There are far too many serious issues that require attention so that they are not repeated again and the Reserve Bank of India or some central institutions cannot undertake this task as they do not have the resources or the local presence

The concern about who should regulate the microfinance sector is a genuine one and we need to get the framework right. Market review, opinions, stakeholder views and global best practices, all point to the fact that India must get ready to bring all microfinance players under a common minimum standard of regulation. That is a non-negotiable and should be done as early as possible.

That said, given what happened in Andhra Pradesh in 2010, can one institution be expected to deliver the goods? That is a question which needs serious analysis.

In the context of microfinance, the term regulation encompasses a wide spectrum of activities including prudential regulation, consumer protection, market regulation and the like. And a regulatory system will be more effective and efficient if the responsibilities are assigned to the institutions/bodies that have the powers, resources, skills, and knowledge to perform their roles most effectively.

In my humble opinion, having seen this and other crisis situations in microfinance in India, I believe that the following regulatory arrangement would perhaps be most appropriate in the Indian context:

a)    Prudential regulation for all types of MFIs must be undertaken by the Reserve Bank of India (RBI) which can also confer on them the legitimacy to operate in the larger financial sector. Such regulation must ensure minimum standards on various parameters, including governance, risk management, compensation, internal controls, MIS and the like.
b)    Market regulation of listed microfinance institutions (MFIs) should be under the oversight of the Securities and Exchange Board of India (SEBI).
c)    Consumer protection and redressal must be led by the respective state governments who are locally present and have the wherewithal to supervise microfinance on the ground.
For all those who believe that the microfinance bill would be better without the intervention of the state government, here are a list of ground level issues from Andhra Pradesh and other states. I would like practitioners and the government to ask the question as to whether the proposed microfinance bill would be able to prevent the occurrence of the following problems, and if so, how? Make no mistake, if these problems cannot be prevented by the bill, a microfinance crisis will surely reappear again, and therefore, the bill, at best, will be a paper tiger with little ground-level impact. Here are some key problems.

1. Information issues: Many a time, I have seen incorrect or misleading information (example, of interest rates on loans) provided as part of the sale strategy, so as to influence sale positively for the MFI/institution. The MFIs have usually done this by specifying “flat rates” and thereby made clients to feel that the loans come at a low cost. Even when the intended strategy is to talk of reducing balance interest, at point of sale, this is most often mentioned as a flat rate. Likewise, compulsory (insurance) charges are usually not mentioned and all terms and conditions are not clearly stated to the client (including penalty payments for delayed loan installments).

2. Sales techniques: There have been cases where MFIs have used inappropriate sales techniques: (a) hard selling through multiple home visitation; (b) promise to ‘green’ loans where refinance is provided to enable client to pay back earlier/another loan (resulting in multiple lending, over-indebtedness etc); (c) daily and/or frequent door-to-door solicitation with special limited-time offers; (d) request for kickback (bakshish) as a percentage/flat fee made by the field staff/agents/others; and (e) even intimidation sometimes.

3. Loan policy and origination systems: In many cases, I have seen fraudulent implementation of loan policy with part payment to client and part payment to field staff, as a result of which many problems occur at the time of repayment. (Please read report on increasing frauds in MFIs.)

4. Loan contracts and processing: Loan contracts have inappropriate wording regarding client obligations that they (clients) may not understand and this has been an issue in Andhra Pradesh. Often times, written documents do not reflect the terms and conditions agreed before the transaction was made—in other words, in real time and at the field level in remote villages, the terms and conditions are changed to the detriment of the borrowers.
Further, in many cases, clients are not given copies of contracts, policies, records or other documents and this has again been a major issue in the present crisis. And as the Andhra Pradesh experience has shown, in many cases, the MFI loaning process has been reckless during implementation; that is, without due reference to the borrower’s ability to repay, resulting in over-indebtedness and multiple lending. Please note that in many of these cases, the correct policies perhaps existed on paper, but violations occurred during ground level implementation due to their use of the decentralised agent model where many MFIs had virtually no control whatsoever over the deteriorating ground situation in many villages.

5. Loan costs: Sometimes, loan contracts do not provide full disclosure of costs and other terms and, therefore, the product cost is much higher than disclosed because of various hidden charges. The product cost is also higher than disclosed because of the difference between intended and realised pricing – interest stated on the contract, versus interest collected at real time from the client. This is an issue that has come up time and again in Andhra Pradesh and other states in the last few years.

6. Loan transactions: In many cases, I have seen inaccurate recording of client’s transactions with a view to collect more money from clients–loan repayments with wrong balances in terms of loan outstanding, and/or other aspects. I have also witnessed the use of illegal/fraudulent methods of repayment collection, where field collection agents do not show full repayment made by the client in the record books, and they pocket some money and lable the client delinquent. Likewise, pre-payments made by clients are shown as regular payments towards loan installment and the field agents take away the clients’ prepaid (extra) money. All of this results in huge monetary losses for low-income and vulnerable clients.

7. Loan collection: Often times, I have seen illegal and abusive behaviour in the conduct of transactions and this includes various forms of harassment to force clients to repay, even when they have genuine difficulties. Many a time, I have seen physical violence and hard intimidatory actions (like the Zero PAR policy of sitting/sleeping outside the clients’ house until the weekly repayment is received) against clients—who have no legal recourse or defense—in case of their being labeled delinquent. In my opinion, the physically abusive behavior in the loan collection process that was taking place on a regular basis at the local level in Andhra Pradesh is perhaps one of the major causes for clients to commit suicide. Further, while most MFIs and their contracts talk of collateral free lending, often times, collateral like ration card or house patta (title deeds) are physically and forcibly taken during the collection process. This is especially true for delinquent clients.

8. Other issues: I have also come across imposition of unnecessary fees or surcharges, and consolidation of debts at a higher rate. The icing on the cake was the provision of a special loan to enable clients to pay insurance premiums for a larger loan taken.

Now, please analyse for yourself and tell me whether and how the proposed microfinance bill can ensure that the MFIs and their staff do not do all of the above in real time, while having committed to the code of conduct, or responsible microfinance? I am not clear on this at all and if we rely on the RBI or a central institution (without local presence) to deliver the goods on the above consumer protection aspects, it would be analogous to searching for a needle in a haystack. Make no mistake about that!

Without question, these aspects cannot be monitored and set right by the central bank, or any other national institution, or MFI association, as they do not have the local presence and resources. It did not happen last time around and it will not happen now. This can only be done by the state governments and them alone. And if such issues are brushed aside and the proposed microfinance bill is unable to prevent occurrence of these and similar problems, the microfinance crisis will reappear again and in much larger vein all over India. Something, that would effectively set India and its low-income economy, back by several long years.

(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.)