Low-income people want appropriate products and quality service and MFIs which focus on meeting client needs in an ethical manner will be the most successful in the long-term

The year 2010 will certainly go down as a watershed in the history of Indian microfinance. It was a year when the industry consistently made front-page headlines in the mainstream media. It all began with India's largest MFI, SKS Microfinance (SKSML) filing its draft red herring prospectus (DRHP) with the Securities and Exchange Board of India (SEBI) in the first quarter. There was all-round optimismⁱ  along with the belief that the industry was now poised for greater glory and prominence in the country's financial sector. However, the turn of events that followed was tumultuous to say the least; from the filing of the DRHP to the devastating suicides in Andhra Pradesh (said to have been caused by multiple lending and over indebtedness), the promulgation of the Andhra Pradesh Ordinanceⁱⁱ , the related court drama and subsequent enactment of the act and finally, the appointment of an RBI Board sub-committee for microfinance. Reeling from multiple shocks, the captains of the industry, as also other stakeholders, were left rather clueless on what had possibly gone wrong. One stakeholderⁱⁱⁱ  famously noted, "Microfinance in India has become a macro-mess".

As someone who has been involved with what is now called the microfinance industry, for a little over two decades, I must admit that I was indeed saddened to see perceptions about microfinance change, and rather quickly during this period. Microfinance in the past, was widely regarded as a tool for poverty alleviation and MFIs were held in high esteem. However, in the light of the events of 2010, they began to be viewed differently-mainly as profit-seeking moneylenders, as the former RBI governor Dr YV Reddy famously noted.

Since then, a lot of water has flown under the bridge, but all is not lost. Indian MFIs and microfinance can salvage the lost ground, but they need to put clients first. For this, they must get back to the basics and do some of the following if indeed they are to rebuild their (lost) credibility and revive (the glory of) the industry.

1.    Build (lasting) client relationships
In the initial years of microfinance, most MFIs had great social acceptability and local support, because their first and foremost task was getting to know clients rather than mere lending. This has to happen again and MFIs must start to view low-income people not just as mere clients who borrow, but rather respect them as producers of goods and services (micro-entrepreneurs) who contribute to the growth of the country and its economy. MFIs must also be able to empathize with low-income people in the various life-cycle events and situations that they have to confront in their daily struggle for survival. This should result in stronger bonds being built with clients and facilitate creation of longer lasting relationships with them as well as with the larger community.

2.    Recognise the fact that more credit is not always good
Much of the problems have occurred in India because MFIs got into a race to outwit each other, in terms of building larger loan portfolios and servicing a larger number of clients, to show better results, attract more equity, get greater valuations and create greater wealth for themselves and their shareholders. These objectives resulted in indiscriminate (multiple) lending (and related negative impacts) that created over indebtedness among clients, rather than servicing them in a meaningful manner.

Without question, MFIs must ensure that their strategic vision does not seek to maximise credit (borrowing), but rather attempts to encourage a wide range of need-based financial services (including fair-priced loans) that are appropriate for the particular circumstances of its low-income clients. In fact, their strategic goal must be to minimise destructive (sub-prime like) lending, for which they must commit to sound underwriting of loans in line with the borrowers' ability to repay.

3.    Commit to avoiding over-indebtedness through various steps
MFIs should invest in systems and human resources to ensure better loan origination procedures as spelt out in the Malegam Committee Report (MCR). This apart, they must facilitate mandatory training for low-income clients as well as the field staff to avoid over-indebted customers. In fact, both of these are not new and many of the MFIs did this in the mid-to-late 1980s and early 1990s. As the CGAP^iv  module on delinquency has always stressed, there are no bad clients but only bad loans with institutions being primarily responsible for any delinquency. Therefore, it goes without saying that it is the MFIs that have a major role in reducing delinquency and curbing the development of a poor credit culture. In the long run, MFIs should also look at enhancing their MIS to implement credit scoring and support the establishment of transparent credit bureaus.

4.    Deliver high quality and appropriate financial services
Thus, MFIs must focus on delivering a range of vulnerability-reducing and risk-mitigating financial services (product and cash-flow based business cycle loans, post harvest/production loans, savings, insurance, pensions and the like) as per the needs of clients, rather than thrust more and more standard (Grameen or other type) loans on clients.

A related issue here is that good service will depend on the ability of all (field) staff to improvise and be flexible in handling sensitive client situations. They will need to learn to balance the benefits of a culture of compliance with a culture of customer service, and at no time should they resort to any unethical means to overcome situations. This essentially pertains to coercive recovery practices that have gained prominence in India during the past few years.

5.    Set operational, branch and field staff incentives such that they do not distort the rules under any circumstances
Incentives to operational managers and branch/field staff have an important role in shaping the MFI in terms of its client orientation. And without any doubt, staff incentives must be in tune with the strategic vision to enable access to a wide range of financial services to low-income people. Therefore, having a narrow incentive scheme that pays attention to either loan disbursement and/or collection, will surely set the stage for unethical and fraudulent behaviour. In fact, new age financial institutions all over the world ensure that ethical handling of customers and responsiveness to their complaints are an integral part of their incentive and reward systems for staff.

That said, in many places where serious problems like multiple lending, frauds, high levels of willful default, the use of agents, exist on the ground, a common denominator can be usually found, and it is a fact that "staff" turnover has also been very high. One must also remember that all and sundry are hired as staff and especially, without sufficient background checks (due diligence) and placed on the job without requisite training. And much of this has happened as the drive to grow quickly and reach scale has prompted many MFIs (and especially, some of the newly-established commercially oriented entities) to use all possible methods to achieve this^v .

In fact, a lot of this has to do with the overall incentive system for staff at MFIs, where the unspoken rule is to either 'disburse a lot quickly or perish', as a result of which the decentralised agent model came into vogue. Thus, aspects such as "building scale quickly", the "pressure to reduce interest rates" and the "desire to be a cost leader and maximise profits and value to shareholders", seem to have pushed the Indian microfinance industry into poor human resources practices and that must change for sure.

It must also be noted that working and living conditions of staff in the microfinance industry is dismal. In many places, there are no service rules and, often, it's a very high-pressure, 24x7 schedule. Typically, there are no contracts issued by many institutions and the hiring/firing is done verbally and at the whims and fancy of the superiors. Grievance procedures do not seem to exist in most MFIs, and faced with such a situation, it's hardly surprising that the level of frustration among genuine staff is rather high. In fact, some (good) staff have crossed the line because of such an environment and moved towards (unethical) behaviour such as that listed above. It is, therefore, imperative that MFIs address the prevalent problems and focus on building professional and ethical human resource systems, with the right incentives, for operational managers and branch/field level staff.

6.    Ensure that senior management and board compensation throughout the microfinance system is aligned with client interests
The best example of a poorly aligned compensation system is from the subprime mortgage mess where, actors ranging from frontline personnel to top executives at lending companies, brokerage firms, investment banking companies and ratings agencies, all responded to a compensation system that encouraged making abusive loans. In fact, "compensation was one factor among many that contributed to the financial crisis that began in 2007''.^vi  I guess that this issue applies to the microfinance situation as well and all stakeholders, including MFIs, should ensure that compensation/incentive system for senior management and board are driven solely by a common vision in design and delivery of fair and sustainable financial services (including credit) that meets the needs of low-income clients.

7.    Have a mechanism to get client feedback and respond sincerely to customer complaints
MFIs, at a minimum, should have a designated department (or at least an officer) responsible for handling complaints in a professional and sincere manner. All staff must view customer complaints not just as a valuable source of client feedback, but also as useful information for adapting the product and delivery process to better meet client needs. The toll free complaint number set up by SKS Microfinance deserves mention and MFIs must attempt to look at such mechanisms to get organised client feedback and channelise the same for delivering responsive financial products in tune with the needs of their clients.

8.    Ensure transparency on product terms, institutional policies and operational model and facilitate real-time implementation of stated terms, policies and model on the ground
Transparency is extremely critical for MFIs to build trust with clients and all other stakeholders in today's environment. This would include: (a) Educating (not just informing) low-income clients on all product terms, as per the contract (including interest to be paid or received); (b) Enabling clients to understand all other policies of the institution (such as penalties for repayment, recovery processes, etc) and the working model; and (c) Ensuring that these product terms, policies and models are not distorted during implementation^vii  through appropriate controls.

Only this will enable clients to make informed and knowledgeable purchase choices and MFIs must strive to facilitate this. The interest rate issue is critical and clients need to know they are paying or receiving and MFIs must clearly indicate the nominal and effective interest rates as well as total cost to client under normal and delinquent situations. Apart from the transparency aspect, pricing of loans should be fair in that low-income clients do not have to pay for the inefficiency or unnecessarily elaborate policies at MFIs.

To summarise, the role of the board and the senior management in ensuring all of these aspects during implementation is critical. In fact, the level of success achieved in translating these intended strategies to realised actions on the ground will almost depend exclusively on the level of commitment and leadership that senior management and board show towards implementing these. And I hope that these leaders recognise that, just like many of us, low-income people want appropriate products and quality service, and that MFIs which focus on meeting client needs in an ethical manner will be the most successful in the long-term. Let us make no mistake about that!

  ⁱAt the height of this optimism, some of them even likened the 'arrival of micro-finance' on the national and international stage to the information technology (IT) boom of the 1990s.
  ⁱⁱAndhra Pradesh Micro Finance Institutions (Regulation of Money Lending) Ordinance, 2010 which later became an Act of the Legislature
  ⁱⁱⁱMr Aloysius Fernandez, made this comment at several fora, including in papers written by him
  ^ivConsultative Group to Assist the Poor
  ^vSome specific comments are in order here: (a) The lack of background checks has meant that staff who have committed frauds in one place (MFI) have got into higher positions in other MFIs and naturally, they also re-socialize new staff at the other (new) MFI and attune them towards not so good practices. The lack of background checks has also resulted in people with criminal records entering the MFI roster and moving on from one MFI to another, often engaging in increasing frauds at the various levels; and (b) The lack of training has meant that the staff do not understand the mission of micro-finance or that of the MFI and this has again resulted in the excessive drive towards growth, scale and profits - as a result, several MFIs have moved towards using agents for loan disbursement and recovery and also have lent for purposes, that need not be strictly called as micro-finance
 ^vi Quoted from BIS paper on Compensation and Corporate Governance, 2010.
  ^viiFor example, the use of agents and other such mechanisms in the model during real time operations must be avoided at all costs and this will have to be done using appropriate human resources policies and staff incentives.

(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.)