MFIs should not garner deposits from low-income customers. The RBI, which will become the sole Indian microfinance regulator, also feels so—and there are a number of facts that support the apex bank’s view

There is an ongoing debate on whether MFIs (microfinance institutions) in India should be allowed to access savings from low-income people and/or access public deposits. While opinions range from a strong ‘yes’ to an absolute ‘no’, the debate has reached an emotional high with many stakeholders openly arguing for letting MFIs access savings of low-income people. However, a recent article in Mint suggests that (http://www.livemint.com/2011/10/18190834/RBI-against-letting-MFIs-colle.html), the RBI (Reserve Bank of India), which is to become the sole regulator of microfinance in India, has argued against letting MFIs garner savings from low-income people. It was a huge relief to read this, and without any doubt, the RBI is ‘spot on’ when it says that MFIs should not be permitted to access savings of low-income people.

That said, what then is the rationale for such a strong (negative) view with regard to letting MFIs access savings of low-income people? Indeed, there are six good reasons as to why MFIs should not be allowed to take savings at this point. While a lot of experts talk of ‘turf war’ and other such aspects, it is about time that we clearly understand the fact that ground realities in India make it almost impossible to let MFIs gain access to savings of low-income people. As someone who has worked in over 500 districts in India in the past two decades, I would like to put across the following reasons for not allowing MFIs to access thrift of low-income people at this juncture:

a)    First, internal controls at most (if not all) MFIs are very weak. Further, in many cases, they are almost absent and therefore, the question of letting MFIs access savings does not at all arise. In fact, if permitted, it would surely become a recipe for disaster. Please look at the burgeoning frauds in Indian microfinance for which concrete evidence has been provided in the following Moneylife article (See: Increasing frauds, internal lapses at MFIs: Need to strengthen supervisory arrangements to protect the poor ).

As summarized in the above article, “A long list of instances of failures in microfinance institutions holds several important lessons for the RBI and the finance ministry on the regulation and supervision of the sector and this is a very good reason for not permitting savings by MFIs.” The article continues, “As Microfinance Focus (http://www.microfinancefocus.com/sks-microfinance-faced-408-cases-cash-frauds-fy-2011) recently noted, ‘According to auditors, SKS Microfinance recorded 408 cases of cash embezzlements and frauds in the financial year 2011… The 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 nonexistent 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.’

Without question, the burgeoning growth of Indian microfinance led by a flawed business model (as stated by Dr C Rangarajan) has meant that frauds and control failures have become more common in Indian MFIs. Therefore, 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.”

b)    Second, the agent-led decentralised model in Indian microfinance is still prevalent and please look at clear evidence as reported by Moneylife with regard to the same: (a) Proposed Microfinance Bill has to look at the centre leader as a microfinance agent ; (b) How and why did microfinance agents become a part of the Indian microfinance business? ; (c) MFIN-NCAER study: Here’s the proof that microfinance agents are thriving in Tamil Nadu; and (d) MFIN-NCAER study unearths agents’ role in microfinance, but does not find these middlemen in Chennai.

In real terms, as the above articles suggest, agents have spread their tentacles far and wide across the country, and they are indeed breeding resentment against many MFIs. Many MFIs are helplessness as far as these (Frankenstein’s) monsters are concerned. And let us be absolutely clear—until and unless the problem of agents is acknowledged, it cannot be tackled fair and square. And without question, unless the agent menace is solved completely and shared JLGs/clients are apportioned properly to MFIs, Indian microfinance cannot get back on the rails. And with such agents being an integral part of the MFI operations in India, it would certainly be foolhardy to let MFIs access public deposits (or savings from low-income people).

c)    Third, there is a huge governance deficit in many Indian MFIs—and directors, have more often than not, been found guilty of taking/supporting several irresponsible and improper actions that further their own rather than client interests. Please see previous Moneylife articles regarding the same: (a) MFI corporate governance norms: How can these be put in place? ; (b) Governance of MFIs: Time to implement ‘connected lending’ provisions of RBI circular of 2007 July 28, 2011 02:50 PM ; (c) Establish standards for MFI independent directors as first step to ensure good corporate governance ; and (d) Does a five-star board guarantee good corporate governance? )

To cite an example from the above articles, was it appropriate for a large NBFC MFI, established primarily to provide access to finance to low-income people, to lend to its founder (and then) managing director to buy shares in the same company at par value? Consider yourself as an institutional/retail investor in a micro-lender and you may have bought equity because you believe that MFIs provide access to finance for low-income people and enable them to have a better life. Alternatively, you could be a development finance institution (DFI)/bank that has provided a loan to an NBFC MFI as part of the priority sector obligations and/or other schemes. Or you could be a multi/bilateral institution that seeks to improve the lot of excluded and disadvantaged people in an emerging market through development of the private (financial) sector using institutions like NBFC MFIs. Or most importantly, you could be one of those several thousand small (low-income) savers who want to have a safe place to store their own (hard earned) money. How would you react when you hear that one such NBFC MFI—where you have invested your hard-earned money as equity or lent priority sector funds and/or saved your small amounts (‘Mickles’ as Staurt Rutherford would fondly call them)—has, in turn, lent to its own founder managing director, a huge sum of money to buy shares in the same MFI and especially, at par value? I am not sure about whether all these stakeholders would desire such a happening in the first place.

And very often, people look at high-profile membership of the board as a surrogate for good corporate governance, and microfinance is no exception. But despite having the equivalent of five-star boards, many NBFC MFIs in India have come under attack for serious weaknesses and lapses in corporate governance, caused, among other things, by huge conflicts of interest, related party transactions and weak independent directors. So, under such circumstances, permitting MFIs to access hard-earned savings of low-income people would again be a pathway to microfinance disaster. This is surely another good reason for not allowing MFIs to access public deposits (including savings of low-income people).

d)    Fourth, much like the sub-prime crisis, the incentives have been hugely skewed in Indian microfinance as espoused by the poor governance of compensation (a) Regulating the compensation awarded to bosses of MFIs ) and (b) Four ways to improve the regulation of compensation at MFIs).

From the above articles, it would be clear that the senior management of the concerned MFIs—  that claim to be serving the poor—received unusually high payments that was not determined through an explicit process. As has been often mentioned, without question, irrational and ad hoc compensation practices (at some MFIs) have been a major factor that has contributed (in some measure) to the microfinance crisis in 2010. And permitting institutions where the ‘Governance of Compensation’ has been and continues to be very weak and laden with conflict of interest, again does not seem to be a good idea at all.

e)    Fifth, RBI’s ability to supervise microfinance is poor (http://www.smeworld.org/story/money/does-rbi-have-capacity.php) and there is a real logistical problem on how to ensure protection of low-income clients on the ground. Also, codes of conduct have rarely worked and compliance reporting on codes of conduct have been very biased. Without question, it is clear that policy (and/or lack of it) has played an important role in the disorderly growth of MFIs and the challenges arising therein. As noted in the above article, if the concerned RBI departments could not monitor 13 NBFC MFIs that were supposedly systemically important, then how can they be expected to set up supervisory mechanisms for several hundred MFIs (that also access thrift) as per the proposed Microfinance Bill? And when it failed to supervise credit appropriately, what is the guarantee that RBI can supervise small savings better? Without sufficient supervision, none of this will work on the ground. With several hundred (or even many thousand) organisations (including cooperatives) to be regulated/supervised and no single regulator/supervisor having the wherewithal to achieve this effectively (especially, without constructive support from the concerned state governments), supervising micro-savings will not be an easy task for the RBI. This again provides strong support for the case against letting MFIs access small savings of low-income people.
 
f)    Sixth, industry bodies like MFIN have not delivered—see the following article with regard to lack of accountability on the part of MFIN (Has MFIN, one of the self-regulatory bodies in Indian microfinance, been accountable for its actions and statements? ).

Apart from the study on suicides which is yet to be made public, the findings of the MFIN enquiry initiated in February 2011 with regard to governance and transparency are not available in the public domain, despite a promise by MFIN to do so within 30 days. These coupled with the ‘not-so-objective’ MFIN-sponsored NCAER study (that suffers from several serious shortcomings) and burgeoning growth of many MFIN members during the years preceding the crisis, makes one wonder, whether at all, MFIN can function as an objective association (without conflicts of interest) and become an effective self-regulatory body for Indian microfinance. And given this serious weakness in self-regulation and the inability of the RBI to supervise microfinance appropriately in the past (as argued above), permitting MFIs to access savings of low-income people would certainly be akin to creating a runway to another microfinance crisis.

Therefore, until and unless many of the above aspects are sorted out, MFIs should not be permitted to access savings of low-income people and/or public deposits. As Dr YV Reddy (former Governor, RBI) notes in a very interesting article in the Economic and Political Weekly (http://epw.in/epw/uploads/articles/16635.pdf, vol xlvi no 41, October 8, 2011, Microfinance Industry in India: Some Thoughts), “The present thinking of including thrift as one of the functions of MFIs allows a backdoor entry into banking by these institutions. Softer regulation of MFIs in relation to banks which are deposit-taking institutions poses a very serious danger to the integrity and stability of the financial sector, as a whole.” I hope that this message reaches all concerned stakeholders (involved in making the decision on whether or not to let MFIs access thrift in India) in a loud and clear fashion.

(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).