Do the management information systems of Indian MFIs have transparent business rules in line with good practices, as well as regulator/supervisor norms in critical areas such as (but not limited to) :
Transparency and verification must be possible with regard to the sequence of appropriation of client repayments, which needs to be as per good practices standards and regulator norms. The sequence in which client repayments must be appropriated should always be as follows - fines first (if applicable), then penal interest (if applicable), interest overdue, then interest due (if due on the date on which repayment comes in), then principal overdue and lastly, principal. If principal is appropriated first, then, while portfolio quality would appear better, the yield on portfolio would reduce and so would the profitability/sustainability of the MFI.
The method of calculating age of a past due loan, should be through recommended best practice proceduresv .
Grace periods (in terms of days or number of installments) and the specific processvi used by the MIS for calculating various portfolio quality indicators (like 'portfolio at risk' or PAR) must be clearly discernable and/or transparently stated, if hard-coded in the MIS. For example, client repayment could be over 46 installments across a 52-week loan term-this means that at any time, a client could have skipped six installments and still not be classified as a past due account. This has serious implications for asset classification and provisioning and it needs to be recognised. Therefore, unusually long grace periods, or repayment moratoriums, must be stated upfront in a transparent manner.
There must be standard good-practice procedures for regular monitoring and management of past, due or impaired assets/credit relationships, evaluating the adequacy of credit (loan) loss provisionsvii and credit (loan) loss allowances, etc.
10. Given all these aspects, what are the minimum MIS standards that have to be set for enabling accreditation, and/or licensing of MFIs as per the proposed microfinance development and regulation bill?
Without question, there is a critical need to establish minimum standards for certain non-negotiables like MIS, in Indian MFIs. The Union Ministry of Finance (MoF) and the RBI should utilize this opportunity to draft the microfinance development and regulation bill to enable the microfinance industry to 'arrive' in terms of having transparent, integrated and comprehensive management information systems that really work on the ground. This indeed is a crucial first step, even before we talk of a national credit bureau, as only then would the proposed credit bureau be able to have reliable and valid (MIS) data, so necessary for reducing the occurrence of multiple, ghost and over-lending by Indian MFIs.
iThe example of SKS is being used for illustrative purposes and I would like to state that from my own knowledge of MIS in the Indian micro-finance industry, the SKS MIS is perhaps one of the better operating systems in the Indian microfinance industry.
iii From the perspective of users of information and enabling them to make meaningful evaluations/decisions, information from MIS should be comprehensive in terms of aggregation, and consolidation and assessment of information across products, processes, client segments, geographies and activities.
ivData/information needs to be compared across institutions and over time. Hence, standardized procedures must be used to develop the MIS and standard definitions of indicators, and standard methods for calculating the same must be rigorously followed. This does not imply loss of flexibility, but rather suggests standard use of best practices-oriented indicators and methods for portfolio quality measurement. This is often reflected in the methodology of developing the business rules.
vWhere age of past due loan = date of calculating age - earliest unpaid overdue (in days). Using the installment method of ageing requires adjustments to be made as this method understates age of past due loan, after the loan term and overstates age of past due loan within the loan term.
vi While selecting past due loans for calculating portfolio at risk (PAR) of any age, the reference point is to choose every loan that has either fines, or interest, or principal overdue. Technically, it is possible to have past due loans with 'zero' principal overdue and some interest/fines overdue, and hence, using only principal overdue to determine aggregate loan outstanding of the past due loans could actually understate the risk in the portfolio
vii In case of ageing with weekly/daily installments, define age categories based on number of installments skipped, rather than in days. This is to ensure appropriate provisioning. For example, in a weekly payment model, < 30 days past due could actually be 4/5 installments skipped. For example, the traditional 10% provisioning would not be appropriate here and a much higher provisioning may be required, depending on the context and actual ground situation.
viiiEnsure automatic integration of portfolio and accounting modules, in that data entered in one, for example loan disbursement through the portfolio module, automatically gets reflected in the other, as loan outstanding under assets in the balance sheet. This is very critical.
ixAsset and Liability Management
(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.)