Money & Banking
Regulation and supervision of microfinance investment vehicles: A suggested practical framework—Part I

Irrespective of wherever the fund or fund managers get investment from, regulating/supervising MIVs at the place of incorporation and/or where their establishment exists would be most appropriate

Micro-finance investment vehicles (MIVs) have been a topic of recent discussion, courtesy the recent book by Hugh Sinclairi . Currently, as has been noted in my previous articlesii , given the state of the MIVs, it is highly unlikely that they undergo any meaningful regulation/supervision. However, as the recent debate has shown, there is indeed a critical need to regulate/supervise the MIVs. This is because MIVs-apart from being investment companies and/or financial intermediaries-have very diverse operations in terms of innovative products, geographies and so on. And most importantly, they are able to provide crucial capital to microfinance institutions (MFIs), which then leverage the same (from commercial banks/others)-manifold-and enhance outreach of their services.

Readers may want to recall that much of the impetus for devastating growth of the MFI sector in Andhra Pradesh (AP), which then led to the 2010 crisis, came from: a) MIVs/other investors (irresponsibly?) who pumped in huge amounts of money (in relatively shorter amounts of time) into MFIs after the 2005-2006 Krishna crisis; and b) riding on the back of these investments, MFIs were able to leverage huge amounts of commercial bank lending and growiii  (using multiple lending, ghost lending and over lending) at phenomenal rates. This, in short, resulted in the 2010 AP microfinance crisis which is still unprecedented (as of today) in terms of its sheer enormity, scale, and impact.

Please see the kind of investment that some Indian MFIs received during the years preceding the 2010 AP microfinance crisis and the kind of growth they experienced. You will understand what I am saying. And, several salient points deserve mention here:  

a)    "First, with no causality being implied, all I can say is that the period of very rapid growth in Indian microfinance (April, 2008-March, 2010iv ) is associated with significant equity investments into Indian microfinance ($486.58 million).

For example, almost 75% of the total portfolio of the top 14 Indian MFIs (with six AP headquartered MFIs), as of end March 2010, had been accumulated during the period April 2008-March 2010. In numerical terms, this is approximately $2.791 billion, which is huge by any standards. During the same period, the big six AP headquartered MFIs also increased their gross loan portfolio by almost $2.077 billion .In other words, the six AP headquartered MFIs accounted for almost 74.41% of the total portfolio ($2.791 billion) increase for the top 14 MFIs during April 2008-March 2010. 13 of the 14 MFIs were NBFCs.

b)    Further, it is in the same period of April 2008-March 2010, that the top 14 Indian MFIS (with six AP headquartered MFIs) added nearly 14.27 million active borrowers. And interestingly, the big six AP headquartered MFIs accounted for almost 9.76 million of these active borrowers (about 68.34%).

c)    Thus, irrespective of whether growth of active borrowers or gross loan portfolio is considered as a measure, the period April 2008 to March 2010, is clearly "The Period" of burgeoning growth in Indian microfinance. What is noteworthy here is that this period is also associated with significant equity investments of $486.58 million.

d)    The period, April 2009-July 2010, which is part of the fastest growth period (of April 2008-March 2010), shows the highest equity investment in a single year in Indian microfinance (approximately, $387.30 million).

Based on the above, the assertion that equity investment perhaps induced faster growth in Indian microfinance would not (perhaps) be a mis-statement. Equity investment by MIVs/others is what turbo-charged Indian microfinance, after the Krishna crisis of 2005-2006. This, in turn, seems to have led to more and more investment into MFIs and caused further (very) rapid growthv  and thereby, attracted more equity investments at very high valuations. This is one possible explanation for the association of rapid growth (of Indian MFIs during April 2008-March 2010) and burgeoning equity investments (in Indian MFIs during the same period and thereafter)."vi

Therefore, given the above, I think that it is imperative that any kind of MIV (irrespective of its legal form, geography of incorporation, countries of investment etc) should be subject-under its extant laws-to some minimum regulation/supervision  as is required for any form of organization involved in making investments (often collected from investors) and engaging in financial intermediation. Looking at the assets that MIVs control (Table 1) and keeping in mind the potential damage that they could cause by their irresponsible investments (as was done in India), the case for minimum regulation/supervision becomes very strong indeed.

Therefore, given the above background, regulation/supervision of MIVs in (at least) these three countries (Luxembourg, The Netherlands and US) becomes the imperative need of the day. Let us be clear on that! However, it is certainly not an easy task because the issue of regulation across diversely incorporated MIVs (see Table 1) operating in multiple countries would require complex arrangements with a great deal of co-ordination between regulators across countries. And while that certainly can be a long term goal, let us make a start first and pluck a low hanging fruit here-the supervision of MIVs by existing regulators/supervisors. Hence, what I am proposing is sort of an immediate solution (or quick win). In other words, what I am saying-in effect-is that let us first make a beginning by creating a framework for enhancing supervision of MIVs by existing regulator's in these three countries! And regulators in other countries could follow, as dictated by their strategic situation and requirements.

While there are many facets that regulators would have to consider when looking at ways to supervise MIVs, in my opinion, an important aspect to look at is the level of analysis and the issues that are relevant at each of these various levels. Typically, four levels of analysis are usually relevant with regard to MIVs:

While supervision of MIVs should concern levels 1, 2 and 3 primarily, levels 1 and 2 would be most important from a regulatory/supervisory stand point in the home (parent) country. As levels 3 and 4 would require significant coordination with regulator/supervisors in the host country so as to understand the nature of the investee and their operations, these levels are dealt with, separately, in forthcoming articles.


And before we get into the levels of analysis issue, one critical point must be made—for all practical purposes, irrespective of wherever the fund or fund managers get investment from, regulating/supervising them at the place of incorporation and/or place at which their establishment exists would be most appropriate. Sometimes, even these could be in multiple countries (as noted earlier) and that needs to be appropriately handled.


Having set the context here, a sequential article (Part II) looks at the above levels of analysis and offers starter questions that regulators/supervisors need to ask at each level with regard to MIVs and their operations...


(Ramesh S Arunachalam has over two decades of strong grass-roots and institutional experience in rural finance, MSME development, agriculture and rural livelihood systems, rural and urban development and urban poverty alleviation across Asia, Africa, North America and Europe. He has worked with national and state governments and multilateral agencies. His book—Indian Microfinance, The Way Forward—is the first authentic compendium on the history of microfinance in India and its possible future.)

i Confessions Of A Microfinance Heretic: How Microlending Lost Its Way And Betrayed the Poor by Hugh Sinclair (

ii Why not regulate and supervise microfinance investment vehicles in their country of incorporation?; Triple Jump’s Response to Hugh Sinclair’s Book: Does It Raise More Questions than Provide Credible Answers?; Why blame the MFIs alone?; Should not microfinance investment vehicles be judged by the same standards set for retail MFIs?; and Does Sinclair’s Open Challenge (to the Global Micro-Finance Industry) Make His Claims True?

iii See Mix Market  - ‘MFIs, unlike before, were able to deploy funds as micro-finance assets’. In my opinion they did so using multiple lending, ghost lending and over lending and primarily consumption/loans.  

iv Mix Market data and please see technical appendix 9 in the book - The Journey of Indian Micro-Finance: Lessons For The Future - for the structure and calibration of the Mix Market database

v This issue is almost similar to the aspect of which came first, the Chicken or the Egg?

vi Source: Quoted from The Journey Of Indian Micro-Finance: Lessons For The Future by Ramesh S.Arunachalam and disclaimers given the book apply with regard to the data!

vii Regulation is essentially about making rules and/or principles and influencing behaviour and enforcement. Supervision concerns continuous or specific verification of the application of these principles/rules through various mechanisms.



Much-maligned entry load was a cheaper option!

Cold calculations show that such is the draconian charges SEBI plans to introduce for fund investors, that even the horrible practice of entry load would have been a cheaper option for investors. The new charges also perversely penalise committed investors

Exactly three years ago the Securities and Exchange Board of India (SEBI) abolished entry load in order to reduce costs for the investors and induce investments. However, investors didn’t seem too keen and instead of inflows, we have seen a total net outflow of nearly Rs20,000 crore from equity funds till July 2012. Sometime later the regulator also brought in a transaction charge for investments above Rs10,000 to incentivise distributors. However, a majority of distributors opted out from the transaction charge. Now, in order to increase penetration into cities other than the top 15, SEBI has allowed the asset management companies (AMCs) to charge up to a maximum 30 basis points (bps) extra in the total expense ratio (TER) on the total corpus of the scheme.

Here is the strange fallout that bureaucrats in SEBI either overlooked or knew about. The proposed regulation will actually be more expensive than the highly controversial entry load that was abolished! This move may help increase penetration (we feel will it will only encourage unethical practices) but at whose cost? The additional TER will be charged to the entire corpus and investors would have to forego a part of their returns for the benefit of the AMCs. And SEBI not only is asking existing fund investors to subsidise the marketing efforts of fund companies but is hitting where it hurts most—long-term holding.

Let us analyse how the additional TER will affect the performance of a scheme which most analysts have kept quiet about, possibly because of vested interests.

We will look at three different scenarios, one is the present scenario where there is no entry load charged, the second is where an entry load of 2% is charged and the third is where there is an additional TER of 30 bps is charged. We have assumed the schemes deliver a return of 10% in all scenarios before deducting costs.

In the present scenario, ignoring the transaction fee (as it is not applicable to all distributors), if one invests say Rs1 lakh in an equity mutual fund scheme which charges the maximum TER of 2.50% and makes a return of 10% pre-expenses, the investor would have a corpus of Rs4.06 lakh after 20 years. This would mean that post expenses the investor earns a return of just 7.25% compounded annually. Not at all attractive for investors to give up the safety of bank deposits.

In the earlier regime, when entry load was applicable, the invested corpus would get reduced by 2% at the start. Therefore if an investor puts in Rs1 lakh, the amount invested would be Rs98,000. If this grows by 10% and if the expense ratio is 2.5%, the investor would be left with Rs3.97 lakhs after 20 years, working out to an annual compounded rate of 7.14% post-expenses. Note that the entry load made a dent on the return, but a small one.


Now if SEBI goes ahead and allows fund companies to charge the additional TER, the TER would go up to 2.80%. At that expense ratio, after 20 years, Rs1 lakh at 10% return before expenses would grow to Rs3.81 lakhs at a compounded rate of 6.92%. This is lower than 7.14% return that comes from 2.5% expense ratio and 2% entry load. Returns work out better when entry load is charged! In fact, with a 2.8% expense ratio, approximately just after six years, the total returns post-expenses, starts falling behind scenario 2 (2% entry load plus 2.5% expense ratio). The lesson: if you are a long-term investor, you will be penalised, even as SEBI and fund companies preach at every breath the benefits of long-term investing.

In order to negate the additional TER, SEBI has asked AMCs to create a separate plan for direct investors with a lower expense ratio. Seeing the practices of AMCs in the past, they may just reduce the TER by 30 bps which they would be charging to reach smaller cities.

Clearly, the great mutual fund experts, who are in the SEBI board and SEBI’s mutual advisory committee, have either not applied their mind or decided to be the mouthpiece of the fund industry to the detriment of investors’ interests. Some critics have said that SEBI has just managed to complicate the industry even further. Why is there a need to charge an additional TER to the entire corpus? In order to compensate the AMCs for reaching smaller towns and cities, SEBI could have just reverted back to the “entry load” for just these cities. It would have benefited the investors of these cities in the long run, as well. The AMCs too would have made their cut for reaching smaller investors. This would reduce costs for the AMCs as well as they would not have to put in resources for creating a separate plan for the direct mode. But the fact that these simple and commonsensical ideas are not in the proposal indicates mal-intent and not incompetence.



Narain Jagirdar

5 years ago

This shows there are few regulators in India who work for the common man for whom they are there in the first place. Leads me to suspect SEBI is sleeping, in which case it is time to wake them up, or it is trying to hoodwink the public but stealthily working for the funds. If the latter be true, time for the public to regulate the regulator by asking the government to pull up the regulator.


5 years ago

Now, it is time to draw attention of Finance Ministry. It seems that in the month of June, Finance ministry spoke publically to do something regarding Mutual Fund Industry and SEBI did the thing in hurry.


5 years ago

Now, it is time to draw attention of Finance Ministry. It seems that in the month of June, Finance ministry spoke publically to do something regarding Mutual Fund Industry and SEBI did the thing in hurry.


Sabapathy Narayanan

In Reply to NAYAN 5 years ago

We will have to bring it to the notice of Finance Ministry & office of PMO about the pros & cons of latest circular of SEBI. Their intervention is must to revitalize the industry. Only God has to help and save!
Sabapathy Narayanan

Vaibhav Dhoka

5 years ago

SEBI is moving away from its PREAMBLE To protect investors intrest to Protect:-AMC'c Brokers and other intermediarias.GOD SAVE US FROM SEBI's Clutches.Instead of being SAVIOURS They arebecome KILLERS.

Sanjay Tiwari

5 years ago

Hi. Great analysys.

I wish this article reaches the concerned like SEBI, FM and others.

Simple Entry load is Win Win for the Long Term investor, Distributor, and Amc's. It means, investor who stays for long periods pays less.

SEBI should open a Tutorial for - HOW TO MESS UP THINGS, AND KILL A INDUSTRY.

God bless us all.

Sanjay Tiwari - Bangalore

Vikas Gupta

5 years ago

You had written & analysed correctly. SEBI is not doing the right things to curb the misselling at all. I am quoting an example:-
Indusind Bank, Rohtak is forcing its Bank Customers to apply MF only through their Broking. If an Customer invests through any other intermediatory, The Customer receives a call from the Home Bank Branch forcing him/her to invest only through them. If The Customer submits the application at any office situated beyond Home Bank Branch,HE/She is forced back to redeem/Switch over his/her purchase though any other intermediatory but SEBI/AMFI is unable to stop this unethical practices of Indusind Bank at all.


5 years ago

It will be better if SEBI will take care only the stock market and leave the MF space altogether. The big bosses in SEBI seems to be idiotic in common terms.

Nandan Gumaste

5 years ago

Hi Jason,

You call entry load highly controversial, a horrible practice, and still advocate it for small city investors.Why?If entry load is bad, it is bad for large as well as small city investors.It seems you are as confused as SEBI.If Rs 20000 crores have been withdrawn from Equity MFs, AMCs need to reach out to large city investors as well.Everybody, SEBI, AMFI, the media and the distributors should focus on this aspect, rather than shooting in the dark



In Reply to Nandan Gumaste 5 years ago

This is all you understood of this analysis? Great

vijai pratap

5 years ago

thx for your well-analysed and very informative article. may i humbly submit that even with this enlightening message from you, the fact of enhancing the ER was good enough for any one to judge that 'entry-load' was a better option.

well, hats off to the wise sebi!

i hv been investing directly, 'load-free' since the beginning but now will be paying extra.

instead, a lower entry-load should have been introduced.

its just like the quixotic 'rajiv-gandhi-new-stockmarket' investment scheme, which is bound to fail.

CRR row: RBI's Subbarao doesn't see end in sight during his term!

While the SBI chairman termed the statement of the Governor Subbarao as 'a joke', Dr Charkabarty said the SBI chief is not ready to listen to the regulator, and there cannot be any regulatory issues

Mumbai: Reserve Bank of India (RBI) Governor Duvvuri Subbarao played down the cash reserve ratio (CRR) controversy between his senior most deputy and the nation's largest lender State Bank of India (SBI), saying that he is not too sure whether the two will sink their differences before he demits office, reports PTI.
SBI Chairman Pratip Chaudhuri's call last week for abolishing the mandatory CRR had attracted a sharp reaction from RBI Deputy Governor KC Chakrabarty. CRR is the amount of deposits that banks park with the RBI as a prudential measure without earning interest on it.
Chakrabarty had this week frowned on Chaudhuri's contention saying, "If the SBI chairman is not able to do business as per our regulatory environment, he has to find some other place."
In his first public comment since the controversy began on 23rd August, Subbarao told bankers at a FICCI-IBA seminar, "I have an important announcement to make. Late last night I signed off a paper forming a committee. The terms of reference for the committee are whether we should continue with CRR or not. Members of the committee are Dr Chakabarty and Shri Pratip Chaudhuri.
"Process of the committee will be that both of them will be locked up in a room until they reach a conclusion and the time frame is that they will not submit their report till my term as governor is over," Subbarao told the audience in a lighter vein.
After the speech, when asked if he was serious or joking, Subbarao retorted: "What do you think?"
However, both Chakrabarty and Chaudhuri continued their spat publicly at the same venue, after Subbarao left.
While the SBI chairman termed the statement of the Governor as "a joke", Charkabarty said the SBI chief is not ready to listen to the regulator, and there cannot be any regulatory issues.
"The debate is on. I think he (Governor) meant it as a joke. Of course, I hold the view it (CRR) is not helping anybody," Chaudhuri said.
To this, Chakrabarty retorted: "First make up your mind whether you want to listen or not. You don't want to listen to my views. I have made it very clear that there is no question of a debate on a regulatory issue," the deputy governor retorted.
However, he continued to add that "jokingly, we can have a mock fight. I've no problem; he (SBI chief) is a good friend."
On 23rd August, Chaudhuri had said in Kolkata that the RBI should either do away with CRR or compensate banks for the losses incurred, as banks are not earning any interest on it.
Pegging the loss of banks due to CRR at about Rs21,000 crore, out of which Rs3,500 crore to his bank alone, he said, "CRR does not help anybody and it is unfairly put on the banks. Why is CRR not applied to insurance and other companies who are mobilising deposits from the public?
Calling for its phase out within a reasonable time-frame, he said that would release scarce capital resources which will help the banks in reducing rates for the industry.
But this had invited a sharp reaction from Chakrabarty.
Yesterday, Chaudhuri again reiterated his view saying it (CRR) lacks reason and added that merely citing some existing rules do not justify their practice.
"I feel that though people have said that it cannot be done, there have not been enough grounds to say why? Just to argue that this is the rule and this is the law... I do not think it is the best way to justify a particular set of (rules)."
By doing away with the CRR, which is currently pegged at 4.75%, and on which banks earn no interest, the banking system can get as much as Rs2.6 lakh crore lendable money.
There has been a public debate ever since Chaudhuri spoke of the need to do away with the CRR last week. The worst criticism came from the regulator itself.



nagesh kini

5 years ago

Gurpur has elucidated in an article in these columns at length why the concept of CRR Kenysian era monetary measure in a costly NPA.
The RBI Dy. Governor's remark on the SBI Chief is absolutely in bad taste. There was nothing wrong in the latter expressing his views. The DG has gone overboard for nothing.

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