The business correspondent model offers a unique possibility for mainstream low-income financial services. But recent experience has shown that there are huge risks as well, which is why it must be regulated carefully

The Reserve Bank of India (RBI) has facilitated the adoption of a very important strategy to try and achieve financial inclusion, that is to use business correspondentsⁱ  to serve and service excluded segments of the population. While this is yet to take off in any serious manner for various reasons, given the current microfinance scenario, this model may be worth exploring in greater depth, because it offers a unique possibility to mainstream low-income financial services, with banks as the principals and microfinance institutions (MFIs)/other forms of institutions as agents.

Under the business correspondent model, banks can "outsource" certain activities to their business correspondents. According to the RBI circulars in place, "The scope of activities may include (i) identification of borrowers, (ii) collection and preliminary processing of loan applications, including verification of primary information/data, (iii) creating awareness about savings and other products and education and advice on managing money and debt counseling, (iv) processing and submission of applications to banks, (v) promoting, nurturing and monitoring of self-help groups/joint liability groups/credit groups/others, (vi) post-sanction monitoring, (vii) follow-up for recovery, (viii) disbursal of small value credit, (ix) recovery of principal/collection of interest, (x) collection of small-value deposits, (xi) sale of micro insurance/ mutual fund products/ pension products/ other third party products, and (xii) receipt and delivery of small value remittances/ other payment instruments."ⁱⁱ 

Thus, while the idea of using business correspondents (BCs) is indeed appealing because of various benefits BCs may seem to provide, there are huge risks as well, given the activities that can be outsourced. This is especially true in the existing environment in India, where there are many controversies with regard to the kind of financial services provided to low-income people, the type of service delivery methods employed, the abnormal prices charged by the informally outsourced entities (such as centre leaders and others acting as microfinance agents who are in many ways similar to BCsⁱⁱⁱ).

In fact, the informal outsourcing of loans disbursal and 'collecting back the loans' has led to the proliferation of 'microfinance recovery agents' who have caused tremendous hardships for clients in Andhra Pradesh and other states in the past few years! As noted in previous Moneylife articles, the new breed of microfinance agents, who functioned almost like BCs, certainly seemed to have created havoc in the lives of low-income people. And these experiences certainly have strong implications for the use of the BC model that the RBI is advocating!

That said, what then are the regulatory implications for the use of the business correspondent model in India, and especially in the context of the 2010 microfinance crisis?

Most importantly, it is imperative for the RBI to ensure that banks have an appropriate due diligence process in selecting their business correspondents (BCs). The RBI must likewise ensure that banks avoid appointing all and sundry as their business correspondents, just to meet any internal or policy targets that may be imposed on them from time to time. Further, such due diligence processes must not just exist on paper, but rather they must be implemented in real time at the banks, and this is something that the RBI must ensure by its supervisory function through the department of banking supervision.

That DFIs like SIDBI and the banks failed miserably to see the unethical practices in Indian microfinance that ultimately led to the 2010 microfinance crisis, is something that we should not forget at this juncture. While we tend to blame MFIs, equity investors and/or regulators largely for what happened in Andhra Pradesh in 2010, what about the role of commercial banks and DFIs like SIDBI? Were they not responsible in anyway? There is no doubt that without their (SIDBI and commercial bank) funds and lazy attitude to supervision of priority sector loans, much of the multiple, over- and ghost-lending by MFIs, and strong-arm recovery practices witnessed in the past few years would not have happened. Let us be absolutely clear about that! And what is scary is that neither SIDBI nor the commercial banks seem to have learnt from the 2010 microfinance crisis, to improve the supervision systems on the ground with regard to priority sector lending. Many continue to be in a denial mode, blaming the Andhra Pradesh government, when in reality they were hugely responsible for much of the mess in Indian microfinance. This is to set the record straight!

Therefore, the RBI, while encouraging the use of the business correspondent model, must also ensure that the banks employ appropriate (due diligence) criteria to assess, prior to selection, a business correspondent's capacity and ability to perform the various required activities effectively, reliably and most importantly, to a high standard, together with any potential risk factors associated with using a particular business correspondent. That is very critical.

Further, the RBI must place emphasis on ensuring that business correspondents appointed by the banks are sensitive to the needs and situations of low-income clients and do not harass/oppress them in terms of over-lending and use of strong-arm recovery tactics. Thus, the RBI must also enable the concerned banks to put in place 'adequate client protection measures' in the entire scheme of "outsourcing" their activities to BCs. And without question, RBI's supervision including on-site examination of banks must verify the implementation of these in real time.

OK, given that due diligence of business correspondents by banks is critical, what should it typically include? In simple terms, such due diligence must include assessment with regard to (this is not exhaustive by any means):

a.    Commitment to low-income people

Whether the business correspondent is interested in delivering last-mile financial services to low-income people in an ethical and efficient manner? This essentially deals with the real commitment and sensitivity of the business correspondent to low-income people.

b.    Understanding financial inclusion and its objectives

Whether the business correspondent understands (and can meet) the objectives of the bank in performing the specified activities related to financial inclusion? The broad objective should be financial inclusion and creating financial access for low-income people. It must not degenerate into money-lending under any circumstances, as we witnessed in Andhra Pradesh in the past few years.

c.    Capacity to perform outsourced activities

Whether the business correspondent has the governance, financial soundness and managerial capability to successfully perform the various (outsourced) roles and activities in a fair, ethical and efficient manner? This must include a proper assessment of the business correspondent to effectively carry out loan origination, disbursement and collection activities.

d.    Consideration of special needs

Whether the business correspondent has the reach, resources and capacity to meet any special needs of low-income and excluded clients of the bank? In case the bank has any special needs, such as servicing geographically dispersed/ disadvantaged clientele and/ or performing any special activities for them, the reach, capacity and resources of the business correspondents must specifically be assessed with regard to such activities, and they should not be outsourced to BCs who do not meet these criteria. That is critical, and making the assumption that the BCs will over time acquire the expertise has, many a time, proved costly in similar situations.

Two other aspects require consideration while appointing business correspondents. (a) If a business correspondent fails, or is otherwise unable to perform the outsourced activity, it may be costly or problematic (for the bank) to find alternative solutions. Thus, transition costs and potential business disruptions should also be considered, as also the larger (regulatory and other) implications of not being able to complete such activities. (b) Additional concerns may exist if the BCs are to be appointed to service remote and/ or communally sensitive areas (like Nizamabad^iv  in Andhra Pradesh is one such example). In such areas, in case of an emergency or extraordinary situation, the bank may find it more difficult to implement appropriate responses in a timely fashion. Therefore, the bank may also need to assess the local or special conditions that might adversely impact the BC's ability to perform the various (outsourced) tasks effectively for the bank.

While these are some starting guidelines to assess business correspondents and choose those who meet the various criteria in terms of resources, capacity, goal congruence and other aspects, the key point that should not be missed is the aspect of banks developing a proper due diligence framework for business correspondents and also implementing it on the ground. Banks have been very naïve in choosing their partners in Indian microfinance and have consequently found themselves in rather precarious situations. Therefore, it is sincerely hoped that the RBI will ensure that banks follow a proper process of selecting BCs, so that there is a win-win situation for all stakeholders concerned.

  ⁱPlease see following RBI circular - http://www.rbi.org.in/scripts/BS_CircularIndexDisplay.aspx?Id=6017
  ⁱⁱRBI circular given above and other circulars, www.rbi.org.in
  ⁱⁱⁱPlease see following Moneylife articles:
http://www.moneylife.in/article/how-and-why-did-microfinance-agents-become-a-part-of-the-indian-microfinance-business/19301.html and
http://www.moneylife.in/article/implementation-safeguards-against-notorious-agents-are-an-imperative-for-the-proposed-microfinance-bill/19017.html