If the concerned RBI departments could not monitor five of the top 13 NBFC-MFIs that were supposed systemically (very) important, then, how can they be expected to set up supervisory mechanisms for several hundred MFIs as per the proposed Microfinance bill?

If equity was in some ways responsible for the burgeoning growth of Indian microfinance institutions (MFIs), the (huge) amount of (priority sector) debt leveraged by these 13 NBFC-MFIs (in top 14 MFIs) and other NBFC MFIs is another issue here.

Obviously this hugely increasing trend of priority sector funds being absorbed by NBFC-MFIs would be clear from the filings made by them to the Department of Non-Bank Supervision, RBI. In numerical terms, the growth of debt for MFIs, in terms of funds accessed from commercial banks and SIDBI, is given below and this growth is best described as phenomenal:

As can been be seen from the above table, bank loans outstanding with MFIs increased several fold after the Krishna crisis. Specifically, during the year before the 2010 Andhra Pradesh (AP) crisis, it increased phenomenally to about 6.40 times the loan outstanding of the base year (2006-07). Likewise, SIDBI loans outstanding with MFIs increased several fold after the Krishna crisis. Specifically, during the year before the 2010 AP crisis, it increased phenomenally to about 6.92 times the loan outstanding of the base year (2006-07). The steep growth of commercial bank and SIDBI loans outstanding with MFIs, over the years succeeding the Krishna crisis, is captured in Figure 1 below:

Figure 1: Commercial bank and SIDBI loans outstanding with MFIs during years 2006-2010

As N Srinivasan says in the 2010 State of Sector Report, “Bank loans to MFIs did not exhibit any overt signs of increased risk perceptions towards the microfinance sector. …Public sector banks have taken to MFI financing in a big way. Public sector banks (not including SIDBI) had an exposure of Rs4,737 crore to MFIs in comparison to private sector banks’ exposure of Rs 4,133 crore. Foreign banks had outstanding loans of Rs1,994 crore and FWWB had increased its exposure from Rs295 crore last year to Rs360 crore. SIDBI almost doubled its exposure to Rs3808 crores during the year. At this level SIDBI had a share of more than 25% of the market.”

And readers would recall that the top five AP-headquartered MFIs thrived on this burgeoning debt provided by SIDBI and commercial banks as evident from the table below:

Again, all of the above raises some very crucial questions for the RBI, the Department of Non-Bank Supervision and other RBI departments. A key issue here is whether or not the concerned departments (Department of Non-Bank Supervision, Department of Banking Operations Development and Department of Banking Supervision) felt alarmed about this burgeoning growth of priority sector lending (PSL) and other funds from SIDBI/Banks to NBFC MFIs in terms of the following aspects:

• Which banks/DFIs are providing these PSL funds to various MFIs? What do the growth trends say? Has growth been unusually large in comparison to previous years? Is there any cause for alarm given the huge growth of (PSL and other) funds from banks and DFIs to MFIs? How has this growth in priority sector loans been absorbed by MFIs? Overall, what can be said with regard to due diligence by banks/DFIs in terms of sanctioning and disbursement processes with regard to priority sector funds and loans to MFIs?
• How and where are the MFIs investing these priority sector loans and other funds? As microfinance assets? What other assets? Specifically, for what purposes are these PSL and other funds being used by the MFIs? Especially, did DFIs/banks look for any differences between the proposed and actual end use of priority sector funds by MFIs? Is there any reason to believe that these priority sector loan funds may be used for non-priority sector purposes? If so, what are the reasons and what are the ways of addressing this?
•  Do returns by NBFC-MFIs show unusual trends with regard to microfinance asset growth? Is there any cause to believe that growth in micro-finance assets has occurred through multiple lending, over lending and/or ghost lending? Have any of the institutions provided interest free loans from their PSL funds to their promoter, senior management and/or board members? If so, for what purposes?
•  Plus several other questions

Now, in summary, as this and other previous Moneylife articles (Lessons from the commercial micro-finance model in India; Dissecting the mechanics of growth in Indian microfinance; and The special category of NBFC MFIs: Lessons for the Department of Non-Bank Supervision, RBI) have shown, there are several unanswered aspects with regard to RBI’s role leading to the 2010 Indian microfinance crisis:

1.    Did the Department of Non-Bank Supervision miss any of these (significant) trends? If so, why? What lessons can be learnt from this with regard to supervisory arrangements in the future (especially those given in the proposed micro-finance bill)?
2.    If not, having spotted these happenings in the first place, why did it not take necessary corrective action? Again, what lessons can be learnt from this with regard to supervisory arrangements for the future (especially those given in the proposed microfinance bill)?
3.    If the concerned RBI departments could not monitor five of the top 13 NBFC-MFIs that were supposed systemically (very) important, then, how can they be expected to set up supervisory mechanisms for several hundred MFIs as per the proposed Microfinance bill?

And without sufficient supervision, none of this will work on the ground and therefore, it is important for the RBI, DNBS and other concerned departments to take stock of what happened and why from a regulatory/supervisory standpoint. That is certainly some food for thought and let me reiterate that India is a great country for legislation but the implementation record is rather poor in many cases. We certainly require a microfinance bill to provide legitimacy to the microfinance sector and that is a noble objective indeed but we cannot and must not stop with that. Rather than being a paper tiger, the bill should have the teeth and mechanisms to ensure orderly growth of the sector and for this, the most critical aspect is to look at the supervisory capacity of the RBI (and/or other organizations) and evaluate it to see what needs to be done to ensure ground level implementation. I do hope that the concerned people and powers that be, pay attention to these critical issues.

One last point—I have flagged issues and again, the objective here is not to undermine the capacity of concerned people or the good work being planned. The objective, solely, is to assist in enabling the development of better regulatory and supervisory mechanisms that can work on the ground towards the benefit of large numbers of low income people, who continue lack access to quality and affordable financial services at the grass-roots—a very necessary condition for the inclusive growth that India seeks to achieve.

(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)